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39–537 PDF 2007

RECENT EVENTS IN THE CREDIT AND MORTGAGE

MARKETS AND POSSIBLE IMPLICATIONS FOR

U.S. CONSUMERS AND THE GLOBAL ECONOMY

HEARING

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

SEPTEMBER 5, 2007

Printed for the use of the Committee on Financial Services

Serial No. 110–58

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin, 

LINCOLN DAVIS, Tennessee 

ALBIO SIRES, New Jersey 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

TIM MAHONEY, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

CHRISTOPHER S. MURPHY, Connecticut 

JOE DONNELLY, Indiana 

ROBERT WEXLER, Florida 

JIM MARSHALL, Georgia 

DAN BOREN, Oklahoma 

SPENCER BACHUS, Alabama 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

PETER J. ROSKAM, Illinois 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III)

C O N T E N T S 

Page 

Hearing held on: 

September 5, 2007 ............................................................................................ 1

Appendix: 

September 5, 2007 ............................................................................................ 65

WITNESSES 

WEDNESDAY, SEPTEMBER 5, 2007

Bair, Hon. Sheila C., Chairman Federal Deposit Insurance Corporation ........... 23

Dugan, Hon. John C., Comptroller of the Currency, Office of the Comptroller 

of the Currency ..................................................................................................... 21

Sirri, Erik R., Director, Division of Market Regulation, Securities and Exchange Commission .............................................................................................. 24

Steel, Hon. Robert K., Under Secretary for Domestic Finance, U.S. Department of the Treasury ........................................................................................... 19

APPENDIX 

Prepared statements: 

Ackerman, Hon. Gary L. .................................................................................. 66

Brown-Waite, Hon. Ginny ................................................................................ 70

Kanjorski, Hon. Paul E. ................................................................................... 71

Price, Hon. Tom ................................................................................................ 74

Bair, Hon. Sheila C. ......................................................................................... 76

Dugan, Hon. John C. ........................................................................................ 98

Sirri, Erik R. ..................................................................................................... 121

Steel, Hon. Robert K. ....................................................................................... 129

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Frank, Hon. Barney: 

Press release dated September 4, 2007 .......................................................... 135

(1)

RECENT EVENTS IN THE CREDIT AND 

MORTGAGE MARKETS AND POSSIBLE 

IMPLICATIONS FOR U.S. CONSUMERS 

AND THE GLOBAL ECONOMY 

Wednesday, September 5, 2007

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 10:33 a.m., in room 

2128, Rayburn House Office Building, Hon. Barney Frank, [chairman of the committee] presiding. 

Present: Representatives Frank, Kanjorski, Waters, Maloney, 

Velazquez, Watt, Ackerman, Sherman, Meeks, Moore of Kansas, 

Capuano, Hinojosa, Clay, McCarthy, Baca, Lynch, Miller of North 

Carolina, Scott, Green, Cleaver, Bean, Moore of Wisconsin, Davis 

of Tennessee, Sires, Hodes, Ellison, Klein, Perlmutter, Murphy, 

Donnelly; Bachus, Baker, Castle, Biggert, Miller of California, 

Capito, Feeney, Hensarling, Garrett, Pearce, Neugebauer, Price, 

Davis of Kentucky, McHenry, Campbell, Roskam, and Marchant. 

The CHAIRMAN. This hearing of the Committee on Financial 

Services will come to order. I’m going to make an opening statement, but then I’m going to leave temporarily. There is a hearing 

before the Committee on Education and Labor on a bill that would 

ban discrimination in employment based on sexual orientation. I 

trust people will understand why I will temporarily absent myself. 

You notice that given these two important issues today, I am wearing pinstripes and a lavender tie. 

[Laughter] 

The CHAIRMAN. I did not want to indicate any set preference for 

which issue I was going to deal with. But I will make my statement. There will be other opening statements, and we will then get 

back. 

Before I get into the substance, I just want to say that I apologize: we originally had been scheduled for a two-panel hearing. I 

apologize to my colleagues on the other side because they helped 

us to prepare, and I apologize to those who were asked to testify. 

We will get to them. But there was some miscommunication and 

I take responsibility for that. I was not able to do what I thought 

we should be doing. 

But secondly, and this is another important reason for the 

change. On Friday, as you know, the President announced a new 

initiative in connection with the subprime issue. That would have 

2

been part of our second panel. And so, since the President announced that proposal, we will not be getting into that issue today. 

We will be focusing today on the question of what happened in 

the market situation, and my concern is this: For some time now, 

we have seen the subprime crisis. I believe that those in charge 

were a little bit surprised that the subprime crisis spilled over as 

much as it did into other parts of the mortgage market. And more 

specifically, you know, you are supposed to pretend that you don’t 

like to say, ‘‘I told you so.’’ But as I have said before, I find that 

to be one of the few pleasures that come with age. 

In other words, there was an underestimated extent to which the 

subprime crisis would spill over into the rest of the mortgage market. But I think the far greater surprise was the extent to which 

the residential mortgage crisis had a negative impact on the market in general. I don’t know anyone who was predicting that a failure in subprime was going to lead to a problem in selling commercial paper, and yet it has. 

It doesn’t seem that any of us charged with responsibility for 

knowing what was going on anticipated this. Now I hope this is 

containable, and we will be working together to try to deal with the 

subprime part of it and other parts of it. But what we have to address, what I want to focus on today, is an important question. 

I guess my initial view of it, in the subprime market, it is clear 

that financial innovation outstripped regulation. Twenty years ago 

mortgage loans were made by institutions that were regulated by 

the Comptroller, by the FDIC, and by the OTS. They have been 

doing a good job, and I have acknowledged that the institutions 

represented here and the OTS have done a good job. 

We then developed a new model for mortgages. Mortgage brokers 

and people who sold to the market, what Ben Bernanke called in 

his Jackson Hole speech last Friday, the ‘‘originate-to-distribute 

model.’’ That was the innovation. And it was an innovation that 

brought a lot of good, that increased funding in the market, that 

helped a lot of people buy homes. 

But it was largely unregulated. And I think we have had a test 

case recently about regulation, sensible and intelligent regulation, 

which is I think what we get from the Comptroller, from the FDIC 

and the OTS, and from the Federal Reserve. Part of our job is to 

see if we can extend that sensible regulation, not overdoing it, but 

regulating. 

Similarly, I think there is some consensus now that what’s gone 

on in the secondary market without any regulation at all is problematic. And again, Chairman Bernanke, who is rarely confused 

with Ralph Nader, said in his Jackson Hole speech that the originate-to-distribute model must be modified, is being modified, to include more investor protection and disincentive for irresponsibility. 

I read today in the Financial Times, Martin Wolf, again, people 

who have come from a generally more conservative perspective, 

say, mortgages by the stricter regulation—talking about 

securitization. The second objective of regulation is to insulate financial markets from the sort of panic seen in recent weeks. The 

only way to do that may be to re-regulate them comprehensively. 

Restrictions would have to be imposed on products sold or the ability of institutions to engage in transactions. 

3

You don’t get operation. I understand. But just as it seems clear 

now, and I think there’s a consensus, and the President essentially 

became part of that on Friday, there is a consensus that regulation 

in the mortgage market has not kept up with innovation. And that 

when innovation greatly outstrips regulation, then regulation 

should catch up, but regulation has to be sensible. Regulation cannot be too negative. But one of the arguments against regulation, 

for instance regulation of the secondary mortgage market earlier 

was, well, if you do that, you impinge on the market. You will kill 

the market. Well, that market is at least in a deep coma, and the 

notion that regulation of the secondary mortgage market is somehow going to interfere with a thriving market doesn’t seem so persuasive. 

And in fact, and I think this is what Martin Wolf is saying, and 

it is what Chairman Bernanke was saying, it is what we know 

about mortgages, the right kind of regulation may be able to respond to one of the greatest needs we have today in the market: 

investor confidence. What we have is a severe lack of investor confidence, even in things where they shouldn’t lack confidence. 

Giving the investor some assurance of quality in what he or she 

is being asked to invest in is part of the role of regulation. It’s not 

negative. It can help the market. And so, one, there is some consensus that we need to do that in the mortgage market, and I 

think the President is saying that and Chairman Bernanke is saying that. The open question for us is, do we now, in the broader 

market, have to deal with that? And I notice Secretary Steel talks 

about the proposals that will be coming forward. 

I think this is the question before us: Has innovation in the 

broader financial market been made possible by technology, enhanced by the increased liquidity in the world, with globalization? 

Yes. It produces a great deal of advantages. I’m a great believer in 

the capitalist system. I don’t think phenomena occur unless they 

meet some real need and provide some real good. People are not 

fundamentally irrational. And the question is not whether these innovations were beneficial or not but whether or not allowing the innovations to go forward with no regulation on the innovative sector 

produces some harm. And can we, if that’s the case, can we come 

up with regulation that will diminish the harm without killing the 

whole operation? I know there are some who believe that regulation will always just damage the market. And regulation will always just be terrible. And there are people who say, you know 

what? You may think that there are abuses. There have been 

abuses. But if you regulate this, you’re going to kill it. And if you 

really want to read those arguments made passionately and openly, 

go to the Congressional Record and read the debates on the establishment of the Securities and Exchange Commission in the 1930’s, 

because they are similar arguments. 

My understanding is that you can have bad regulation. But I do 

think that the subprime market and what we address today is innovation has come and is useful, but there is a problem. And in 

particular, as I said, we clearly have a problem with a lack of investor confidence. Maybe that’s short term, but I will say this: I 

know that we have tried to talk the investors out of being nervous, 

and I don’t think that works very well. I don’t think trying to bolVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
4

ster confidence by talking to them is enough. There have been 

steps beyond that. There have been increases by the Fed in money 

being available. There are other things that we have talked about 

doing. 

I guess the fundamental question I hope we would be addressing 

today, and going forward, is this, just to repeat. Giving the innovation that we have—and by the way, I should say one other thing. 

This does not to me focus on the institutions that are doing the innovating. The institutional form, whether it’s private equity or a 

traditional investment bank or a hedge fund, seems to me far less 

important than the substance of what they are doing, of the great 

growth of derivatives and the fact that technology has made volatility more of a potential problem, because people can do so much 

more, leverage. 

Those are the issues. And no matter who is engaging in them, 

and the question is, yes, they have—the innovations that have 

helped in many ways. But they may well have gone beyond reasonable regulation. And the question is what, if anything, should we 

do in our regulatory structure to catch up? I will say it does seem 

to be clear. I was not pleased that so many of us were surprised 

by the impact that the subprime crisis had on the entire financial 

system. I don’t want to be surprised. I don’t want the Federal Reserve to be surprised. I don’t want Treasury to be surprised. This 

is not an individual failing. It may be that there is a systemic problem here and that we at least need more information. 

So that is the area on which I want to focus. As I said, I know 

there will be questions specifically about subprime. Members can 

obviously ask whatever questions they want, but I do want to reiterate that on September 20th, we will be having a hearing on the 

President’s proposal on subprime and other proposals. We will discuss that in great detail then, so I would hope that today we could 

focus to a great extent on what the implications of the past few 

months are for that broader question: Has innovation in the financial system so far outstripped our regulatory system that the time 

has come to examine that regulatory system and try to come up 

with ways to catch up without obviously diminishing the advantages? 

With that, I am going to leave, and I am going to ask Mrs. 

Maloney, the chairwoman of the Financial Institutions Subcommittee, to take over. We will finish the opening statements, and 

I hope to be back in time. I apologize again for leaving. 

Mrs. MALONEY. [presiding] The Chair recognizes Mr. Bachus for 

his opening statement. 

Mr. BACHUS. I thank the lady. And I thank the chairman for convening this hearing. This hearing is really about the mortgage market and the disruptions we’ve seen in the mortgage market. But as 

we talk about the mortgage market, we all need to understand that 

95 percent of the mortgages in America are being paid. They’re in 

good shape. So what we’re talking about is some subprime mortgages, and we’re not talking about even a majority or close to a majority of those. 

And last week, the President and the Administration and private 

institutions talked about beginning to work out some of these mortgages. So, for many of these people who are late on paying their 

5

mortgages, in fact, all of them who really should have been in loans 

in the first place, that had an ability to pay, I think in almost all 

cases, they’re going to be given an ability to pay with better terms. 

So there is some good news, some news that really ought to shore 

up confidence in the mortgage market. 

Now the concerns in the subprime market, as the chairman said, 

we all know what’s happened. They’ve caused, number one, some 

liquidity problems. Some people call it a crisis. This hearing is 

called, ‘‘turmoil in the mortgage market.’’ That’s a little overdone. 

Because people who have good credit, people who are paying their 

bills on time, people who have a downpayment, they’re able to walk 

in right now and get a loan at very low rates, lower rates than I 

could get when I bought my first home, when the rate at that time 

was 12 percent. Today the rate is 6 percent. So there’s an awful 

lot of good news out there. 

When you look at unemployment, we talk about the markets—

is a recession coming? Unemployment is at a 6-year low. Real 

wages are rising. You look at all the figures; they’re all good. I 

mean, I can remember times when inflation was 10 and 12 and 14 

percent. Senior citizens were seeing their money, their buying 

power disappear. It’s very low. It’s under control 

Exports continue to be up. So we have a sound economy. I know 

that there are some market challenges. There have been some excesses in the market. There have been some deals that probably 

shouldn’t have been made. Investors listen. Banks have a tendency 

sometimes to pull liquidity in. 

But, if anything, I’d say about the mortgage market, you look at 

where there are no serious problems, and that’s the vast majority 

of mortgages. There are no serious problems. And those are loans 

made by banks, thrifts, in some instances credit unions, where they 

know their customers or they have become familiar with their customers. They’ve assessed their credit history, and they’ve made 

loans according to sound underwriting principles, made loans according to the guidance of the regulators. Those loans are not in 

trouble. 

Where we have problems is where they push the limit. The chairman says where they’ve used innovative things. I’ll use, by ‘‘innovative,’’ where they didn’t get an appraiser, or they had no documentation on financial information, or the people had no source of 

income. Now that is innovation. When you make a loan to someone 

with no income, that’s innovation. When you make a loan to someone and they have no income and you tell them they don’t have to 

pay the taxes or they don’t have to escrow insurance payments for 

a year or 2 years, that’s innovation. And that was bound to fail. 

And I will say this. The chairman and I and some other members 

of this committee got together a year or two ago and we had really 

no resistance from the regulators. And we talked about changing 

some things. We talked about the fact that in 95 percent of these 

cases, we were dealing with the same mortgage originators, whether they were bankers or brokers. They were being kicked out of one 

State, moving to another State, making these same bad loans, and 

yet we have a State system that we could incorporate and call for 

national registration. We didn’t do it. So these bad actors continued 

6

to go to community after community and do the same thing over 

and over, and they left a wake of these bad mortgages. 

The Appraisers Association has called for—and I have introduced 

legislation to call for—better appraisals, for some standards there. 

We ought to do that. We ought to look at when we don’t require 

people to escrow taxes and insurance, particularly people who have 

no stream of income or no ability to suddenly come up with taxes 

and insurance. 

But the one thing we shouldn’t do is rush out and change a market that is working and working well, and has brought homeownership to historic highs. We should not panic. This morning we got 

some job figures that are low, but they are coming off very high job 

creation. We’re going to continue to get times of weaknesses and 

strength, but what we do not want to do, what we can’t do, is 

panic. We need to take a measured approach. 

Characteristic of this Congress in the past has been a rush to 

legislation in times of crisis, which has left us all with a hangover 

when it was over, because the regulation had unintended consequences. It might have boosted confidence. What do you do, and 

do something, do something now. And it may have made people feel 

good, but long-term, it resulted in too much regulation. We found 

that regulation has costs for consumers, costs for mortgages, and 

it eliminates some of the choices that people have made. In fact, 

the majority of people who have used new, ‘‘innovative’’ products, 

at least where they had an ability to pay, those people are in those 

homes, they’re making those payments, and they have homeownership. And if we cut out some of those innovative products, they 

wouldn’t have homeownership. 

We welcome our witnesses. We look forward to hearing from you. 

But I go out there and I find that basically we have a strong economy. We have some investor confidence problems. We have some 

liquidity problems. But this economy is strong, and we should not 

panic ourselves into a recession. 

Thank you. 

Mrs. MALONEY. I thank the gentleman. Pursuant to committee 

rules, the Chair will extend the time for opening statements for 10 

minutes on the Democratic side, and the Republicans will likewise 

have an extension of time. And I now recognize Congressman Kanjorski for 5 minutes. 

Mr. KANJORSKI. Madam Chairwoman, I commend you for convening this timely hearing. As we begin our fall legislative session, 

it is very appropriate for us to examine what transpired in the capital markets during the last month or so. The apprehensions of 

many participants in our financial markets about their exposures 

to financial products backed by American subprime mortgages 

helped to trigger significant volatility in our credit markets at 

home and abroad. This instability affected not only housing markets, but it also seeped over into other commercial sectors. 

Today’s hearing will help us to understand at least some of the 

factors that contributed to this turmoil and the response of our regulators to these problems. It will also help us to discern whether 

Congress needs to take further actions to restore the confidence of 

investors in America’s dynamic capital markets. Although I have 

7

not yet arrived at any conclusions, I have already identified at 

least three concerns I expect we will begin to address today. 

First, I would like to learn more about the transparency of our 

capital markets related to subprime mortgage-backed securities, 

consolidated debt obligations, credit default swaps, and the parties 

that package and hold these increasingly sophisticated financial 

products. 

From what I have read, it appears that the participants in our 

capital markets, as well as their regulators, have had significant 

difficulties in determining exposures to subprime mortgages that 

have defaulted or will likely default. We know from past experience 

that transparency and access to information provide the lubricant 

for our capital markets to work well. 

Second, I, like you, Madam Chairwoman, am very interested in 

exploring the role that credit rating agencies played in contributing 

to these events. Many have already criticized their assessments of 

the creditworthiness of the financial products backed by subprime 

loans. Some have suggested that their actions may have contributed to engineering the faulty financial products. 

While we took action last year to reform the oversight of rating 

agencies, we may still need to do more. The testimony provided by 

our witnesses today will help shape the hearings that the Capital 

Markets Subcommittee will hold on these issues in the coming 

months. 

Third, I am very interested in examining how well the regulators, created in the last century, are responding to the problems 

of the new century. Our capital markets have significantly evolved 

since the creation of these overseers. After all, no one had conceived of mortgage-backed securities at the time we created the 

Federal Reserve and the Securities and Exchange Commission. 

Moreover, banks traditionally engaged in the role of making mortgages based on the amount of assets they needed on their books. 

Today, financial companies accessing our capital markets often 

help families to buy homes. As a result, the traditional lines between prudent regulation, investor protection, and consumer protection have blurred. Regulators now have multiple missions, such 

as the Commission’s safety and soundness oversight of investment 

banks. 

In other instances, regulators are responding to problems in our 

capital markets using indirect means such as the decision last 

month of the Federal Reserve to lower the discount rate in response to marketplace uncertainty. Consequently, I intend to focus 

increasingly on whether our present regulatory architecture can 

anticipate and manage the risks of the modern financial system as 

the Capital Markets Subcommittee proceeds with its business during the remainder of the 110th Congress. 

I look forward to working with everyone interested in these 

issues in the coming months and invite them to share their ideas 

on these matters. 

In sum, Mr. Chairman, we live in an increasingly complex and 

interconnected financial marketplace. We need to move deliberately 

and strategically to explore whether we need to update the regulatory architecture of our financial system. If we come to the conclusion that we do need to pursue such a change, we must also 

8

move carefully to modify the system in a way that protects investors and ensures the long-term stability and viability of our financial system. 

These are complex problems and questions, and I look forward to 

exploring them. Thank you, Mr. Chairman. 

Mrs. MALONEY. Thank you. Mr. Baker, for 4 minutes. 

Mr. BAKER. I think the chairwoman for her recognition. I know 

that it has been made clear that the economic fundamentals are excellent outside the mortgage-impacted sector of the market. The 

global economy is very strong. Exports are up. There are a lot of 

good things to talk about, and the aberrant circumstance we now 

face in the mortgage market is certainly disappointing, but not all 

that unexpected. 

When one looks at the pressure from investors to seek higher 

rates of return and the diversification of tools to spread mortgage 

risk across broader sections of the market, and to do so in a global 

fashion, it created a hunger in the investing world that naturally 

the provider of product would going to attempt to meet. 

At the same time, the ability to acquire a home loan at historically record low cost enabled people to step into that next level of 

home or that first-time home buying opportunity on the belief that 

before the adjustable rate trigger was pulled, escalating values 

would continue and the takeout would come from the realization of 

profit from that sale before income constraints caused the aberrant 

result. 

It was a good plan. I came from Louisiana in the 1980’s. We had 

a thing called an S&L in those days. And you used to walk across 

the parking lot and make a deal with your banker on a new development in 20 minutes. It seems like history is repeating itself here 

to some extent, in that over-aggressive lending fueled the ability 

for more people to buy, which fueled an increase in home prices, 

which built the view that this was all very solidly constructed, so 

investors were comfortable in throwing more money into the market for the chance of a greater rate of return. And somehow we are 

surprised that we now have a correction. 

I don’t come to that conclusion. I recognize that business cycles 

are cycles, and that at some point, regulatory review or market 

pressure, and in this case, I am, to some extent, not surprised that 

it’s an international response. Many homeowners are now coming 

to an understanding of the definition of LIBOR, not even knowing 

that their rate trigger was tied to the London rate. And there is 

now for the first time in many years a divergence between treasuries and LIBOR which is uncharacteristic, but to a great extent, 

it’s because European lenders are now worried about counterparty 

risk. It’s whether or not we will be able to pay our obligations back 

to European lenders. 

This is not something I believe should cause a great surprise or 

frustration with our mortgage market. Certainly we should have 

the highest standards of disclosure. We should expect nothing but 

professional conduct from mortgage brokers and other originators, 

and where we find those practices are deficient, certainly actions 

should be taken. But I suggest that most of the tools to respond 

to those crises or problems are well within the hands of the Treasury or the Federal Reserve. 

9

And so I urge great caution in having the Congress hamhandedly interject more risk in the American taxpayer pocketbook 

or constructing more constrictive rules that will in essence preclude 

a more logical market-based recovery. Certainly there is risk in the 

world, and you can’t protect everyone from every conceivable risk. 

You should discuss it. You should disclose it. You should do your 

best to explain it. But at the end of the day, all you can do is explain it; you can’t understand it for people. And as a result of inappropriate risk-taking, if people lose money, that should not come as 

a big market surprise in a capital market system. 

This review, I think, is highly appropriate. But before this Congress acts to take on unwarranted response to a market disappointment, we should be very careful to understand the consequences of 

our action. 

I yield back. 

Mrs. MALONEY. Thank you. The Chair recognizes herself for 3 

minutes. First of all, I want to thank our chairman, Mr. Frank, for 

holding this hearing on really the biggest financial story of the 

year: The turmoil in the credit and mortgage markets, and its impact on consumers and the economy. 

After Hurricane Katrina, over 300,000 people lost their homes. 

About 10 times as many people may lose their homes to foreclosure 

due to the subprime crisis. 

The response from the Administration has been slow. Therefore, 

I was extremely pleased to hear the President’s announcement last 

week. His proposed changes at FHA to provide refinancing options 

to more homeowners and to help borrowers by refinancing them 

into FHA loans is an important first step. I also support his proposed temporary legislative fix to change tax law so that canceled 

mortgage debt is not treated as income. Individuals facing foreclosure should not get the double whammy of paying taxes on the 

loss in value of their home. 

These are helpful actions that Congress can take immediately, 

and I support them, but it is not enough. Another item that can 

be quickly achieved is GSE reform. Fannie Mae and Freddie Mac 

are providing much needed liquidity in the prime market right 

now. If there was ever a time when they should expand their activities, even if it’s temporary, it is now. We need to raise the ceiling on the amount of mortgage that can be refinanced and raise 

caps temporarily. We passed a GSE reform bill in the House. It 

needs to pass the Senate, or the Administration needs to take action to raise the limits. 

I have always said that markets depend as much on confidence 

as on capital. Right now there is a loss of confidence in rating 

agencies, and they deserve it. Large amounts of debt that are or 

have been highly rated are headed for default. As with Enron, the 

rating agencies have been dead wrong. Investment guidelines and 

capital standards need to be more accurate. We need to review the 

way rating agencies are compensated by their clients and look for 

ways to strengthen regulatory oversight of these agencies. 

We also need a uniform national standard to fight predatory 

lending. We need to set a single consumer protection standard for 

the mortgage market. The Fed has taken important steps in reguVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
10

lation, but we need to do more. We have a great deal to do, and 

I look forward to the testimony from our distinguished panel. 

I now recognize Congressman Miller for 2 minutes. 

Mr. MILLER OF CALIFORNIA. Thank you very much. I commend 

Chairman Frank and Ranking Member Bachus for holding this 

hearing today. This is a—if we look back at recessions, this is a lot 

different than the mid-1970’s, 1980’s recession. Remember prime 

was in the 20’s, so if you could get a 12 percent fixed rate 30-year 

loan, people would close your house immediately. I mean, you can 

sell them. The 1990’s recession, high unemployment, the same situation. It seems like the press beat this issue to death for several 

years before they could get a decent housing recession going, and 

finally it really occurred. It’s interesting when you look at buyers. 

If there’s a line forming, they’ll get in line to buy a house, yet 

they’ll walk by a house that’s a good deal when the bad time occurs 

and never even make an offer. 

But the situation we’re facing today in the subprime marketplace, we’ve talked about defining subprime and predatory in recent years. And I think today is a good example of what predatory 

is when you see it in reality. When you make a subprime loan and 

you lend money to a person that they’re never going to be able to 

repay on a normal marketplace, that’s predatory. But they have 

gotten by with it in recent years because when a house increases 

in value 10 to 15 percent a year, when you buy a $200,000 home, 

5 years later it’s worth $325,000, you can sell it and still make a 

profit even if you can’t make the payment in 5 years. But today we 

have a lot of people who are stuck with a loan they made—they 

borrowed from a lender, and now they can’t remake the payment. 

We spent a lot of time in this committee in recent years worrying 

about safety and soundness on GSEs as Freddie Mac and Fannie 

Mae, and it seems like in the marketplace today, they’re not the 

ones who are having the problem. It seems to be the subprime and 

the jumbo marketplace. And if you look at the situation in the 

jumbo and subprime, only about 18.2 percent of the loans are fixed 

30-year loans. In the GSEs, 82 percent of the loans are fixed 30-

year loans, and that’s why they’re doing very, very well. 

I think we can do something to help the market today, especially 

in high-cost areas, in raising conforming limits. You have a liquidity situation occurring out there in these high-cost areas. In my 

district, for example, I’ll give you an example, FHA. In 5 years, 

from 2000 to 2005, the FHA loans dropped 99 percent. In my district in 2000, they made 7,000 loans. In 2005, they made 80 loans. 

If you look at FHA overall in California, it went from 109,000 to 

5,137. 

Now I’m not talking about going out and making risky loans. But 

if you use reasonable underwriting criteria and standards, you can 

make a high-cost loan in those areas that’s very safe and very 

sound. That’s something that I think we need to look to. 

I yield back. 

Mrs. MALONEY. I thank the gentleman. The Chair recognizes 

Congressman Baca for 3 minutes. 

Mr. BACA. Thank you, Madam Chairwoman, and I want to thank 

Barney Frank and the minority leader for having this important 

hearing. As chair of the Congressional Hispanic Caucus, as a memVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
11

ber of the Financial Services Committee, I am especially concerned 

about the impact the foreclosure epidemic is having on our families, and all of us are very much concerned. We’ve seen what has 

happened nationwide. We’ve seen what’s happened in our area. The 

fact is, subprime lending is concentrated in minority populations 

and in minority neighborhoods, and that’s a concern to a lot of us 

as we’ve seen what has happened. 

And I’d like to relate that, especially in my district, minority 

homeowners were more likely to receive higher rate loans than 

white homeowners, even with the same income level. And when 

you look at the same income level, but the disparity in terms of minorities receiving the higher rates, some or most of these families 

could have qualified for better or more affordable loans but were 

instead steered into subprime loans by the lender or broker to 

make a profit, and this continues to go on. 

And we need to have accountability. We need to make sure that 

this does not happen. Because when someone loses their home, this 

is the American Dream for someone to obtain a home, have a 

home, and all of a sudden, they are being steered in the wrong direction. And most of these families, you know, need to be in these 

homes. According to the Center for Responsible Lending, almost 20 

percent out of 375 subprime loans made to Hispanics in the year 

2000 are likely to foreclose. And that’s a high number when you 

look at it, not to mention the impact it’s also having on the AfricanAmerican community, that more than likely will end up losing 

their homes. 

In my district, the Inland Empire has the fourth highest foreclosure filing in the Nation among the larger metro areas, and was 

the hardest hit in California through the first half of 2007. In San 

Bernardino alone, there were 19,185 foreclosures filing in the first 

half, representing a staggering 345 percent increase from the previous year. 

Overall, there is one foreclosure filing in every 33 households in 

the Inland Empire. That’s a lot. One out of 33 households are filing. So if you look at your neighborhood, the market value, the closure, the impact it’s having in our area, that’s a direct impact. And 

a lot of us, when you look at the neighborhoods too, within the 

area, what is it doing to the rest of the market with a lot of foreclosures that it’s having in our area? So one out of 33 households. 

I drive down, foreclosure sign. 

No one gains when people are thrown out of their homes, the 

housing market falls, and entire neighborhoods are affected. This 

is having a terrible impact on our national economy, as I stated, 

and also within our neighborhood and the cleanups in the areas. 

I look forward to hearing the witnesses’ testimony today. Thank 

you very much, Madam Chairwoman. 

Mrs. MALONEY. Thank you very much. The Chair recognizes Congressman Hensarling for 2 minutes. 

Mr. HENSARLING. Thank you, Madam Chairwoman. And, I, too, 

want to thank our chairman for calling this hearing. As we contemplate perhaps some kind of legislative remedy, I once again 

want to remind our colleagues we should always be careful about 

our unintended consequences. And I want to associate myself with 

the comments of our ranking member to put the challenge in the 

12

proper context. That is, I still believe, last I looked, that subprime 

lending was roughly 13 to 15 percent of the entire mortgage market. And of that, 83 percent are still paying on time. So we need 

to make sure we put this in the proper context. 

Now clearly, there may be broader threats to the economy, and 

that’s something that deserves a serious look. We need to also take 

a look at why it is that borrowers default on their loans. Well, the 

number one reason still continues to be personal setbacks—job loss, 

illness, or disability. That’s why we have the social safety net. 

Some may fail to understand the consequences of their action, and 

clearly there may be more opportunity for this committee in the 

area of financial literacy, not to mention more effective disclosure, 

since I do believe that on occasion less could be more. 

Fraud is certainly out there. Fraud has been there since the 

dawn of man, and we need to examine, is there proper enforcement? But there’s another reason that borrowers default, and that 

is, is that they do foolish things. And perhaps part of personal freedom is the freedom to do something that may be foolish. 

The question is, did some borrowers in the appreciation, in the 

housing appreciation, use their homes as a personal ATM machine? 

And what does it mean for national policy for us to go and bail 

these people out? Will we incent even more bad behavior? So I 

think we have to take a very serious look at that for the greater 

macroeconomic implications. We do need to see that perhaps the 

tools that are available to the Fed and Treasury are not adequate 

to the task. 

So I would caution us once again, Madam Chairwoman, to be 

very wary of unintended consequences, and I yield back the balance of my time. 

The CHAIRMAN. I thank the gentleman. I would note that the 

hearing has changed, and while we did discuss transgender issues 

at the other hearing, we’re back to a more conventional format here 

today. 

The gentleman from New Jersey is recognized for 2 minutes. 

Mr. GARRETT. Thank you. As indicated, we have recently seen a 

steep decline in two specific sections of the market. We talked 

about the subprime market, and also the jumbo mortgages. However, most housing data shows that these numbers, while they are 

rising dramatically, are expected to peak basically in the next several months. And the problems that we see are basically due to bad 

prior underwriting practices. And Chairman Bernanke indicated 

some of the causes when he stated increased reliance on 

securitization has led to a greater separation between mortgages 

and mortgage investing. 

I think you have to step back for a second and realize that the 

push by some in Congress and the Administration and society in 

general to increase homeownership rates has led to more lenders 

expanding into various segments of the mortgage market, especially subprime, and to be able to better serve this market, there 

have been large numbers of newly created and increasingly complex products. And if you add to that the lowering underwriting 

standards and incorrect or questionable ratings of borrowers, it increased the risk incurred to that segment of the market and homeownership. 

13

But you have to ask yourselves something. Owning your home is 

an extremely noble goal, is long part of the definition of the American Dream, but not everyone in the current financial conditions is 

allowed to have that in their own reality. The Federal Reserve 

states that the United States is at full employment when the unemployment rate is between 4 and 5 percent. So we have to ask, 

at what point do we define the country at full homeownership? 

Now, while it is essential for Congress to examine what led to the 

situation and what steps either the Administration or Congress or 

both should take to ensure that these problems do not expand into 

the rest of the marketplace, we have to, as Mr. Hensarling just 

said, put this in perspective. And the perspective is this: The 

subprime market makes up around 13 percent of the entire housing market, and the problem in the subprime area is around 12 or 

13 percent, so we are looking at dealing with something a little less 

than 2 percent of the overall entire market. 

And finally, we must remember again what Chairman Bernanke 

recently said, that the failure of investors to provide adequate oversight of originators and to ensure that originators’ incentives were 

properly aligned was the major cause of the problem that we see 

today in the subprime market. 

But he continued, finally, and said, in recent months, we have 

seen a reassessment of the problems in maintaining adequate monitoring and incentives in the lending practices. In essence, the market has worked itself out to deal with those poor underwriting 

practices of the past. 

And with that, Mr. Chairman, I yield back. 

The CHAIRMAN. The gentleman from Texas is recognized for 2 

minutes. 

Mr. NEUGEBAUER. I thank the chairman. I want to associate myself with a lot of the remarks that have already been made, but, 

you know, one of the things I want to point out is that this is not 

an issue that we haven’t seen before. Those of us who have been 

in the housing business for a number of years remember the 

1980’s, and where we saw some of the similar kind of problems 

with, as the gentleman said, an endangered species called savings 

and loans. They’re not endangered anymore. They’re not here anymore, and they’re not here anymore because, quite honestly, they 

asked for some expanded responsibilities and abilities that they 

were not able to manage. 

And so where we are faced today is with problems with an industry that got very aggressive, very ‘‘innovative,’’ is the word that has 

been used, and now what we need today is to let the marketplace 

work this problem out. One of the things we do, though, I think 

is a huge mistake, we have some of the players that were a big 

help for us in the 1980’s, and that was Fannie Mae and Ginnie 

Mae, their ability to come in and provide some liquidity and some 

mortgage abilities in the 1980’s really helped keep—mitigate the 

1980’s from being any worse than they were, although I don’t know 

how they could have gotten much worse than they did. 

But I think what we need to look at today, and I’m going to be 

interested to hear from the panel, is how we give the marketplace 

a little flexibility and liquidity here to work through this process 

without, as many of our colleagues have already said, undermining 

14

the greatest housing system in the world. Countries all over the 

world look to America as the leader in how to develop housing and 

housing finance, and so I hope that we’ll be able to look at that. 

One of the things that I think we have today is Ginnie Mae and 

Fannie Mae, because of the limitations. We’ve been having discussions here in this committee over the last few months about putting limitations on the people who probably know more about mortgage lending than anybody in the world, when we probably should 

have been talking about limitations on some folks that didn’t know 

as much about mortgage lending as Fannie Mae and Ginnie Mae 

do. 

You know, the term ‘‘subprime’’—I think even my third-grade 

grandson understands what ‘‘subprime’’ is. And he can’t go home 

and explain to his parents that he got subprime grades because of 

the interpretations and criteria that the marketplace was using at 

that particular time. And so I think what we have to understand 

is that subprime is subprime, and that the marketplace looked the 

other way. It took a different view. I mean, those of us in the housing business have marveled at the innovation that has gone on in 

the last 2 years of people getting home loans how they could have 

never—couldn’t even get car loans in many cases, and were able to 

get home loans. And so, hopefully over the next few hours here, we 

can hear from the experts and hear some ways that we—how we 

fix this without wrecking a very efficient system, one allowed to 

work in a market-based way. 

The CHAIRMAN. The gentlewoman from California is recognized 

for 3 minutes. 

Ms. WATERS. Thank you very much. I want to thank Chairman 

Frank and Ranking Member Bachus for holding today’s hearing. I 

believe this hearing is timely, because of the recent turmoil in financial markets here and abroad related to subprime mortgagebacked securities. 

Let me just say, Chairman Frank and members, about a yearand-a- half ago, I was in Cleveland, Ohio, in Congresswoman 

Stephanie Tubbs Jones’ district. There was a big town hall meeting 

there, and at that town hall meeting, the citizens described that 

there were blocks and blocks of boarded-up housing and that those 

who remained were at great risk because the boarded-up housing 

was under the control, sometimes, of criminals, that the deterioration of those homes was causing the price of their homes to go 

down, and on and on and on. 

None of us really understood what was going on, and surprisingly, none of our regulators were able to understand what was 

going on and to try and inform us so that we could at least try to 

provide some assistance to people who were getting into some of 

these subprime loans, who did not understand what they were getting into. 

Now what is so disturbing about all of this is this: For those of 

us who have worked for years to try and open up opportunities for 

people who have been locked out of the mortgage market, folks that 

we really believed that, given a chance—they may not be able to 

have a downpayment. They may have even had some credit problems, but people who work every day, who pay their rent, and who 

pay their electric bills, we’ve always wanted them to have an opVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
15

portunity, and we fought with the financial services in order to do 

this. 

And we welcomed subprime. And we agreed that subprime did 

not have to be predatory, that there was a case to be made that 

people who presented some risk, not extraordinary risk, should be 

afforded a mortgage and that they should be expected to pay on 

time, and that the subprime market could charge them a little bit 

more for that loan. We all agreed to that. And we thought that the 

regulators not only were watching what happened with loans that 

were delinquent that were on the books of these financial institutions, we thought that they would know when something went 

wrong. 

And evidently, they did not know, and we’re all kind of surprised 

to find out that once the originators discovered that they could 

package anything and have it packaged and securitized and the investors would put money into it, that they could just throw anything into the package. 

And so all of these exotic products, it’s not simply no downpayment, but we’re talking about products where you don’t even verify 

the employment of the individual, particularly with some of these 

jumbos that were going out. And we still don’t know today how 

they would get a handle on these products that came into being 

that have created this unsettling of the market. And so I remember 

when Federal Reserve Chairman Bernanke was here with testimony to the full committee in 2007 on the mid-year Monetary Policy Report, and I raised these concerns, and he did not have any 

answers. 

So the bottom line is, it seems for those of us who fight for opportunities for people who should have loans, it’s either feast or famine. So now we’re going to get to a point where nobody is going to 

be able to get a loan. And I really want our regulators to tell us 

why they didn’t know, and what can be done about it, and how we 

don’t have to, you know, revert to drying up the opportunities for 

everybody because we’ve gone into this situation. 

I yield back the balance of my time. 

The CHAIRMAN. The gentleman from California. We went a little 

long in the opening statements today, but we only have the one 

panel, so I think we’ll be able to sustain an attention span through 

that. The gentleman from California, for 2 minutes. 

Mr. CAMPBELL. Thank you, Mr. Chairman. I want to join the 

chairman in saying that I, too, thought some weeks ago that this 

subprime problem would be contained, and I represent the district 

where it was pointed out that there have been more subprime failures on Jamboree Road in Irvine, California, my district, than in 

any other State. So I’m pretty familiar with—and pretty close to 

some of what’s gone on here. 

And, you know, Chairman Bernanke before this committee several times had said that his greatest concern for the economy in 

the future would be a hardfall in the housing market. The housing 

market was clearly teetering before the subprime problem spread 

to Alt A and through to—through now into AAA housing loans and 

credit. And, frankly, from what I understand, it has spread through 

into commercial real estate loans and is impacting that, too. 

16

So I come into this hearing and in fact back to this Congress 

today with no preconceived notions on what we should do or what 

we shouldn’t do, but in fact to listen. Because I come in with great 

concern for this economy and for what effect a hardfall in the housing market led into by this credit problem and/or in commercial 

real estate could lead to as far as our national economy. 

It seems to me just as an observer that there is a risk premium 

that is being put on by investors around the world now on loans, 

on packages of loans securitized by real estate in the United 

States, and that that risk premium is there because they no longer 

trust what is coming out of this market, what these loans are purported to be and what checks have been done or not done, and that 

perhaps one of the things—and I’ll be very interested to hear from 

the panel—is that—is what can we do to restore some confidence 

or to add some confidence or some transparency so that that risk 

premium goes down, and so that investors around the world once 

again can look at a package of real estate loans from the United 

States as being something that is worthy of investing in without 

an inordinate risk premium there. 

I look forward to hearing the testimony from the panel, and I 

thank the chairman. 

The CHAIRMAN. The gentleman from Georgia, for 2 minutes. 

Mr. SCOTT. Thank you very much, Mr. Chairman. And I, too, am 

looking forward to this hearing. But I wanted to just make a few 

brief remarks if I could because I’m anxious to hear what you have 

to say. I represent the Atlanta region, Atlanta, Georgia, which 

right now has the second highest number of foreclosures anywhere 

in the United States, and this is not a new phenomenon. 

I heard very clearly some of the points that were raised on the 

other side about laissez faire, let the market take care of itself, but 

this is not something new. This has been going on a long, long 

time, certainly in my region, and I think it’s wise of us to look at 

some of the basic issues of why this is happening. I think we need 

to prepare legislation or initiatives, whatever, in a very calm and 

responsive way, but certainly we have to look at what’s causing 

this. Number one, what’s causing this is loans are being made to 

people who ought not to get these loans. Something ought to be 

done about that. Something ought to be done about loan originators 

who are sitting and they know that these people do not have the 

capacity to pay. They know that they have weak credit histories, 

but yet, they are still making the loans to these individuals. 

Secondly, we have over-aggressive, eager loan originators. And 

then thirdly, we have consumers—and this is really the heart of 

the matter—we have consumers in this country, most of whom, 

who are just woefully lacking in financial literacy and education 

before they sign on the dotted line. And we have moved very slowly—as a matter of fact, we have not moved at all—in putting forward a very aggressive financial literacy program with at least a 

toll-free number where people who are on the margins, who are in 

these subprime markets, who are most at risk, can at least have 

a place to call before signing on the dotted line. 

And so it is my hope that in the hearing today, we will be able 

to discuss some of these issues. But I also want to put my two 

cents in for taking an intelligent look to see what our institutions 

17

can do that are there. The President has already moved with the 

FHA and first-time home buyers and giving them some help, which 

I applaud. But we have Fannie Mae and Freddie Mac, whose limits 

should be lifted. And let me also commend our banks, that are 

doing an excellent job, particularly Atlanta Federal Home Loan 

Bank in my hometown, of getting more money into the market to 

help with the liquidity problem. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Finally, I will recognize the ranking member for 

a unanimous consent request. 

Mr. BACHUS. I thank the chairman. Mr. Chairman, the ranking 

member of the subcommittee, Mrs. Biggert, is presently in a conference in the Senate on the student loan bill, and she has played 

a significant role in addressing subprime problems, and I would 

like to ask unanimous consent to submit her statement into the 

record in Mrs. Biggert’s absence. 

The CHAIRMAN. Without objection, it is so ordered. 

And we will now turn to our witnesses. Before we do, I want to 

enter into the record a press release dated yesterday: ‘‘Federal Financial Agencies and Conference of State Bank Supervisors Issue 

Statement on Loss Mitigation Strategies for Services of Residential 

Mortgages.’’ 

Catchy title, guys. But it’s a very important statement. It is from 

the bank regulators, the Conference of State Bank Supervisors, and 

it’s a very encouraging example of Federal-State cooperation and 

the National Credit Union Administration. It is really quite important; I think it builds in part on some of the work that we have 

done in conjunction with the SEC where mortgages are held in 

portfolios of institutions, and you can get workouts at least directly. 

A large part of the problem has been that the mortgage is held 

after securitization, and it has not gotten enough attention, I think, 

that the SEC, to its credit, at our request, got the Financial Accounting Standards Board, to its credit, to make clear that the appropriate accounting standard allows the servicer of securities to 

show flexibility if the holders will be better off. 

As we know, increasingly now, with increased property values, 

with the kind of domino effect, it is better in many cases to forego 

every last right of the contract which would lead to foreclosure and 

instead do a workout. I very much appreciate what we have here, 

and I thank the regulators, some of whom are represented here. 

They have now written to the—they’ve issued this statement, and 

they are telling the securitizers to please take advantage of the 

flexibility. So this is one more example. 

And for those who are paying attention to this, to members, this 

is something—we’re going to send this around to all members. If 

you are talking to people in your districts who have these mortgage 

problems, if you are talking to the advocacy groups, many of which 

are doing a very good job, the counseling groups, they should know 

both about what the Financial Accounting Standards Board just 

said, and the fact that all of the regulators have urged them to go 

forward with it. 

With that—and I ask that this be put into the record. Without 

objection, it will be. 

18

And with that, we will begin the testimony with Secretary Steel. 

Well, one last explanatory point. There is one missing face at the 

table today, if we look at institutions with responsibility. It’s the 

Federal Reserve System. Originally I had invited the Federal Reserve, but there is a Federal Open Market Committee meeting on 

the 18th of September. The Federal Reserve System asked us if 

they could defer appearing, given how close it is to an FOMC meeting, because they fear that people might draw the inference that 

whatever they did at the September 18th meeting might have been 

influenced by what was said today. Though, frankly, I will ask for 

the indulgence, that seems to me less of a terrible thing than to 

others. This is an institution, the House of Representatives, that 

can vote on the most intimate and important questions affecting 

humanity; war and peace and life and death, and all manner of 

other things. But apparently, God forbid we should ever talk about 

a quarter percent on the interest rates, because that is beyond the 

competence of a democratic institution. I don’t agree with that, but 

I have deferred to it in this instance. We will get back to the Fed 

later. 

The gentleman from Alabama. 

Mr. BACHUS. Mr. Chairman, you noted the absence of the Federal Reserve. I also would like to say that the director of the OTS— 

The CHAIRMAN. Yes. 

Mr. BACHUS. —John Reich, is not here, and of course, they regulate our thrifts, including Countrywide and— 

The CHAIRMAN. Will the gentleman yield? The gentleman is 

right. I was hoping that this hearing would not focus so much on 

subprime, that we would be doing that on mortgages at the September 20th hearing, and that this would get to the broader ones. 

And we do have two of the bank regulators because they have regulatory authorities that go beyond that. The thrifts is—the OTS has 

done a good job, and I acknowledge that. They will be at the next 

hearing. 

Mr. BACHUS. And actually, I guess my reason for pointing that 

out is that he has done a good job. 

The CHAIRMAN. No question. 

Mr. BACHUS. You and I have both discussed privately that the 

OTS— 

The CHAIRMAN. Yes. And OTS is part of this group, and I agree 

with that. I would note just for the purpose of symmetry, that they 

used to have a practice in the House called ‘‘pairing,’’ where a 

Member on one side of an issue and a Member on the other side 

of an issue could both be absent, and they would kind of get credit 

for canceling each other out. 

I would note that while we don’t have the Federal Reserve here 

today, neither do we have the gentleman from Texas, Mr. Paul. 

And I think from the standpoint of people who know Mr. Paul, having both the Federal Reserve and Mr. Paul not here is a reversion 

to the old pairing system, so we have managed to reach some parity there. 

Mr. Secretary, please begin your testimony. 

19

STATEMENT OF THE HONORABLE ROBERT K. STEEL, UNDER 

SECRETARY FOR DOMESTIC FINANCE, U.S. DEPARTMENT OF 

THE TREASURY 

Mr. STEEL. Chairman Frank, Ranking Member Bachus, and 

members of the committee, I very much appreciate the opportunity 

to appear before you today to present the Treasury Department’s 

perspective on the recent events in the credit and mortgage markets and their impact upon consumers and the economy. The 

Treasury Department and Secretary Paulson know these events 

are of considerable interest to the American people, this committee, 

and other Members of Congress. 

To give context to the current market situation, let me begin my 

remarks today with a brief description of both domestic and global 

economic conditions. In the United States, the unemployment rate 

is 4.6 percent, closest to its lowest reading in 6 years. Real GDP 

growth was 4 percent in the second quarter, supported by strong 

gains in business investment and in exports. Core inflation is 

under control. Since August of 2003, 8.3 million jobs have been created, more jobs than all of the major industrial countries combined. 

The global economy continues to grow at around 5 percent annually with many emerging market economies growing even more 

rapidly than the global average. Over the past several years, these 

favorable economic conditions—low unemployment, low inflation, 

low interest rates—serve to fuel a demand for credit and investment, and the marketplace responded with a vast supply of both 

to satisfy consumers and the sophisticated market participants. 

At the consumer level, this demand was very noticeable in the 

mortgage industry, and in recent years particularly, the subprime 

area. For the first time in the early 1990’s, consumers with lower 

incomes and challenged credit histories, typical subprime borrowers, were able to access mortgage credit at interest rates a few 

percentage points higher than prime borrower rates. Homeownership became more widely available in the United States, growing 

from 64 percent in 1994 to 69 percent today. 

Mortgage securitization has played a significant role in this 

growth. Typically, the mortgage originator distributes its loans to 

a securitization sponsor, who pools together the mortgages into 

mortgage-backed securities. Investor demand for mortgage-backed 

securities provided capital to mortgage originators, who were then 

able to use this capital to make more loans. 

Throughout most of the 1990’s, annual mortgage origination 

stood at approximately $1 trillion. With the historical low interest 

rate environment of 2001 to 2003, mortgage origination climbed to 

almost $4 trillion in 2003. Infrastructure buildup and the entry of 

many new participants into the mortgage industry matched this increase. As interest rates began to rise in 2004, mortgage origination fell to just under $3 trillion. With this decline, there was significant overcapacity in the mortgage industry. 

To satisfy continued investor demand for mortgage-backed securities and their excess capacity, some mortgage originators relaxed 

their underwriting standards, lending to individuals with a lower 

standard of documentation, and thereby selling mortgage products 

which for some buyers would become unaffordable. 

20

The combination of rising interest rates and mortgages resetting 

at higher rates, and a decline in house price appreciation, led to 

rising delinquencies and defaults among subprime borrowers, first 

widely evidenced in the autumn of 2006. In 2007, this trend has 

continued. 

In turn, the mortgage-backed securities investor has felt the repercussions of the weakness in the mortgage assets underlying 

some of these securitized products. Over the past several months, 

a small number of U.S. and foreign financial institutions and hedge 

funds invested in mortgage-backed securities have reported large 

losses. Some have suspended or limited redemptions consistent 

with their authority, while others have liquidated or received capital infusions so as to continue. 

The uncertainty regarding the future prospects of these mortgage-backed securities compelled investors to reassess the risk of 

these securities and subsequently reassess price. This reappraisal 

has spread across other parts of the credit market spectrum, first 

affecting residential mortgage-backed securities and then spreading 

to other asset classes, and in particular, securitized products. 

This reappraisal of risk is normal and typically follows periods 

of widely available credit when markets have undervalued risk. As 

in other times of reappraisal, investors adverse to risk and protective of their capital, have fled to quality assets, demanding and 

driving up the prices, and in turn driving down the rates of securities such as Treasury bills. 

In early August, this uncertainty and subsequent illiquidity 

began to spread to asset-backed commercial paper, typically a highly liquid market. In response, the Federal Reserve took several 

measures to increase liquidity and promote the orderly functioning 

of financial markets. The Federal Reserve provided additional reserves through open market operations in order to promote trading 

in Fed funds markets at rates close to the target rate. The Federal 

Reserve also lowered the discount rate and changed the Federal 

Reserve’s usual practices to allow the provision of term funding at 

the discount window. Such actions have helped to stabilize the 

markets. 

The ultimate impact of these different events on the economy has 

yet to play out. At the time of its discount rate cut, the Federal Reserve noted, ‘‘the downside risks to growth have increased appreciably.’’ 

The Treasury Department respects the independent action and 

leadership of the Federal Reserve. Like the Federal Reserve, the 

Treasury Department shares the perspective that recent market 

developments pose downside risks to economic growth. However, 

the economy was in strong condition going into the recent period 

of volatility, and while certain sectors like housing are undergoing 

a transition, overall economic fundamentals remain strong. And 

while recent difficulties in the subprime mortgage market are having and will continue to have a profound effect for many families, 

the underlying strength of the economy should allow for continued 

growth. 

The Treasury Department closely monitors the global capital 

markets on a daily basis. Under Secretary Paulson’s leadership, 

the President’s Working Group on Financial Markets will examine 

21

some of the broader market issues underlying the recent market 

events, including the impact of securitization and the role of rating 

agencies in the credit and mortgage markets. 

The Treasury Department will also be releasing early next year 

a blueprint of structural reforms to make financial services industry regulation more effective, taking into account consumer and investor protection and the need to maintain U.S. capital markets’ 

competitiveness. 

Most important, in addition to efforts to fully understand the 

current situation in the financial markets, last week, the President 

announced a series of market-based initiatives to help homeowners 

keep their homes. For example, the Administration, led by the 

Treasury Department and the Department of Housing and Urban 

Development, has undertaken several actions to provide assistance 

to homeowners, including the Administration’s continued pursuit of 

legislation modernizing the Federal Housing Administration. 

Coordinating with HUD, the Treasury Department will also 

reach out to a wide variety of entities, such as NeighborWorks 

America, mortgage originators and servicers, and government-sponsored entities like Fannie Mae and Freddie Mac, to identify struggling homeowners and expand their mortgage financing options. 

The Treasury Department looks forward to working with Congress 

in the days ahead on these important issues. 

In conclusion, it is crucial that policymakers understand these 

issues and their underlying causes, and continue to enhance the 

capital markets’ regulatory structure to adapt to market developments. 

I appreciate having the opportunity to present the Treasury Department’s perspective on these important issues and I look forward to your questions. 

[The prepared statement of Under Secretary Steel can be found 

on page 129 of the appendix.] 

The CHAIRMAN. Thank you. Next, we have the Comptroller of the 

Currency. 

Mr. Dugan? 

STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER OF THE CURRENCY, OFFICE OF THE COMPTROLLER OF THE CURRENCY 

Mr. DUGAN. Chairman Frank, Ranking Member Bachus, and 

members of the committee, I appreciate this opportunity to provide 

the OCC’s perspective on recent events in the credit and mortgage 

markets. 

As you know, we are the primary supervisor for the very largest 

commercial banks that play critical roles in virtually all aspects of 

today’s capital markets, including the credit markets for mortgages, leveraged loans and asset-backed commercial paper that 

have received so much attention. The OCC maintains teams of examiners onsite at each of these institutions to monitor their activities. 

More broadly, for the last 20 years, national banks across the 

country have become very substantial participants in residential 

mortgage markets where they originate, hold, sell, buy, service, 

and securitize most types of mortgages. These of course include 

22

subprime mortgages, but let me emphasize that national banks 

have proportionally been less involved in that market, originating 

less than 10 percent of all subprime mortgages in 2006, and have 

experienced default rates that are significantly lower than the national average. 

Given the large aggregate credit exposure of national banks, the 

recent volatility in credit markets has clearly been a concern for 

both the OCC and the banks that we supervise. These challenging 

market conditions affect all market participants, including not just 

the largest national banks that participate actively in capital markets, but also the many mid-size and community national banks 

that engage in mortgage activities across the country. 

Let me be very clear, however, that the worst problems that we 

have seen in markets—insufficient liquidity resulting in substantial declines in capital and sometimes in failure of individual 

firms—have occurred outside the commercial banking sector. The 

national banking system remains safe and sound. Unlike many 

non-bank lenders, national banks generally have strong levels of 

capital, stable sources of liquidity, and well-diversified lines of business, all of which have allowed them to weather these adverse market conditions. 

As a result, national banks remain active in major markets and 

continue to extend credit to corporate and retail customers, including mortgage credit. 

With respect to general market conditions, I am encouraged by 

the recent actions to restore liquidity that have been undertaken 

by the Federal Reserve, other central banks, and various market 

players, including some major national banks. Nevertheless, the 

situation does remain fluid and it may take some time until markets fully stabilize. 

We are therefore continuing to watch conditions very closely and 

talking on a regular basis with other financial regulators to address issues that may arise. While recent market conditions have 

certainly been painful, and may continue to be painful for some 

time, we believe they are likely to cause some positive changes in 

the longer term as markets re-evaluate and reprice risk. 

Part of today’s problems in credit markets resulted from underwriting standards that had relaxed too much, whether in subprime 

loans or leverage lending, to pick two examples, which was at least 

partly the result of investor willingness to assume greater risk to 

achieve higher yields. 

In both cases, market participants are now demanding changes 

in the form of more conservatism. While legitimate concerns remain about the pendulum swinging too far and too suddenly in the 

opposite direction, we remain hopeful that markets will stabilize at 

an equilibrium where lending standards are more rational and 

pricing more accurately reflects risk. 

Such a positive outcome would apply in the future to loans that 

are yet to be made. Unfortunately, the same cannot be said for 

many loans that have already been made, and in particular for 

many homeowners holding subprime mortgages. 

For those Americans who may be facing unmanageable mortgage 

obligations, recent events are far more serious than a simple marVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
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ket correct. They may instead result in foreclosure and all its potentially devastating effects on families and communities. 

The OCC recognizes the need to do all we can to reduce the inevitability of that outcome. We have taken concrete steps to encourage both lenders and borrowers to respond to these situations in 

ways that minimize the likelihood of foreclosure while preserving 

safety and soundness. 

Just yesterday, as the chairman stated, the banking agencies 

jointly released a statement encouraging lenders and servicers to 

work with borrowers to take appropriate steps to avoid foreclosure 

even where loans have been securitized. With the prospect of significantly increasing foreclosures looming on the horizon, we are 

fully committed to working with all interested parties to help address the many significant issues that could arise. 

Thank you very much. 

[The prepared statement of Comptroller Dugan can be found on 

page 98 of the appendix.] 

The CHAIRMAN. Thank you, Mr Dugan. 

Now, the chairman of the FDIC, Ms. Bair. 

STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN 

FEDERAL DEPOSIT INSURANCE CORPORATION 

Ms. BAIR. Chairman Frank, Ranking Member Bachus, and members of the committee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation on the credit and 

mortgage markets. 

Events in the financial markets over the summer present all of 

us here today with significant challenges. My written testimony 

gives details about the developments that led to the current market 

disruptions. 

I would like to focus my comments this morning on the condition 

of the banking industry and the role banks can play in addressing 

the current credit challenges. Recent events underscored my longstanding view that consumer protection and safe and sound lending 

are really two sides of the same coin. Failure to uphold uniform 

high standards across our increasingly diverse mortgage lending 

industry has resulted in serious adverse consequences for consumers, lenders, and potentially, the U.S. economy. 

Insured financial institutions entered this period of uncertainty 

with strong earnings and capital, which put them in a better position both to absorb the current stresses and to provide much needed credit as other sources withdraw. Also in times of financial 

stress like these, the full benefit of Federal deposit insurance becomes evident. 

Insured deposit accounts give consumers a safe place to put their 

money during times of uncertainty, and confidence in the safety of 

their deposits helps to preserve the liquidity and integrity of the 

financial system. 

Last month, the FDIC released second quarter 2007 financial results for the 8,615 FDIC-insured commercial banks and savings institutions. These showed an industry with very solid performance. 

Second quarter earnings were the fourth highest quarterly total on 

record, only 3.5 percent below the all-time high, and more than 90 

percent of all FDIC-insured institutions were profitable. 

24

While the overall financial results are positive, the data also included some worrisome information. The interest rate environment 

continues to be difficult for financial institutions. Of most concern, 

credit quality is likely to get worse before it gets better. 

Noncurrent one to four family residential mortgage loans represented 1.26 percent of all such loans at the end of June, the highest noncurrent rate for these loans since the first quarter of 1994. 

Many credit needs of both businesses and individuals will need 

to be funded in the coming months. This will present both challenges and opportunities for FDIC-insured depository institutions. 

Among the challenges for the industry are increased credit 

losses. If the housing downturn continues, some institutions that 

are currently in good shape could face capital challenges resulting 

from losses in mortgage-related assets. 

At the same time, this situation may create opportunities for insured institutions to expand market share and to improve interest 

margins, as funding that was previously provided by the secondary 

market begins to shift to banks and thrifts. 

Growth of portfolios, if it occurs, would pose a risk-management 

challenge for many institutions. Institutions that grow their loan 

portfolios will have to maintain sufficient capital to support that 

growth, however the currently strong capital base of the industry 

puts it in a position to be a more important source of financing for 

U.S. economic activity during this difficult period. 

The recent events in the financial markets also remind us that 

strong capital requirements are essential and that models have 

their limitations in the assessment of risk. These are important lessons to remember as we approach implementation of Basel II. 

Finally, it is crucial that we use all available tools to assist deserving borrowers who will soon be facing problems as mortgages 

reset in the coming months. It is also important that regulators do 

all they can to improve consumer protection and make certain that 

rules for all market participants are consistent. 

I applaud the fact that Chairman Bernanke has promised to propose HOEPA rules before the end of the year to impose more uniform standards on bank and nonbank mortgage market participants. 

The uncertainty that now pervades the marketplace, which in 

many respects is attributable to underwriting practices that were 

sometimes speculative, predatory, or abusive has seriously disrupted the functioning of the securitization market as well as the 

availability of mortgage credit for some borrowers. 

The FDIC will continue to work with our colleagues and the regulatory community to address these issues. That concludes my testimony. I would be happy to respond to questions. Thank you. 

[The prepared statement of Chairman Bair can be found on page 

76 of the appendix.] 

The CHAIRMAN. We will now hear from Mr. Sirri, with the SEC. 

STATEMENT OF ERIK R. SIRRI, DIRECTOR, DIVISION OF MARKET REGULATION, SECURITIES AND EXCHANGE COMMISSION 

Mr. SIRRI. Chairman Frank, Ranking Member Bachus, and members of the committee, thank you for inviting me here to testify on 

25

behalf of the Securities and Exchange Commission about recent 

events in the subprime mortgage and credit markets and the Commission’s responses. 

There is no question that over the past 2 months, the defaults 

by homeowners with subprime credit and mortgage obligations has 

had a broad and significant impact. In addition to the difficulties 

that this has caused borrowers and others in their communities, 

the sharp rise in defaults has reverberated throughout the financial markets. 

As default levels on subprime mortgages exceeded expectations, 

market participants began to question the value of a variety of financial products. And as valuations came into doubt, liquidity in 

these products fell sharply, which further complicated the task of 

valuing particularly complex instruments. 

Derivative referencing mortgages were not the only instruments 

that experienced an unexpected decline in liquidity. A variety of 

other complex financial products that involved non-mortgage assets 

suffered diminished liquidity as well. 

As liquidity for structured products diminished, market participants needing to raise funds to meet margin calls or investor redemptions sold their less complex financial instruments such as equities and municipal securities, placing downward pressure on 

prices in these markets. 

Overall, these dynamics have significantly impacted a wide range 

of market participants from individual investors to systemically important financial institutions. 

In this environment, as in more benign environments, the Commission seeks to fulfill its basic mandates: to protect investors; 

maintain fair and orderly markets; and facilitate capital formation. 

My written statement describes a full range of issues on which 

the Commission is engaged, but in my oral statement, I will focus 

on three things: our outreach to a variety of market participants 

to understand potential exposures to subprime mortgages and related products and to evaluate operational and liquidity issues that 

could require regulatory response; our implementation of the rules 

governing nationally recognized statistical rating organizations, 

NRSROs; and our oversight of consolidated supervised entities. 

As a matter of course, the Commission and its staff are in regular contact with the industry to gather information and determine 

where regulatory action is needed. This is particularly true now, 

given the current state of credit markets. Similarly, we regularly 

confer with the President’s Working Group agencies to discuss market conditions and share observations about issues facing those 

market participants under the PWG’s members’ respective jurisdictions. 

All of this discussion and information sharing has ultimately led 

to a more consistent and coordinated response to the credit market 

events across markets and their participants. In June of this year, 

the Commission adopted rule governing NRSROs. The purpose of 

the rating agency act is to improve ratings quality for the protection of investors and to serve the public interest by fostering accountability, transparency, and competition in the credit rating industry. 

26

The Commission believes that disclosures required by the credit 

rating agency act and its implementing rules will assist users of 

credit ratings in assessing the reliability of an NRSRO’s ratings 

over time and will provide transparency with respect to the accuracy of a credit rating agency’s ratings in connection with structured financial products related to subprime mortgages. 

Given recent events in the subprime mortgage and credit markets, the Commission has begun a review of NRSRO policies and 

procedures regarding ratings of residential mortgage-backed securities and CDOs, the advisory services that may have been provided 

to underwriters and—provided to underwriters and mortgage originators, their conflicts of interest, disclosures of the rating processes, the agencies’ rating performance after issuance, and the 

meanings of the assigned ratings. 

Also important to systemic health of the financial services sector 

is the vitality of the largest financial services firms. The Commission supervises five securities firms on a groupwide basis: Bear 

Stearns; Goldman Sachs; Lehman Brothers; Merrill Lynch; and 

Morgan Stanley. For these CSE firms, the Commission provides 

holding company supervision in a manner that is broadly consistent with the oversight of bank holding companies by the Federal Reserve. 

The program’s aim is to diminish the likelihood that weakness in 

the holding company itself or any unregulated affiliates would 

place a regulated entity such as a bank or a broker dealer or the 

broader financial system at risk. 

CSEs are subject to a number of requirements under the program, including monthly computation of capital adequacy measure 

consistent with the Basel II standard, maintenance of substantial 

amounts of liquidity at the holding company, and documentation of 

a comprehensive system of internal controls that are the subject of 

Commission inspection. 

Further, the holding company must provide the Commission, on 

a regular basis, with extensive information about capital and risk 

exposures, including market and credit exposures. Given the recent 

events in mortgage and credit markets and their potential impact 

on financial institutions, the Commission’s staff is monitoring the 

liquidity available to the CSE parent with greater frequency than 

normal during these periods of unusual market stress. 

In addition, the Commission staff is also monitoring contingencies that might place additional strains on the balance sheets 

of CSE firms. These include the potential unwinding of off balance 

sheet funding structures, such as conduit structures. We are also 

monitoring the potential funding requirements and certain leverage 

lending commitments that are made by the CSE firms, typically to 

fund corporate acquisitions or restructuring. 

The Commission staff is also engaged in the ongoing oversight on 

valuation at the CSE firms. Current market conditions have increased the challenge of marking certain complex positions to market. We are reviewing the valuation methods that are used by each 

firm to ensure that they are robust and consistently applied across 

all of the firm’s business. 

I hope my remarks today have highlighted the Commission’s ongoing and heightened activities. In light of the recent mortgage 

27

market events, I believe that the regulatory committee must continue to engage with the systemically important banks and securities firms, encouraging additional efforts to improve and expand 

risk management capabilities. We will work with our PWG colleagues and other market participants to further this agenda. 

Thank you for the opportunity to testify and I would welcome 

any questions. 

[The prepared statement of Mr. Sirri can be found on page 121 

of the appendix.] 

The CHAIRMAN. Thank you, Mr. Sirri, and now we will begin the 

questioning. 

And again, I will remind members—obviously members can do 

what they want—but with specific reference to the current 

subprime crisis, the potential foreclosures, we will be having a 

hearing entirely on that subject on September 20th with Treasury, 

HUD, OTS, the bank regulators, and others to talk about the President’s proposal and what we can do. 

My own intention is to focus on some of the implications that we 

may have for the broader questions. As I said, members are free 

to ask what they want, but in fairness to the witnesses, they didn’t 

come, I think, briefed to fully talk about the President’s program, 

and that will be coming up a little after that. 

I am most concerned at this point about the potential broader 

implications, and it does seem clear that we have a set of financial 

markets today that are very different than they were 10 years ago, 

but our regulatory structure is essentially the same as it was 10 

years ago. 

We are not talking about more regulation necessarily, we are 

talking about more appropriate regulation, regulation that responds to what we now have. And again, I was particularly 

pleased, Mr. Dugan, in your testimony, and I was glad to see those 

figures. 

It is clear, with regard to subprime, that the regulated sector of 

the mortgage industry clearly has performed in a much more responsible fashion than the unregulated sector. There are a large 

number of very responsible people in the unregulated sector. The 

difference is that the minority that might be inclined to be irresponsible ran into fewer obstacles there than they did in the regulated sector. 

And it is not my impression that the FDIC, the OTS, the OCC, 

and the Credit Union Administration, also not here, but part of 

this, it’s not in my experience that they refuse loans that should 

have been made. In other words, people have said, ‘‘Oh, sure, they 

don’t make bad loans, but they don’t let anybody make any good 

loans.’’ 

The fact is that I think the balance of making the loans that 

should be made and not making those that shouldn’t be made was 

approximated much better thanks to sensible regulation. And 

that’s—I want to just talk about—we’ve been told earlier—Mr. 

Steel, maybe I’m misreading this a little bit, but I was struck by 

your statement, ‘‘The Treasury Department will also be releasing 

early next year a blueprint of structural reforms to make financial 

services industry regulation more effective, taking into account conVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
28

sumer and investor protection and the need to maintain U.S. capital markets competitiveness.’’ 

Maybe I’m overanalyzing this. Maybe this is the old new criticism of years ago in the literary world hanging on. That was big 

when I was going to college; they’re all dead now. But it did seem 

to me the emphasis on consumer and investor protection getting 

equal attention with competitiveness, I’m not sure I would have 

seen that earlier. 

That is, we did hear a lot earlier this year, last year, about the 

need to improve the competitiveness of our financial markets, and 

the general argument was—the thrust of it was that we’ve overregulated some. People said, ‘‘Why can’t you be like that nice FSA,’’ 

that Financial Services Authority. ‘‘Don’t be so nitpicky.’’ ‘‘Why 

don’t you talk principles to us?’’ ‘‘Why are you always making all 

these rules on us?’’ and ‘‘Why do you have so many regulators?’’ 

I mean if this was England, this hearing would have been over 

because there would have been one of you, so that would have been 

much easier. People think that would have been a good deal. We 

don’t know which one of you it would be, maybe one of those three. 

You’d still be here, Mr. Steel. 

But the tone does seem to me to have shifted. The notion that 

the overwhelming need is for us to reduce regulation so that we 

can be more competitive with less regulatory regimes elsewhere, 

particularly England, I think there has been a shift, and I welcome 

that. That doesn’t mean we need to be heavy handed. 

And indeed, we’re getting that even from England. In the New 

York Times last Wednesday, August 29th, there was a quote from 

Chris Rexworthy—easy for them to say—director of advanced regulatory services at IMS Consulting, a former regulator with the Financial Services Authority. 

Mr. Rexworthy said that regulators talk about the importance of 

stress testing; recent development creates concerns that ‘‘institutions are either not investing enough effort in this, getting it 

wrong, or just producing things too complex for their risk assessment models to cope with.’’ Continuing the quote, ‘‘greater cooperation on the international stage between regulators is undoubtedly 

one of the things we need to see more of.’’ And it says U.S. regulators were. 

I quoted Martin Wolfe earlier in the Financial Times saying, ‘‘the 

only way to insulate financial markets against the sort of panic 

seen in recent weeks may be to reregulate them comprehensively.’’ 

He then expressed his skepticism about our ability to do that. 

And I guess, again, the issue is not increasing regulation of those 

things that we have always regulated but addressing the question, 

have the markets now come up with new things for which we don’t 

have an appropriate set of regulatory tools, the leveraging derivatives. And it is not simply that they have come up with new things 

but that precisely because they are leveraged, etc., that the potential negative may be even greater, that people have come up with 

the ability to do more, make more money but also perhaps incur 

more risk. 

And I am particularly driven by that because it does seem clear 

that we did not expect the subprime issue to have the broader negVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
29

ative issues it has. So I just wonder if any of the members of the 

panel—let me ask all of you just briefly to address that. 

Mr. Steel, let me begin with you. 

Mr. STEEL. I would agree with your description and when Secretary Paulson focused on this issue of competitiveness, then one 

of the first things that he raised was the issue of the regulatory 

structure in our country. And it’s something that he’s focused on 

and has asked people at Treasury to work hard to deliver a blueprint: what we think it should look like if we were starting fresh. 

Point two, I don’t view a review of the status quo to mean necessarily less regulation. I think the issue is appropriate regulation. 

Business models have changed and the markets have changed. 

Really, that’s in the wrong order. Basically, business models have 

changed to meet the markets, and as a result, our goal is to look 

at this afresh and focus on the issues. And I don’t think that means 

less investor protection or less consumer protection, it means having the right lens on these issues. And today, the patchwork nature 

of what has developed over decades, since the last century, is just 

not as attuned as it should be. 

Point two is last Friday the President specifically tasked Secretary Paulson to look at the ingredients of this latest period of turmoil, securitization, rating agencies, and to also have a fresh look 

on that. As I said to you in the past on other issues, there should 

be no acceptance of the status quo. Innovation acquires adaptation, 

and we have to keep moving with the innovation and to present the 

right regulatory focus. 

The CHAIRMAN. The gentleman from Pennsylvania, the chairman 

of the Capital Market Subcommittee, is planning hearings on the 

credit rating agencies’ piece of this. It’s an issue that he has been 

working on for some time. He has been somewhat pressured to be 

concerned about that when some others were not, and so he will 

be continuing that fairly soon. 

Is there any comment? 

Mr. DUGAN. Yes, Mr. Chairman. I mean I think the issue you 

raised is the unevenness of Federal regulation and then regulation 

in the markets that mortgages were not being provided by federally-regulated entities. I think personally I believe there is a need 

for some kind of uniform standard. The question is what is the best 

means to get there. 

I think right now the market itself has corrected and many of the 

most aggressive products are simply not being offered: 2/28s, for example, declined substantially in the marketplace. But I think even 

in terms of a standard, Federal regulators have come out with 

guidance, as you know. The States have embarked upon a serious 

effort to adopt a same kind of guidance. And if they do that on a 

uniform basis, that can help address that need. The Federal Reserve has also indicated its willingness to go forward with regulations under HOEPA by the end of the year. 

That will be a uniform standard. The question is, do you need 

to go beyond that? Will that be enough? I think that’s the question 

you’re grappling with and it is a difficult and a delicate balance because of the fear of going too far, but the issues that are being put 

into play, you’re having the hearing on on the 20th, I think, is totally appropriate. 

30

The CHAIRMAN. Thank you. And you said the market is corrected, 

and I do think we would agree. Unfortunately, it is over-corrected 

right now. And the only thing I’m saying is there is a potential 

problem of over-regulation, but among the fears that do not keep 

me awake very long are that the Federal Reserve will overdo consumer protection. That one I’m not too worried about. 

Ms. Bair? 

Ms. BAIR. Well, I think the FSA model does have some advantages in that all financial services regulation is under one umbrella. We compensate for that, though, through our informal communications. The FDIC hosted a series of securitization 

roundtables. The servicer statement we issued yesterday was an 

outgrowth of that. Those were jointly hosted with the other bank 

regulators; they also included the SEC, OFHEO, and Treasury. Bob 

Steel was there. 

So I think through informal mechanisms, we do a lot of communication. The President’s Working Group on Financial Markets is 

also an umbrella group that I think helps ensure that there is appropriate coordination, even though we have these multiple, separate regulatory structures. As I’ve told Bob, we’d love to have a little more involvement of the FDIC in the President’s Working 

Group. 

But I think they are very competently handling a lot of the policy 

and market issues that are arising in this context. So I think overall it’s not perfect. If you were starting from scratch, you might do 

something different, but overall, it works pretty well. 

The CHAIRMAN. Mr. Sirri? 

Mr. SIRRI. Chairman Frank, you make an important point that 

innovation and regulation have a tough time together, and as a 

regulator, we sense that, I think, on a regular basis. 

We do have some tools at our disposal. So for example with systemically important, large broker-dealers, we meet that challenge 

with liquidity. We require tremendous amounts of liquidity at the 

holding company level, so when there’s uncertainty, when we don’t 

know what’s going to happen, there’s liquidity available to ensure 

the solvency of those firms and to protect against defaults. 

But there are also things that have changed here. Congress, for 

instance, provided us new authority into the Credit Rating Agency 

Reform Act. This will for the first time give us the ability to register, regulate, and inspect credit rating agencies. That’s new for us 

and I think it’s an appropriate piece of legislation and we look forward to implementing it. 

The CHAIRMAN. Thank you. 

The gentleman from Alabama is recognized. 

Mr. BACHUS. Thank you. 

I’d first like to start by commending Chairwoman Bair. 

Congressman Scott mentioned earlier the importance of financial 

literacy and Mr. Hinojosa and Ms. Biggert and Mr. Scott have 

talked about the importance of that. I want to commend you on 

your book for elementary school children where you used the two 

animal figures to really teach planning ahead and setting aside. 

It’s a very good book. 

31

One of the positive things that may come out of all this is that 

book, or something like it, may be offered in elementary schools. 

It’s something I probably should have read earlier, too. 

Let me also say, we talked about the credit rating agencies and 

I’m going to direct this to Director Sirri. The three main credit reporting agencies, Moody’s, S&P, and Fetch, receive substantial revenues from their structured finance businesses. Unfortunately, it 

appears that in this instance, the rating agencies failed to re-evaluate the ratings given to mortgage-backed securities until their 

losses were already widely known in the market. 

In some cases, these securities received ratings that made them 

appear safe as Treasury bills. As the principal regulator of the rating agencies, what is the SEC’s plan to deal with the conflicts of 

interest inherent in a system where rating agencies are compensated by the issuers of the securities being rated? And I know 

the President’s Working Group worked on that too, and if you have 

a comment, Secretary Steel? 

Mr. SIRRI. Thank you. 

We are charged under the statute with looking at issues relating 

to conflicts of interest. There are two important conflicts of interest 

that I think merit particular attention. The first is the one that you 

cite, how credit rating agencies are paid. Typically, they’re paid by 

the underwriter or the issuer. That presents a conflict, but we believe that conflict is manageable. 

Firms should have credit rating agencies policies and procedures 

in place and they should adhere to those policies and procedures 

when they evaluate deals. We are going in to look at those firms 

now, to look at their policies and procedures and to look at the actual ratings and their practices to understand what was actually 

done. 

The second important conflict is one that could arise with respect 

to the disclosure of their methods and the meaning of ratings. 

Again, credit rating agencies should be clear about those and they 

should adhere to those practices as they rate particular securities. 

If we see conflicts, if we see that they’re not following their procedures with respect to information, then again we would be empowered to follow-up there. 

Mr. BACHUS. Secretary Steel, Friday, when the President and the 

Secretary outlined their proposal on helping homeowners, one of 

their proposals was a plan supporting the State-based efforts to 

create a comprehensive mortgage broker registration system. Mr. 

Scott earlier said something about it twice. He mentioned mortgage 

originators. I will tell you that not all of these bad loans are mortgage brokers; a lot of them are mortgage bankers. They are people 

inside banks, so they are federally-regulated. 

I’ve introduced, along with Mr. Gillmor, Mr. Price, Mr. Miller, 

and Ms. Biggert, legislation to establish a national registration system for all mortgage originators. It is very similar to what I think 

the President outlined last Friday, but would you comment on the 

need for the creation of such a system? And I think Mr. Scott in 

his opening statement pretty much told you about the problem we 

had with just a small group of mortgage originators. 

Mr. STEEL. Well, sir, I think that as the President said on Friday, and I would confirm to you today, this is an issue that reVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
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quires attention and people shouldn’t be able to move from jurisdiction to jurisdiction. And bad actors need to be catalogued and followed. I am familiar with your legislation and others, and we at 

Treasury would be completely consistent with the ideas of what 

you’re trying to accomplish. I think that what we need to work on 

and consult with you and other people on the table today is what 

is the best way to accomplish that. And the devil is in the details 

on this, but you should rest assured that the idea of cataloguing 

and being on top of this so people cannot move, bad actors cannot 

pack up and move to a new jurisdiction and act badly again, it is 

something we should track down and eliminate. 

Mr. BACHUS. Well, the States already have a system that works 

if we required it in all States as opposed to establishing something 

all new. And it applies to both originators and brokers, and I know 

that the Federal regulators have resisted that. But let me tell you 

that a lot of people have suffered as a result of not having a national registration that people can go to and quickly see. I know 

that Chairman Frank talked about the need for this, and we’ve discussed it, and it’s in our legislation. It was in the legislation that 

he and I proposed last year. 

Mr. STEEL. Thank you. 

Mr. BACHUS. My final question. 

Comptroller Dugan, you were over in the Senate. You were a 

lawyer at the Senate Banking Committee during the S&L crisis. 

You were heavily involved in the government’s response during the 

first Bush Administration to the savings and loan crisis in the late 

1980’s. Based on that experience, I know earlier you talked about 

unintended consequences and the government making things 

worse, and I think that certainly happened with savings and loans. 

Would you like to share any advice for us as we attempt to address these issues on how we might avoid some mistakes of the 

past? 

Mr. DUGAN. Certainly, and I do think this situation today is 

quite a bit different than the one that we had with the savings and 

loan crisis. 

Mr. BACHUS. Oh, absolutely, and let me say, I’m not in any way 

equating the seriousness of that situation. The economy is very 

strong today. The fundamentals are very good, so I associate with 

Secretary Steel in his talk about how strong the fundamentals are. 

And I know that we’ve all talked about the strength of the banking 

system. 

Mr. DUGAN. I think there were some good things that the government did when it got to the point of responding to that problem. 

There were some things that were issues. I think one of the lessons 

learned was when we waited so long to respond, and when I say 

we, I mean the entire Federal Government. Whether it was Congress or the regulators, it meant that the reaction in some cases 

wasn’t overcorrection and resulted afterwards in allegations of a 

credit crunch and people being too conservative in the kind of credit that they were willing to provide to consumers. 

And that’s why I do think in the current environment, we have 

tried to stay on top of this at the Federal level, at the supervisory 

level, to impose guidance and new standards. We have to be sensitive not to pushing that too far so that people don’t stop altoVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
33

gether providing the kind of credit to creditworthy subprime borrowers over time. We don’t want that to happen. 

And so I think staying on top of things in an orderly way and 

addressing problems as they arise instead of waiting too long to 

react, I think, is absolutely critical. 

Mr. BACHUS. Thank you. 

The CHAIRMAN. Thank you. Actually, I’d forgotten that you had 

been counsel to the Senate Banking Committee and any advice you 

can give us on how we can improve our relations with that entity 

would also be very good. 

[Laughter] 

Mr. DUGAN. Where you stand is where you sit. I’m not touching 

that one. 

The CHAIRMAN. I’m not saying that. I’m just saying, since you sit 

where you sit after they voted, I don’t expect you to answer the 

question as a confirmed appointee. 

The gentleman from Pennsylvania. 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

Having been in recess for the month of August, it was interesting 

to see the credit crisis unfold, and, with our not being in Washington, unable to get any responses or understandings, I suspect all 

of us have come up with different conclusions of what caused the 

problem, what some of the solutions may be, and what I am most 

interested in—the long term ramifications of what may happen if 

other things exacerbate the situation. 

For instance, if the real estate prices were to continue to fall precipitously, if we were to move into a recession, if the resets in the 

mortgages will come due in 2008 and 2009, are we doing an analysis to come up with a methodology of how to handle those problems or are we just going to breathe more simply within a month? 

The credit crunch seems to be over and we go back to the normal 

state that we were in before the past 2 months? 

As regulators, what are your intentions along those lines? 

Mr. STEEL. Oh, I’ll start sir. From the seat that I occupy, I think 

of this just exactly along the same lines as you do. I think there 

are four issues that are the gating points for us. 

Number one, there are principles that should drive what we 

think about in the near term. And number one, the first and foremost thing to focus on, is how to have the most successful efforts 

to keep American homeowners in their homes. Number one. 

Number two is in the process of doing that, we should be sure 

not to provide any rescue or bailout to investors or lenders who 

made these loans. 

Number three, we should quickly get at the issues that seem to 

be party ingredients of these challenging market conditions: 

securitization; rating agencies; and things like that. 

And the fourth thing is to take what we learn in the third bucket 

and apply it to the longer-term perspective of what the right, regulatory framework is for the financial system. Those would be the 

four ways that I would think through the issue, and that’s the time 

sequence too. First and foremost is how can we help people who 

were facing the resets stay in their homes? 

Mr. KANJORSKI. Okay, let me, along those lines, suggest something because we mentioned the historic nature of the S&L crisis, 

34

which I do see a parallel to, although the panel does not seem to 

see it. I don’t see that it is nearly the nature of the same crisis, 

but the solutions that are being batted around, perhaps in the Administration, sound somewhat similar to the S&L crisis. 

If you recall, in the late 1980’s, somebody came up with the brilliant scheme of supervisory goodwill. Does anybody remember that 

dirty word? And we took the good S&Ls and forced them to put supervisory goodwill on their books and forced them to take bad 

S&Ls. And I think there has been some analysis of the S&L problem at the late period of the 1980’s showing that it would have 

been only a $20 billion problem if we had addressed it at that time. 

For $20 billion from one source or another, all of the bad mortgages 

and bad situations in the S&Ls could have been resolved. But instead, we used the supervisory goodwill concept, and we infected 

good S&Ls with bad S&Ls and bad paper. And, ultimately, within 

2 or 3 years, the problem became a $200 billion problem. 

Now, I hear people talking about those two great institutions, or 

three great institutions already out there, but particularly Freddie 

Mac and Fannie Mae. The people are suggesting we get these folks 

involved and have them empowered to buy some of this bad paper 

or bad mortgages. I have great fear in doing that because the very 

same scenario, which I suggested in my earlier question, should we 

do that, would put them at risk and certainly strain their positions. 

And then we would have the real estate market really go awry and 

have us go into a recession. And then all hell is going to break 

loose and we are going to have a multi-trillion-dollar disaster or 

perhaps a systemic failure on our hands. 

Are the regulators talking about that? Are you discouraging, in 

the Administration, the talk of using Fannie Mae and Freddie Mac 

as the lone ranger here? 

Mr. STEEL. I guess it’s back to me. I think that dealing with this 

issue in my mind is a three-part process. Number one, working 

with the servicers to identify those loans that are facing resets and 

basically getting direct line of sight early for borrowers who are 

facing resets. Number one. 

Number two is getting those borrowers, once they’ve been identified, connected with qualified counselors, for example 

NeighborWorks, so they can get good, impartial advice on where 

they stand and what the best solution is to their situation. And the 

third part is trying to develop innovative products, both with private sector participants, public sector, like FHA, and also with the 

GSEs. At Treasury, we have reached out to GSEs to talk about specific products that they can offer. These are products that should 

be based on marketplace values, not in a subsidy form. And I’m 

convinced that by focusing on these three aspects: one, servicers; 

two, counseling; and then three, new products that actually can 

allow them to work, will be the right way to focus on it. 

Mr. KANJORSKI. Mr. Steel, I appreciate that, and I have a great 

deal of respect for you, as an individual. But, one, your Administration is not going to be in office when the full impact of our financial 

crisis hits, probably in 2 years, 21⁄2 years, or 3 years from now. And 

two, I find it very hard to believe that somebody sitting somewhere 

in a position of regulatory authority did not start to raise the question that liars’ loans may not be the best banking practices anyone 

35

ever heard of, or that 110 percent financing of mortgages may not 

be the most positive thing that people ever heard of. 

The excesses that were allowed to build up and occur strike me 

as almost panic, get on board, and get all you can while the good 

days last. And I do not have a great deal of confidence that you’re 

all going to be able to predict what is going to happen over the next 

2, 3, 4, or 5 years to the safety of the system if you have missed 

identifying that we are on our way to a very serious problem when 

all this occurred. 

I mean, I am not at all surprised that it happened. As a matter 

of fact, it is probably more delayed. I thought that it was going to 

happen a little sooner than it has happened. I still can’t conceive 

of people buying securities based on 110 percent financed loans of 

applications made by people who did not have the capacity to pay 

the initial loan. I have only sat on a small bank board, but I can’t 

ever remember that type of loan getting the approval of the board 

of that bank. But apparently, it got the approval of some of the regulators. 

Is that correct, or not? 

Mr. DUGAN. Well, I would just say from the point of view of the 

SEC, and I think it’s true of the other Federal regulators, there 

were concerns registered by the regulators that we advised the institutions we supervised. We did have concern with a number of 

the practices that you just described, and particularly the combination of those practices. 

And that is the kind of advice that we begin giving our examiners that then spread to the guidance that we put into place with 

the non-traditional mortgage guidance which began in 2005 and 

then was ultimately adopted last year and then the subprime guidance. There has been a process about that. I think it goes back to 

something Chairman Frank said earlier. More of that was being 

done by the Federal banking regulators than was going on outside 

of the bank regulatory system. 

The CHAIRMAN. Ms. Bair, do you want to respond? 

Ms. BAIR. Yes. I think the bank regulators have issued very 

strong guidance, both with regard to non-traditional mortgages as 

well as subprime, requiring things like underwriting at the fullyindexed rate, and placing severe restrictions on stated income 

loans. The Fed now has a very unique opportunity to extend those 

types of rules to the non-bank sector, and that is exactly what 

Chairman Bernanke has proposed. They will be moving with it before the end of the year, so I think we are moving ahead with the 

tools that we have. 

The CHAIRMAN. The gentleman from Louisiana. 

Mr. BAKER. Thank you, Mr. Chairman. 

Mr. Steel, I read with great interest your narrative about the 

process which has led us to the current circumstance and with regard to regulated financial institutions, there appears to have been 

guidance issued by regulators and apparent exposure and actual 

losses are significantly less than other sectors of the market that 

were non-traditional lenders. But now we see the contagion moving 

over to the commercial paper side, because of much of the collateral 

being provided by real property. And we’re not sure how far the liVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
36

quidity squeeze will actually go, thereby denying people access to 

credit, not even mortgage borrowers, just traditional businesses. 

I read with some concern that a vacuum cleaner company withdrew its intended plans for a debt issuance because of market conditions, and it’s one after another that are now reigning in their 

expected growth plans. And that will have another layer of effect 

with lack of jobs that would have been created, construction opportunities, and so this will continue to have some effect, unknown to 

one extent. 

My question is, isn’t it generally true that market operatives are 

going to act on that information much more quickly than a regulatory regime and the regulators’ role is to observe, watch, and advise. But it’s to stem the contagion as best we can once it starts, 

because the guys who were putting their money up and writing the 

check, who were looking across the table at the guy who’s selling 

them the product, are the ones to be asking the right questions before the contractual obligation is entered into. 

My observation is that there is very little, I think, that the 

United States Congress could put into effect to keep people from 

making bad business judgments unless we’re going to require Federal Government representatives on corporate boards. I mean, 

where are we going with this? 

I understand that businesses make money. I also understand 

businesses lose money. Our job is to just watch and make sure it 

doesn’t get into innocent third parties who had no participation, no 

judgment, did not condone, have knowledge of, and make sure 

they’re not hurt. But as to gains or losses within the normal world 

of businesses, is there a role, in your view, for the Federal Government to step beyond where we are today? 

Mr. STEEL. Well, Congressman, I think the way that I would reference back my comments earlier that I made with regard to 

Chairman Frank’s opening observations, and that is that the regulatory structure we have to our view could use a fresh relook. 

That’s what we at Treasury plan to do, and I can’t tell you where 

that will go. Let’s do the work before we have the conclusions. 

Mr. BAKER. But in the world of lending, if you wish to come to 

my institution, and you have a poor credit history, and you’re buying a modest home, and I choose to make you the loan, and you 

signed the deal, there’s not a governmental role in prohibiting that 

activity. Certainly, we should make the borrower aware of what 

he’s getting into. We should condone professional conduct by the 

lender, but we can’t prohibit somebody from entering into an ill-advised deal. 

Mr. STEEL. Judgment and risk taking are part of the process and 

people exercise good judgment and sometimes less good judgment. 

Mr. BAKER. Is there anything that we could require in the way 

of disclosure between business participants in the mortgage world 

because of the significant implications to the broader economy that 

is now not disclosable to parties to transactions? 

Mr. STEEL. Well, I think that the regulators, both Federal and 

State, have given several different examples since earlier this year. 

Whether it’s the issue about the subprime standards that should 

be used for underwriting and just lately, yesterday, the way in 

which modifications and refinancings can be reviewed. 

37

I think in the same basis, the Federal Reserve Board intends to 

provide comment by the end of the year on both TILA and HOEPA, 

and these are forward looking reviews of how we’re doing currently. 

And I would think that those are the right places to place the bets 

for the best feedback on these issues. 

Mr. BAKER. Well, I just hope we will use our best financial judgment in moving forward with such recommendations. I want to join 

with my colleague from Pennsylvania with regard to the expression 

of concern about the expansion of responsibility of Fannie and 

Freddie, and Federal Home Loan Bank for that matter. 

I would add on to his observation about the S&L crisis, the next 

step in resolution was to create the RTC, the Resolution Trust Corporation, whose mission in life was to take a dollar’s worth of assets and sell them for 13 cents. It was a heck of a job and it only 

ensured that we had inordinately larger taxpayer losses than we 

would have had, had we used I would call common sense asset disposition methodologies. 

And this is bad stuff. People are losing money. Homeowners will 

be denied access to credit. Businesses are going to be adversely impacted and I think it is a business lesson learned that when you 

go too far out on the risk of chasing greater return, there are consequences. And, unfortunately, I think that’s what this episode is 

teaching us. 

One last thing: from the early identification of defaults which I 

think you alluded in your testimony was October or November of 

last year, until the time the broad market liquidity crunch occurred, how quickly did one follow the other? 

Mr. STEEL. Well, I think that all of us—excuse me. Let me speak 

for myself. I think that the way in which the credit questions 

spread from subprime mortgages to other types of collateralized 

mortgages into other types of securitized product was faster and 

swifter than I would have imagined. And so that happened more 

quickly. But we had talked and I feel as though there was a lot 

of voice given to the fact that in general, the economy, people had 

become quite risk-comfortable in lots of ways. In almost every asset 

class you go through, people were demanding less and less return 

for accepting marginal risk. 

So I think the tinder was dry for something like this to begin, 

and where it would begin and how it would spread is pretty unpredictable. But I think the risk premium and the way that was being 

priced made it apparent that we were at risk of people having 

taken too much risk and then retrenching from that risk-taking 

process, which is where we are now. But now there are signs that 

the risk-taking is beginning to come back into the system. 

Mr. BAKER. But it wasn’t an irrational jump to risk. It was more 

of a slide into risk over a period of time. 

Mr. STEEL. Yes, and I think as I said in my written testimony, 

usually the ingredients to this are increasing comfort with risk and 

periods of economic activity, low interest rates, etc., make people 

comfortable. Investors, basically, are stretching for return and 

therefore accepting more risk, and borrowers take advantage of 

that situation and you have this cycle that works in that fashion. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. Thank you, Mr. Chairman. 

38

Actually, we got exactly to the point where I wanted to pick up 

anyway, because Mr. Dugan has on a couple of occasions used the 

benchmark as the conventional institutions that the Comptroller of 

the Currency regulates have done much, much better in terms in 

this foreclosure process than others, which I think is a relevant criteria, but leaves open the question of how have those institutions 

done in this crisis in comparison to prior times? 

Is the level of foreclosures as a result of this comfort with taking 

more and more risk, how has that played itself out, not in comparison to subprimes, but in comparison to historical patterns? 

Mr. DUGAN. So the question is on foreclosures, generally, across 

the whole mortgage market. Well, I would say that clearly the 

trend line is up overall. It is not at the record levels that we have 

seen in the middle of recessions like we had in 2001, for example. 

Mr. WATT. But the President told me we weren’t in the middle 

of a recession. So in comparison to like times, did this comfort that 

Mr. Steel has described with taking more and more risk, did it result in the traditional mortgage market accepting more and more 

risk in comparison to like periods of time in history? 

Mr. DUGAN. Well, I think if you look at, and I have a graph here 

that I actually could show you, if you look at the actual aggregate 

level of delinquencies and defaults, it hasn’t gone up that much historically. The real spike has been more on the subprime area. But 

you are right that the level has gone quite a bit higher than it has 

been in non-recessionary times, which is an indication of the nature of these products, the lax risk underwriting that Secretary 

Steel was just referring to. 

So, it’s sort of a combination of both. We have not seen the same 

leakage of problems to other parts of the prime. 

Mr. WATT. You made that point several times. I just wanted to 

make sure that in saying that we don’t hide the fact that across 

the market the acceptance of risk has been, I guess, in the former 

Secretary’s words, there was an irrational exuberance in the mortgage or lending market for a period of time. 

Is that generally accepted now? 

Mr. DUGAN. Well, I guess I would say that there were certainly 

parts of the market, not including the subprime that we tried to 

address in the non-traditional mortgage guidance where there were 

certain features about negative amortization and interest-only 

loans, and somewhat lower downpayments that we were raising 

concerns about that we hadn’t seen previously. 

So, to that extent, I would agree with you. 

Mr. WATT. Okay. And one of the concerns that some of us have 

expressed and tried to get to the bottom of is the extent to which 

institutions that are regulated by the OCC at some level are owners or investors, or have subsidiaries that deal in subprime mortgages substantially. 

To what extent are you all monitoring that, because one of the 

concerns I had with one of my own institutions—two of my own institutions—from my congressional district buying into Countrywide, for example, was that they were going into an area of the 

market that might not be subject to the same level of regulation. 

39

Mr. DUGAN. Well, if it’s a national bank or a subsidiary of a national bank, we regulate it the same. We regularly give it fullblown, on-site banking supervision. 

If it’s an affiliate of the bank through the holding company, then 

that’s regulated by the Federal Reserve. And in the case of Countrywide, that’s a thrift, and the entire organization is subject to 

regulation by the Office of Thrift Supervision. So I can only speak 

specifically to the ones that we regulate directly. 

Mr. WATT. All right, my time has expired, apparently. So I’ll 

leave that alone. 

Mr. KANJORSKI. [presiding] The gentleman from Texas. 

Mr. HENSARLING. Thank you, Mr. Chairman. Again, I share the 

concern of many on this committee with the broader capital markets’ reaction to what we see in the subprime mortgage market. 

To ensure that we have the facts, since in some previous testimony it has been mentioned in several opening statements, but as 

I understand it, subprime borrowing accounts for roughly 13 percent of the outstanding mortgage debt in the United States, and 

the latest data that has come across my desk show that 83 percent 

of all subprime borrowers are paying on time, which means 17 percent were either delinquent or in foreclosure. 

I think somebody, and perhaps it was Ranking Member Bachus 

or another member, I do not recall, did the math and said that we 

have roughly 2 to 3 percent of the mortgages that are in foreclosure. 

I would like to ask anybody on the panel, do you have a different 

set of facts? I am just trying to assess the scope of the problem 

within the subprime mortgage market. Are those roughly accurate 

facts? 

I see a nodding of the head in the vertical position. 

Mr. DUGAN. Yes. 

Mr. HENSARLING. Those are roughly the facts. I do not want to 

put words in anybody’s mouth. I think I heard, Secretary Steel, you 

say something along the lines that we have seen some positive 

changes in that market, and something along the lines of investors 

are demanding changes. I think I heard the Comptroller say the 

market has corrected some of the worse abuses. 

Is that an accurate assessment of what I heard earlier today? 

Can you give us a little bit of greater detail on exactly what market 

players are doing? 

Mr. DUGAN. Yes. I guess there would be two aspects. If you look 

at underwriting standards in the subprime market, I think there 

clearly has been a move away from low documentation mortgages 

to demand more documentation. 

There has been a move towards going away from low or virtually 

non-existent down payments to higher down payments. 

There has been a move away from the shorter dated 2/28 and 3/

27 mortgages to longer term mortgages. 

Just to be clear, that was happening but in the most recent liquidity situation where so much of the subprime market depended 

on the securitization, there really are not many subprime loans 

being originated that cannot be held on the balance sheet of depository institutions at the moment. 

Mr. HENSARLING. Mr. Steel? 

40

Mr. STEEL. I think your characterization is correct and there is—

let’s pick one more example. It has been written about to a great 

degree, that there were a large amount of leverage loans that were 

in the process of being distributed that basically did not get distributed because of the market turmoil. 

Those loans came to rest on the balance sheets of institutions 

and now, just as we sit here today, they are beginning to move and 

be distributed at prices different, lower, than they were originally 

bought by the financial institutions. That is happening, to use my 

words earlier, as credit is being re-priced and returns are being offered at a more appropriate level as opposed to the level where people might have hoped they could be distributed earlier. 

That seems to be happening in that example in an orderly way 

and just beginning. There will be losses by the financial institutions that took them onto their books, but the distribution should 

happen over the weeks and months ahead and in what I would describe as an orderly way. 

I defer to the regulators because they are looking at their books. 

That would be my description of the situation. 

Mr. DUGAN. I would agree with that. 

Mr. HENSARLING. I think there is general acceptance from most 

people on the committee that risk based pricing of credit in certain 

innovative products within the mortgage market have helped lead 

to some of the highest rates of home ownership that we have had 

in the history of our Nation. 

I know there are some advocacy groups who have come to this 

committee to essentially outlaw certain mortgage transactions, like 

the 2/28, that they think are particularly abusive to the consumers. 

Are there certain mortgage products that you see that have such 

a threat perhaps to our economy that this committee should just 

consider outlawing certain mortgage products, and if so, what 

standard of judgment should we use? Whomever would like to answer that one. 

Comptroller Dugan? 

Mr. DUGAN. I guess I will start. I, for one, would be quite reluctant to outlaw any particular product normally speaking. Having 

said that, I do think there are some terms which we thought were 

so potentially questionable and abusive, we did add it to our guidance on subprime, for example, having prepayment penalties that 

extend beyond reset periods to me is something that goes beyond 

the pale of what a normal market should operate. 

Secondly, I think there is a very good case that a lot of these 

loans with these features were not being adequately disclosed, and 

I think it is absolutely critical that they be disclosed and there be 

a competent system for disclosing them. 

In terms of actual products, I think there are many different 

kinds of innovations that have led to positive things and sorting 

out which ones are the most positive and somewhat less positive 

is generally not something that the Federal Government is good at 

doing. 

Ms. BAIR. If I could, back to your earlier question, those statistics 

are certainly ones I would agree with and have used myself. 

I do think it is important to understand the context. A lot of 

those current loans are current at the starter rate of these 2/28s 

41

and 3/27s. We will be having a lot of resets, which is why we got 

the servicer guidance out. We think there will be about 1.5 million 

mortgages throughout this year and next that will be resetting 

where borrowers cannot make the higher payment. That is one of 

the reasons we got the servicer guidance out. 

I would agree with John. I think it is very problematic to just 

try to prohibit products. I do not think that is particularly helpful. 

The approach we used in the subprime and the NTM guidance 

regarding adjustable rate or so-called teaser rate mortgages, is requiring underwriting at the fully indexed rate. So you can make 

the loan, but just make sure that the borrower can re-pay the loan. 

I think that is a pretty basic underwriting standard. For banks, 

it is certainly familiar. I think it will be helpful and should be applied across the board. 

Certainly, prepayment penalties have been subject to a lot of 

abuse and that might be one good area where you might just want 

to add certain categories of inappropriate practices. 

Mr. HENSARLING. Thank you. I am out of time. 

Mr. KANJORSKI. The gentleman from New York, Mr. Ackerman. 

Mr. ACKERMAN. Thank you, Mr. Chairman. 

I am one of those who are surprised that everybody seemed surprised with what has happened in the market. While I would agree 

with the math that several of our colleagues have cited of the very 

small percentage of subprime loans that have evidently set off the 

chain reaction of things that have happened, one percent of one 

percent of a problem with a clot in your bloodstream causes the 

end of the total system. 

Despite the fact that the math might argue that it is only a small 

percent, the consequences in certain systems can be absolutely 

dire. I think that is what we have here. 

I am really surprised at the surprise. If we had allowed State 

motor vehicle bureaus to operate and have an independent system 

of basically unregulated originators of driver’s licenses, and they 

went out and had advertising to potential drivers who wanted licenses that said, ‘‘Need a driver’s license, cannot drive? No problem. No test needed. Road rage convictions? Legally blind? Do not 

worry.’’ 

Then we were shocked to see accidents up and down the highway, most of them involving a lot of good drivers, all caught up in 

a catastrophic situation. 

We have all seen the ads, yet, I do not know if alarm bells went 

off in people’s heads or they just ignored it. I do not know if anybody has taken a look at where the problem is with the small percentage as cited of subprime borrowers who cause the problem 

versus others and whether these so-called subprime loans were 

originated by bank banks or non-banks to see where we should be 

focusing our attention. 

I guess the first question I would ask is, when these people advertise, whom are they trying to reach? I guess it is a question that 

is more rhetorical than anything else, when you advertise ‘‘Cannot 

get credit, no problem. Bankrupt? No problem. No background 

check. No income verification.’’ 

You see this in ad after ad after ad. Then we are wondering why 

these people who have been seduced by the very important lure of 

42

home ownership wind up in the tragic situation of losing everything, besides the damage that it has done to the financial markets. 

My first question would be, who is supposed to do the oversight 

of the people who are doing this kind of advertising, the results of 

which should have sounded the alarm bells? 

Ms. BAIR. I think the Federal Reserve Board has the authority 

for unfair and deceptive acts and practices which can include deceptive communications. That is shared jointly with the FTC. 

I share your concern. I still see them. I have some friendly mortgage originators who spam fax me at least twice a week; I am still 

getting them. 

Mr. ACKERMAN. Which agency has done anything about it? 

Ms. BAIR. I think the Federal Reserve, under its HOEPA and 

TILA authority, can address unfair and deceptive communications 

to consumers. 

Mr. ACKERMAN. They can, but have they? 

Ms. BAIR. And the FTC may, as well. 

Mr. ACKERMAN. ‘‘Can,’’ but have they? 

Ms. BAIR. I do not know that they have specifically addressed 

teaser rate advertising, but we are certainly hoping that will be 

one area they will be looking at as part of this package of rules 

they are currently working on under HOEPA. 

I think advertising a teaser rate without fully disclosing the fully 

indexed rate compared to a 30-year benchmark comparison is 

something that is highly problematic. In our guidance to our own 

banks in terms of consumer communications, we have said that the 

communications need to be balanced, that you should not disclose 

a teaser rate without also disclosing the fully indexed rate. 

Mr. ACKERMAN. It is not just disclosing. If they are advertising 

no background checks, if they are advertising if you do not have 

good credit, do not worry about it, we are going to get you a mortgage, it is obvious that they are marketing to people who are going 

to have problems. 

They are not trying to deceive anybody necessarily. They think 

they are going to be able to make the mortgage payments and do 

not understand what is going to happen in the market when the 

interest rates go up. 

Ms. BAIR. Those are bait-and-switch tactics, and we see these. I 

ask my staff sometimes to follow up, to find out what is going on. 

Frequently, it is a bait-and-switch, where they say you can get the 

credit under these circumstances, and of course, you cannot, once 

you call. 

That type of bait-and-switch is generally regulated by the FTC. 

If they are not banks, we really cannot do much about it. I do not 

think those are banks that are doing those types of communications. 

Mr. ACKERMAN. I suspect you are right on that. Just to get an 

idea, what do you think if your agency has some oversight responsibility in this area? 

Ms. BAIR. For non-banks? 

Mr. ACKERMAN. For anybody that— 

43

The CHAIRMAN. Will the gentleman try to phrase his question in 

a way that the recorder can more accurately capture it? I do not 

think hand raising makes its way into the record. 

Mr. DUGAN. I think all of us have the power to take action for 

unfair and deceptive practices on an enforcement basis. 

Mr. ACKERMAN. Have we? 

The CHAIRMAN. If the gentleman would yield, is that not only for 

banks? You can do it for national banks, FDIC, the State banks, 

but the issue is if they are not a bank. 

Mr. DUGAN. That is right. If they are a bank, we can, but we cannot write rules about it. That is the other issue. 

Mr. ACKERMAN. If they are not a bank, who oversees this? 

Mr. DUGAN. The Federal Trade Commission. 

Ms. BAIR. Right. 

Mr. ACKERMAN. And they are not here? 

Mr. DUGAN. Correct. 

Mr. ACKERMAN. I see my time has expired. 

The CHAIRMAN. I do want to make it clear that the Federal Reserve asked not to be here today. They will be here after the hearing on September 20th, 2 days after the Open Market Committee. 

It would be about as far away from an FOMC meeting as we could 

get. 

The Federal Reserve is the one agency to whom we would ask 

those questions. Maybe it should be the FTC, too. Primary jurisdiction of the FTC is with our friends in Energy and Commerce. They 

agreed before that they would not object if we had them here. We 

should probably add the FTC for the September 20th panel. 

Mr. ACKERMAN. I thank the chairman. I ask unanimous consent, 

I have an opening statement that I would like to place in the 

record. 

The CHAIRMAN. Yes, so moved. 

The gentleman from California. 

Mr. CAMPBELL. Thank you, Mr. Chairman. I am going to focus 

my questions less on the damage that has been done and more on 

the potential damage that could be done, which would be much 

much greater if this whole thing leads to an economic slump. 

Secretary Steel, you mentioned the same thing I mentioned in 

my opening statement, about this risk premium that exists out 

there for all kinds of loans now, commercial real estate, residential 

real estate, etc. 

If people coming into the market cannot get new loans or the 

loan rate to buy that house that has been foreclosed or whatever 

is too high, then that is the sort of thing that will lead to a drop 

in housing prices which can then lead to lots of undesirable things. 

Do we want to do anything to try to deal with that risk premium 

and is there anything we can do to try to deal with that risk premium in this committee? 

Mr. STEEL. Let me comment, to try to answer the question, in 

a broad sense, and then I am not sure about this committee, but 

let me just speak— 

Mr. CAMPBELL. Yes, I should have made it broader. 

Mr. STEEL. My experience would suggest that this is a process 

that basically has to work itself through. Right now, as I tried to 

say earlier, when the questions about the subprime market spread 

44

to other securitized products, then at some point people just said 

I do not care for any risk right now, I will take a time out. The 

market effect was that when you saw the price of Treasury bills 

move up dramatically and rates go down, people chose to kind of 

find the safest harbor to be part of. 

What we are seeing now—that went on for a short period of time. 

Now what we are seeing is liquidity return to the market and 

begin to look to take on risk, but at different prices with greater 

returns than they might have had 6 weeks ago. 

The example I gave of the leverage loans that were issued at 100, 

bought at 98, and maybe now will be distributed at 95. 

What happened is that asset is still a good asset but it is a more 

attractive asset at the clearing price as the market digests all the 

ingredients and goes to a new level of risk premium. 

Mr. CAMPBELL. I guess my question, to delve further into it is, 

is there adequate transparency on the real risk? Some of what I 

have heard is people say we thought this was AAA paper, we 

thought this, we thought that, we did not know you were not using 

docs, we did not know this, we did not know all this other stuff. 

Therefore, they are now making that risk which may or may not 

be appropriate into virtually everything that is out there. 

Mr. STEEL. This might be unpopular but that is okay. I think 

there is also some attention needed on investors. Investors basically were at the scene of the situation and maybe they should 

have asked for more information. I think what you will see in addition to the re-pricing of risk will be a re-basing of information and 

diligence on behalf of investors, which will also be a good thing to 

have develop here. 

I think it is quite logical that as the market evolves and adapts, 

people might decide they want better—investors might decide they 

want better line of sight on descriptions, on characteristics, and on 

understanding before they invest, and move to the strategy of 

maybe investigate before you invest, and do it more directly as opposed to third party verifiers. 

Do not take somebody else’s perspective, maybe look yourself to 

see what is under the portfolio as opposed to taking somebody 

else’s word. I view that as a good and logical process, and the investors not doing their work is consistent with what I tried to describe of the syndrome that developed— 

Mr. CAMPBELL. Can we help that process? 

Mr. STEEL. I think the things we are trying to do in the Administration were basically to look at some of the root causes, and my 

third point to Mr. Kanjorski’s question was what are some of the 

issues here where better diligence, where we can be helpful, 

securitization, rating agencies, and things like that, and trying to 

bring diligence to those audiences. 

Mr. CAMPBELL. I am running out of time. If I can quickly get one 

more question for Mr. Dugan and Ms. Bair. 

Relative to the regulated entities, my question is broadly what 

level of concern should we have relative to the financial health of 

regulated entities with questions like do any of the regulating entities, banks and so forth, have recourse on some of the loans that 

they packaged and sold? 

45

Did they have resource with originators who no longer exist perhaps for things that were packaged and sold, and do you analyze 

or look at any regulated entities’ loan portfolio, how much of it is 

resetting and to what degree it has a greater percentage of resets 

with maybe Alt-A or some other sort of credit risk that bears a risk 

to their portfolio? 

Ms. BAIR. We have been closely monitoring this on a number of 

fronts. The first thing we did several months ago was to identify 

our institutions that had significant and direct exposure to 

subprime and Alt-A. 

Again, as indicated earlier, a lot of this lending, especially the 

very weak underwriting, was done outside the banking sector. We 

had some banks. We identified a couple of banks. Those have undergone heightened monitoring and examination processes. There 

have been some put-backs of loans that had early defaults or violated covenants or whatever. We closely monitored that. 

I think the good news and bad news of securitization was that 

the risk has been more dispersed. A lot of this lending was done 

outside banks, and even when the banks were doing it, it was 

securitized, and most of it now has been put back. 

There is not a lot of concentration on the balance sheets of the 

banks for which we are the primary regulator. 

We are closely monitoring. We are doing special exams of those 

that we think have particular exposures. Overall, we think the 

banks are in pretty good shape. 

Mr. CAMPBELL. They are not holding recourse on paper that is 

not on their books? 

Ms. BAIR. Are you referring to the ABCP market? John might 

want to address that. If you are talking about the commercial 

paper market, there are liquidity and credit supports that large 

banks provide. In the asset-backed commercial paper market, there 

has been a lot of press about some of those assets coming back on 

the balance sheet of the larger banks. 

Mr. DUGAN. I think there are some circumstances in which there 

are contingent funding lines, for example, that may need to be 

drawn down. Banks do have to hold capital even on that contingency. They would have to hold more capital to the extent they 

brought it directly back on their balance sheet. 

With respect to some of the subprime loans that you were asking 

about which were originated and sold by them, in most cases, we 

believe there is no legal recourse that would require them to take 

the mass of those assets back on their balance sheets. 

It is something that we look at, and as Chairman Bair indicated, 

we do think it is a manageable level of credit exposure to subprime 

loans that the national banks now have. 

The CHAIRMAN. If the gentleman would yield, does that have any 

relevance to the entities that you supervise under your consolidated supervision? 

Mr. SIRRI. I think from our point of view, we are mostly concerned again about issues about liquidity at the holding company 

level. Right now, as we have gone into these firms and looked at 

them, we have been quite content that they have adequate risk 

management procedures and liquidity in place. 

46

The CHAIRMAN. The ones you supervise are not threatened by 

this? 

Mr. SIRRI. No. 

The CHAIRMAN. The gentleman from California. 

Mr. SHERMAN. Let’s talk about these no income verification 

loans. There are kind of two financial worlds out there, the world 

of securities that you folks represent, and the world of taxation 

that Mr. Steel may bump into if he walks down the hall of Treasury. 

The question is why have you, as regulators of the financial markets, turned a blind eye to the fact that those you are regulating 

were facilitating tax fraud or at least insulating those who chose 

to commit tax fraud from any inconvenience when they went to get 

a loan? 

Did you take into account in deciding to allow and to continue 

to allow these no income verification loans the effect that has on 

whether paying taxes continues to be the norm in our society or 

more and more taxpayers just begin to think that they are suckers 

for filling out an honest return? 

I will start with Mr. Steel. You had a chance to make it more 

difficult for those who chose to commit tax fraud, did you take into 

consideration the effect of your decision on the overall tax system? 

Mr. STEEL. At Treasury, we are not making the specific rules 

that— 

Mr. SHERMAN. Let’s move on, to Mr. Dugan. 

Mr. DUGAN. I just want to be clear about the question. When you 

say ‘‘tax fraud,’’ I am not quite sure what you mean. 

Mr. SHERMAN. When you have a no income verification loan, this 

is basically a loan for those who have decided to commit tax fraud, 

those who decided not to file, those who decided to file phony returns. People saying I have money to pay the mortgage, I just have 

not told the IRS about it. 

Why do the folks who regulate the financial field—why did they 

not take into consideration the effect on our tax system of allowing 

the very kind of advertisements that Mr. Ackerman was talking 

about and the general impression that those who commit tax fraud 

will not be impeded in their effort to get a home with no credit? 

Mr. DUGAN. I guess our view on this is a little bit different. If 

there is no obligation to collect income in order to make a loan 

ever, theoretically, if someone had $1 million and they wanted a 

$10,000 loan, and they had it in their bank account, you would 

never have to look at their income. 

On the other hand, there are many in most cases where income 

really is quite important to— 

Mr. SHERMAN. If I can interrupt. These are all stated income 

loans. It does not say income, we do not know. There is a standard 

number that is not subject. They are not asking about a no income 

stated loan. I am asking about no income verification loans. 

The loan docs have a number and you deliberately advertise that 

you are not going to verify it, this is a loan packaged for those who 

choose not to complete an accurate tax return. Why did you allow 

it? 

Mr. DUGAN. I think our concern is more that people would pretend or potentially invite them to pretend they made more income 

47

than they actually made in order to get a bigger loan that they 

could not repay, and that is something— 

Mr. SHERMAN. That is what you also invite with this. 

Mr. DUGAN. That is where we look at, will this loan get repaid? 

It is something we have very strong concerns about. I gave a 

speech about this about 6 months ago. 

Mr. SHERMAN. Strong concerns. Did the agencies prohibit those 

under their umbrella from buying and holding and processing these 

no income verification loans? 

Mr. DUGAN. I think what we would say is that this practice 

began to creep into the mortgage underwriting practice as a more 

and more standard practice, particularly in the subprime and the 

Alt-A area, and over time, we began issuing stronger and stronger 

directives against it, culminating in the most recent subprime guidance. 

Mr. SHERMAN. After the hurricane hit, you decided to issue something saying they should be built to standard. You could have prohibited this practice 10 years ago. It was going on 10 years ago. 

Why did you not? 

Mr. DUGAN. I am not sure actually that it was going on, to a 

great extent, 10 years ago. It has developed over a period of time 

where some lenders maintain that they can determine the repayment capacity solely from— 

Mr. SHERMAN. Ms. Bair, are you going to tell us that we did not 

have no income verification loans until just the last couple of 

years? Have you been looking at this at all? 

Ms. BAIR. In the interest of self-defense, I have only been here 

a little over a year in this job. John is relatively new as well. I 

would say John has been one of the leading critics of stated income 

and was very active in making sure we had very strong standards 

against stated income in our guidance. 

Mr. SHERMAN. They were still making stated income loans 3 

months ago. A strong press release is not action. 

Ms. BAIR. Not in banks. Not in our banks. If we find out, we do 

not allow it. We have cited banks. I do not think those are banks 

that are doing it now. 

Mr. SHERMAN. Let me go to Mr. Sirri. Why do we allow the financial markets to trade in no income verification loans and why 

do we allow them to be highly rated? 

Mr. SIRRI. The one thing that we do not tolerate in securities 

markets is fraud. What we have to be clear about is what is the 

disclosure that surrounds these instruments. 

Our authority is limited. We will not tolerate fraud and we will 

follow through where that appears to be the case. For there to be 

fraud, there has to be some type of misrepresentation or omission 

associated with the offering of the security. 

Mr. SHERMAN. Is not misrepresenting a security—when it is 

backed by quite a number of loans issued by people or taken out 

by people who are attracted by lenders who advertise if you want 

to lie about your income to either the IRS or to us, please come in, 

you are the kind of customer we want, why would such loans be 

part of A rated pools? 

Mr. SIRRI. It is a difficult question. The issue evolves around the 

facts of the particular offering. It depends upon the disclosure. For 

48

example, the underwriter may state, we do not attempt to verify 

any of the characteristics about the collateral. Where they state 

that, the case for fraud may be more difficult. 

It is very, very difficult to make a general statement about this. 

Mr. SHERMAN. I believe my time has expired. 

The CHAIRMAN. I thank the gentleman. The gentleman from 

North Carolina. 

Mr. MCHENRY. Thank you, Mr. Chairman. Thank you all for 

being here today. 

What the chairman said in his opening remarks, the discussion 

on a disincentive for irresponsibility, and when we see not those 

that many of you regulate but some in the subprime mortgage sector going bankrupt, I think that shows the real disincentive for irresponsibility. Bad judgments. Bad business calls. 

This discussion about the income and everything else, that is an 

area where the marketplace is regulating itself and righting itself. 

The question is, what do we do as a body, as a Congress, as a 

government, do we overreact in this time and further clamp down 

credit which will, I believe, exacerbate the problem going ahead 

when people are going through these resets and trying to access 

the credit markets again. 

To make sure the market can actually work and function so we 

can get some of these folks when the reset comes, get them into 

mortgages that they will not automatically default on again, or just 

simply default on the mortgages they currently have. 

I think we actually need to make sure that when and if we do 

act, we have to do it in a sensible way and a measured way. We 

cannot overreact. 

Ms. Bair, in your testimony you state that non-traditional loans 

‘‘invite unscrupulous lenders to impose onerous terms on less sophisticated borrowers who might not fully understand the true 

costs and risks of these loans.’’ 

In June, the Federal Trade Commission released a very interesting study, and I think an important study about mortgage disclosures, including, ‘‘The current disclosures fail to convey key 

mortgage costs to many consumers,’’ and ‘‘In both prime and 

subprime, borrowers failed to understand key loan terms.’’ 

In their study they found, as you well know, that about a third 

of borrowers could not identify their interest rate; half could not 

correctly identify the loan amount; two-thirds could not recognize 

that they would be charged a prepayment penalty; and nine-tenths 

could not identify the total amount of up-front charges. 

I know there is some corrective action taken from the Fed and 

other Federal agencies. What is happening on that? How is that 

working? What can be done? 

Ms. BAIR. I think, clearly, mortgage disclosure needs an overhaul. I do not think we can solve it all with disclosure. I think 

there are certain basic core underwriting standards that need to be 

affirmed across the market, not just with banks. 

The disclosure clearly needs to be more understandable and more 

meaningful. I think this needs to be joint with the Fed and HUD 

because HUD has part of the jurisdiction over this. 

To the question earlier as well, about misleading teaser rate advertising, we not only need to make sure we affirmatively require 

49

helpful and understandable disclosures, but also get more aggressive in terms of prohibiting marketing practices that are deceptive. 

Mr. MCHENRY. I am just asking about mortgage disclosures. This 

is a huge component of it. When you have a stack of paper in front 

of you, you are signing a legal document for the largest financial 

transaction most Americans will ever make in their lives, and people walk away not having any inkling of what they signed. 

What can be done administratively to correct this mortgage disclosure issue or what should be done constructively, legislatively, 

to ensure there is real disclosure? 

Ms. BAIR. The Fed has jurisdiction over this under HOEPA and 

TILA, and HUD under RESPA, for closing documents. It is something again for insured banks. We certainly require they make balanced fair disclosures in terms of clear disclosures, understandable 

disclosures. A lot of this is in the non-bank sector and we do not 

have jurisdiction. 

Mr. MCHENRY. My time is running out. Mr. Steel, the President 

announced his policy on Friday, that I am sure you were a major 

part of constructing. 

What is being done within the regulatory process to actually fix 

that issue or should Congress act to ensure there is a key amount 

of disclosure so people understand the key terms of the loans they 

are making or they are signing and agreeing to? 

Mr. STEEL. I think this idea of understanding really, the President charged the Secretary of the Treasury to focus on this and 

come back and report. The Federal Reserve is also working on this. 

This is another aspect also that has been part of the program mentioned on Friday of financial literacy. 

The Secretary of the Treasury has been charged to look into this. 

The Federal Reserve is working, and financial literacy is part of 

the same issue. We look forward to collecting ideas, working with 

Congress, and figuring out the best way to bring light on this issue. 

Mr. MCHENRY. Thank you. 

The CHAIRMAN. As I recall, it was part of the President’s plan to 

do a re-do of RESPA, so on September 20th, we will get some more 

answers. We will hold the parties on notice that there is interest 

on that piece of it, improvement to convey information. That will 

come before us again on September 20th and HUD will be here 

then. 

The gentleman from Kansas. 

Mr. MOORE OF KANSAS. Thank you, Mr. Chairman. 

Mr. Steel, the Fannie Mae portfolio is currently capped at $727 

billion, according to the consent decree by Fannie and its regulator, 

OFHEO; is that correct? 

Mr. STEEL. Yes, sir. 

Mr. MOORE OF KANSAS. Can you explain the factors that were involved in determining this dollar level? What was the rationale or 

what is the significance of this $727 billion cap? 

Mr. STEEL. I was not here at the time, but let me tell you what 

I know from having studied this. Basically, there were several factors and there were a list of seven or eight that went into the calculation. This was negotiated between the safety and soundness 

regulator, OFHEO, as you correctly described, and the two entities. 

50

There were adjustments made to the capital required, a premium 

capital was required. There were specifics as to the business model 

they could pursue and limitations on growth in the portfolio until 

certain conditions were met. This was negotiated between the safety and soundness regulator and the entities themselves. 

Mr. MOORE OF KANSAS. Do you know what kind of conditions you 

are talking about here? 

Mr. STEEL. Specifically, I can give you an example of one. There 

was a premium of capital required, where the normal amount of 

capital would be ‘‘X,’’ then in this case it was ‘‘1.3X’’ until certain 

conditions were met, so as to allow them to move back into a more 

normalized state. 

Mr. MOORE OF KANSAS. As you just indicated, the consent decree 

says that since this portfolio cap for Fannie Mae, it lays out several 

scenarios that might warrant temporary flexibility. One of the scenario’s is for market liquidity issues; is that correct? Do you know? 

Mr. STEEL. I do not know that specific language, but that sounds 

correct, sir. 

Mr. MOORE OF KANSAS. There appears to be a real problem of liquidity in the secondary markets right now and we are seeing 

many lenders change their credit criteria for the loans they will 

make, some to the point where it is even affecting the terms and 

availability of credit for customers with good credit histories. 

I think it is important that we improve the regulation of the 

GSEs and I hope the Senate will soon vote for legislation like the 

House has passed that would accomplish this goal, but I also think 

the GSEs could play a positive role in helping alleviate some of the 

problems that we are experiencing in the market today. 

Given the Administration’s position against a temporary increase 

in the cap, should the committee conclude that your position is that 

our Nation is not facing a market liquidity issue that could be benefitted by Fannie refinancing more of these loans? Should there be 

more flexibility there? 

Mr. STEEL. There are three or four questions. Let me try, and 

please help me if I do not speak to the issue on your mind. 

Mr. MOORE OF KANSAS. I will. 

Mr. STEEL. The issue of the size of the portfolios is an issue for 

the independent safety and soundness regulator. I am not privy to 

the request that was made or to the response provided by the independent regulator to the regulatee. I know what I have read just 

as you have. 

There is the ability—the issue of increasing the caps on performing loans really lies with Congress. That is the issue. 

There are flexibilities that Fannie and Freddie can decide relative to their business model and they have announced initiatives 

to try to be helpful. 

The last point I would make is that at Treasury, we have had 

a constructive dialogue with Fannie Mae and Freddie Mac about 

the issues going on in the mortgage market and how they might 

be helpful, given the current guidelines under which they operate. 

They are constructive people, and we are trying to work with 

them to imagine when I described earlier what I view as the threepart dance of identification, counseling, and products; hopefully, 

51

the GSEs can be part of this product solution within the current 

construct of how they are allowed to operate. 

Mr. MOORE OF KANSAS. Can Fannie and Freddie help improve liquidity through an increased cap to refinance more mortgages? Do 

you believe that is a possibility? 

Mr. STEEL. I think the area they are prescribed to operate in, the 

conforming loan market, has been one that has been working 

among the best of the different markets, and that one has been 

working well. 

Mr. MOORE OF KANSAS. Thank you, sir. 

The CHAIRMAN. Interesting point. You say the area where they 

are allowed to operate has been working well and the areas where 

they are not allowed to operate have not been working so well. 

Would not the logical thing be to suggest that maybe we should expand the area of their activity so that other places could work well, 

like in the jumbo area? 

Mr. STEEL. I think that your question is a fair one and I thought 

about it a great deal. I think the issue here, sir, is a balance between— 

The CHAIRMAN. I like that. That is good. I will take it. The gentleman from New Mexico. 

Mr. PEARCE. Thank you, Mr. Chairman. 

Mr. Steel, I do not want to spend too long on this, if we are to 

look at risk reward and the opposite of reward is pain, if we could, 

and I do not think we can, but if we could categorize all the pain 

that has been felt from the situation, that is the opposite of reward, 

who has borne what percent of the pain? 

In other words, loan originators have probably experienced some 

of the pain. Capital market investors feel some of the pain. Probably some of the large funds. 

If you can kind of categorize how much pain has been felt by 

what sector and do not leave the consumer out either. 

Mr. STEEL. I think that was going to be my starting point, sir. 

If you look at this issue, the people, as I said earlier when I walked 

through the focus of the Administration, the first issue is to focus 

on homeowners. 

Mr. PEARCE. No, I am not asking what we are going to focus on. 

I am asking where the real pain has been experienced in the past 

in this circumstance that has already occurred. Is that even too 

complex to even address? 

Mr. STEEL. I will do my best. I wanted to make the first point 

that I think the most pain is being felt by the homeowners. Now 

I will move onto the question in the marketplace, who has been affected. 

I think we saw this first spread in mortgage backed securities 

where basically the market has re-valued those types of assets, and 

in particular, those dominated by subprime. That is where the 

most market value has been re-evaluated. If you looked at that, 

that would be second. We know the size of that relates to the different pieces of the mortgage market. 

Secondly, you would have to say that the next risky category of 

mortgages has felt some distress also, but there have been ripple 

effects out into other parts of the system, as I alluded to earlier in 

leveraged loan areas. 

52

Mr. PEARCE. Mr. Dugan, if I go to your report and I am looking 

on page two, I read a very straightforward comment that insufficient liquidity has occurred outside the commercial banking sector 

and the national banking system remains safe and sound. 

For me as a pilot, vibrations are something that sometimes you 

get a little tremor and that is it, that is the last you feel of it. Your 

wing might be about to fall off, but it is the only indication you are 

going to have. 

When I go to Ms. Bair’s page 20, she gets to the real concern I 

have that this tremor indicates maybe our banking system is not 

quite so sound. She talks about the lower capital levels required 

under Basel II, and she begins to say on page 21 that the entire 

assumption is insufficient given poor performance, and in fact the 

risks and stresses are impossible to quantify. 

What we have done under Basel is we have scooted the risk derivatives and all those things that none of us know exactly about 

except you guys at the table, we have scooted those outside the 

measurement criteria. 

I do not think it is possible for us any longer to say that our 

banking system is really in good shape, because the risk criteria is 

not measured by you all in the banking system. It is someone else’s 

problem just outside there. 

Long term capital management brought us very close to a realization that the system is very high-strung, it is very highly-wound, 

and small tremors can mean large problems. 

Mr. Sirri also addresses that same problem, the diminished liquidity, on page one of his testimony. 

We hear your testimony saying everything is great, the banking 

system is really sound, but I see these warning signs from the others. Can you address that if you would, please? 

Mr. DUGAN. Sure. I guess what I was trying to say in the testimony is that the liquidity issue that we have seen in the market 

has been far more pronounced outside the banking system than it 

has been inside the banking system because inside the banking 

system, you have insured deposits. You have a federally regulated 

scheme. You have the Federal Reserve’s discount window standing 

behind certain kinds of loans. All of those things have meant that 

institutions that are banks have had far greater access to liquidity— 

Mr. PEARCE. I am about to run out of time here. 

Ms. Bair, if we are going to take that, that the liquidity is sound 

inside the system, is it possible for illiquidity, non-liquidity, whatever we are going to call it, to transpose itself right through those 

barriers, that is the banking system, is that possible or is that a 

fear that I have that is just not possible? 

Ms. BAIR. I would not say it is impossible. I would not want to 

suggest it would happen either. I think all institutions are being 

challenged right now. There is no doubt about it. 

But one advantage banks have over non-banks is the ability to 

access deposit funding as well as other sources of liquidity such as 

the Fed’s discount window. I think those are tools that put banks 

in a better position. But everybody is being challenged right now. 

53

Mr. PEARCE. They have access to capital based on the capital requirements and the capital requirements continue to drop and 

drop. 

Ms. BAIR. Not yet. We are still on Basel I. Regarding Basel II implementation, we will do a parallel run next year and then start 

up implementation a year after that. So we are still on Basel I. The 

leverage ratio is over 8 percent, which is historically a very strong 

high level. Banks have $255 billion in excess capital. That is a level 

above an aggregate that they— 

Mr. PEARCE. Is Europe on Basel II? 

Mr. BAIR. Europe is implementing now. 

Mr. PEARCE. I think it was Mr. Sirri’s comments that we are in 

an international market. Their illiquidity is going to transpose 

right across the system. 

Maybe this tremor was just a slight tremor and maybe the wing 

is not going to fall off. I hope, Mr. Dugan, you are correct. I am 

going to lie awake at night for a while longer. 

Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from California. 

Mr. BACA. Thank you very much, Mr. Chairman. 

The first question I would like to ask is for Sheila Bair. Please 

describe the law that prevents brokers from selling people loans 

that are mostly costly when borrowers could qualify for better 

loans? This also applies to Mr. Dugan. Could you also respond? 

Do mortgage brokers have any duty to offer consumers the best 

loan available to them? Question number one. What Federal safeguard should mortgage brokers and lenders put in place to ensure 

that all subprime borrowers are not taken advantage of and receive 

substantial loans. 

The next question will be to all of you. Are any of you concerned 

that mortgage brokers are not federally regulated? 

Ms. BAIR. I think a lot of these issues can and will be addressed 

by the Fed. We do not, but the Fed does have rulemaking authority 

for all participants in the mortgage process, whether it is banks or 

non-banks. I think there is latitude to address practices by brokers, 

even though they are not lenders. 

I think disclosure, if you are going to do a teaser rate loan, requiring disclosure of the fully indexed rate as well as a 30-year 

benchmark is absolutely essential. Safeguards against steering are 

absolutely essential. 

The thing that frustrates me about the hybrid ARM market is if 

you look at the rate sheets of a lot of these subprime lenders, the 

30 year fixed rate is not that much higher than the starter rate of 

the 2/28, and I think a lot of these folks could have qualified for 

a 30 year fixed without the payment shock, maybe $50 or $100 

more a month, which I think would have been manageable and 

preferable to having these payment shock loans that were underwritten under the premise that they would just refinance in a couple of years. 

I think the guidance that we put out for subprime is a starting 

place for standards that should apply across the board and I think 

that can address a lot of the abuses that we have seen going forward. 

Mr. BACA. Mr. Dugan? 

54

Mr. DUGAN. I agree with those remarks. We have tried to address what we believed were the significant abuses as it relates to 

the institutions that we regulate. 

I think the issue that has come up in a number of contexts about 

the most aggressive, most egregious practices, were occurring outside of the federally regulated sphere, and I think the central question confronting the Congress and the public policymakers alike is 

how to get a uniform standard in place so that the regulation 

matches what we now have at the Federal level. 

As we were talking earlier, I think the notion is the States are 

trying to implement something new in that area to come up to that 

standard. I think the question of when the Federal Reserve will act 

by regulation, which I am sure you will talk about, and then the 

further question is, is that enough, whether you will need additional legislation, and I think that is the question that will be very 

much on the committee’s mind. 

Mr. BACA. Is there an oversight that looks at when you identify 

a subprime or mortgage loaner that actually gives the higher loan, 

is there some kind of an oversight to make changes to protect that 

consumer as well that may have signed on, once they have signed 

a contract? 

Ms. BAIR. I think there are some short term rescission rights, but 

I think longer term, again, the ones I have seen were underwritten 

based on the assumption of continued low interest rates and home 

price appreciation, so there is never an expectation that a borrower 

could make the payment when it reset. 

I think our push has been to try to encourage responsible 

subprime lending. Fixed rate mortgages are more appropriate, I 

think. Subprimes by definition are likely to have had less experience, or trouble with their financial management. To give them a 

product that makes them make guess about the direction of home 

prices as well as the direction of interest rates, I do not even want 

to do that. I think that is pretty challenging. 

I think the direction is we want to encourage responsible 

subprime lending and come up with standards that will make the 

market more conducive to fixed rate products that are more appropriate. 

Mr. BACA. I know I asked the question of all of you but I am just 

about to run out of time. I want to ask the following question. 

What is your response to the home mortgage disclosure data that 

show that over half of African Americans and nearly half of Latinos 

are in subprime loans compared to 17 percent of white families, 

and have you looked into the cases of this, and are you concerned 

about its implication, and what do you think the Federal banking 

regulators, such as yourselves, or the Federal enforcement agency, 

could make more of an impact in fighting discrimination against 

Latinos, African Americans or protected classes? 

Mr. DUGAN. Congressman, there was a hearing here last month 

about home mortgage disclosure and this very issue was front and 

center. It is a concern for all of us when we see that raw data suggesting that African Americans and other minorities are receiving 

a disproportionate share of higher-priced loans. 

55

I do think it is quite important and it is part of our job to get 

behind that initial data, to make sure you are comparing people 

who are similarly situated to see the same kinds of loans. 

We have not found the kind of discrimination that initial data 

would suggest, but it is something that every time we see that 

data, we need to re-double our efforts to make sure we are looking 

at the right loan characteristics. 

Mr. BACA. Thank you. 

The CHAIRMAN. The gentleman from Texas. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. 

Before I get started, I know most of the people here know, but 

we lost a dear colleague today, a member of this committee, Congressman Gillmor. My prayers and thoughts—and those of everyone on this committee and this Congress, I am sure—go out to his 

family. 

I want to change direction a little bit and talk a little bit about 

how we fix some of the current situations that are involved in the 

marketplace today. 

One of the things I said earlier was if we provide enough liquidity and capital into the market, that will give the marketplace time 

to work this out. 

In the 1980’s, we formed the RTC and we did some things which 

ended up being very costly for the American taxpayers and brought 

quite a bit of disruption to the real estate marketplace. 

What I think we want to try to do is let the marketplace clean 

this up with the least amount of disruption to really a very important part of our economy, and that is our real estate economy. 

One of the things that I know is different between now and the 

1980’s is we were dealing with financial institutions, and now we 

are dealing with people who are holding pieces of paper, and in 

many cases, people holding pieces of pieces of paper. 

As we have these people who would probably be in the marketplace to buy some of these individual mortgages or pieces of these 

tranches and so forth, because of the documents and the relationships between the master servicers and the trustees, there is probably not a lot of flexibility. 

We certainly do not want to go down the road of the Federal Government un-doing agreements in the marketplace that would cause 

a tremendous amount of disruption. 

What I am wondering is, in the banking and financial marketplace today, are there any things that would be in place or inhibitions for the banking system to be able to help facilitate and finance, breaking these pieces up, because there is tremendous opportunity up side for people that are buying some of these discounted mortgages, if you can get them back into a conforming situation, and obviously that increases the value of that underlying 

mortgage, and then obviously the security as a whole. 

What I am told is because of the different pieces, that a lot of 

these master agreements do not allow a lot of flexibility for the individual mortgages in the underlying paper to be worked out or 

payment modifications or rate modifications. 

If there was liquidity in the marketplace, say for the banking industry or something like that, to help finance some of these entities 

that are willing to go in and look at being able to break out porVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00059 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
56

tions of those mortgages, is there anything that would be prohibitive in the current structure that would cause a bank to say, I do 

not want to get involved in that because that is going to be a classified loan, or it is going to change my capital structure? 

I throw that out as a question. 

Mr. DUGAN. That was one of the reasons why the agencies put 

out the recent guidance. I think there has been a lot of mis-information about the flexibility that servicers have to restructure individual loans once they have been sold. 

I think this committee sent letters to the SEC and the SEC and 

the FASB have responded to clarify there is flexibility. We as bank 

regulators issued a statement to servicers under our jurisdiction 

jointly to urge them to take advantage of that flexibility more generally. 

I think once you go beyond that, it is always governed by the 

terms of the service agreement, that contract with investors, and 

sometimes they do impose limits beyond the kinds of limits I was 

just describing. 

I think to the extent that there are not such limits, there is quite 

a bit of flexibility. I think in some cases loans can be restructured 

in ways that the lender, or in this case the investor, would end up 

losing less money than they would if there was a foreclosure, so 

there is an economic incentive to do so. 

I think in other circumstances, there will be some creative thinking required about different kinds of products, and I think that is 

what the Administration has been talking about, something they 

are going to be looking at very hard. 

Mr. STEEL. I would only add that I think you are on exactly the 

right track. We need to encourage the servicers to take full advantage of the flexibility that might be in their documents and to pursue that, and the guidance provided by the regulators has encouraged that. 

Then we need to look for additional ways to try to have as many 

of these loans reorganized to a market-based level as we possibly 

can, and put a thumb on the scale on behalf of the homeowner, 

would be our perspective. 

The CHAIRMAN. There are going to be some votes fairly soon, so 

we are going to hold strictly to the 5-minute rule. 

Mr. Lynch? 

Mr. LYNCH. Thank you, Mr. Chairman. 

I just want to go back to the other gentleman from Texas, Mr. 

Hensarling, who basically laid out a scenario that suggested that 

this problem was somewhat contained, and that most people, 87 

percent of the people are still paying their mortgages, and that this 

problem is contained. He did not want to put words in your mouth, 

as he said, but he looked for your assent and he seemed to get it. 

Mr. Dugan, your testimony does not seem to say that. It says 

that more recent data indicate that 90 day or more delinquency 

rates for securitized subprime mortgages have increased to over 13 

percent in June 2007, and your testimony also says that increased 

foreclosure activity continues to spread and intensify, and according to RealtyTrac Inc., new foreclosure filings across the Nation, including default notices, auction sale notices, and bank repo’s, increased to 180,000 in July 2007; that is 93 percent higher than reVerDate 0ct 09 2002 16:53 Dec 17, 2007 Jkt 039537 PO 00000 Frm 00060 Fmt 6633 Sfmt 6633 K:\DOCS\39537.TXT HFIN PsN: TERRIE
57

ported in 2006. There is a fair degree of alarm here, and it is at 

odds, that exchange between yourself and the gentleman from 

Texas. 

I just want you to tell me if you think this thing is contained. 

You also say if problems in the general housing market continue, 

we expect to see a further increase in mortgage delinquencies. 

Where are we? 

Mr. DUGAN. I would say two things, and I am sorry if there was 

a misunderstanding. I think with respect to the standards for new 

loans to be made to new borrowers, I think there has been something of a market correction, even an overcorrection, about the 

kinds of standards that would be put in place. 

Where I do think there is still an issue are people who have 

loans now, and I do think you are absolutely right that we are seeing a trend line in which more foreclosures are increasing, delinquencies are increasing. 

If you think about the way we look at it, a huge part of the 

subprime market where the most aggressive underwriting was taking place involved these 2/28 loans, and the period in which the 

standards were most lax was at the end of 2005 and all through 

2006. 

If you fast forward 2 years from those dates, you will see that 

this quarter coming up, you are going to see more resets, extending 

all through next year. That is the period, I think, that we are all 

concerned about seeing an increase in foreclosures that we are trying to get our arms around. 

Mr. LYNCH. Let me ask you, in comparing mortgage activity, it 

seemed that the riskier, the more innovative mortgage products 

that were out there were being written largely by private mortgage 

companies, and when you look at the performance of the GSEs, 

Fannie Mae, Freddie Mac, you saw a smaller share of those riskier 

mortgages being written, the subprime mortgages in general, being 

written by the GSEs. 

With respect to their portfolio cap, would it not be helpful, and 

I know it has been suggested by some that there be a modest increase in what their portfolio cap is right now by about 10 percent, 

would that not help the liquidity problem, to have them step in, in 

some way, to provide some relief there? 

Mr. STEEL. The area that Fannie Mae and Freddie Mac focused 

on, the conforming loan market, as described, has been the area 

that has been working the best. They had the ability to help out 

in the top part of the subprime loan area. 

Someone has suggested here—people have suggested on a couple 

of occasions that a large number of subprime borrowers could have 

qualified for prime borrowing, and in those cases, the GSEs could 

help. 

They are operating under negotiated limits, if safety and soundness issues would have failed—the area in which they are proscribed to operate has been the one that has been operating best. 

Mr. LYNCH. The negotiated limits were not made with a recognition of the situation we have right now. That is all I am asking for, 

some flexibility here. We have some proven entities here that could 

be helpful, yet we have an arbitrary limit that has been adopted 

largely by the President. 

58

I just think there is some relief here that could be had if we lifted that cap. That is all. 

Mr. STEEL. Those limits were negotiated between the regulator 

and the regulated entities, and they also related to certain requirements have to be met and then the caps are lifted. Those characteristics are being worked through, and I think Fannie and Freddie 

are moving towards compliance. 

The CHAIRMAN. If the Senate were to take up the bill that passed 

the House, we would then have all those conditions satisfied. 

The gentleman from California. 

Mr. MILLER OF CALIFORNIA. Thank you, Mr. Chairman. 

It seems like a lot of the problems that are created in the marketplace were caused by the huge amount of dollars coming out of 

the stock market that lenders wanted to take advantage of, and 

they used it for subprime. 

Chairman Bair, on page five, I really enjoyed your comment. You 

said, ‘‘In the absence of GSE sponsorship,’’ that means there was 

a lack of GSE product out in the stock market to buy. ‘‘ABS’s,’’ 

which are asset backed securities, ‘‘were able to enhance marketability and obligations by restructuring theirs.’’ 

You also say there are trillions of dollars from investment grade 

mortgage backed securities that would have been better suited for 

hedge funds. 

Would you please explain that a little better? 

Ms. BAIR. I think we were just trying to put this in historical 

context. I think the enhanced returns and enhanced risks of the 

private label securitizations, lower rated tranches— 

Mr. MILLER OF CALIFORNIA. The rates they would give to normal 

GSE sponsorships, they were able to get to these other forms. 

Ms. BAIR. These are non-conforming loans. They did not meet the 

criteria that Fannie and Freddie had. 

Mr. MILLER OF CALIFORNIA. Absolutely. There is a huge demand 

in the marketplace for those types of loans. 

Ms. BAIR. Certainly for the returns that were provided. Those 

loans now are not so popular. 

Mr. MILLER OF CALIFORNIA. What normally would be sponsored 

by a GSE, there was a huge demand for those, and there was a 

huge void because they were not able to put out as many as they 

did so the private sector filled those with very questionable risky 

loans to basically get a return. 

Secretary Steel, you and I, I know we had a great conversation 

about what we thought the market should be and who should be 

playing in it. What do you think about the President’s current position on raising FHA limits, when we talked last time, that was not 

even on the table? 

Do you think that is an appropriate move at this point in time? 

Mr. STEEL. There are two or three parts to the proposed FHA 

modernization bill that the Administration has been supporting. It 

relates to risk based pricing and other aspects which will allow 

FHA to do more and to be more active. That is really the proposal 

that is— 

Mr. MILLER OF CALIFORNIA. They have to have reasonable underwriting criteria, so these are very safe loans we are making. 

59

The problem I have, and many in this House have today with the 

GSE situation is, we think that it is being absolutely unfairly applied. What I mean by that is there are some members in whose 

districts the median home price is $150,000 and a GSE loan in that 

area is $400,000. That is almost triple what it should be, yet there 

are areas of the country that are high cost, like my area, for example. I gave statistics that in 5 years, FHA loans dropped by 99 percent because they are high-cost areas. 

I am going to ask you a fair and reasonable question, and I 

would like a reasonable answer based on the criteria. 

Do you think GSEs’ underwriting criteria is adequate and their 

appraisal criteria to meet safety and soundness requirements 

today? 

Mr. STEEL. I’m sorry. 

Mr. MILLER OF CALIFORNIA. Do you think the underwriting criteria that GSEs apply to their loans and appraisal criteria are adequate for safety and soundness purposes? 

Mr. STEEL. The loans that they are doing today are appropriate 

for safety and soundness, yes. 

Mr. MILLER OF CALIFORNIA. Then my question is, when you look 

at areas of the country that have risen in price uncharacteristic of 

other parts of the country, but it is just because of supply and demand and the cost of land in the regions and stuff, do you not believe that if we apply the same safety and soundness criteria currently applicable to all other GSE loans, in those high-cost areas, 

there might be room to move up? 

The reason I am asking that is because one thing the market 

needs is immediate liquidity, but it needs long-term liquidity, to 

deal with the housing problems we are facing in this country today 

and the foreclosure problems, money for a year or two does not 

benefit anybody, the long term criteria loan is what the market 

needs. 

When you look at the GSE criteria, what they have done, they 

have lent money to people on 30 year fixed rate loans. It is what 

we need in the marketplace instead of these exotic loans that are 

out there. 

Do you not think there is room if we applied good underwriting 

standards and appraisal standards to move up in some of these 

areas? 

Mr. STEEL. You were good enough to explain to me the last time 

I was here with visuals about the prices and how it affected your 

constituents, and even first responders in your area, and made that 

clear. 

I accept the point. When we worked through the GSE bill that 

passed the House, we worked with you to try to understand these 

issues. 

Our goal is to work with the Senate and together to have a GSE 

bill— 

The CHAIRMAN. Let me just interrupt. In fairness, when we outlined what we were talking about, we did agree, and it was last 

minute, I understand, the President did make these proposals. On 

September 20th, we are going to go over these in detail. I would 

hope that by September 20th, we can get some of these answered 

more. 

60

We did basically ask them to be ready to come and talk about 

this more on September 20th. 

Mr. MILLER OF CALIFORNIA. Some of us, and I know Chairman 

Frank and I even believe that FHA should be higher in some of 

these areas. We would like to see that approach. 

I am just throwing it out. The GSE comment was not a matter 

of trying to be argumentative. In our areas, the high-cost areas, we 

are looking at if a GSE loan goes up to the amount we propose, 

people save about $175 to $180 a month in their payment. That is 

huge for people who might lose their home. I just wanted to throw 

that out as something for you to think about. 

Mr. STEEL. I do not think that question is argumentative at all. 

I look forward to continuing the discussion. 

Mr. MILLER OF CALIFORNIA. Thank you, sir. 

The CHAIRMAN. We will all stipulate this is one time the gentleman was not being argumentative. 

The gentleman from Georgia. 

Mr. SCOTT. Thank you, Mr. Chairman. 

I would like to ask very quickly each of you if you could respond 

to this first question. Who has been hurt the most by the subprime 

mortgage crisis? 

Mr. STEEL. I will start, sir. I think as I answered the question 

for Mr. Pearce, that if you applied who would be most affected, I 

think it is the homeowners who were in the most perilous position. 

If I might add, relative to your opening statement, HUD does 

have a national hotline for subprime assistance, and that is available for people who want help with subprime issues. 

Mr. SCOTT. What we had in mind in terms of our hotline was a 

human being at the other end of the line, the people who were targeted most in predatory lending are largely unsophisticated and 

uneducated. They are people who need to call the hotline but have 

somebody ‘‘hot’’ at the end of the hotline. 

Mr. STEEL. This has been connected to counseling services at 

HUD to try to help these people. 

Mr. SCOTT. Is that consistent with the others, the homeowners? 

[Panel nods affirmatively] 

Mr. SCOTT. What I cannot understand is this reluctance to provide at least in a moderate way Fannie Mae and Freddie Mac from 

having the flexibility in this area. It is particularly true when you 

look at the fact that it is a part of their charter obligation to provide liquidity and stability to the secondary mortgage market, particularly during periods of market dislocation. 

They have a consent order with OFHEO that allows for adjustments to the portfolio cap to address market dislocations. 

It is particularly needed, I think, and it could be temporary. It 

could be 10 percent. It could be 12 percent. It could be targeted. 

I think for the Administration to just clamp down and say no concerns me. 

The CHAIRMAN. Would the gentleman yield? This may have been 

my fault. I want to ask if we can defer that until the 20th when 

we have the hearing on the President’s plan in context. Maybe I 

am hoping I will get an answer I will like more later. In fairness, 

we did say we would expect answers to that on September 20th. 

61

Mr. SCOTT. All right. With that in mind, that was basically the 

gist of my concern. I will wait until September 20th. 

The CHAIRMAN. I thank the gentleman. That was my cause of the 

confusion. The gentleman from Texas. I apologize for rushing you, 

but I would like to get to everybody. 

Mr. GREEN. Yes, Mr. Chairman. I will accelerate the pace. Let’s 

talk quickly if we may about the risk layering that has been mentioned by you, Ms. Bair. Who is going to regulate this when you 

have all of these various and sundry risks being placed on top of 

each other? 

Right now, there is nothing regulating it. Who would you propose 

regulating this? 

Ms. BAIR. We do regulate bank lending and we have through our 

guidance and supervisory activities put a lot of constraints on risk 

layering. Again, in the non-bank market, those are state regulated 

entities. The Federal Reserve does have the ability to impose national standards on the non-banking— 

Mr. GREEN. If I may, you mention in your paper, and it is very 

well done, by the way, I enjoyed reading it, are you saying there 

is more that you will do in the area of risk layering? 

Ms. BAIR. I think the risk layering was addressed, and I believe 

we are hopeful that the Fed will be able to address it as well under 

the HOEPA rules for non-bank lenders. We can only reach risk 

layering lending practices in the banking sector. 

Mr. GREEN. Who is going to deal with the 2/28s and 3/27s and 

the onerous prepayment penalties? Who will eventually step in and 

regulate that or deal with that? 

Ms. BAIR. For the non-bank lenders, the States do have some authority. They worked with us in developing our guidance and are 

trying to apply it. 

The Federal Reserve Board, I think, is really going to be key 

here. They are undertaking a rulemaking right now. 

Mr. GREEN. If I may quickly, we have pension funds that are investing in hedge funds, hedge funds are investing in the subprime 

market fronts. Many of these pensioners do not really understand 

how at risk their pensions are. 

Who is going to look at this and make some determinations that 

maybe this area needs some sort of scrutiny because of the risk 

that the pensioners are placed at by virtue of the way this 

connectivity has developed? 

Mr. STEEL. I can start if you wish and maybe defer to the SEC. 

This is an issue of private pools of capital that has been a focus 

of the President’s Working Group. We believe there are four different actors in this situation. 

There are the regulators, the regulated entities that finance the 

private pools of capital, the managers themselves, and investors. 

All four need to be diligent and vigilant with regard to their responsibilities. 

When I spoke about this issue to Chairman Frank before, I said, 

and I remember quite clearly, the status quo is not acceptable. We 

are working hard now to increase the focus on this and develop 

best practices for each one of these people. 

Mr. GREEN. Thank you very much. I yield back, Mr. Chairman. 

I would like to say that I think the President has stepped up to 

62

the plate. I think the Fed Chair stepped up to the plate. People are 

expecting the Congress to step up to the plate as well. People understand there is a crisis notwithstanding what is being said. 

Thank you. 

Mrs. MALONEY. [presiding] Thank you. The gentlelady from Illinois. 

Ms. BEAN. Thank you, Madam Chairwoman. 

Mr. Steel, during the month of August, both the President and 

the Treasury Secretary publicly opposed raising the portfolio level 

for GSEs, which seems at odds with the President’s recent announcement of lacking illiquidity, but is clearly inconsistent with 

the overwhelming bipartisan support of GSE reform earlier this 

year. 

Given there is general consensus about the importance of a 

strong independent GSE regulator and yet it was the President, 

not OFHEO, who publicly stated that the caps would not be lifted 

until Congress passed GSE reform, should we be concerned that 

Administration policy might be influencing or interfering with what 

is supposed to be an independent safety and soundness regulator’s 

authority? 

Mr. STEEL. I do not think so. I do not remember the exact timing, 

but if my memory is correct, OFHEO had already announced their 

decision and communicated it to the regulatee at the time this 

question was asked of the President. 

Ms. BEAN. Thank you. Second question, does the Treasury have 

broader concerns about the impact of what started in the subprime 

space on the overall economy, not just for those who have subprime 

loans and those who are unfortunately dealing with foreclosures, 

but for those in our districts who historically have good credit but 

have in many cases taken their credit card debt and then gone and 

gotten a home equity loan at a better rate or they have refinanced 

their home by borrowing against the equity to reduce that debt and 

that has helped stimulate our consumer spending, given that now 

the value of homes has come down so there is less equity to borrow 

against, there is less credit available now in the new space of access to credit, and you also consider some of the recent articles 

about how incomes in many cases are below levels that they were 

in 2001. 

For many again who are historically good credit consumers, what 

is your concern about how that may affect the overall consumer 

spending? 

Mr. STEEL. I think the second paragraph of my statement that 

I provided at the beginning really focused on the fact that the overall condition of the economy is quite good. If you pick any area, 

growth, inflation, employment, these are constructive things. 

We had a period in the marketplace that has been unsettling. 

There are some signs now that this unsettled feeling is beginning 

to improve. There will be other issues or challenges that I am sure 

will develop as this process continues of improving, but I would be 

optimistic that while there may be some penalty to growth, because 

of this turmoil in the markets over July and August, we are still 

on a projectory to have good solid growth in the second half of the 

year. 

63

Ms. BEAN. No concerns that what could be a short term problem 

in the B to C space could roll into the B to B space long term? 

Mr. STEEL. I promise you I am concerned every day, but I think 

the specifics of this in terms of basically trying to understand what 

the likely effect will be on the real economy, I would stand with 

the description I have provided. 

Ms. BEAN. Thank you. 

Mrs. MALONEY. Thank you. The Chair notes that some members 

may have additional questions for this panel which they may wish 

to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to 

these witnesses and to place the responses into the record. 

The Chair recognizes herself for 1 minute, and then the gentleman for 3 minutes. I just have to ask a question about my home 

State, New York. In July, Governor Spitzer announced a very aggressive program. He announced $100 million to help at-risk families keep their homes, through partnering with Fannie Mae and 

Freddie Mac, who will be financing this initiative, the State of New 

York hopes to be able to refinance literally hundreds, possibly thousands of at-risk homeowners from the 2/28s and 3/27s and the 30 

and 40 year fixed rate mortgages at competitive interest rates and 

keep them in their homes. 

I understand that several other States have entered into relationships with Fannie and Freddie to do the same thing, specifically Ohio and Massachusetts. 

We are concerned that we are going to be right up against the 

cap, and this would hinder the ability of New York to work on a 

local level to help people stay in their homes. 

Again, it is a question that has been asked many times, but if 

there was ever a time that we should have more liquidity in the 

market and have more flexibility for Fannie and Freddie, it seems 

to be now. 

Secondly, I support the initiatives that have come forward from 

the President and the Administration, but by even your account, 

this will only help 80,000 borrowers stay in their homes. There are 

at least two to three million who face foreclosures in the next 2 

years, by even the Administration’s accounts. 

What are we going to do about them? We are concerned that because of Hurricane Katrina, 300,000 people lost their homes, but 

10 times as many people may lose their homes in the subprime crisis. And what about the new guidance that came out, and it really 

responds to a letter from Congress on the servicers having more 

flexibility. 

That in no way is going to take care of all of this problem. First 

of all, the problem of New York and Massachusetts and Ohio, 

where they have this relationship that can help keep people in 

their homes, but they need the flexibility if Fannie and Freddie are 

up against the cap to be able to keep them in their homes through 

this refinancing program. 

Mr. Steel? 

Mr. STEEL. Thank you. Let me try to start at the back and go 

forward. I am not familiar with the specifics of the New York proposal, so I look forward to learning about that and coming back to 

you. 

64

Mrs. MALONEY. Very quickly, working with Fannie and Freddie 

that are financing that to help people stay in their homes, but they 

are going up against their cap, which means they may not be able 

to refinance them, to help them stay in their home. 

It is a big problem. We need to raise those caps even if it is temporary. 

Mr. STEEL. I think we are meeting with Fannie and Freddie, too, 

to talk about creative solutions for how to deal with this. There are 

other alternatives besides just buying loans yourself, and there are 

other ways in which they can increase their capacity. 

With the second issue, 80,000 is the number of incremental FHA 

by the changes we have suggested. The total number is closer to 

300,000. 

Also, there are two million resets we are facing over the next 18 

months, roughly two million. That includes things that are speculators, and it includes numbers that are not owner-occupied. We 

are focused on the homeowners basically themselves, individual 

single family owner occupied. That number is less than two million. 

The third point is there are lots of things we are working with 

to focus on the servicers, the counselors, and other products to attack the rest of them. 

I am optimistic that we will be successful to a great degree. 

Mrs. MALONEY. Thank you very much. The Chair recognizes the 

gentleman from the great State of New York for 3 minutes. 

Mr. MEEKS. I will only take 1 minute. Mr. Steel and Mr. Sirri, 

a quick question. This is the general market I am trying to find out 

about. Has the market reaction to holders of the subprime loans affected AAA rated money market mutual funds to your knowledge? 

Mr. SIRRI. Money market mutual funds by definition have to hold 

very liquid paper. Under rule 287, which governs those funds, at 

a minimum, 95 percent of assets has to be in the highest rated 

paper, the other 5 percent can mean one notch lower. That is only 

a minimum. Besides that, the advisor has to go through their own 

credit analysis. 

I think at the moment, events have not had a substantial effect 

on money market funds. Were that to have an effect, we have rules 

in place that would allow advisors to purchase some of that paper. 

In addition, our staff stands ready to work with those funds in case 

there is any dislocation in that market. 

Mr. MEEKS. So far, it seems safe. Someone told me some people 

are putting money in there as a safe haven, investing in these. 

Mr. SIRRI. So far, we have detected no serious problems. 

Mr. MEEKS. Thank you. Last question of the day. 

Mr. STEEL. I agree with Mr. Sirri. 

Mr. MEEKS. I have been hearing this for a long period of time 

now. Are we heading for a recession given what is happening? Are 

we headed for a recession, in your opinion? 

Mr. STEEL. Our view at Treasury is that the economic growth 

that has been going on in the second quarter will continue at a 

positive projectory into the third and fourth quarters and the economy seems strong. 

Mrs. MALONEY. That is a good point to end on. The meeting is 

adjourned. We have missed a vote. The economy is strong. 

[Whereupon, at 2:07 p.m., the hearing was adjourned.] 

(65)

A P P E N D I X

September 5, 2007

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