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S. HRG. 110–1018

THE REAL ESTATE MARKET:

BUILDING A STRONG ECONOMY

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

FEBRUARY 28, 2008

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

DEBBIE STABENOW, Michigan

MARIA CANTWELL, Washington

KEN SALAZAR, Colorado

CHUCK GRASSLEY, Iowa

ORRIN G. HATCH, Utah

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAT ROBERTS, Kansas

JOHN ENSIGN, Nevada

JOHN E. SUNUNU, New Hampshire

RUSSELL SULLIVAN, Staff Director

KOLAN DAVIS, Republican Staff Director and Chief Counsel

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee

on Finance ............................................................................................................ 1

Salazar, Hon. Ken, a U.S. Senator from Colorado ................................................ 3

WITNESSES

Lindsey, Dr. Lawrence, president and CEO, The Lindsey Group, Washington,

DC .......................................................................................................................... 3

Seiders, Dr. David, chief economist and senior staff vice president, National

Association of Home Builders, Washington, DC ................................................ 5

Callahan, Timothy, chief executive officer, Callahan Capital Partners, Denver,

CO .......................................................................................................................... 7

Schwartz, Jeffrey, chairman of the board and chief executive officer, ProLogis,

Denver, CO ........................................................................................................... 9

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

Opening statement ........................................................................................... 1

Callahan, Timothy:

Testimony .......................................................................................................... 7

Prepared statement with attachment ............................................................. 29

Responses to questions from committee members ......................................... 70

Grassley, Hon. Chuck:

Prepared statement .......................................................................................... 78

Lindsey, Dr. Lawrence:

Testimony .......................................................................................................... 3

Prepared statement .......................................................................................... 80

Responses to questions from committee members ......................................... 92

Roberts, Hon. Pat:

Prepared statement .......................................................................................... 95

Salazar, Hon. Ken:

Opening statement ........................................................................................... 3

Schwartz, Jeffrey:

Testimony .......................................................................................................... 9

Prepared statement with attachments ........................................................... 96

Responses to questions from committee members ......................................... 118

Seiders, Dr. David:

Testimony .......................................................................................................... 5

Prepared statement with attachment ............................................................. 126

Responses to questions from committee members ......................................... 137

Smith, Hon. Gordon H.:

Prepared statement .......................................................................................... 141

COMMUNICATION

National Multi Housing Council (NMHC) and National Apartment Association (NAA) ............................................................................................................. 143

(1)

THE REAL ESTATE MARKET:

BUILDING A STRONG ECONOMY

THURSDAY, FEBRUARY 28, 2008

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC.

The hearing was convened, pursuant to notice, at 10:17 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus

(chairman of the committee) presiding.

Present: Senators Kerry, Stabenow, Salazar, Grassley, Snowe,

Smith, and Sununu.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. The hearing will come to order.

A Chinese proverb says that even good swimmers drown and

good riders get thrown. Today, much of the housing market is

under water. Last year, 1.3 million homes went through foreclosure. Today, more than 1 in 10 homeowners owes more on their

homes than their homes are worth. A wave of declining home values washed over the market. The national average home price is

down almost 9 percent from last year, and in many neighborhoods

and regions that decline has been 20 percent, or even 30 percent.

For most Americans, their home is their biggest asset. Homes

represent about a third of household net worth. Americans borrow

against their homes. We take out home equity lines of credit to buy

everything from cars to college. When the value of that home deteriorates, so does the ability to make those purchases.

At first, the choppy waters swamped just a part of the housing

market. It started with exotic mortgages, and now it is affecting

homeowners throughout the country. It is affecting families who

have spent a lifetime building a clean credit record. These families

are also seeing the value of their homes decline. Even good swimmers are finding their heads under water.

Today, we will discuss the effect that the housing market is having on the economy and we will discuss options that this committee

can pursue to prevent the credit crunch from doing further damage. There are signs that what started as subprime losses is spilling over into other areas of the economy. Car debt, credit card debt,

and student loan debt are all in jeopardy of suffering from the

same credit crunch. Each of these debts is securitized and sold on

the secondary market. Just as investors are refusing to purchase

subprime securities, they are also leery now of auto, student loan,

and credit card debt.

2

And today we will also examine the spillover of the credit crunch

into the commercial real estate market. Residential and commercial real estate markets are tied together: often residential and

commercial mortgages are pooled together in securities, often they

are sold as a package on the market.

The same investors who have suffered losses on residentialbacked securities have also been the traditional buyers of commercial-backed securities. With risks so great, investor capital for the

real estate market is drying up and those investors who are willing

to purchase commercial-backed securities are demanding higher interest rates in return.

When the cost of capital increases, developers spend more and

build less, borrowers have to put up more equity, and borrowers

get smaller loan proceeds. Companies re-think transactions. Fewer

properties change hands.

In the final 3 months of the last year, nationwide office property

sales fell by 42 percent. That is the biggest drop since 9/11. In the

first 3 quarters of last year, $100 billion in property changed

hands; in the 4th quarter of last year, just $5 billion.

Commercial real estate prices are falling at an annual rate of 11

percent, and, even though the Federal Reserve has cut interest

rates to the lowest point since 2003, the interest rates for borrowing for apartment buildings, offices, retail properties, and hotels

have climbed 125 basis points in January.

Well, the waves have swamped the residential market and engulfed the commercial market. Today we will hear from witnesses

who have decades of experience. They are strong swimmers among

economist and business executives, and I hope that they can help

us learn how to cut through the waves. I hope they can help us

guide the economy through rough waters, and I hope that they can

suggest policies that will help more Americans keep their heads

above water.

Senator Grassley has another hearing. He is in the Judiciary

Committee right now, actually on a bill that he is sponsoring. He

will be here shortly.

[The prepared statement of Senator Grassley appears in the appendix.]

The CHAIRMAN. Our first witness is Dr. Lawrence Lindsey, president and CEO of the Lindsey Group, a global economic advisory

firm. Dr. Lindsey has worked in the administrations of President

Reagan, George H.W. Bush, and President George W. Bush. Dr.

Lindsey has also served as a member of the Board of Governors of

the Federal Reserve System from 1991 to 1997.

Dr. David Seiders is the chief economist and senior staff vice

president at the National Association of Home Builders. Dr.

Seiders has also served as senior economist at the Federal Reserve

Board in Washington.

The third witness is Mr. Timothy Callahan. Mr. Callahan is the

chief executive officer of Callahan Capital Partners, a real estate

private equity firm that focuses on U.S. office property.

We will then turn to Mr. Schwartz, another witness before us

today. I guess Senator Salazar is going to introduce Mr. Schwartz.

Thank you very much. Now I turn to Senator Salazar to introduce our final witness.

3

OPENING STATEMENT OF HON. KEN SALAZAR,

A U.S. SENATOR FROM COLORADO

Senator SALAZAR. Thank you very much, Chairman Baucus. It is

my honor to have Jeff Schwartz here presenting testimony to our

Finance Committee today with respect to commercial real estate.

Jeff Schwartz is the chairman and CEO of ProLogis, a major real

estate company that has focused in on distribution facilities. They

have 510 million square feet of distribution space under management in 105 global markets. We are proud to have them as a corporate citizen in our State of Colorado, headquartered right off

Pena Boulevard, in between Denver International Airport and

downtown Denver.

I want to say just two things about Jeff and many of his cohorts

here. They are great contributors to our economy, providing highquality jobs to our State, to our country, and indeed to our world.

Second, I have been tremendously impressed, Mr. Chairman, on

what they have done with respect to embracing the green energy

future of America.

ProLogis actually was the first LEED certified building at their

headquarters in Colorado, the first LEED certified building in the

entire State of Colorado, so I’m very proud of the work that they

have done in that area. Mr. Schwartz, I welcome you here.

I will say just a word also about Mr. Callahan. I know you are

based in Denver and have a host of real estate activities also in

Denver, CO, so we are proud to have you here as well.

The CHAIRMAN. Thank you, Senator.

We will begin, first, with you, Dr. Lindsey. As you all know, we

have a 5-minute rule here for your testimony, but your printed remarks will automatically be included in the record.

Dr. Lindsey?

STATEMENT OF DR. LAWRENCE LINDSEY, PRESIDENT AND

CEO, THE LINDSEY GROUP, WASHINGTON, DC

Dr. LINDSEY. Thank you very much, Mr. Chairman. It is a pleasure to be here to discuss what I think is the most important economic problem facing the country, and that is the condition of the

mortgage market.

As you said, sir, housing is much more than a place to live. It

is also collateral for other spending, and I think, even more importantly, a key step on the ladder to our ownership society.

I would like to stress three points today. First, as severe as our

current problems are, neither problems nor the search for creative

solutions is anything new in the American mortgage market. In my

written testimony I cite a number of examples of the collapse of different mortgage models and creations of new ones, and, each time

a new approach was developed, it worked based on the failures of

the previous model. We have had at least four of those in the last

100 years.

Today’s problems are no different. The root cause of this cycle of

creativity and collapse is the constant need to find low-cost means

of providing liquidity for what is essentially an illiquid product:

housing.

Second, we have to recognize that this is not a subprime crisis,

as some call it, but a problem faced by every homeowner. Over 75

4

million American homeowners face the prospect of historically unprecedented declines in the value of their most important asset.

The consequences of this will make housing an even less liquid

asset. It will not only curtail spending, but it will have knock-on

effects in our National labor market as worker mobility becomes

impaired.

I point out that this actually happened in Japan during the

1990s after the collapse of their housing market. So, solutions that

focus on the subprime problems like foreclosures but make the

mortgage market even less attractive for new money are counterproductive, both for lower-end borrowers and for the broader public.

Third, at this stage in the cycle, the most important thing public

policy can do is allow, and possibly promote, the development of

creative solutions in private mortgage markets and avoid one-sizefits-all approaches. This is politically quite a courageous thing to

do, as the clamor for short-term fixes, protections of those who face

losses, and a search for scapegoats is quite naturally and understandably the focus of media and public attention.

But misplaced emphasis on these issues will likely lead to mistakes and will sow the seeds for future failures in the mortgage

market, to the detriment of our economy, tens of millions of homeowners, and ultimately the beneficiaries of politically based solutions.

These points lead me to conclude that the next step in the evolution of our mortgage system must be to assure ample liquidity to

those involved in the mortgage process. This will involve helping

homeowners with cash flow and assuring lenders that they are investing in secure products.

They must not be taken by surprise by rapid changes in the credit-worthiness of the securities they underwrite. I recommend a Federal Board of Certification, composed of senior government officials,

that could administer standards for mortgages that are packaged

in mortgage-backed securities and certify, for a fee, that the mortgages represented in that security meet those standards.

This does not involve a Federal guarantee of the security, even

an implicit one, nor does it involve a guarantee of the mortgage

portfolio. All the Certification Board would do is assure investors

that the mortgages of a security meet the standards they claim to

meet with regard to such features as documentation, loan-to-value

ratios, debt service-to-income ratios, and borrower credit standards.

The current rating system is broken. The Federal Government

can provide assurance about the quality of the products of the security market. Obviously a variety of such standards could exist and

investors could pick the standard and implied level of risk they

want, knowing that the mortgages in the security actually conform

to that standard. Nor does this preclude other institutions from offering mortgage-backed securities without government certification

if they can find a market for them, nor should we expect that all

mortgages should be securitized. Borrowers who do not meet certifiable standards but who lenders deem credit-worthy nonetheless

should be able to borrow.

This committee should also consider two temporary tax measures

to improve the cash flow of those who own homes. This is a tarVerDate 11-MAY-2000 14:30 Mar 15, 2010 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 55139.000 SFIN1 PsN: SFIN1
5

geted way of stabilizing home prices by subsidizing those who hold

housing on their balance sheet. First, mortgage interest might become an above-the-line deduction, available to non-itemizers as

well as itemizers, on a temporary basis.

Half of all homeowners do not itemize on their tax returns. These

are disproportionately moderate-income individuals who might be

bearing a disproportionate amount of the strains of the deteriorating housing market. On the other end of the housing scale, individuals who are either trying to obtain jumbo mortgages or who are

forced to carry two mortgages because they have had to buy a

home without being able to sell their old home, are coming against

the cap on the size of the mortgage interest deduction.

A temporary lifting of that cap—and I stress temporary—might

be a worthy change to consider in this environment. Providing a

mechanism to reassure purchases of mortgage-backed securities

and improving homeowner cash flow seem like the two most prudent steps the Congress could take at this time to preserve home

values during this difficult period.

Thank you, sir.

The CHAIRMAN. Thank you, Doctor.

[The prepared statement of Dr. Lindsey appears in the appendix.]

The CHAIRMAN. Dr. Seiders?

STATEMENT OF DR. DAVID SEIDERS, CHIEF ECONOMIST AND

SENIOR STAFF VICE PRESIDENT, NATIONAL ASSOCIATION

OF HOME BUILDERS, WASHINGTON, DC

Dr. SEIDERS. Mr. Chairman and other members of the committee,

my name is David Seiders. I am chief economist at the National

Association of Home Builders. I would like to testify today on the

current condition of the housing market and on some policy options

to strengthen the economy through the housing sector.

I think it is worth saying that the U.S. housing market now is

in the most pronounced downswing since the Great Depression,

and the bottom is not yet in sight. New home sales and singlefamily housing starts already are down by more than 50 percent

from their recent peaks, and the supply of new homes for sale is

up to nearly 10 months, with serious down-side implications for future housing production.

The dramatic housing contraction obviously has exacted a heavy

toll on economic growth and employment during the past 2 years

and has pushed the economy to the brink of recession. In addition

to the sharp declines in home sales and housing production, we are

also seeing falling home prices and serious declines in mortgage

credit quality. These factors have taken a toll on household wealth

and provoked a surge in mortgage foreclosures, as well as a substantial decline in home ownership and serious damage to financial

institutions holding mortgage assets.

The pronounced decline in mortgage credit quality first became

evident in the subprime mortgage sector last year and resulted in

serious damage to major components of U.S. mortgage securities

markets. Furthermore, bank lending standards for all types of

home mortgage loans have tightened substantially since last sumVerDate 11-MAY-2000 14:30 Mar 15, 2010 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 55139.000 SFIN1 PsN: SFIN1
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mer. These forces have combined to create a bona fide credit

crunch in the housing sector.

The Federal Reserve has been easing monetary policy aggressively since last fall, and probably will do more in the near future.

These actions definitely have improved the functioning of shortterm money markets. However, it is important to note that rate

cuts by the Fed do not necessarily translate into lower mortgage

rates.

Long-term rates include an inflation premium, and, if market expectations of inflation rise as the Fed eases monetary policy, then

little or no benefit will be transmitted to mortgage rates. I think

this problem highlights the importance of congressional action with

respect to fiscal policy in the current environment.

The recently enacted Economic Stimulus Act of 2008 may keep

the economy out of recession this year, or at least limit the severity

of recession, and NAHB applauds the work of the Congress on this

bill. However, this short-term stimulus package does not address

the deep problems posed by the housing contraction that is at the

root of today’s economic and financial market problems.

Some argue that the best way to bring the housing market back

into balance is simply to permit housing prices to fall quickly over

a short period of time. However, this would most likely cause further substantial damage to the economy, to financial markets, and

to America’s homeowners. A second round of fiscal stimulus, directed squarely at the housing sector, is a far better path to take.

With respect to stimulus options for housing, NAHB has the following tax policy recommendations for the committee. First, create

a tax credit for the purchase of a home. Consumer interest in home

buying appears to be perking up a bit, although home sales still

are deteriorating. A temporary tax credit for home buyers could

quickly energize the markets, reduce the heavy overhang of vacant

housing units, help stabilize house prices, and halt the destructive

decline in mortgage credit quality. There are several options for

such a credit, which are summarized in some detail in my written

statement.

Our second recommendation is to expand the Mortgage Revenue

Bond program. This program offers a method of increasing housing

demand and responding to foreclosure concerns. A special allocation of bonds to be used for either purchase or refinancing would

be beneficial for housing and the economy.

Expanding the reach of the MRB program would be particularly

helpful for communities facing waves of foreclosures or heavy inventory conditions. The committee adopted this proposal during its

work on the first economic stimulus bill, and we urge that it be included in any future package.

The second stage of economic stimulus should also lengthen the

time-frame for businesses to carry back net operating losses as deductions against previously paid taxes, from 2 to 5 years. In the

case of home builders, the immediate boost of financial resources

would lessen the need for high-cost financing or for accelerated

sales of land and housing inventory onto glutted markets. Again,

we appreciate the committee’s efforts in moving this provision as

part of the first stimulus package.

7

Finally, we recommend that housing be designated as an eligible

investment for tax-preferred retirement accounts. The downpayment remains the single largest hurdle for most first-time home

buyers, particularly considering today’s much tighter lending

standards, at least compared to previous years. Congress could increase capital available for down-payments by allowing these downpayments to qualify as eligible investments for tax-favored retirement accounts.

NAHB looks forward to working with the committee and the

Congress on these and other options for addressing the crisis in

housing. Thank you for the opportunity to testify today, and I am

happy to answer any questions you may have.

The CHAIRMAN. Thank you, Dr. Seiders.

[The prepared statement of Dr. Seiders appears in the appendix.]

The CHAIRMAN. Mr. Callahan?

STATEMENT OF TIMOTHY CALLAHAN, CHIEF EXECUTIVE

OFFICER, CALLAHAN CAPITAL PARTNERS, DENVER, CO

Mr. CALLAHAN. Thank you, Chairman Baucus and Ranking

Member Grassley, for conducting today’s hearing on the real estate

markets and the economy. It is certainly timely.

As mentioned, Callahan Capital Partners is primarily focused on

office properties throughout the United States. My previous experience as CEO of Trizec Properties and Equity Office Properties, two

of the largest public U.S. office REITs, certainly gives me some perspective on the markets generally across the United States.

As you may know, real estate in the U.S. generates economic activity to about 20 percent of GDP, creates some 9 million jobs, and

certainly significant tax revenue at all governmental levels. Commercial markets depend on a healthy economy for occupancy and

a liquid financing market for new investment. Both are challenged

today, but perhaps the latter much more.

The role of Congress in responding to this turmoil is certainly

important. However, the dramatic headlines of housing and financial market crisis we see every day are important not to overreact

to. Excessive tax breaks and government spending may serve to

only increase supply in the wake of weakening demand. Overtaxation could encourage further hamstringing of borrowers and

weaken the resilience of investors. Aggressive regulation of lenders

risks tying the hands of institutions involved in finding solutions

to the problems of today.

The last decade has certainly been robust for the real estate markets. Wall Street created new pipelines and conduits to inject large

global capital pools into U.S. real estate markets, creating solid

economic bases that did not previously exist, but it has also tied

us very tightly to global capital markets, events, and flows.

Currently, fundamentals are solid, occupancy rates are strong,

price depreciation has been impacted, but probably more for those

who in fact need debt right now than on a general basis because

of lack of transactions. Unlike previous cycles, this is not characterized by the lack of equity capital available. There is an abundance

of that. There is not an imbalance between supply and demand;

however, without equilibrium in the credit markets, we face

daunting problems.

8

The uncertainty in the economy is a strong contributing factor to

these problems. Consumer confidence is evaporating and business

confidence may follow. The economy certainly needs the support of

both, but in particular today the support of business spending.

After such a robust period of growth, it is not surprising, and

probably was inevitable, that there would be a slow-down. But

what was surprising, totally unexpected, was the dramatic retrenching in the debt markets. What started out as a subprime crisis rapidly spread into other structured credit products, such as

Commercial Mortgage-Backed Securities, as investors began to

question valuations across a broad spectrum of securitized loans.

In June, what started as tremors quickly became crisis in July

and August, with more investors fleeing the markets. Massive

losses recorded by several financial institutions drove more investors to the sidelines. Some of those investors saw pricing opportunities in late October, but were quickly proved wrong. More write-offs

followed, and the downward spiral continued.

Lenders, at this point unable to move product off their books,

were not able to regenerate capacity for new loans, effectively

gridlocking the system. The CMBS market alone, about $750 billion in 2007, or 20 to 30 percent of commercial lending capacity,

has been in large measure removed from the system. This has created an investor confidence crisis that threatens to get worse before

it gets better. Some balance-sheet lenders, like life insurance companies, are filling a small part of this, but they do not have the capacity to fill the capital withdrawn from the market.

You will not see evidence of this in default statistics at this

point, but, with the passage of time and the slowing economy, especially heavily leveraged borrowers from 2006 and 2007 will come

under increasing pressure and then, unfortunately, many prudent

investors, with the unfortunate timing of debt coming due in the

near term, could be impacted as well. This downturn will create opportunities, but for those with capital, they need the debt markets

to function to invest.

Ironically, this should be the best of time for real estate, but,

without the combination of debt and equity available, the heart of

our business will slow dramatically. Considering the size and scope

of the real estate business globally, that is no small matter. So that

brings us to the question of, when does this downward cycle of debt

end? I think that is the question right now that I think is on most

people’s minds.

For the government’s role in answering these questions we certainly support the actions taken on the stimulus package and by

the Fed on rates recently, but in conclusion we believe it is important that government take appropriate steps to shore up investor

confidence and consumer confidence, create a conducive environment for business investment, and implement appropriate monetary policy. With respect to commercial real estate, we do not believe new stimulative tax or spending policies are needed.

However, we would urge the committee to add clarity to real estate tax policy by reauthorizing the expired tax extenders, notably

leasehold depreciation of brown field clean-up. It is a very stressful

time in the markets, but these markets need to solve some of these

problems themselves. We do urge Congress to refrain from imposVerDate 11-MAY-2000 14:30 Mar 15, 2010 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 55139.000 SFIN1 PsN: SFIN1
9

ing a burden of new taxes, such as carried interest, on the industry. It is an unnecessary stress at this point in time for entrepreneurs and investors of all sizes and it favors emphasizing debt

in a time when the debt crisis is really at its height.

Thank you very much for the opportunity to come before you and

present our views.

The CHAIRMAN. Thank you, Mr. Callahan.

[The prepared statement of Mr. Callahan appears in the appendix.]

The CHAIRMAN. Mr. Schwartz?

STATEMENT OF JEFFREY SCHWARTZ, CHAIRMAN OF THE

BOARD AND CHIEF EXECUTIVE OFFICER, PROLOGIS, DENVER, CO

Mr. SCHWARTZ. Thank you, Chairman Baucus, Ranking Member

Grassley, and members of the Senate Finance Committee. Again,

thank you for holding this important hearing on the state of the

real estate market and the vital role commercial real estate has in

the global and national economy.

While our company provides infrastructure for the supply chain

of large manufacturers, large retailers, and major companies of all

sizes throughout the U.S. and North America, I am here today also

representing NAREIT, or the National Association of Real Estate

Investment Trusts, the representative voice of U.S. REITs and publicly traded real estate companies.

Mr. Chairman, I appreciate the opportunity today to provide an

overview of the health of the commercial real estate market.

As you and other members of the committee are well aware, commercial real estate contributes approximately 6 percent of the total

GDP in the United States today, and publicly traded real estate

represents between 10 and 20 percent of that total. That includes

companies like ProLogis and other Real Estate Investment Trusts,

as well as all public real estate companies today.

Additionally, much of the commercial real estate owned by institutions is held through private REITs. When it comes to building

and maintaining a strong economy, the role of commercial real estate should not be overlooked, nor underestimated.

My written statement provides many charts and data points concerning the health of the commercial real estate sector. In brief, the

fundamentals as far as vacancy rates, net operating income, and

the balance between supply and demand generally appear to be

fairly healthy. However, credit markets have tightened appreciably,

and many commercial property owners and developers are having

difficulty accessing capital to operate their businesses.

This credit crunch has severely cut back on the amount of

Commercial-Backed Mortgage Security issuances, formerly a leading source of liquidity, and it has caused reduced bank lending and

significantly more difficult terms. This has appreciably slowed

down the number of commercial real estate transactions and has

initiated the decline in commercial property values, even while fundamentals throughout the country remain strong.

Further, the health of the commercial real estate sector is closely

tied to the broader economy. When economic activity slows down,

demand for office space also contracts. Similarly, decreases in retail

10

spending over time will affect demand for retail leasing. Commercial real estate fundamentals have so far weathered the significant

capital market dislocations, but, without renewed liquidity in the

real estate and financial sectors, the situation, as well as the entire

economy, could deteriorate rapidly. Mr. Chairman, we thank the

committee for holding this hearing at this critical time when economic storm clouds are developing on the horizon.

As to what actions the committee should consider taking, our

overriding recommendation would be, first, as Tim said, to do no

harm. To the extent that legislative steps regarding tax policy are

taken, we caution you to move in a careful, deliberative manner so

that upheaval in the financial markets is not accelerated and so

that harmful unintended consequences do not mar the coming

years.

Instead, measured steps may provide a path to ensuring that

real estate markets remain liquid and healthy. We do believe that

several provisions contained in legislation now before this committee, S. 2002, introduced last year by Senators Salazar and

Hatch, are part of the solution, as they will increase transaction

volume and, consequently, liquidity within the REIT and commercial real estate markets.

Mr. Chairman, we commend Senator Salazar, my Senator from

Colorado, Senator Hatch, as well as the other five members of this

committee who are co-sponsoring S. 2002 for their foresight in

sponsoring legislation that would help facilitate healthy activity in

the commercial real estate market at a time when it is needed.

NAREIT applauds you for holding this hearing and thanks you

for the invitation to provide the insight we have on the state of the

commercial real estate market in the United States. We stand

ready to assist this committee and the Congress to achieve the

overall goal of building a strong economy.

I would be happy to respond to any questions later, but then

again, thank you.

[The prepared statement of Mr. Schwartz appears in the appendix.]

The CHAIRMAN. Thank you, all of you.

I am going to ask each of you to just give a very brief response

as to what you think the most responsible action is that Congress

can take. The Fed is taking its action on the rates, but what is the

most responsible action that Congress could take, recognizing that

there is a real problem, a lot of people thrown out of their homes,

foreclosures, the credit crunch? Yet we do not want a moral hazard

here. We want to be responsible. Maybe some of this is going to develop in ways we do not yet foresee, both plus and minus.

Do you have some recommendations? I know the Federal board

certificates, a tax credit for new home buyers. The question is, is

that just for investors, is that just for owner-occupied purchasers,

and so forth? So I am just going to start with you, Mr. Schwartz.

I do not have a lot of time here, and neither do you, more importantly. [Laughter.] Just, the bottom line: what is the right thing to

do? If you do not have a precise prescription, if you might point us

in the direction you think makes more sense.

11

Mr. SCHWARTZ. Clearly, the biggest issue is the illiquidity in capital markets and the lack of counter-party trust in financial institutions. I realize that is not the direct province of this committee.

The CHAIRMAN. I am asking you whatever you think the answer

is, irrespective of committee jurisdiction.

Mr. SCHWARTZ. You need to fix the banking problems. Nobody

has trust in the banking system. Other banks do not trust their

counterparts. They are not trading with each other. There has been

a complete breakdown. There is no trust in the CMBS markets.

There is actually no liquidity at all. BBB rates on CMBS have gone

from 150 basis points above Treasuries, to 800 to 1,000 basis

points.

The CHAIRMAN. Do you think that will help deal with the foreclosure problems and the housing problems?

Mr. SCHWARTZ. I think a healthier economy clearly will. You will

have less chance of a recession, and if you do have a recession it

will be a shorter, shallower one.

The CHAIRMAN. Mr. Callahan?

Mr. CALLAHAN. I think it is important to give some degree of confidence to consumer and business investors. I think right now people see turmoil in the marketplace. It is a very complicated problem. I was in banking for 14 years before getting into real estate

on the principal side.

I think right now the lack of solutions is somewhat driven by the

fact that people are baffled by what has happened, and what has

happened so quickly. So I do think there is the potential for the

law of unintended consequences by acting too quickly, but at the

same time looking at the problems and consulting—I would agree

with Jeff—with the banks to determine how we in effect free up

the lending side.

The CHAIRMAN. So what would you do? Let us say the President

would call you and say, Mr. Callahan, you have carte blanche here.

You solve this for us. And you have power. You are the czar. What

would you do?

Mr. CALLAHAN. Well, I think certainly on the housing side, that

started this crisis, and I think there needs to be stability on the

housing side. I do believe that there is capital out there, and if you

can find a way to encourage that capital to invest in the housing

side, primarily, I think that that brings stabilization to that and

I think would bring some stabilization——

The CHAIRMAN. But do we take any action? Does Congress do

anything now, or wait?

Mr. CALLAHAN. I would be cautious to take action at this point

in time without understanding the problem. As I said, I feel that

there are some experts who have been in these debt markets for

a considerable period of time, even with all the complications of recent years that have developed. I think that people are still looking

to understand the basic cause of what started this, and I think to

try to react at this point in time prematurely could, in fact, be

damaging.

The CHAIRMAN. Dr. Seiders, you are the czar.

Dr. SEIDERS. I am the czar. I think a short-term stimulus policy

is what the economy and housing really need right now. We really

need to stop house prices from falling, if at all possible. That is the

12

factor that is taking a heavy toll in the financial markets, not just

the mortgage markets, but global capital markets and so forth. So

I think a tax credit for home buyers, whether it is for buyers of

new homes that are currently in inventory or for first-time buyers.

You asked about, should it be for investors? I think limiting it

to primary residences would make perfect sense to get the supply/

demand condition in the housing market improved quickly. We do

see what looks like a growing interest, or a percolating interest,

among potential home buyers. Nobody really wants to buy yet, it

appears from the numbers. But a window of opportunity for a tax

credit to buy a home, I think, would be reasonable at this time.

The CHAIRMAN. What is more important to you, the Net Operating Loss change or a tax credit proposal?

Dr. SEIDERS. I think they are both important, but I would say

the tax credit most likely would be first.

The CHAIRMAN. All right.

Dr. Lindsey, you are now czar. There are a lot of czars here, but

you are now the czar.

Dr. LINDSEY. We are competing czars.

The CHAIRMAN. Yes.

Dr. LINDSEY. I think Mr. Schwartz pointed out what the big

problem is, which is illiquity and the lack of counter-party trust.

I agree with that. When I was a Governor at the Fed, I had the

housing portfolio back in 1991 to 1997. We had a housing crisis

back then. This town and the financial markets settled on

securitization as the best way around the last housing finance collapse, which was the S&Ls, which had their own problems. What

we found in the last few months is that we have had a lack of trust

in the securitization process.

So I recommend the certification as a way of reestablishing that

trust. We do not really have an alternative in the near term toward

using mortgage-backed securities as the primary way of getting

money to savers. But the providers of money do not trust the securities they are buying, and reestablishing that trust is key.

When I was a Governor, I was also chairman of the Neighborhood Reinvestment Corporation, and that was to encourage investment in low- and moderate-income areas. Actually, we had such a

board back then, Neighborhood Housing Services of America. It

raised money, and that money was then used by the local neighborhood reinvestment outfits to put money into those neighborhoods.

It provided basically a ‘‘Good Housekeeping Seal of Approval’’ so

the people could invest with confidence. I think that the best thing

the government can do now is not put money in, but restore confidence by certifying and taking up the job that the rating agencies

have let everyone down on.

The CHAIRMAN. Thank you very much.

Senator Grassley?

Senator GRASSLEY. Larry, you indicated that solutions which

focus on subprime problems would make the mortgage market even

less effective for new money. So my question is 2-fold. One, would

this hold true for tax legislation as well? If so, what type of tax relief, in your opinion, could have a negative impact on the mortgage

market?

13

Dr. LINDSEY. Senator, the great advantage of this committee is

that it has the minimum possibilities of doing harm that exist in

other committees, so I agree with you that most of the tax ideas

discussed here would not be in that area. What I would be concerned with is things like changes in the bankruptcy law, which

would basically erode the value of collateral. I am very concerned

that Congress should move in that direction.

Just to quantify it, the mortgage bankers, whom I agree might

not be the most disinterested party, estimate that that bankruptcy

provision would cost 150 basis points to borrowers. I think that is

high. But if you suppose it is only a fifth or a sixth as much, if you

think about it, all of Fannie and Freddie’s benefits amount to just

30 basis points, so doing just a little bit of harm involves wiping

out all the benefits from institutions like Fannie and Freddie just

like that. So you have heard, do not do things that cause unintended consequences. I would second that. On tax measures, what

I would be careful of is setting in place things which can be gamed.

I am sorry, I have to disagree with you on the home buyer credit.

One thing we could all do is sell houses to our neighbors, just swap

houses. That involves the purchase of a house. What we do not

need, necessarily, is more turnover. What we need is more willingness to hold housing, because we have too much housing out there.

So I would not focus on the transaction in tax legislation, I would

focus on encouraging people to hold more real estate in their portfolio than they otherwise would.

Senator GRASSLEY. Well then, when it comes to that, putting a

floor on the housing market, what tax solutions would you provide

in that area? For example, some have recommended increasing the

cap on Mortgage Revenue Bonds or providing a home buyer credit

for distressed properties. How would you react to those, or any

other suggestions you might have from a tax standpoint?

Dr. LINDSEY. Neither of those is a bad idea. They do have their

drawbacks. One of the challenges with Mortgage Revenue Bonds is

their administration, often by local communities. We have been

through this before where we tried essentially politically based solutions and it ends up with a lot of squabbling, it ends up with stories in the newspapers, it ends up with a little bit of a taint of corruption sometimes. We have to solve the problem, and maybe that

is the price of putting up with it. But I would prefer as least targeted a piece of tax legislation as could possibly be arranged, because the more targeted the solution is, inevitably the more it looks

like a fish that has been hanging around too long.

Senator GRASSLEY. Mr. Callahan, you cautioned us not to do

things in the tax area that would bring about over-supply. Are

there any tax measures, specific tax measures, that you think

should be pursued that would stimulate supply?

Mr. CALLAHAN. Well, I think that to the extent that incentives

are given to solve problems that in fact cause problems for others,

I think that that would be detrimental. As I said, unintended consequences. So the problem in these markets is that everything is

linked. We used to have very dedicated investors that were very

specific to their investment.

I think the housing and the business investment credit markets

are very much tied today, so I think that my concern is that at this

14

point in time the solution, in part, is freeing up credit in a way

that allows people to have normal refinancing, whether it be homes

or whether it be situations with regards to the commercial property. I think that part of the challenge right now is people cannot

find the floor.

So, when I talk about the banks, I think part of the problem for

the banks is that we need to find a way to give them the latitude

not to be driven to mark to market—an interesting term in today’s

world, when I think it is very hard to find the market, and those

downturns and the spiral have created problems, I think, in terms

of finding value.

So I think, rather than look for a tax solution, I think it is, in

fact, a systematic solution on the credit side that would give you

the ability to then examine what tax alternatives would give you

the best alternative at that point in time and be most effective.

Until the credit side is solved, I think it is difficult to know the effect of those tax impacts.

The CHAIRMAN. Senator Sununu?

Senator SUNUNU. Thank you, Mr. Chairman.

Dr. Lindsey, in your written testimony you included a pretty

thorough overview of a lot of the historical situations the country

has faced before dealing with credit, with real estate, some of these

financial issues. I think that was very helpful to have, especially

if you are a younger member of the Senate and were not necessarily in public service in the 1980s and the 1990s through the

S&L crisis, and other challenges the country has had to deal with.

Could you make some comparisons to real estate crises and credit crises in the 1930s, the 1980s, and the 1990s? In particular, talk

about the government-sponsored funds that were established to address those problems. One of the proposals that has been made by

the chairman of the Banking Committee is to resurrect the Home

Owners’ Loan Corporation, which was a real estate fund created in

the 1930s to buy, hold, and sell residential real estate.

We had the S&L crisis and the Resolution Trust Corporation

that dealt with insolvent institutions, and an instrument called

FADA in the 1980s that had a similar responsibility. Talk about

those government-sponsored funds, which obviously involve a government commitment of some sort, how they differed, and whether

or not such a fund would be an appropriate response to the current

situation.

Dr. LINDSEY. Thank you. It is amazing to see the same problems

crop up again and again. I think the proposal that Senator Dodd

is talking about, and I know some of my friends at the American

Enterprise Institute and Alan Blinder have advocated, hearkens

back to what was done in the 1930s. I think the 1930s is a different time than what we have. I think the proposal bears most

close resemblance to what you mentioned, which was FADA, the

Federal Asset Disposition Agency. There are lots of brain cells that

have died in my head, and that was one of them. I was reminded

of it when I saw the proposal.

Unfortunately, that was a brain cell that I wish just stayed dead.

FADA was an effort by us to basically do what that proposal would

do, which is to use money, Federal money, to buy homes that were

in distress and sell them. Now, we could do that during the 1930s,

15

frankly, because we had a less transparent government than we

have now.

But in the 1980s, when we created FADA, we quickly got into

problems where special interests, lobbyists, what have you, got involved, and Congress ended up dissolving it 18 months after it

started because it was just such a mess. I mentioned the rotting

fish earlier. I am afraid that the practical implication of that idea—

it may be a well-intended idea—is that it does not work because

government works on a deal-by-deal basis when you do that kind

of thing, and deal-by-deal bases often involve special interests.

I think the RTC, which we all remember, was also a painful

memory, but because they were dealing with the disposition of

whole institutions, it was painful, but we got it over quickly. I

think if we did the house-by-house process we would end up causing a lot of problems and a lot of distress.

Senator SUNUNU. How much money—taxpayer money, Federal

money—was put at risk in dealing with the RTC, and how much

taxpayer funding potentially would be put at risk with a residential

real estate trust that took ownership of tens of thousands of mortgages?

Dr. LINDSEY. Well, the total RTC disposition, I think the budgetary cost was about $150 billion before it was all over. The size

of the current toll, part of the problem is, it is all going to depend

on how far down housing prices go. But let us talk about some

numbers. We started with $21, $22 trillion in residential real estate. Some estimates are that that could decline by 20 percent in

value. I think it is a little high, but it is a good place to start because it is an easy number to work with. That is a $4-trillion loss

that someone is going to have to hold.

Now, the more money that the government gets involved in trying to guarantee that $4-trillion hole, the more that is going to be

eaten by the taxpayer. I do not think anybody here wants to think

about a number like $4 trillion. So that is the potential size of the

loss. Even if the government just took 10 percent of that and had

a very effective program, you are talking about ultimately a $400

billion loss.

Senator SUNUNU. One final question, because my time is expiring. There are vacancies on the Board of Governors right now.

Dr. LINDSEY. Yes.

Senator SUNUNU. My question is, does that have any effect on

this situation? Does it limit their ability to react if things deteriorate further, if we have an additional crisis? What limitation does

that place on the board?

Dr. LINDSEY. Absolutely. There is a provision in the Federal Reserve Act, letter A, that would allow the Federal Reserve to lend

money in emergency situations to non-member banks. That requires 5 board members for approval. Right now, there are two vacancies that have been awaiting confirmation since last July, I believe. There is one more person who has been renominated for a

term that expired at the end of last month. If any one of the current 5 members gets the flu, the Fed would not be able to use its

powers in an emergency. I think it is very dangerous, and I would

urge the Senate to speedily ratify the President’s nominees who

16

have been sitting there already for 8 months waiting for confirmation.

Senator SUNUNU. Thank you.

The CHAIRMAN. Thank you, Senator.

Senator Stabenow?

Senator STABENOW. Thank you, Mr. Chairman.

This is an incredibly important subject. It starts with families.

Most families save through the equity in their home. That is how

they become a part of the great American middle class. But I am

hearing the same thing we all are in terms of how this has moved

from subprime, to the prime market, to the larger capital markets.

Frankly, I hear, in talking to folks who have nothing to do directly with housing who are involved in the investment community,

the financial community, great, great concern, as I know all of you

have expressed. The overwhelming comments I am hearing relate

to creating certainty in the marketplace and how that happened.

I would like to ask a question, though, specifically to mortgages,

because Allen Blinder was mentioned a few moments ago. One of

the things he has said is, no one understands how mortgages are

sliced and diced and tranched in the complex derivative instruments. One of the problems right now is, nobody knows who holds

their mortgage, or may not know who holds the mortgage securities. It is incredibly complicated. It is not surprising that people are

not renegotiating their mortgages if they do not know whom to go

talk to.

We know that many people avoid talking to the banker, the lender. But I am wondering if you might speak to the whole question

of the complexity involved in millions of mortgages that have been

repacked and resold and what we might do related to that.

Then also related to that, Professor Blinder, as has been said,

recommended as part of getting at that and the confidence in the

banking institutions and certainty, that we temporarily look at the

Home Owners’ Loan Corporation from back years ago in the 1930s.

That was set up for 7 years and then it went away. It was to purchase mortgages, to get them off the books, to be able to create

some certainty in the marketplace.

So I would appreciate if any of you would like to speak to issues

of the complexity as it relates to what is happening for people, and

also if any of our other witnesses besides Dr. Lindsey would want

to respond in any different way to the notion of a Home Owners’

Loan Corporation set up temporarily.

Dr. SEIDERS. Maybe a few words. The homeowner obviously deals

with the servicer of the loan, not the investors, who are spread all

over the globe, perhaps.

Senator STABENOW. Right. Right.

Dr. SEIDERS. And, for example, the Hope Now program, the

administration-sponsored program, is a proactive approach to get

homeowners who are in trouble, or think they might be, to contact

their loan servicer. So I think that the complexities of the mortgage

securities market spread the ownership of the mortgages all over

the place, diffused the risk, and so forth, hid the risk. Nobody quite

understood what kind of risks were in these structures.

I think somebody has already mentioned, the rating agency had

no ability to truly assess the prospective quality of the various

17

tranches of mortgage-backed securities that were marketed, particularly during the boom period. What is really needed there—I

guess Larry talked about this—is true transparency in the markets.

The rating agencies need to get up to speed on how to properly

assess and rate securities in an environment where house prices

are falling, or can fall. The models they were using prior to the

break in the markets really were not recognizing the possibility of

price declines, working mainly off of credit scores and that kind of

thing.

So I think there is a lot to be done in terms of the transparency

in the markets, the ability to rate the securities properly. In terms

of dealing with the consumers, it really is the servicers. I think

that some of the actions, the proactive steps to get contact made

between the homeowner and the loan servicer, are critical.

Senator STABENOW. Dr. Seiders, before my time is up, let me just

ask one more thing, since you are speaking, specifically on the

NOL provisions that many of us have worked on and I am pleased

are in the package on the floor. But I am hearing concerns from

homebuilders because their expected losses are through 2009 and

the provisions that we have right now go through 2008. I am being

asked, and others are being asked, to look at extending that a year.

I wonder if you would like to explain what the concern is there.

Dr. SEIDERS. Yes, we definitely support that, moving that out to

2009 with a 5-year carry-back. Some, particularly the big builders,

tell us that this really will be important to their operation and

their planning. Obviously, some are looking toward 2009 being a

pretty tough year on the profit front, as well as recent years and

2008.

Senator STABENOW. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator Stabenow.

Senator Salazar?

Senator SALAZAR. Thank you very much, Chairman Baucus.

Let me first say that I think it is a very timely matter for this

committee to be trying to address, the housing issue, one, because

it is on the floor, two, because it is a reality that is facing the people of my State and the people of our country.

Our own estimates in Colorado indicate that we will have somewhere in the neighborhood of 50,000 homes that will go into foreclosure in 2007 and 2008. Economists also are telling us that, when

you look at what the impact of that will be in terms of other homes

in Colorado, approximately 700,000 homes will go into a declining

state of value during that same time period.

So you are right, Dr. Lindsey, when you say that this was a problem in the housing market that extends beyond those who are

going into foreclosure, and really is a problem that affects all of

home ownership in our State of Colorado, as well as all across

America.

So one of the things that I would be very interested in hearing

from you, to the extent that you have studied it, is whether or not

the 2008 Mortgage Foreclosure Prevention Act, which we currently

have on the floor of the Senate, which I think we may start considering later this afternoon or tomorrow, will be helpful to us in adVerDate 11-MAY-2000 14:30 Mar 15, 2010 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 55139.000 SFIN1 PsN: SFIN1
18

dressing this housing crisis that we face. That is a general question

that I hope, before we end the hearing, I can hear from all of you.

Before doing that, I also just want to address the commercial real

estate world that both Mr. Schwartz and Mr. Callahan have testified about. I understand your testimony has said that the fundamentals are still good, but that there are additional things that

we might be able to do to provide some needed steps to make sure

that we maintain a robust commercial real estate market here in

this country.

In that regard, I want to first talk about the bill that Senator

Hatch and I introduced, which, with the help of Senator Baucus

and committee staff, has been hopefully something that we can

move forward with. It includes the co-sponsorship of Senator Kerry,

Senator Smith, Senator Bunning, and Senator Crapo, a good bipartisan coalition. The legislation is designed to modernize the tax

laws governing Real Estate Investment Trusts. We all know that

REITs play a major role in the commercial real estate industry and

are responsible for significant investments in hotels, apartments,

shopping centers, and office properties.

Our legislation would go a long way towards stimulating investment in, and activity by, this very important industry by making

a number of small, but important, changes to the rules that dictate

what kinds of entities REITs can buy and sell and how long they

must hold their assets before they sell them. These changes would

have a meaningful stimulative impact on an informed player in the

industry, and I hope the committee can work to enact them.

I would ask Mr. Schwartz and Mr. Callahan to simply summarize what benefit that legislation would bring to the commercial

real estate world.

Mr. Schwartz?

Mr. SCHWARTZ. Yes. Thank you, Senator Salazar. S. 2002 would

have the impact of increasing transaction volume in commercial

real estate. It would lessen the restrictions on REITs, or Real Estate Investment Trusts, on selling assets. As my friend Mr. Callahan mentioned, in mark to market issues, particularly in CMBS

and in all valuation, it is an issue today within the financial sector.

So, increasing the transaction volume in the commercial real estate market will create standards that appraisers and the market

can work from, and with that, increase liquidity, which will increase transparency throughout the market. It also allows REITs

to use a measurement of either book value, which is the current

standard, or alternatively fair market value, in setting the threshold of what they can sell each year. Obviously, the fair market

value is significantly higher than book value. Book value has depreciation and looks at historical values. This helps, again, increase

transaction volume.

S. 2002 is really a clean-up bill. The bill will make slight modifications in the REIT rules that are necessary after REITs have

evolved over the last 48 years, clean up some items, and also allow

us to do things within Taxable REIT Subsidiaries, which are full

taxpaying entities. This last change will also increase transactions

and increase liquidity within the market. So, although this bill is

a part of the solution, it is not the solution by itself but represents

a step in the right direction. I see no negative consequences to it

19

whatsoever, just positive consequences, such as increasing liquidity

and transparency in the markets.

Senator SALAZAR. So it is one of those measured steps that you

believe we should take.

Mr. Callahan?

Mr. CALLAHAN. Well, I am currently here today testifying on behalf of the Real Estate Round Table, and I am currently on the private side. But from my past experience with regards to being CEO

of two public companies, I think that it just a continuation of addressing the modernization of REITs and the impact that they have

generally on the economy. This has become a growing part of the

real estate business from somewhat a standing start in the early

1990s. So, I think it is very productive in that way.

I think, as Jeff mentioned, the fact that these entities, as well

as those that are not overly leveraged, are those that will really for

the most part be able to make transactions happen, that will give

us the data, that will allow the market to clear.

I think the clearing of the market, the establishing of those data

points, are the most critical elements now for banks so that the

true mark to market can be determined and we just do not have

the continued downward spiral on fear as opposed to the reality of

what pricing may be in the marketplace. So, I would say it is positive in that respect for that question.

Senator SALAZAR. I appreciate that very much. Just in closing,

my fear is we have a problem in terms of housing and liquidity

there, that we do not have that cancer, if you will, that we now are

trying to deal with, spread over to other areas of the real estate

industry. My hope is that S. 2002 will help us do that.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you.

Next is Senator Smith.

Senator SMITH. Thank you, Mr. Chairman.

Dr. Lindsey, Dr. Seiders, one of you, in your testimony, indicated

there is a school of thought out there that we should just let this

market work and hit bottom, and I believe the point would be that

that would allow the market to work itself out faster, and that anything we do would just simply delay where it inevitably will go

anyway.

Dr. SEIDERS. I think that was certainly the implication of my remarks. I think if you look at what is happening, one of the hallmarks, if not the key, of this astounding housing down-swing is

falling house prices. We have never seen anything like this before,

except perhaps in the Great Depression. I presume it was there.

We do not really have the documentation for that peiod.

This really is the biggest problem in the financial markets, because, the more that house prices erode, the more the quality of the

mortgage debt out there goes down and the more fearful financial

market participants become in general about, where is all that

stuff? We talk about the slicing, dicing, and the tranching, and so

forth. It is in the Collateralized Debt Obligations, it is in the Structured Investment Vehicles, it is in hedge funds, and so forth. The

reason the markets have frozen up is because nobody knows exactly what they have or what the prospective quality is.

20

I think to just allow the prices to go down fast is the wrong path

to take. By the way, in the fourth quarter of last year the rate of

decline in house price depreciation accelerated dramatically. Toward the end of the year, the annualized rate of decline in house

values was about 20 percent. This is a frightening development. I

think if there is any way to slow that down and let the adjustment

process work its way out over a longer period of time, I think that

is highly advisable in this environment.

Senator SMITH. By the way, I do agree with you, but I think

what I am asking is, is this not really just at its most basic economic root a supply and demand problem?

Dr. SEIDERS. It certainly is gross over-supply.

Senator SMITH. Yes.

Dr. SEIDERS. There are a number of reasons for that, back in the

housing boom. Yes.

Senator SMITH. Well, I, for one, do support doing something. In

fact, Senator Kerry and I introduced in the stimulus package a provision—an amendment that I think was a gross oversight in not

being included in the final package—allowing temporary expansion

of Mortgage Revenue Bonds to include some of these distressed or

at-risk subprime mortgages so people can work out instead of looking for a bail out. But I do think we need to do that much. I guess

I am trying to get a handle on what we ought to be doing that

would be helpful but will not disrupt the immutable cycles of supply and demand.

Dr. SEIDERS. Well, first of all, I really do think that a temporary

home buyer tax credit is a good idea—and I think some of the potential problems that Larry Lindsey pointed out are easily avoided

in the structure of the credit. To get some of the excess supply off

the market quickly will really be a key factor in helping to stabilize

house prices. I think that is the absolute key to the evolution of the

economy and the financial markets generally, not just in the mortgage area.

Senator SMITH. And is that going to restore the trust that you

all indicate is lacking in financial markets?

Dr. SEIDERS. You stop those house prices from falling right away,

you remove some of the fear.

Senator SMITH. All right.

Dr. Lindsey?

Dr. LINDSEY. I support market mechanisms, but sometimes there

are feedback loops within markets. That is where our problem is

now. The lack of trust that was mentioned in the mortgage market

started this process. When you cannot get a mortgage, a tax credit

is not going to do you any good. You have to get the mortgage funding flowing again. I think the key there is, again, to build some

kind of confidence in the way the mortgage bonds, the mortgage securities are evaluated.

So while we certainly would want markets to adjust, the reason

the house prices are falling is the lack of mortgage money. That is

the market that is broken, and that is the market that you should

look to repair.

Dr. SEIDERS. We are not excluding, by the way, policies on the

mortgage market. We just did not bring them up here because this

is a tax committee. We are talking about expansion of the FHA

21

program, expansion of what the GSEs will be doing, Fannie Mae

and Freddie Mac. These are both either full faith and credit or a

strongly implied Federal guarantee.

Those securities, both the Ginnie Mae securities and the mortgage-backed securities of Fannie Mae and Freddie Mac, are working. Spreads have widened out to some degree on the GSE side, but

those markets are working, and will work unless the government

forsakes Fannie and Freddie, and they are certainly not going to

do that.

Senator SMITH. Well, I just would make the closing comment,

Mr. Chairman, that I am not in the housing business, but I have

been in the food business. When we over-plant peas one year and

all of our competitors do and there is a glut on the market, the

price really falls. The next year it is really hard to get credit to

plant the same amount the next year. I think those fundamentals

are still in play.

But having said that, markets are forces that we cannot ultimately control by government unless we are willing to take over a

market, and I am not. I am willing, though, to help to try to underpin this in ways that are responsible, these loops of information

you talk about, Dr. Lindsey. I am prepared to do something, but

I do not think we should lose sight of the fact that this is a free

market, and it is working right now because there is a glut and

over-supply.

The CHAIRMAN. Thank you, Senator.

Senator Kerry?

Senator KERRY. Thank you, Mr. Chairman.

Gentlemen, thanks for being here. I agree with Senator Smith,

that obviously you do not want to take over a market. The market

is usually best left to its own devices. But as we all know, government plays a critical role with respect to the impact on the market

and the judgment that it makes, whether it is through Fed rates—

that is government. The government decides to set the Fed rate

and that has an impact. Regulatory oversight has an impact. All

kinds of things have an impact.

It seems to me pretty clear that when you have a major move,

as we have had in the market the way we have seen this decline

in prices and the foreclosure crisis growing—there is an article in

the Boston newspapers today that the mayor of Boston is super

concerned.

I have been talking with mayors all over our State, meeting with

them: 400 foreclosures in the city of Brockton, 400 more coming,

600 in Boston. This is big stuff. It rips apart the community. Your

7–11 and convenience store gets hurt. Your gas station gets hurt.

Your tax base disappears. You have to lay off police, fire fighters.

Then it goes spiraling downwards. So it seems to me clear that government has the capacity here to be able to change the mood as

well as to provide some incentives that make a difference.

Now, a number of questions. One, on this Mortgage Revenue

Bond that Senator Smith and I are advocating, it seems to me that

it makes sense, if you have somebody who can afford a fixed rate

at 5 percent but they cannot afford when the ARM starts kicking

in and it goes up and suddenly they are going to face a foreclosure,

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we are better off keeping that person in their home, are we not,

and negotiating a fixed rate? Do you want to comment on that?

Dr. LINDSEY. I would certainly agree with that.

Senator KERRY. So, if that is true, you have to have the ability

to do that, which means increasing the availability of the Mortgage

Revenue Bond so that—I know Dr. Lindsey commented that perhaps there had been some fraud at the local and State government

level.

I want to make it clear, I do not think in that program—that is

an empowerment of the local community to say, here we have increased capacity to renegotiate with you on your home, avoid having you thrown out, and put a stop measure in place on these foreclosures. That makes sense, does it not?

Dr. SEIDERS. It does to me.

Senator KERRY. What would the impact be in terms of stimulus?

Dr. SEIDERS. Well, I think you are talking about just one of the

factors that can help to limit the foreclosures, but also to stimulate

buying by first-time home buyers, primarily. That is what the

Mortgage Revenue Bond program is for. Again, it is a way to help

to whittle down the excess inventories and to help to stabilize the

price side.

Senator KERRY. To what degree—and I would like each of you to

comment on this—is this market readjustment, the depreciation in

the value of homes, a reflection of perhaps an over-valuation that

came about as a consequences of a balloon, in effect, as a result of

these subprimes being put out at a market that was not realistic?

I mean, not unlike other bubbles we have had in technology and

elsewhere where there is an irrational exuberance, is it fair to say

there might have been irrational exuberance in the real estate

market and we are now adjusting the way we ought to be?

Dr. SEIDERS. There definitely was a run-up in house prices, both

nominal and real, that really did get out of bounds. I think the

massive deterioration of mortgage lending standards, not just in

subprime, but we now know in other parts of the mortgage market

as well, fueled the demand that pushed the prices up. The price appreciation pulled in hordes of investors and speculators on top of

everything else and pushed the boom even further. So we know

that we had an unsustainable housing boom in 2003, 2004, and

2005, both in volume terms, and particularly in price terms.

Senator KERRY. I was hearing stories of people, as I travel

around the country, down in Florida and elsewhere, folks who have

never been in the real estate industry were flipping apartments,

buying them and taking on mortgages. It became almost sort of an

investment game. So some of this adjustment, I assume, is good.

Obviously foreclosing on people who want to stay in their homes is

not, but some of it is appropriate to the market, is it not?

Dr. SEIDERS. No question about that. Over the longer term, we

will be moving toward a more sensible, defensible system and so

forth on the mortgage side. The problem is the immediate timeframe and the big risk to the economy and to the financial markets

of further damage from further large declines in house prices.

I mean, more and more analysts are viewing the house price decline as just an uncontrollable, bottomless pit. The investment community gets wind of that, what do you really want to buy? Is there

23

any mortgage paper in this investment I am thinking about? So it

freezes the system up.

Senator KERRY. Well, Dr. Lindsey, you may want to comment on

this also. While the Fed rate and interest have gone down, the discount window has not changed. Is that not accurate? And does that

not contribute somewhat to the illiquidity issue?

Dr. LINDSEY. Well, the Fed has lowered the discount rate in concert with its reduction in the Fed funds rate, and they have instituted this new term, ‘‘auction facility,’’ as a supplement. I think the

Fed is doing a good job. I had the privilege of working with you

back in 1992 when we had some problems in the last S&L crisis

in Massachusetts.

Senator KERRY. Right.

Dr. LINDSEY. I think, with regard to Mortgage Revenue Bonds,

I think that they can be viewed as a partial solution. But given the

magnitude of what is involved, I think the better focus is on opening up the mortgage market to new suppliers of credit and reestablishing new suppliers of credit. Unless we do that, we are not going

to be able to stabilize house prices.

Senator KERRY. Well, that is interesting. I do not disagree completely. How would we do that, though? Obviously we ought to take

whatever measures are available, in my judgment, and it ought to

be cumulative. But when you say opening it up to other entities,

shape that a little bit.

Dr. LINDSEY. The biggest problem that we have is that no one

trusts the securitization process any more.

Senator KERRY. Right.

Dr. LINDSEY. And one thing that I suggested was that the Federal Government could certify a mortgage-backed security, not that

it would not default, not that any one mortgage in it was bad, but

that at least the mortgages within the security met the standards

that were advertised. This is not a rating of it. It just says everyone in there put 10 percent down, everyone in there has a loan-tovalue ratio of X, et cetera. That is what is lacking right now. I

think that would be a big step toward encouraging people around

the world to buy our mortgage paper, to step up and buy it.

Senator KERRY. I think that is accurate. I have heard from a lot

of people in financial services that there is a lot of paper out there

now people are trying to push, and one of the things that is creating this uncertainty is that a lot of people are holding paper and

they do not know what is in it. A lot of portfolios people are not

sure whether it is at risk or not at risk because people do not really

know what it is.

The CHAIRMAN. Can I ask a question along that same line here?

So much of this is lack of trust among banks, securitization, rating

agencies, and so forth. Just, how do we get at solving that? In the

old days, I am told, in the Asian financial crisis, Chairman Greenspan and Secretary Summers—I do not know who was then the

head of the Fed in New York—could just get together, get the

bankers in the room and make telephone calls around the world

and kind of put confidence back together again and get things sort

of stabilized. At least, that is the myth. I remember that photograph on the cover of Time magazine. There was Greenspan, Summers and Rubin, the big saviors.

24

What I hear today is, the world has changed so much. There are

just so many different players. It is globalization with pension

funds and private equity. There is just so much out there, you cannot get everybody in the same room. They say, all right, disclose,

guys, what is on your balance sheets. Where are you? How do we

work this out with these rating agencies? How do we find the capital to give you a little confidence with your bank, et cetera. So how

do you get confidence back in securitization? How do you get confidence back among the banks? How do we do that?

Dr. SEIDERS. Mr. Chairman, if I might, I think the breakdown of

the securities markets, mortgage and others, really are of the fully

private markets. There was tremendous development there during

the boom periods. I believe there is trust in government-related securities and in housing.

The CHAIRMAN. That is government-related.

Dr. SEIDERS. Well, yes, but they are already there. We are talking about the FHA and VA programs, securitized through Ginnie

Mae, full faith and credit, gilt-edged. We are talking about Fannie

Mae and Freddie Mac buying mortgages, packaging them up, selling them into the securities market. These are all still very well

regarded.

The CHAIRMAN. The other securitization is falling apart.

Dr. SEIDERS. That is correct. Because of that, we are going to be

seeing more out of Fannie Mae, Freddie Mac, and FHA, and also

more lending back to the depositories.

The CHAIRMAN. How do you get the banks to trust? How do you

loosen up credit here?

Dr. SEIDERS. One of the things on the bank side, by the way,

which is going gangbusters, is the third housing GSE, the Federal

Home Bank System, which has been lending billions and billions

of dollars to the depositories, the member banks, and thrifts, which

can then be used for lending into the market—primarily into housing, since the loans or the advances from the Federal Home Loan

Banks have to be collateralized by certain things, and mortgages

are key.

The CHAIRMAN. Dr. Lindsey, your view?

Dr. LINDSEY. Yes. Two thoughts on that, Senator. The first, with

regard to, could you just call the people into the room, I think the

real reason we cannot do that today is transparency. The problem

is, the TV cameras would probably have to be in the room as well.

You cannot have a transparent society and have three people make

all the calls and fix the banking problem.

The CHAIRMAN. We will all just get on a conference call. [Laughter.]

Dr. LINDSEY. And make sure there are no leaks. I mean, what

we have moved to, and I think it is not a perfect change, but I do

think we have a more transparent world, and I think we have to

live with that world. That is one reason why it cannot be fixed the

way it was in the past.

The CHAIRMAN. But how do we fix it?

Dr. LINDSEY. Well, again, I think the government does have a

role. My second point was, on Fannie and Freddie, the main thing

that Fannie and Freddie do is provide a certification that all the

mortgages in the pools that they are putting out meet certain

25

standards. Fannie and Freddie require that you put 20 percent

down on the house. They require a check of the loan-to-value ratio,

of the debt-to-income ratio.

Now, I think we need a greater variety of standards than what

Fannie and Freddie offer, and that is why I am suggesting that we

trust the private marketplace. But the government has to say that

the standards are being met in the private marketplace. No one is

going to trust the letters AAA any more, but they will trust someone who says, yes, we have audited this mortgage-backed security

and they all have a certain amount of——

The CHAIRMAN. Maybe I am wrong. I am hearing you saying, basically pay less attention to the big banks, the Citigroups and all

that, let them work that out, but focus more on Fannie, Freddie,

and so forth. Is that correct?

Dr. LINDSEY. Yes. And we need not to put too much burden on

the existing institutions. We need to create more institutions. We

need as many credit channels in this society as we can get because

a lot of them are getting clogged. Senator Stabenow, when she was

here, mentioned the problem with auto finance. We have the same

problem there as well. The auto companies could raise money

through industrial loan corporations, but they have been blocked at

the FDIC for various political reasons.

Again, you have every major source of consumer credit gradually

being choked off, and what you have to do is, the Congress should

move to open as many as possible and provide transparent assurances to the investors that the securities they are buying are actually what they are advertised to be.

The CHAIRMAN. Senator Salazar?

Senator SALAZAR. Dr. Seiders, you described in your testimony

and in front of this committee that this is the worst set of conditions you have seen for housing since the Great Depression. You

say there are actions that we ought to take to try to address those

issues. Now, your organization, and through your testimony, you

support some of the ideas that have come out of this committee, including the increase in Mortgage Revenue Bonds, which I support.

Senator Kerry and Senator Smith are carrying that. Net operating

loss carry-back provisions, which Senator Conrad and I have tried

to push through and were supposed to be part of the stimulus

package, we included those in this 2008 Foreclosure Prevention

Act, which will go to the floor hopefully later today or tomorrow.

In addition, there are other things that are included. We are including $200 million for mortgage counseling. There is other money

included in there for community development block grants for communities that are particularly affected. When you look at that legislation that we have brought to the floor, which is essentially the

framework around which we will work to try to address the housing crisis, is that legislation that you support?

Dr. SEIDERS. I would say that we support probably everything in

it except the bankruptcy provision.

Senator SALAZAR. So you would support everything that is in

there except for the bankruptcy provision. Let me ask you on the

bankruptcy provision——

Dr. SEIDERS. Well, the provision that we have a problem with is

allowing the bankruptcy judges to adjust the terms of the mortVerDate 11-MAY-2000 14:30 Mar 15, 2010 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 55139.000 SFIN1 PsN: SFIN1
26

gages, change the interest rates, write down the principal, and so

forth. As Larry Lindsey suggested, I do not think that the securities markets need another massive uncertainty dropped on them.

I think that the efforts that are currently under way, like the

Hope Now program, should be given a chance to work. These

proactive attempts to try to go out there and work out a lot of these

potential problem mortgages, to head off foreclosures, and so forth

and so on, are a process that seems to have momentum.

Senator SALAZAR. Let me ask you this. I appreciate the fact that

we are trying to deal with a complex issue to deal with, as you

called it, the greatest pain since the Great Depression in housing.

It seems to me that on the bankruptcy issue, at least in the conversations that we have been having, that we put some tight rails

around those bankruptcy provisions so that you require the showing of need before you have the bankruptcy relief, and you also

limit it to only a certain group of homeowners, those homeowners

already in foreclosure. We are going to try to limit it, in a way, so

it does not have the kind of impact or parade of horribles that I

think some have been trotting out.

My question, I guess, is whether or not you think that we could

put the kinds of limitations around access to the bankruptcy courts

for homeowners who are in their foreclosure that would actually

make that work. My thought has been that, if bankruptcy is in fact

an option, that you might be able to induce, incentivize homeowners, as well as the lending institutions, to get together and to

reach agreements on the modifications of loans, which is essentially

much of what we are trying to do with other aspects of the legislation.

Dr. SEIDERS. Well, I am sure we could go back and re-look at

some of the details with some of these points that you have made.

Senator SALAZAR. And Dr. Lindsey, do you have a comment overall in terms of what we have included in this legislation? Obviously

there will be a number of different amendments that we will forward, but what is your view of the legislation? Is it the pill that

we need to cure the sickness here?

Dr. LINDSEY. Senator, if you are trying to encourage new money

to flow into the mortgage market, you do not want to establish a

precedent where you change the terms retroactively on deals that

have already been made. Is it theoretically possible that you could

wall things off? I am sure it is. But you will be sending the signal

to every major investor around the world, sovereign wealth funds,

pension funds, insurance companies that buy mortgage securities,

that the Congress of the United States can change the contract

that you have just signed, and will because of political reasons.

When other countries do that to our firms, we get upset. We do

not invest in Venezuela, for example, when they do things like

that. For us to do the same thing here just is not a positive step

forward. So I would urge you not to have that provision in the bill.

You are sending the signal——

Senator SALAZAR. Let me ask you just one question on that, Dr.

Lindsey. And I am not an expert on the bankruptcy code or the

bankruptcy law here, but it seems to me if I have a vacation home

or I have a yacht, I could access the bankruptcy court to discharge

27

the debt with respect to those homes. We put limitations on accessing the bankruptcy court with respect to our primary residences.

Now, it just strikes me, looking at it from a layperson’s perspective here, that there is an inequity there that somehow we might

address in the context of dealing with this issue, if we could put

some rails around it so it is not something that is going to be taken

advantage of by people who simply want to walk away from their

debt.

Dr. LINDSEY. Well, what happens, most bankruptcy law is statebased law. Usually there is a difference between recourse states

and non-recourse states. Basically you can either go after the collateral or you can go after the person. That is kind of the way it

works. What you would be doing is, you would be breaking that—

in general, nobody goes after the person. All that is left is the collateral. I think you would be making a change with regard to housing bankruptcy provisions that would not be sending a helpful signal.

Senator SALAZAR. Let me just make a concluding comment on

that. That is that this is going to be the housing deal that we are

going to try to move forward with in this Senate. Obviously it will

be improved with significant amendments that I am talking about,

and some of my colleagues are talking about as well. This issue on

the bankruptcy provision. If you all have some thoughts on how we

can deal with that in a way that does not create the kinds of consequences you are talking about, I would like to hear more about

that.

Mr. Chairman, I really want to thank you for holding this hearing, because it is not only about housing, it is also about the real

estate market and what is happening in the commercial real estate

world. So, thank you very much.

The CHAIRMAN. Thank you, Senator.

Following on a bit, what is the genesis of that provision in the

bankruptcy code that prevents a bankruptcy judge from discharging or modifying the terms of the debt in your home, mortgage in your home, as opposed to yachts and other loans and so

forth? What is the origin, what is the genesis, what is the rationale? Does anybody know?

Dr. LINDSEY. I do not. I imagine it goes back to the original idea

of—I am sure, in order to encourage money to flow into housing at

some point along the way, Congress thought that was the best way

to do it. It goes to the principle that everyone here has talked

about, and it is the principle of unintended consequences. I think

foreclosure is a terrible thing to have happen. I understand the

human and political element involved, but that is why——

The CHAIRMAN. That raises another question that probably

comes to the mind of some. We have a lot of incentives in American

law to promote housing. I mean, mortgage interest deduction, the

exclusion of the sale of a home, property deduction, State and local

tax deductions, plus this, perhaps. How far do we go here? Some

are suggesting, as you are, Dr. Seiders, still another. You have suggested some more, Dr. Lindsey, to draw the lines on the proposed

standard deduction. I mean, when one takes standard deduction, I

know some of you think those should be temporary, but temporary

is a fleeting concept around here. What do you think?

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Dr. SEIDERS. It is very easy to make a home buyer tax credit

very temporary, and we would not recommend that as an enduring

policy.

The CHAIRMAN. Well, it can be enacted temporarily, but you

know about our so-called extenders. I mean, they want to be extended. People pressure to extend them, that kind of thing.

Well, this has been very helpful. Thank you very much for your

contributions. I mean it, it has been very helpful.

The hearing is adjourned.

[Whereupon, at 11:42 a.m., the hearing was concluded.]

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