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TRANSPARENCY AS AN ALTERNATIVE TO RISK

RETENTION

HEARING

BEFORE THE

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES

AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

OF THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

MAY 11, 2011

Serial No. 112–37

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.fdsys.gov

http://www.house.gov/reform

(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

DARRELL E. ISSA, California, Chairman

DAN BURTON, Indiana

JOHN L. MICA, Florida

TODD RUSSELL PLATTS, Pennsylvania

MICHAEL R. TURNER, Ohio

PATRICK T. MCHENRY, North Carolina

JIM JORDAN, Ohio

JASON CHAFFETZ, Utah

CONNIE MACK, Florida

TIM WALBERG, Michigan

JAMES LANKFORD, Oklahoma

JUSTIN AMASH, Michigan

ANN MARIE BUERKLE, New York

PAUL A. GOSAR, Arizona

RAU ́ L R. LABRADOR, Idaho

PATRICK MEEHAN, Pennsylvania

SCOTT DESJARLAIS, Tennessee

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

FRANK C. GUINTA, New Hampshire

BLAKE FARENTHOLD, Texas

MIKE KELLY, Pennsylvania

ELIJAH E. CUMMINGS, Maryland, Ranking

Minority Member

EDOLPHUS TOWNS, New York

CAROLYN B. MALONEY, New York

ELEANOR HOLMES NORTON, District of

Columbia

DENNIS J. KUCINICH, Ohio

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

STEPHEN F. LYNCH, Massachusetts

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

MIKE QUIGLEY, Illinois

DANNY K. DAVIS, Illinois

BRUCE L. BRALEY, Iowa

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

CHRISTOPHER S. MURPHY, Connecticut

JACKIE SPEIER, California

LAWRENCE J. BRADY, Staff Director

JOHN D. CUADERES, Deputy Staff Director

ROBERT BORDEN, General Counsel

LINDA A. GOOD, Chief Clerk

DAVID RAPALLO, Minority Staff Director

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND BAILOUTS OF PUBLIC AND

PRIVATE PROGRAMS

PATRICK T. MCHENRY, North Carolina, Chairman

FRANK C. GUINTA, New Hampshire, Vice

Chairman

ANN MARIE BUERKLE, New York

JUSTIN AMASH, Michigan

PATRICK MEEHAN, Pennsylvania

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

MIKE QUIGLEY, Illinois, Ranking Minority

Member

CAROLYN B. MALONEY, New York

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

JACKIE SPEIER, California

JIM COOPER, Tennessee

(III)

C O N T E N T S

Page

Hearing held on May 11, 2011 ............................................................................... 1

Statement of:

DeMarco, Edward, acting director, Federal Housing Finance Agency; Anthony B. Sanders, distinguished professor of real estate finance, School

of Management, George Mason University; Joshua Rosner, manager

director, Graham Fisher & Co. Inc.; and Janneke Ratcliffe, executive

director, Center for Community Capital, University of North Carolina

at Chapel Hill ................................................................................................ 4

DeMarco, Edward ...................................................................................... 4

Ratcliffe, Janneke ...................................................................................... 29

Rosner, Joshua .......................................................................................... 20

Sanders, Anthony B. ................................................................................. 14

Letters, statements, etc., submitted for the record by:

DeMarco, Edward, acting director, Federal Housing Finance Agency, prepared statement of ........................................................................................ 6

Ratcliffe, Janneke, executive director, Center for Community Capital,

University of North Carolina at Chapel Hill, prepared statement of ....... 31

Rosner, Joshua, manager director, Graham Fisher & Co. Inc., prepared

statement of ................................................................................................... 22

Sanders, Anthony B., distinguished professor of real estate finance,

School of Management, George Mason University, prepared statement

of ..................................................................................................................... 16

(1)

TRANSPARENCY AS AN ALTERNATIVE TO

RISK RETENTION

WEDNESDAY, MAY 11, 2011

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND

BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS,

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM,

Washington, DC.

The subcommittee met, pursuant to notice, at 3:22 p.m., in room

2154, Rayburn House Office Building, Hon. Patrick T. McHenry

(chairman of the subcommittee) presiding.

Present: Representatives McHenry, Guinta, Amash, Quigley,

Maloney and Speier.

Also present: Representatives Issa and Cummings.

Staff present: John Cuaderes, deputy staff director; Tyler Grimm

and Ryan M. Hambleton, professional staff members; Peter Haller,

senior counsel; Christopher Hixon, deputy chief counsel, oversight;

Mark D. Marin, senior professional staff member; Rafael Maryahin,

counsel; Laura L. Rush, deputy chief clerk; Becca Watkins, deputy

press secretary; Peter Warren, policy director; Nadia A. Zahran,

staff assistant; Sean Sullivan, intern; Jaron Bourke, minority director of administration; Jason Powell, minority senior counsel;

Cecelia Thomas, minority counsel/deputy clerk; and Davida Walsh,

minority counsel.

Mr. MCHENRY. The hearing will come to order. Today’s hearing

is entitled Transparency as an Alternative to the Federal Government’s Regulation of Risk. I am Patrick McHenry, the chairman of

the subcommittee. Mr. Quigley, from Illinois, is the ranking member.

Sorry for the lateness of the start of this hearing; we have just

had a significant round of votes on the House floor.

As we begin all hearings in this subcommittee, I feel it is appropriate to read the Oversight and Government Reform’s mission

statement. We exist to secure two fundamental principles: first,

Americans have a right to know that the money Washington takes

from them is well spent and, second, Americans deserve an efficient, effective government that works for them.

Our duty on the Oversight and Government Reform Committee

is to protect these rights. Our solemn responsibility is to hold government accountable to taxpayers, because taxpayers have a right

to know what they get from their government. We will work tirelessly in partnership with citizen watchdogs to deliver the facts to

the American people and bring genuine reform to the Federal buVerDate 17-JUN-2003 12:54 Oct 04, 2011 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\68217.TXT KATIE PsN: KATIE
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reaucracy. This is the mission of the Oversight and Government

Reform Committee.

I now recognize myself for 3 minutes for an opening statement.

Today we examine the rule writing of Section 941 of the DoddFrank Act, which mandates Federal regulators promulgate rules

requiring entities to retain a certain amount of risk on securitized

assets. We will compare the rules of risk retention and its special

exemptions to policies and rules that would ensure adequate transparency and standardization under Section 942 of the Dodd-Frank

Act, which requires the SEC to modify Regulation AB to include

loan level disclosure.

The focus of this comparison is to examine the effect that transparency and risk retention have on the market. Most importantly,

how does each influence the availability and cost of credit to borrowers and small businesses?

As Federal agencies issue rules and announce comment periods,

risk retention has become hotly debated. I appreciate the intention

of requiring a little skin in the game, as we will say, the theory

being that if an issuer retains a piece of the ongoing responsibility

for the loans that they write, they have an incentive to make better

loans and price them appropriately. However, like all government

rules and mandates, there are exemptions provided for certain entities.

To begin with, Dodd-Frank exempts FHA from risk retention requirements. It holds this coveted advantage in the marketplace due

to the full backing of the U.S. taxpayer. However, Dodd-Frank does

not impose restrictions on FHA’s underwriting standards, moving

the agency into a position of accepting lower qualified mortgages,

more or less appearing to defeat the stated intention that this administration has said, to reduce taxpayer exposure to the housing

market.

In addition to exempting FHA, the QRM rulemaking does not

permit private mortgage insurance to compensate for lower down

payments. I have concerns about this. This raises a concern that

we are driving out prudently underwritten low down payment option mortgages particularly for first-time home buyers, which I

think further exacerbates the imbalance between the private market and FHA lending.

Second, Fannie Mae and Freddie Mac are exempted under the

proposed risk retention rule, which runs contrary to the language

laid out in the Dodd-Frank Act. And before anyone forgets Fannie

and Freddie, this exemption appears to go against the administration’s proposal, the broad proposal that they have to reform Fannie

and Freddie and wind down the GSEs.

Third, there is no secret that risk retention favors large, well

capitalized banks, as compared to smaller, less capitalized banks.

Only the largest financial institutions have the balance sheet to retain, for extended periods, the 5 percent of all securitization they

can plead. This leads one to ask the question, How will risk retention rules affect the operations and competitiveness of our community and small banks, and small businesses that access their loans

through those institutions?

In addition, today’s hearing gives us an opportunity to gage the

value of risk retention in loan level disclosures and how governVerDate 17-JUN-2003 12:54 Oct 04, 2011 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\68217.TXT KATIE PsN: KATIE
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ment can push forward policies to open up our capital markets

without opening the flood gates of unintended consequences. One

thing is for certain: our families and businesses cannot afford overreaching government policies that increase the cost of credit and

stifle economic growth. It is an imperative that our rules and regulations enable the market to appropriately price the cost of capital

to our families and small businesses, while recognizing the importance of private capital in the housing sector.

I look forward to our panel’s testimony.

With that, I recognize Mr. Quigley for 4 minutes.

Mr. QUIGLEY. Thank you, Mr. Chairman.

Our priority in the final analysis must be to ensure that the reforms are implemented that would prevent a repeat of the 2008 financial crisis. That crisis sparked the worst economic downturn

since the Great Depression. There can be no financial crisis amnesia when it comes to implementing Dodd-Frank.

One of the chief causes of the meltdown was the originate-to-distribute model of mortgage lending. Through this model,

securitization was used as a means for financial institutions to escape all of the risk associated with the mortgage loans they

underwrote.

On October 23, 2008, former Federal Reserve Chairman Alan

Greenspan explained in testimony before this committee, ‘‘Too

many securitizers and lenders believed they were able to create

and sell mortgage-backed securities so quickly that they never put

their shareholders’ capital at risk and, hence, did not have the incentive to evaluate the credit quality of what they were selling.’’

These practices led to riskier loans and misaligned incentives between lenders, securitizers, and investors in mortgage-backed securities. This originate-to-distribute model has ultimately been cited

as a key driver of the current foreclosure epidemic. That is why a

vital piece of Dodd-Frank Wall Street Reform and Consumer Protection Act is its provision on risk retention, Section 941. By requiring securitizers to have ‘‘skin in the game,’’ we make lenders and

investment banks more accountable for the loans they have made

and facilitated.

The title of this hearing suggests that we should view transparency as an alternative to risk retention. I think there is a likely

wide consensus on both sides of the aisle that increased transparency is a laudable goal. However, I would emphasize that increased transparency must not come at the expense of accountability. The proposed risk retention rule, which so many agencies

worked to generate, puts a measure of accountability into effect.

As the Dodd-Frank Act’s risk retention provisions are implemented, we must ensure that creditworthy families are able to access affordable loans. We must also ensure that the Nation’s 5,000-

plus community banks are not disadvantaged in their ability to

serve their customers.

I look forward to the testimony of our witnesses on these issues

and thank them for being here today.

Mr. MCHENRY. I thank the ranking member for his opening

statement.

With that, let me introduce the panel, and then we will swear

you in.

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We have Mr. Edward DeMarco, the Acting Director of the Federal Housing Finance Agency; we have Dr. Anthony Sanders, professor of finance in the School of Management at George Mason

University; we have Mr. Joshua Rosner, a partner at Graham Fisher & Co.; and we have Ms. Janneke Ratcliffe, the executive director

of the Center for Community Capital at University of North Carolina at Chapel Hill.

With that, it is standard procedure of this committee to swear in

all the witnesses, so if you would please stand and raise your right

hands.

[Witnesses sworn.]

Mr. MCHENRY. Let the record show that all witnesses answered

in the affirmative.

With that, as most of you are familiar, we have this lighting system here in Congress: green, red, and yellow. Look, we are Members of Congress; we need very basic things. So I will recognize you

for 5 minutes, and with 30 seconds remaining you will get the yellow light, which means simply wrap up, and red means stop.

So, with that, Mr. DeMarco, you are recognized for 5 minutes to

give an opening statement.

STATEMENTS OF EDWARD DEMARCO, ACTING DIRECTOR,

FEDERAL HOUSING FINANCE AGENCY; ANTHONY B. SANDERS, DISTINGUISHED PROFESSOR OF REAL ESTATE FINANCE, SCHOOL OF MANAGEMENT, GEORGE MASON UNIVERSITY; JOSHUA ROSNER, MANAGER DIRECTOR, GRAHAM

FISHER & CO. INC.; AND JANNEKE RATCLIFFE, EXECUTIVE

DIRECTOR, CENTER FOR COMMUNITY CAPITAL, UNIVERSITY

OF NORTH CAROLINA AT CHAPEL HILL

STATEMENT OF EDWARD DEMARCO

Mr. DEMARCO. Very good. Thank you, Mr. Chairman.

Chairman McHenry, Ranking Member Quigley, members of the

subcommittee, thank you for this opportunity to testify. The Federal Housing Finance Agency believes that enhancing the quality

and quantity of data available to investors in mortgage-backed securities is an important step to encourage the return of private capital to the mortgage market.

To do so, we need to ensure that those owners with capital have

the data needed to estimate and price mortgage credit and prepayment risk. Such transparency is a critical component of a healthy

and efficient secondary mortgage market, whether or not issuers

retain financial liability for some portion of the credit risk of the

assets they securitize.

Risk retention, meanwhile, is a complementary measure designed to give securitizers an economic stake in the credit performance of the loans, just like investors. Risk retention seeks to protect

investors and reduce information asymmetries by requiring that

issuers of asset-backed securities have a financial stake in the performance of loans underlying a security, or, as it has been said,

skin in the game.

Through risk retention, securitizers will have a disincentive to

acquire poor quality loans for securitization because they will be required to actually hold a portion of the credit risk rather than passVerDate 17-JUN-2003 12:54 Oct 04, 2011 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\68217.TXT KATIE PsN: KATIE
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ing it all on to investors. This exposure to credit risk should, in

turn, make securitizers more careful with the quality of loan originations.

As a result of these improved incentive alignments, investors are

expected to be more willing to provide capital for residential mortgages and other types of loans. This may be an important step in

facilitating the return of private capital to the residential housing

market and other lending markets that benefit from securitization.

Regulators published the proposed rule to implement the risk retention requirements of the Dodd-Frank Act in March. In developing that proposal, the agencies sought to implement the provision as legislated, allowing for a range of securitization structures.

The public comment period on the rule extends until June 10th and

the agencies invited comments on more than 100 different questions.

The MBS disclosures of Fannie Mae and Freddie Mac have expanded over the years to offer more detailed information to investors. Both enterprises provide aggregate pool level information that

in many respects aligns with the Securities and Exchange Commission’s Regulation AB requirements. In addition, Freddie Mac provides some amount of loan level information, and both enterprises

in the past year have enhanced their disclosures on mortgage delinquencies.

Enhancing loan level disclosures on Enterprise MBS both at the

time of origination and throughout a security’s life is on our agenda. I believe that improving Enterprise MBS disclosures over time

will help establish consistency and quality of such data. Moreover,

it will contribute to an environment in which private capital has

the information needed to efficiently measure and price mortgage

credit risk, thereby facilitating the shifting of this risk away from

the government and back into the private sector. This will take

time to accomplish, but this is the direction in which we at FHFA

are heading.

In sum, FHFA views risk retention and enhancing disclosure of

the mortgages backing MBS as complementary reforms. We also

see value in moving the enterprises over time toward the loan level

disclosures that the amendments to Regulation AB proposed by the

SEC would require.

Enhancements of Enterprise MBS disclosures have continued to

occur since they were placed in conservatorship in 2008, and FHFA

will continue down that path. We will also work closely with the

other agencies to review the public comments on the interagency

risk retention rulemaking before releasing a final rule that is consistent with the statutory framework. I believe that we are making

progress on many fronts as Congress is beginning to take up housing finance reform.

Thank you for this opportunity, and I would be pleased to answer

questions.

[The prepared statement of Mr. DeMarco follows:]

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Mr. MCHENRY. Thank you.

Dr. Sanders.

STATEMENT OF ANTHONY B. SANDERS

Mr. SANDERS. Chairman McHenry, Ranking Member Quigley,

and distinguished members of the subcommittee, thank you for inviting me to testify today.

Dodd-Frank requires that securitizers retain at least 5 percent of

the risk in all loans that do not qualify as a qualified residential

mortgage and are sold in the securitization market. In theory, 5

percent risk retention would lead securitizers to be more careful in

the loan origination underwriting process.

To be sure, 5 percent retention would be the simplest approach

to implement to encourage approved loan origination underwriting

but, unfortunately, risk retention appears to be the least useful approach. There are four points that I would like to make.

First, the house price collapse that resulted in house price declines that far exceed 5 percent, for example, Las Vegas fell 56 percent from peak to trough. Five percent would have been blown

through very quickly.

Second, risk retention does not directly address origination risk.

Representations and warrants that are found in mortgage loan purchase agreements and related documents directly address origination risk. The avalanche of loan repurchase requests in the aftermath of the housing collapse makes reps and warnings less viable

for non-agency-backed securities.

Third, the FHA, Fannie Mae, and Freddie Mac are exempt from

the risk retention rules. Exempting these players from the mortgage market defeats the spirit of the risk retention since the loan

originator would be tempted to sell or be insured by Fannie,

Freddie and the FHA, rather than keep the retained risk.

Fourth, given Reg. AB, Dodd-Frank 942, and the anticipated

transparency of the ABS markets, the retention rule implies that

qualified institutional investors are not sophisticated enough to understand origination risks and need to be protected beyond greater

transparency. Fannie, Freddie, and others do not require additional

security of 5 percent risk retention since they perform substantial

due diligence and analysis before purchasing securities. And also

securitizers can hedge the risks of risk retention and typically, in

industry experience, they oftentimes keep the piece 5 percent risk

retention anyway.

In summary, it is unclear how risk retention will be implemented, vertical versus horizontal versus L cuts, and even if it is

effective in reducing origination risk.

There are more effective alternatives to risk retention: transparency and improved representations and warranties.

One solution to origination risk is to provide greater transparency to investors. Transparency would permit more accurate

pricing. Greater transparency potentially reduces the asymmetric

information between securitizers and investors.

There has already been a movement in the industry toward this.

Prospectuses and prospectus supplements promote both agency and

non-agency MBS, provide detailed breakdowns of underlying loans

in terms of critical risk measures such as loan-to-value ratio, loan

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type, and credit score. Freddie Mac has taken loan transparency to

a new level in 2006 by providing a file of loan level information.

The non-agency market, as well as the FHA, could provide similar

loan level disclosure.

I would prefer that securitizers provide transparency themselves,

rather than be forced through regulation, however. Some investors

may prefer having less information disclosed, which would result in

higher expected yields, compared to fully disclosed loan information. Investors should retain the right to choose how much information and what they want disclosed by securitizers.

But additional loan disclosures is one prong of the approach to

improving loan quality. The other is to enact a securitization certificate approach to reducing securitization risk. Even though

securitizers could release great loan level information, the market

would still be concerned that the information is inaccurate. There

should be mechanisms to ensure that the disclosed information is

actually correct.

The securitization origination certificate approach has the potential to be effective because it directly addresses origination risk and

contains a fraud penalty. The certificate would travel with the loan

and would verify that the loan was originated in accordance with

the law and that the underwriting data was accurate and that the

loan met all the required underwriting requirements.

The certificate would be backed by a guarantee from the originating firm and demonstrate that they had financial viability. The

seller must provide means of demonstrating financial responsibility, either capital or insurance, for the loans to be put in a

securitization. There should be a penalty for violations of reputations and warranties beyond repurchase obligations and tracking of

violations of representations and warranties available to all investors.

Thank you again for the opportunity to testify. I look forward to

your questions.

[The prepared statement of Mr. Sanders follows:]

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Mr. MCHENRY. Thank you, Dr. Sanders.

Mr. Rosner.

STATEMENT OF JOSHUA ROSNER

Mr. ROSNER. Thank you, Chairman McHenry, Ranking Member

Quigley, and members of the subcommittee, for inviting me to testify on this important issue.

Current problems in the economy stemming from opacity and information asymmetry of the asset-backed market are not addressed

by the Dodd-Frank risk retention rule. While the rule is well intentioned, it is also misguided. Dodd-Frank reasons that if lenders and

issuers retain some financial liability for the underlying loans they

sell, they will have a greater incentive to make better loans and

securities.

On the surface this appears to make sense. If a lender or

securitizer knows he will have to drink some of the poison he offers

to others, then he would think twice about creating the potion. But

as we saw in the past crisis, the banks in direst need for direct government support found themselves in that predicament precisely

because they had swallowed large portions of the poison they had

sold to others. Bear Stearns and Merrill Lynch didn’t even have

operational controls, available information, or an ability to fully

model their exposures.

As we have seen, even with a 5 percent risk retention of each

structure, different structures of similar underlying collateral remain highly correlated. Thus, if securitization returns and grows,

risk retention will create a future systemic risk of already too big

to fail firms transferring those risks to the taxpayer.

A better solution is to create industry standards of useful and

timely disclosures of loan level collateral information so parties to

securitization could analyze the assets’ underlying pools. Even after

the disaster, information asymmetry between buyer and seller remains the standards. I advocate reconsideration of the risk retention rule, but doing so without first addressing the dangerous opacity that remain in the market would only increase risks. This is especially so given that legislators have already reduced information

available to investors through elimination of the Reg. FD exemption for rating agencies.

Currently, with no pre-issuance road show period during which

investors have the ability to analyze a deal and its underlying collateral, the primary market for securitizations is different from the

equity markets. Deals usually came to market before a collateral

pool was even complete, forcing investors to rely on rating agencies’

pre-issuance circulars. These tools have proven laughably inadequate.

Instead, data on specific underlying collateral in each pool should

be made available for a reasonable period before a deal is sold and

brought to market. Such a requirement would enhance investor

due diligence, foster the development of independent analytical

data providers, and reduce reliance on rating agencies. Capital and

markets would be less volatile if investors could fully model the expected performance of underlying loan level collateral and regularly

reassess their deviance from expectations.

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Uniformity in contract is also required. PSAs and reps and warrants define features like rights to put back loans with underwriting flaws, responsibility of servicers and trustees, and the relationship between different tranches. They can be several hundred

pages long. Key terms defining contractual obligations can differ

significantly, and they are not standardized across the industry,

across securities with the same type of collateral, or even by issuer.

It was not until the crisis that investors considered this lack of

standardization. Thus, when panic set in and investors began to

question the value of their securities, they knew that they didn’t

have time to read all the different several hundred page deal agreements, reinforcing the run on the market which caused securities

values to fall further than fundamentals justified.

Legislation should create both servicing standards and a single

standardized PSA governing each collateral asset class with investor and public interest at core. Standards must also focus on addressing a lack of clear definitions in securitization markets. Without a common language, the value of data is diminished. Conversely, if everyone is using the same common language, then it becomes very hard to game the system.

Amazingly, 3 years after the crisis, there is still no single standard accounting or legal definition of either delinquency or default.

Currently, delinquency can be determined either on a contractual

or recency of payment basis. Even among firms that would define

it identically, each servicing agreement can have different interpretations of delinquency reporting. Some may report advances that a

servicer makes to a pool, which could be applied to reduced stated

delinquencies; others servicers may not. The wild west mentality in

securitization needs to be replaced with transparency and an agreement on terms and standards.

Thank you.

[The prepared statement of Mr. Rosner follows:]

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Mr. MCHENRY. Thank you, Mr. Rosner.

Ms. Ratcliffe.

STATEMENT OF JANNEKE RATCLIFFE

Ms. RATCLIFFE. Good afternoon, Chairman McHenry, Ranking

Member Quigley, and members of the subcommittee. As mentioned,

I am with the UNC Center for Community Capital. I also serve on

the Mortgage Finance Working Group convened by the Center for

American Progress to offer a plan for responsible housing market

reform. Please note that the views expressed are my own and that

focus on the mortgage market aspects of the questions raised today.

I am honored to be asked to discuss how transparency and accountability can help restore confidence in the once robust U.S.

mortgage system. Confidence in that system was shattered among

investors and borrowers at both ends of the system, and the taxpayers who find themselves propping it up. Only the full faith and

credit of the government has kept the market open and, ultimately,

private capital must bear a greater share of the load.

The crisis was a result of abuses that arose in a regulatory vacuum and a climate of inadequate transparency, lack of accountability, and misaligned interests. The Dodd-Frank Act identifies

key steps toward a market that is safer for investors, taxpayers,

and for borrowers. One of these is transparency. Lack of transparency in the private label market enabled adverse selection and

underpricing of risk because issuers knew more than investors.

Certainly, better loan level information and product standardization will help usher back in the private market. But even with good

loan level data, private market investors will face potential principal-agent problems and conflicts of interest. Nor will this help

borrowers, many of whom took on loans when the true costs and

consequences were masked by complexity.

The system cannot function well unless borrowers’ interests in

repaying their loans and investors’ interests in being repaid are

served by the agents in between them. So risk retention can help

address these principal-agent problems by aligning incentives and

holding issuers more accountable, as Dodd-Frank intends.

While the regulatory proposal largely mirrors this intent, we are

concerned that a too narrow QRM box may discourage private capital participation and possibly disrupt the fragile market. For example, the down payment criteria may put a pro-cyclical damper

on the fragile housing recovery, particularly if mortgage insurance

is not taken into account. That would be a pity, as we have ample

experience about the right way to finance lower down payment

mortgages.

At UNC we study a large pool of mortgages made in the decade

preceding the crisis under affordable housing and CRA programs.

The borrowers had access to prime fixed rate, long-term amortizing

mortgages that they could afford to repay. These households have

experienced low default rates and, on average, meaningful equity

buildup. We found that non-prime loans made to similar borrowers

were several times more likely to have defaulted than those in our

study. Key factors associated with these higher defaults were adjustable rate, broker channel, and prepayment penalty.

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These findings underscore that risk retention should apply to

product and process factors that increase risk, not to characteristics

of borrowers. That said, overall, the risk retention provisions will

certainly improve accountability and, with greater transparency,

should put more natural market imposed limits on the total

amount of risk taken on by the system.

But even transparency, standardization, and risk retention are

not, in and of themselves, enough to return the market to longterm vibrancy and resilience, and attract the amount of private

capital needed. These are just two of the tools needed to rebuild the

market. The system must also provide for broad and constant liquidity for a nearly $11 trillion market, mechanisms that limit volatility, access to affordable and sustainable financing for home

ownership and rental housing, including for underserved segments,

and preservation of the long-term fixed rate mortgage, which provides economic stability at the household and macroeconomic levels.

All this can be achieved with private capital serving the lion’s

share, with the provision of a limited Federal backstop that is highly protected by adequate private capital in the first loss position,

and that is explicit and that is paid for. Such a mechanism will

provide investors the confidence to deliver a reliable supply of capital for both rental and home ownership options every day and in

every community over economic cycles through large and small

lenders, alike.

In summary, restoring confidence in the mortgage market will

require greater transparency and greater accountability, though we

recommend a broader QRM definition than regulators have proposed. However, the ultimate impact of these measures is highly

dependent on the form that the mortgage secondary market takes.

As you move forward in this complex process, it is important to

bring private capital back, it is important to protect the taxpayers,

but it is also important to restore the financial system so that it

works better for the American households who rely on it for economic security. Transparency and confidence throughout the system depends on having informed borrowers who have access to

sound, well underwritten loans.

[The prepared statement of Ms. Ratcliffe follows:]

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Mr. MCHENRY. Thank you, Ms. Ratcliffe. Thank you for your testimony.

I appreciate the whole panel’s testimony.

With that, I am going to recognize the Vice Chair, Mr. Guinta,

of New Hampshire, for 5 minutes for the first round of questions.

Mr. GUINTA. Thank you, Mr. Chairman.

Thank you all for coming and testifying this afternoon.

The first question I would like to throw out to the panel. My

question is simply this: Who is purchasing these mortgage-backed

securities and what level of sophistication do these buyers have?

Then, second, are these the types of buyers that need assurances

through risk retention or is it, in your opinion, that because of

their qualification they don’t need assurances?

We can start with Mr. Rosner.

Mr. ROSNER. The buyers are qualified institutional buyers; they

are sophisticated investors. The very nature of the structure of selling MBS is that you have to sell the equity RMBs tranch before

you can sell the investment grade rated tranches, so typically the

buyer who is the key buyer is the one who is going to do the most

due diligence if the information is available.

Given the ability to look at loan level data before a deal comes

to market, they will therefore be the determinant of price by determining what they perceive as value. I don’t think they need assurances as much as they need clarity of contract and as much as they

need the loan level data probably in preformatted industry standardized format to do that analysis for a period before a deal comes

to market.

Mr. GUINTA. Dr. Sanders.

Mr. SANDERS. Thank you. I agree with what Josh is saying, and

I would say that PIMCO, LAMCO, Fannie, Freddie, and most of

these investors were talking about, the QIBs, are extremely sophisticated investors; they do their homework, due diligence. I agree

with Josh that it would be nice if they could get information on

loan level details ahead of time. In fact, I am surprised they

haven’t been requesting that over time. But if you look at it again,

as I said, pro-supps and prospective supplements issued by various,

they do go into fairly detailed loan level analysis, but it is not as

much as like Freddie gave out on their loan levels, which is what

I would like to see going forward.

Mr. GUINTA. Ms. Ratcliffe, would you agree that they need clarity

of contract rather than the assurances?

Ms. RATCLIFFE. I think that they are both important. There was

not as much loan level data information, and clearly having that

available to the investors should help their ability to assess the

risk, there is no question of that. I still think that doesn’t take care

of all the principal-agent problems that might arise. There could

still, of course, be misrepresentation; there could still be adverse

selection. And even with full data, a lot of the complicated models

were used; people were not necessarily coming up with the right

answers. So I think there are a lot of different risks inherent in the

system, and each of these solutions we propose addresses a different set of issues, so I am not sure it is an either/or.

Mr. GUINTA. Mr. DeMarco.

40

Mr. DEMARCO. I would only add to what the panelists have said

is that when we think about the holders or investors in mortgagebacked securities, probably important, we want to know who they

are and how they are responding to these things to distinguish between those that are investing in private label mortgage-backed securities for which the credit risk is managed through the

securitization structure and each of the investors, no matter where

they are in that structure, understand they are undertaking credit

risk; and those that are investing in Ginnie Mae mortgage-backed

securities or now with Fannie and Freddie in conservatorship and

operating with the backstop of the Treasury Department, the sense

of government support, the credit analysis and the credit review of

the investors and also what they are looking for in security is clearly going to be different for some of those investors relative to investors in private label mortgage-backed securities.

Mr. GUINTA. Ms. Ratcliffe, I want to go back to something that

you mentioned. You said that only really essentially solves part of

the problem relative to misrepresentations. Don’t we have other

laws, though, on the books now that are sufficient relative to misrepresentation?

Ms. RATCLIFFE. I think it is a matter of the processes and tools

that are available, the remedies that are available to the investors.

I think we had some proposals made here that would again address

some of those a little better, I think.

I guess, while I have the mic, I might also add that the investors

who are making these investments today in the private market, not

in the Fannie-Freddie securities, they are a very small universe of

investors right now who are undertaking actually extensive and

lengthy due diligence. So if what you are talking about instead is

a situation where private investors could return in large scale, it

would probably be a very different scenario.

Mr. GUINTA. And then I only have a few seconds left, but to Mr.

Rosner, can you just talk very quickly about the unintended consequences that you see in risk retention?

Mr. ROSNER. Well, again, the assumption in the risk retention

rule is that the banks acted, the issuers acted maliciously in all circumstances and that forcing them to retain risk would solve for

that. Quite often what we have found is that they made assumptions based on models which proved to be deeply flawed and historic assumptions that proved to be inaccurate and retained risks

themselves. Forcing them to retain risks and creating a system

where everyone is mismodeling the same problem, the same collateral at the same time will risk creating a situation where the correlation ends up demonstrating again to cause a systemic crisis as

it did, and that would be better to have those risks dispersed in

the hands of investors rather than concentrated back in our depository institutions or investment banks.

Mr. GUINTA. Thank you very much.

I yield back.

Mr. MCHENRY. I thank you.

At the request of the subcommittee ranking member, I will first

yield on their side of the aisle to the full committee ranking member, Mr. Cummings.

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Mr. CUMMINGS. Thank you very much, Mr. Chairman. I want to

thank you all for calling this hearing.

As I listened to you, Mr. Rosner, I could not help but think about

all the people who are out of their houses, the ones in my district

who have lost big time; the ones who come to foreclosure conferences, and I have held six of them in the last 2 years, crying.

And it is very unfortunate how short our memories can sometimes be. It appears that some members of the committee do not

recall that one of the frequently cited statements articulating the

causes of the financial crisis was made in this very hearing room

at the very table that you all are sitting at.

On October 23, 2008, at the height of the financial crisis, the full

Committee on Oversight and Government Reform held a hearing

entitled, The Financial Crisis and the Role of Federal Regulators,

at which former Federal Reserve Chairman Dr. Alan Greenspan,

testified, ‘‘What went wrong with global economic policies that had

worked so effectively for nearly four decades, too many securitizers

and lenders believed they were able to create and sell mortgagebacked securities so quickly that they never put their shareholders’

capital at risk and, hence, did not have the incentive to evaluate

the credit quality of what they were selling.’’

Acting Director DeMarco, isn’t one of the fundamental lessons of

the financial crisis that catastrophic danger can be created when

lenders are allowed to avoid all risk and, in essence, all accountability for their actions?

Mr. DEMARCO. I think that is certainly a concern here, Mr.

Cummings. The only thing I would moderate in that is that actually, whether we did not have the form of risk retention that DoddFrank has, yet many of these, virtually all of these issuers,

securitizers, and loan originates of these awful mortgages were retaining risk in some fashion because they have virtually all gone

out of business. The managers and owners of the firm have lost

their capital. The risk retention in other forms through things like

representations and warranties, they didn’t work as well as they

should have, and some of the panelists have pointed out. But your

point is basically well taken, sir.

Mr. CUMMINGS. Let me ask you this. While we can debate additional policy proposals that would provide further safeguards within the securitization process, are we at risk of repeating the conduct which led us to the 2008 financial crisis unless there is some

form of risk retention? I understand you are saying there is already

some.

Mr. DEMARCO. Yes, sir, I think that risk retention in some form

may be an important part of a better operating system going forward. But I think the other things that are being raised at this

hearing, including improved transparency and disclosure to investors, is also absolutely critical to avoiding the kinds of problems we

have had.

Mr. CUMMINGS. In other words, Ms. Ratcliffe, there is nothing

wrong with having both, is that right, having the transparency and

the risk retention? Because when I think about what our country

has gone through, almost brought to our knees based upon what

has happened here, it seems like we would err on the side of proVerDate 17-JUN-2003 12:54 Oct 04, 2011 Jkt 000000 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\68217.TXT KATIE PsN: KATIE
42

tection and being very careful, as opposed to just having one or the

other. Transparency I just don’t think is enough. Ms. Ratcliffe.

Ms. RATCLIFFE. I would agree. Again, there is a whole host of

problems to be solved. Transparency will solve some of them. And

again, as I mentioned in my comments, transparency for investors

is not the same thing as transparency for borrowers, which also

needs to be seen to. Risk retention is part of the solution. Standardization fits within that as well, because if you have well understood product parameters and structures, both for borrowers and

investors, that also enhances their ability to use the data they have

to accurately assess risk and compare risks and price loans and

comparison shop.

Mr. CUMMINGS. Well, let me ask you this, so we do indeed have

some agreement that a policy of risk retention, something that we

achieved last Congress with the enactment of Dodd-Frank, is a necessary safeguard against the market practices which led to the financial crisis. I know some of you all may disagree; I see you shaking your head, Mr. Rosner.

Ms. Ratcliffe, The Wall Street Journal commissioned a study

which found that 61 percent of subprime loans originated in 2006

went to people with scores high enough to qualify for a prime loan

with far better terms. Isn’t it true that the originate-to-distribute

model ended up pushing countless consumers into more expensive

and, thus, riskier mortgages than the consumers were eligible for

based on their credit scores and other characteristics?

Ms. RATCLIFFE. It would appear so, and I would add that in my

comments I mentioned the 30-year fixed rate mortgage, which is a

good example of transparency and standardization. This is a product which, in and of itself, makes for a safer loan. Over time, the

borrower’s debt to income improves; as the loan pays down, the

borrower’s loan to value improves; so it inherently enables greater

number of households to sustain home ownership safely.

It also enables a potential homeowner or potential mortgagor to

be able to compare one loan to another in the Sunday paper or online very easily because there is really only one factor, so it is much

easier to know if you are getting a good deal or not. Once borrowers were led into a marketplace that had much more complex

products and features and options to consider, like the starter rate

and the teaser rate and the maximum lifetime payment and so on

and so forth, it made it much more difficult for them to make good

product selections, and that introduced a level of systemic risk, especially with the adjustable rate mortgage features. When rates

changed and borrowers could no longer afford to make their products, that is a level of systemic risk that better product standardization and transparency could have alleviated.

Mr. CUMMINGS. Thank you, Mr. Chairman.

Mr. MCHENRY. I thank the ranking member and I recognize myself for 5 minutes.

Dr. Sanders, Mr. Rosner, this question is directed to you. In my

opening statement I referenced the fact that Fannie and Freddie

are exempt from this 5 percent risk retention. Currently, we just

recently wrote a check, or the Treasury, the American taxpayer is

in, just in the last week, for over $8 billion for Fannie and Freddie.

This was after we are in for many, many multiples of that curVerDate 17-JUN-2003 12:54 Oct 04, 2011 Jkt 000000 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\68217.TXT KATIE PsN: KATIE
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rently. What problems do you foresee with Fannie and Freddie

being exempt from this risk retention rule? How do you foresee

that playing out?

Mr. ROSNER. At a time where we hear Treasury and the administration talk about reducing the role of FHA, Fannie and Freddie,

and trying to revive private markets to exempt Fannie and Freddie

from the risk retention rule will actually only support and enhance

their dominance in the market and will create an arbitrage where

private lenders will have an enhanced or a necessary situation

where they end up having to sell to the enterprises.

Mr. MCHENRY. Why?

Mr. ROSNER. Because the enterprises actually are considered already to fully retain the risk; therefore, they don’t have to play in

the risk retention.

Mr. MCHENRY. No, no. I mean why would private entities not be

able to compete with that?

Mr. ROSNER. Oh, because private entities would end up having

an unfair economic disadvantage of having to compete by holding

a 5 percent position against the enterprises who don’t.

Mr. MCHENRY. OK. Thank you.

Dr. Sanders.

Mr. SANDERS. I would clarify that. I agree with what Josh was

saying, but it is still clouding them again. Once you exempt

Fannie, Freddie and the FHA from risk retention rules, the originators and securitizers, if they are forced to hold this and they

have to make a decision between holding 5 percent or getting rid

of it and giving it to Fannie, Freddie and the FHA, we have made

it a very clear path and an easy path just to keep Freddie, Fannie,

and the FHA at 95 percent market share; and I think that goes

against what the administration has said they wanted to do. I almost call this the Fannie-Freddie enabling act, as opposed to DoddFrank.

Mr. MCHENRY. Mr. DeMarco, do you agree with these sentiments?

Mr. DEMARCO. Thank you, Mr. Chairman. As one of the regulators responsible——

Mr. MCHENRY. As the overseer of Fannie and Freddie?

Mr. DEMARCO. As the overseer and one of the regulators responsible for putting out this proposed rule, if I could just clarify a couple things. I am sorry this strikes folks as technical, but it is the

way we view it. Fannie and Freddie are not exempt from risk retention. The proposed rule stipulates that because Fannie Mae and

Freddie Mac actually retain 100 percent of the credit risk in the

mortgages——

Mr. MCHENRY. Actually, to correct you there, the American taxpayer has 100 percent of the credit risk.

Mr. DEMARCO. Yes, sir, and I am incredibly mindful of that, and

we are working very hard to protect the American taxpayers’ investment in these companies. But the rule, what the statute requires is for the securitizers, the issuer of an asset-backed security,

to retain a portion of the credit risk, and the regulators have simply acknowledged in the proposed rule that Fannie Mae and

Freddie Mac, when they issue a mortgage-backed security, they are

retaining 100 percent of the credit risk. To the extent that one

44

wants to see their portfolio begin to shrink and reduce their footprint, forcing them to buy back or hold 5 percent of the securities

that they issue is actually going to inflate their balance sheet. And

while I am very supportive of the notion that we need to move the

U.S. mortgage market away from one that is so much reliant upon

government-related entities, I am not sure risk retention is the

most effective or practical means for starting to move the government out and restore private sector participation.

Mr. MCHENRY. What is?

Mr. DEMARCO. I think that having the Congress of the United

States take up a comprehensive housing finance reform where we

can figure out what the ultimate resolution of Fannie Mae and

Freddie Mac are going to be as part of it.

But the other thing is to really get private capital to come back

into the U.S. mortgage market and be willing to evaluate price and

undertake mortgage credit risk, those investors, that private capital is going to want to know what are the rules of the road and

what is the long-term role of the U.S. Government in the housing

market, and those investors are going to want clarity about where

the government is limiting its involvement and just what is being

really put back as available for the private sector so that it is not

competing with entities that are operating with direct support and

involvement from the U.S. Government.

Mr. MCHENRY. Mr. Rosner, back to you. In terms of the QRM,

currently private mortgage insurance is not a part of this solution

or this definition under QRM. Can you discuss would that have a

negative impact, do you think?

Mr. ROSNER. Well, the private mortgage insurance industry has

demonstrated that it offered no economic value in risk transfer.

They were used largely because of the 1992 act, which required the

80-plus LTB to get credit enhanced on the enterprises. In the private market they haven’t really been used. They have been not

demonstrated to have been effective in underwriting their rescission rates on claims have been extraordinarily high, and most of

them are operating under waivers with their State insurance regulators.

So the notion that private mortgage insurance has really helped

the situation in any way I think is fallacious and I don’t think

there is any evidence of that, as witnessed by the economic performance of their insured loans relative to a broader pool of loans.

Mr. MCHENRY. My time has expired, but, Ms. Ratcliffe, it looks

like you are interested in answering that question.

Ms. RATCLIFFE. Well, I would mention that the MI companies,

through the end of 2010, paid $22 billion in claims to the GSEs,

which is 14 percent of the taxpayer payments up to that point in

time. So there is some economic benefit in that capital source market.

Mr. MCHENRY. Mr. Rosner.

Mr. ROSNER. That was with a rescission rate that was, across the

industry, north of 20 percent at this point, it seems, and you are

forgetting that they collected premiums. So really it was a return

of, not a return on that insured premium.

Mr. MCHENRY. Thank you.

I recognize Mr. Quigley for 5 minutes.

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Mr. QUIGLEY. Thank you, Mr. Chairman.

Director DeMarco, less than a month ago the Financial Services

Committee held a subcommittee hearing entitled, Understanding

the Implications and Consequences of the Proposed Rule on Risk

Retention, at which your agency’s chief economist, Patrick Lawler,

testified, ‘‘One of the widely recognized causes of the financial crisis

of 2008 was the poor quality of loans collateralizing many assetbacked securities, with subprime loan mortgages being the most

flagrant culprits. Too often lenders made loans they would not have

been willing to hold themselves only because they knew they could

sell them to securitizers at an attractive price.’’

Are your thoughts and testimony consistent on that in your

mind, with that statement?

Mr. DEMARCO. I am not sure where that statement is attributed

to, but yes, sir.

Mr. QUIGLEY. It was in his testimony.

Mr. DEMARCO. It was in Mr. Lawler’s testimony?

Mr. QUIGLEY. Yes.

Mr. DEMARCO. I think that is consistent with what I have in my

testimony, sir, about part of the problem that led to both the housing crisis and the economic crisis was the bad underwriting that

led to loans being securitized and certainly a securitization model

in the private label market that was pushing these loans through

to investors and really a reliance upon the notion that house prices

were going up, rather than really doing due diligence and good

credit review of the loans to ensure that the borrowers had the capacity to repay and had a credit history to suggest that they would.

Mr. QUIGLEY. Does that strike you, back to the question you were

answering earlier, that transparency is an important asset in all of

this, but it is not mutually exclusive with proper securitization?

Wouldn’t the two go hand-in-hand?

Mr. DEMARCO. Yes, sir. What I would like to say about transparency is if the public policy objective is to see private risk capital

re-enter our mortgage-backed security market in a meaningful way

so that mortgage credit risk is backed by private capital, not by the

government, for that to succeed, one of the necessary steps is for

those investors to have access to a much more robust set of data

both at the time of origination of the security and throughout the

life of the security so that those investors can properly evaluate

and price the mortgage credit risk and prepayment risk of those

mortgages. So we clearly have a lot of work to do to enhance the

disclosure regime, the transparency for private label mortgagebacked securities to really be able to function in a robust way in

this market.

The risk retention that has been proposed and was implemented

in Dodd-Frank and that the regulators are in the midst of trying

to implement now, what that is designed to do, in some ways it is

to say, look, part of this problem that we had is really bad underwriting, we have been doing bad loans, and we want to get more

accountability before that loan hits an investor in the form of a

mortgage-backed security. We want someone else in that pipeline

to have greater responsibility for the quality of that loan and the

quality of the underwriting.

46

So what Congress settled on in Dodd-Frank is a risk retention

requirement that puts that onus principally on the securitizer, and

what Dodd-Frank says is the risk retention should be that the

securitizer retains a portion of the credit risk because they are in

the best position to be able to oversee and have some stake in

whether the loan as originated is a good quality loan or not.

So that is how this is seen as an investor protection really designed to make sure, through this form of the securitizer, that the

securitizer is paying attention to the quality of the loans, to Mr.

Cummings’ point earlier and to yours that there are loans that

were being made here for which the people at the front end of the

process appeared not to be doing anything in terms of proper diligence in making the loan.

Mr. QUIGLEY. Thank you.

Dr. Sanders, I am not sure if you got a chance to weigh in on

the question that was asked, whether these are not mutually exclusive issues.

Mr. SANDERS. No, I have not been able to weigh in on that other

than my testimony. But I think greater transparency is a great

thing and it will help drive better pricing. And I agree with Mr.

DeMarco it will attract better capital. My concern at the beginning

was that I am concerned that risk retention sounds great, but it

sends a false comforting signal to the market because, as I said,

housing prices, if they fall again, is going to wipe out risk retention

in the snap of a finger.

Second, the other issue is that the securitizers themselves can

hedge risk retention. I know from my experience, when we would

be holding the first loss pieces, we could go out and use either interest rate swaps or credit derivatives and just hedge out the risk

retention. So, from our vantage point, it made it neutral.

But the point I want to make is I don’t like the false signal that

everyone suddenly thinks because we have risk retention, the days

of bad underwriting and we don’t need transparency. I am just

worried about that being the case. But, again, transparency is good

and beefing up the reps and warranties in case of violations is really an important step to go forward.

Mr. QUIGLEY. Thank you. I yield back.

Mr. MCHENRY. I thank the ranking member.

With that, we yield to Ms. Speier of California. She is not here,

so Mrs. Maloney from New York is recognized for 5 minutes.

Mrs. MALONEY. Risk retention is basically having skin in the

game, is that correct? Wouldn’t you say they are holding on to a

piece of it? That is the way loans used to be made in banks, and

we didn’t have a problem when that was done.

So I really don’t understand, Mr. Rosner, in your testimony you

express in your written testimony skepticism regarding the risk retention requirement in Dodd-Frank and whether the proposed rule

will ensure better lending, better underwriting or safer markets.

And in it you said, on the surface this appears to make sense; if

a lender or securitizer knows he will have to drink the poison in

the chalice he offers to others, then he would be more careful. That

is one of your quotes. Am I quoting you correctly, Mr. Rosner, and

correctly with regard to the reasoning behind the proposed rule?

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Mr. ROSNER. You are quoting me correctly, but you are quoting

the first part of the quote. If you continue on, what it says is the

lender would have a, on the surface, increased interest in making

sure the loan was appropriate, but as we saw in the case of Bear

Stearns and Merrill Lynch, they died because of risk retention, and

they didn’t offload the risk, which would have been sensible if they

really understood that they were creating poison. Instead, they retained it.

So, in a world where people are mismodeling or misconsidering

or underconsidering, or don’t even have the information to understand what risks they retain, as Stan O’Neal highlighted in his testimony to the FCIC, he didn’t even realize that his firm retained

the risk that it did. You are causing these firms to concentrating

risk and several firms, therefore, to have highly correlated risks to

each other; when, if you had lenders having the loans they made

scrutinized by investors, the investors would price those risks at

such a level where the likelihood is that loan would not be made

in the future because it would not be purchased at a rate that

could allow the borrower to afford it.

Mrs. MALONEY. Well, everybody is for transparency, but Chairman Bernanke testified before several committees that transparency is not enough, that some of the lending vehicles and some

of the loans, some of the financial products are so complicated that

people don’t understand them. I even had before us in one hearing,

we had the head of Freddie Mac say that he read his credit card

disclosure statement, the fine print, for hours with his wife over

dinner, and they couldn’t figure out what it meant. So one way to

make sure that the lender is a little more careful is if he has a little bit of skin in the game, I would think.

Now, how is it better that you have no skin in the game and all

you are doing is getting a fee and moving it off the next day, so

you have absolutely no skin in the game? It appears to me you

would be more careful if you had risk retention, which has been the

traditional way of banking. That is the old way of going to your

community bank and getting a loan. Bankers were very careful in

what they did because they were responsible for that loan.

But the way it became is that no one had any skin in the game; you collected your fee and went to Florida. And we lost $151⁄2 trillion in household wealth. We almost went off the cliff. And most

economists say that the fact that there was no skin in the game,

no risk retention contributed greatly to it. So give me your thinking

again on that so I can understand.

Mr. ROSNER. First of all, in the summer of 2001 I wrote a

lengthy paper called a home without equity is just a rental with

debt, warning that with the changes that we had seen structurally,

which were being unrecognized, we would end up in exactly the

place we did. The end of 2004, 2005, 2006 I spent time with people

at the Fed, with people at Treasury, with people at various regulators warning that we had passed the peak and we were in for it.

In February 2007 I put out a paper on the credit crisis that was

about to happen in the CDO MBS market and how it would impact

the real economy.

If you are asking me to defend the Fed’s understanding of what

was about to happen, or their look now at what happened, I won’t

48

do so. I will continue to say that if investors had the ability to

properly price loans, the loans would be prohibitively expensive

where the risks are too high for borrowers to take them, and that

is a major part of the solution. It is the one that is the most honest

answer——

Mrs. MALONEY. My time is running out. I just want to get one

more question. In arguing against risk retention, you stated in your

testimony, ‘‘To force investment banks to increase concentrations of

held securities will only increase their risks.’’ That appears to be

exactly the point; it will increase their risks; their incentive to

focus on better underwriting, better quality of securities and better

outcome in the market. So if you increase their risk, wouldn’t they

be more careful?

Mr. ROSNER. Only if they are capable of assessing the risk. As

we demonstrated in this crisis, most of them had neither the operational, nor modeling prowess to properly assess risk.

Mrs. MALONEY. You mean investment bankers could not assess

the risk?

Mr. ROSNER. That is exactly right.

Mrs. MALONEY. That I find hard to believe. I mean, I think they

understand risk more than most people.

Mr. ROSNER. Well, most of them aren’t in business today because

they didn’t understand the risk.

Mrs. MALONEY. Well, also they didn’t have skin in the game.

They could just gamble.

Mr. ROSNER. No, Merrill Lynch and Bear Stearns did have skin

in the game; Lehman Brothers did have skin in the game. Those

who were able to rush to the exits and get their skin in the game

out of the house in the few months prior to the full unfolding of

the crisis didn’t have skin in the game, but they too, prior to that,

did have skin in the game, many of them, and would have met the

same fate as those that are no longer with us.

Mrs. MALONEY. So you say the answer is more transparency.

Mr. ROSNER. I say the answer is allow investors to risk price because, again, the investors’ interests are actually aligned with the

borrowers’ interest. Even now, as we are in crisis, the investor understands that a 20 percent principal write-down in many case

many well make a lot more sense than a 70 percent loss given default, and it is oftentimes the investment bank or the servicer affiliated that doesn’t want that to happen.

So the borrower and the investors’ interests are tied, their interests are tied together because one has an interest in getting paid

and the other has an interest in paying. So you need to make sure

that they have the information to properly assess and price the

risk.

Mrs. MALONEY. Well, I would say give them the information,——

Mr. MCHENRY. Thank you. The gentlelady’s——

Mrs. MALONEY [continuing]. But give them risk retention too. I

think that would be safer.

Anyway, my time is up.

Mr. MCHENRY. I thank the gentlelady, who is also a member of

the Financial Services Committee. Thank you for your input and

your questions.

49

I recognize the full committee chairman, Mr. Issa, of California,

for 5 minutes.

Mr. ISSA. Mr. Chairman, I won’t take 5 minutes, and I appreciate

being recognized here.

Mr. MCHENRY. Well, I would be happy if you yielded me the balance of your time. I would appreciate that.

Mr. ISSA. And I shall, Mr. Chairman.

Mr. MCHENRY. Thank you.

Mr. ISSA. Having just come in, this may have been asked, but I

appreciate the concept of somebody retaining skin in the game, but

let me just ask a rhetorical question for a moment. Hopefully it

won’t take the chairman’s time. Your certified public accountants

don’t retain skin in the game, even though they do an audit; they

get paid, they provide a service.

In a sense, although we understand some of the things that went

wrong in some cases, where people were packaging up and selling

products, aren’t there times in which what you really need is full

disclosure, but ultimately, when you buy a car, the car dealer

doesn’t necessarily keep any skin in the game, but if he sells you

a bad car, you go back to him. So as much as I appreciate the nature of the rule, don’t we also have to have out clauses if certain

other things are met? Mr. Rosner.

Mr. ROSNER. Yes. That is why, in my testimony, I feel very

strongly that before a deal comes to market, investors should have

a right to inspect the loan level data and there needs to be standardized pooling and servicing agreements, there need to be standardized representation and warranty agreements that really do define, on a collateral standardized basis, what the rights and obligations of various parties are. This is one of the things that Fannie

and Freddie did do well.

Now, yes, they retained the risk; nonetheless, investors in their

instruments fully understood that, deal-to-deal, they were actually

contractually identical. We have a situation where you had as

many as 300 different pooling and servicing agreements, each with

different rep and warrants attached to it, leading to the crisis. And

when people started seeing early payment defaults rise and

jitteriness in the markets, people said, you know what? I am going

to get rid of these positions because I don’t have time to read 300-

page documents, and I will come sift through the rubble on the

other side. And, unfortunately, that led the stampede from which

we are all suffering and the housing financing system came to a

grinding halt as a result.

Mr. ISSA. I appreciate that.

As promised, I yield the balance to the chairman.

Mr. MCHENRY. I thank the chairman for yielding.

Mr. DeMarco, in terms of some of the steps you have taken in

FHFA in terms of disclosures, there is a uniform mortgage data

program, there have been some significant delays with that, but I

do want to say thank you because these are significant steps for

disclosures, but I also realize there have been some limitations

with this.

Mr. DEMARCO. Well, when we announced it last May, we said it

was a 2-year project, and we are continuing to push ahead and, in

fact, there are some positive steps and results that have arisen

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from this. But it does take time, sir, and we are continuing to do

it, and I do think it is an ingredient to the sort of things that you

and the panelists have been talking about to have enhanced disclosure.

That assumes some things about the data that are being disclosed: Are the data consistently defined? Are they being reported

in a consistent manner, regardless of who the loan originator is or

who the appraiser is? So what this uniform data program is, it is

actually sort of the foundation for this transparency we are trying

to get within the marketplace, a uniform set of definitions and

means of reporting data so that, regardless of who the originator

is and who the securitizer is, there is that kind of standardization

in the market, which should be able to make the transparency that

we are all advocating actually work.

Mr. MCHENRY. Thank you.

Mr. Rosner, so in terms of transparency, what are the unintended consequences of transparency?

Mr. ROSNER. None.

Mr. MCHENRY. What are the unintended consequences of 5 percent risk retention?

Mr. ROSNER. I should correct that. I should correct the unintended consequences of transparency are that there is a thinner

economic opportunity or a thinner margin for the issuers, and so

they will have less of an arbitrage; it will negatively impact, to

some degree, their income. But the benefits will be passed on both

to borrower and investor by the narrowing of that spread.

Mr. MCHENRY. As opposed to a 5 percent risk retention, which

raises the cost of credit for consumers, thereby if credit costs more,

those that are extending it make more, right?

Mr. ROSNER. And I think to Dr. Sanders’ point, the other risk of

risk retention, besides the correlation in the increased cost, is that

it may lead to an increased false sense of comfort that the work

was done, again, by the issuer and, therefore, the investor doesn’t

have to focus on it as much.

Mr. MCHENRY. So rather than fixing this systemic risk problem,

Dr. Sanders, in your testimony you say it actually creates more

systemic risk.

Mr. SANDERS. That is correct, because the risk retention rules as

written simply, just as Josh said, Mr. Rosner said that we have all

sorts of problems it creates, false sense of security, it leads us down

the wrong road, and those are big issues. But when we get back

to the whole nature of what risk retention doesn’t do, as I have

said, Wall Street can hedge away that risk already. So it is not

really a—or sometimes badly, and then they get caught stuck with

the risk, but it can increase the systemic risk of the institutions

themselves.

Can I add one more thing? If we are talking about trying to get

loans to lower income households and more credit impaired households, I view risk retention and the QRMs as actually cutting people out of the market that want to get back in with somewhat impaired credit, etc. I don’t think this is very good for consumers that

have gotten, I think, 40 percent have had serious credit score degradation. This isn’t going to help; this is going to make it worse.

With full disclosure of information and no risk retention, then we

51

are aware exactly what the subprime loans are, then I think the

private sector can move forward with that and that is the good solution.

Mr. MCHENRY. Have you looked at, for instance, auto financing

or subprime auto financing, securitization?

Mr. SANDERS. Yes.

Mr. MCHENRY. Did that world fall off and look like the housing

securitization?

Mr. SANDERS. Housing was something completely different because the automobile industry didn’t have all price of cars fall 60

percent at once, together, not in all areas. But, no, housing was unusual because it fell off a cliff, and that is why risk retention

wouldn’t help that. But again, reps and warranties——

Mr. MCHENRY. But how are they able to actually have subprime

securitization for autos, for instance, and people are buying this,

people are purchasing, sophisticated investors are purchasing these

things? Mr. Rosner.

Mr. ROSNER. First of all, you have to remember the difference in

the duration of the asset. You are talking about a 30-year mortgage

versus, typically, a 60-month auto loan.

Mr. MCHENRY. So that is the only difference?

Mr. ROSNER. That is a major difference. The auto industry also,

the non-captive lenders, really did learn their lesson in the late

1990’s; they went through a crisis very similar. Obviously, it had

less broad economic impact to what the mortgage originators did

recently. Both actually blew up, the original subprime mortgage industry and subprime auto finance industry both blew up in the late

1990’s, and the auto industry ended up sort of reconsolidated mostly by the captives, so there was much more by way of control. But

again the duration, I think, is the biggest difference.

Mr. MCHENRY. OK. Interesting.

With that, Ms. Speier is recognized for 5 minutes.

Ms. SPEIER. I have a somewhat facetious question to ask you, no,

I think all of you. Have you just missed out in the last 3 or 4 years

altogether? I spent 3 years on the Financial Services Committee,

thousands of hours, literally, hearing testimony over and over and

over again, and everyone said the same thing on both sides if the

aisle: if you don’t have any skin in the game, it is real easy to play

the market. And it just seems like it is common sense.

Now you, Dr. Sanders, suggest that if there is full disclosure, you

really don’t need risk retention. Full disclosure to whom?

Mr. SANDERS. Not quite. I am saying you need full disclosure

plus you need to tighten up the representations and warranties to

protect the underwriting. And again reps and warranties already

gives skin in the game. That is what I am puzzled about.

Ms. SPEIER. Excuse me. Full disclosure to whom?

Mr. SANDERS. Full disclosure to investors.

Ms. SPEIER. To investors. All right. Do you think that the investors that invested in Goldman Sachs, in their Abacus deal, I think

it was Abacus, in which they were, for another client, shorting the

same product that they were promoting in the market? Do you

think that was full disclosure?

Mr. SANDERS. No, I don’t think it was full disclosure. But then

again it comes back to what investors would invest in Abacus when

52

they couldn’t see what was inside of it. That has always puzzled

me.

Ms. SPEIER. Now, full disclosure oftentimes to the public, and

certainly to government, is full disclosure to the regulators so they

can, in fact, oversee what is going on. And I am reminded that

when AIG was profiting handsomely from CDOs through their financial products division in London and had stretched themselves

to immeasurable places, I asked the question did the Office of

Thrift Supervision know what a CDO was, and they answered no.

So I think that it is very simplistic, frankly, to suggest that somehow full disclosure is the panacea.

The American people aren’t stupid and the American people get

it. If you don’t have skin in the game, if the banks don’t have to

retain some form of risk, then why wouldn’t you sell garbage over

and over and over again? Because you have no skin in the game;

you have nothing to lose. If you and I were to flip a coin and it

was tails, you win and heads, I lose, why would I play with you?

But that is what you are somewhat suggesting.

I apologize for not really asking a question, but let me just respond to and ask your comments. The Financial Crisis Inquiry

Commission, many hearings, reviewed many documents, and in

part of their report they said, on Wall Street, where many of these

loans were packaged into securities and sold to investors around

the globe, a new term was coined: IBGYBG, I’ll be gone, you’ll be

gone. It referred to deals that brought in big fees up front while

risking much larger losses in the future, and for a long time

IBGYBG worked at every level.

I guess I would just like you to comment on that. Mr. Rosner.

Mr. ROSNER. First of all, there are typically four risks that regulators consider: operational risk, liquidity risk, credit risk, and

reputational risk. And all of the firms that really abused the

reputational risk in exactly the way you are talking about are the

ones that really did go out of business.

Ms. SPEIER. You think Goldman Sachs had a reputational risk?

Mr. ROSNER. Well, hold on, no. Now you are going back to the

question on the Abacus deal, and that actually, the transparency,

the collateral would have actually been helpful and transparency to

the other side investor seems to be a different issue, and that may

be a securities issue. It seems that the SEC felt it was potentially,

and addressed it as such. But even there I would point out that we

get back to the same issue, which is if investors had the information available to them to do the full analysis, they would have and

might not have participated in that deal. We are talking about

qualified institutional buyers; these are sophisticated investors.

And I will add one last piece, which is regarding whether the

regulator did know what was going on with AIG. I would point out,

as I pointed out——

Mr. MCHENRY. The gentlelady’s time has expired. I will give the

gentleman the opportunity to finish the question.

Mr. ROSNER. In an early 2007 paper I wrote, I highlighted the

fact that none of the Federal financial regulators had access to the

CDO deal data because none of them were qualified institutional

buyers. The first was the FCIC, and that didn’t happen until 2007.

That is a problem with transparency.

53

Ms. SPEIER. Mr. Chairman.

Mr. MCHENRY. Yes.

Ms. SPEIER. I realize my time has expired, but I am just curious,

and if you think it is appropriate to ask the question, maybe you

will ask it. I am wondering if any of the panelists feel that——

Mr. MCHENRY. Well, you are asking it, so go ahead and ask. It

is fine. Just the two of us here; we can work this out.

Ms. SPEIER. Good.

I am curious that you believe that there are institutions now that

are too big to fail in this country, and what is the remedy?

Mr. MCHENRY. We will ask the whole panel. I would be interested in everyone’s comment as well. Good question.

Mr. ROSNER. Absolutely. No question. It is one of the things that,

as a financial service industry analyst, bothers me the most. I

would have loved to have seen Dodd-Frank include a simple paragraph that said any institution that requires extraordinary government asset purchase, debt guarantees or more than 60 days at the

Fed window would be operating under immediate supervisory action and their executives and board would be prohibited from employment in the financial service industry for a period of 5 years

in any capacity.

I think that would have forced them to decide either to shrink

themselves to a point where they were manageable or increase

their expenditures on risk management to make sure that they

dealt with their risks. But we have chosen to pretend that they are

not to keep them afloat and, in fact, to codify their too big to fail

advantages in many parts of Dodd-Frank.

Mr. MCHENRY. Dr. Sanders.

Mr. SANDERS. Well, yes, of course there are too big to fail firms,

but one thing I want to point out is that the chairman of the Federal Reserve, Chairman Bernanke, and the Federal Reserve system

already had the regulations in place to prevent too big to fail, and

they just chose not to follow their own regulatory guidelines.

Mr. MCHENRY. Ms. Ratcliffe, if you would like to comment as

well?

Ms. RATCLIFFE. I think to some extent it is not just institutions,

but systems that sometimes we just can’t afford to let fail, and I

think the important thing is to recognize those and proceed accordingly, rather than pretending that there isn’t a situation where

government is going to have to step in to keep systems afloat.

Mr. MCHENRY. Mr. DeMarco, I don’t know if you want to jump

into that one. Not that you have enough balls in the air.

Mr. DEMARCO. I don’t believe any firm should be considered too

big to fail, and I believe that under Dodd-Frank the regulators

have been given tremendous challenge and set of responsibilities to

ensure that we operate the oversight of a financial system in the

future so that institutions are not too big to fail. And it will remain

to be seen what we are doing now to implement our Dodd-Frank

responsibilities to see how this works, but I do not believe that institutions should be considered too big to fail, and I believe Congress has challenged the regulatory community with that objective.

Mr. MCHENRY. Mr. DeMarco, I have two final questions for you,

if I may. If many players get out of the mortgage securitization

business because of this risk retention, holding this capital, how

54

does that play out? Does that make it better for the consumer or

worse?

Mr. DEMARCO. Currently, virtually all mortgages being originated, well over 90 percent are being securitized through Fannie

Mae, Freddie Mac, or Ginnie Mae, so implementation of the risk

retention rule, even as proposed, in the near term, until we reach

a resolution of conservatorships with Fannie and Freddie, will have

limited impact.

So I think that, combined with the fact we put out a proposed

rule here and asked over 170 questions, so the regulators are looking for a lot of input from the marketplace from the whole array

of stakeholders in this and people that have a view. Panelists here

have expressed views. I expect we will be getting comments like

that, comments coming from different angles, and I believe that the

group of regulators charged with implementing this fully intend we

are expecting a considerable volume of comments and we intend to

take a very careful review of that. It is not that common to ask

170-some questions in a proposed rulemaking. The regulatory community is looking for input so that can better inform what we do

in terms of the final rule.

Mr. MCHENRY. So how does this risk retention rule add value?

Mr. DEMARCO. Sir, the intention that Congress had in doing this

I think has been pretty well debated on each side here, but it is

intended to add value by making an explicit statement and creating an explicit particular structure so that issuers of asset-backed

securities retain credit risk here so that they will better discipline

and pay greater attention to the underwriting that is done at the

time of loan origination to enhance the quality of the loans that are

then pooled and sold to investors in asset-backed securities.

That is the theory we are operating behind here and that is the

intended outcome. It does certainly seem to better align the incentives. There are some legitimate concerns that panelists here and

others have raised, and the regulators are going to take a look at

that to see whether the proposal ought to be changed in any way.

But we are operating with a given statute that says several

things: it says that the risk retention is focused on the securitizers,

it says—I would like to correct one thing that was said earlier. The

securitizer with their retained risk is, under the law, not allowed

to hedge that risk. And we are going to get a lot of comments to

see what the market participants view as the potential implications.

Mr. MCHENRY. So that is, to Mr. Sanders’ point, the systemic

risk element added here. If you can’t hedge that risk, financial institutions, do they seek to hedge as much of their risk as they can?

I am asking this rhetorically. Of course you do. If I have an asset,

I want insurance on it. I think most people do that.

Dr. Sanders, I do want to ask you this because in the previous

securitization market—let’s just go back a couple years—in order

to sell a securitized product on the market, you have to first sell

really the mezzanine, right, before you can really sell—that is sort

of the first piece you have to sell. So many firms would retain that

in order for them to sell off, basically that first loss position they

retain.

55

Mr. SANDERS. Yes. It has been industry practice in any deal I

have ever seen they usually retained at least 5 percent, and sometimes up to 20 percent of the deal in the private label market. We

are not talking about agencies. That has always been the case.

Mr. MCHENRY. OK. So what would be the problem of saying this

is a bank regulation, for instance, going back. You realize that

banks are holding more capital on the books, so you raise the regulatory amount that they have to hold on their books, and what do

banks do? They then raise the amount of capital they hold beyond

that because they don’t want to purchase that regulatory mandate,

right? Why not just simply recognize what the market is doing and

say that is great and this rule doesn’t have a major impact? What

would you say to folks who would say that?

Mr. SANDERS. I would say the private sector had already been

doing that as industry practice, and the whole housing price crash

wiped out even their first loss pieces, as we know. Those got

torched very early on. So it not even effective. But what my concern with now going through and stating a 5 percent regulatory is

that we will see, suddenly, everyone maybe even shrink from 20

percent risk retention and go down to 5 percent. So this could actually make institutions more risky, to hold less.

Mr. MCHENRY. Ms. Ratcliffe, do you agree? Disagree? What are

your comments?

Ms. RATCLIFFE. I disagree. There is going to have to be capital

to support the risk somewhere in the system.

Mr. MCHENRY. Where does that come from?

Ms. RATCLIFFE. Well, it can come from a number of sources, but

it has to be out there and it has to be a level playing field. And

for nobody to take any risk on the loans is not going to help us.

I think we did see a lot of people try to hedge their risk and think

they laid it off on somebody else who thought they knew what they

were doing and they thought they had enough transparency and

they thought they had good enough models, and they were wrong.

Mr. MCHENRY. So basically your answer is simply we need

Fannie and Freddie back, because that makes it all work. That

seems interesting to me.

Dr. Sanders, would to respond to that?

Mr. SANDERS. No. Actually, we are going through—Mr. DeMarco

made an excellent point. We have to get private capital back on the

mortgage market, and I think Freddie, Fannie and the FHA, bless

their hearts, unfortunately with a guarantee, are keeping rates so

low, I mean, basis points over Treasury rates, that if we want to

attract capital back, we actually have to kind of have more private

sector participation without the guarantee that will boost yields

and attract investors back. So I really want to go with what the

administration said earlier, start pairing them down, if not dismantle them.

Mr. MCHENRY. Mr. Rosner.

Mr. ROSNER. I totally agree with that. You know, there is a truth

that doesn’t want to seem to be heard on Capitol Hill, which is

mortgage rates have to rise. And no one in Washington wants to

accept that as the necessity or as the reality required for private

capital to come back. That is what is going to have to happen, one

56

way or another, to revive a private label market or even have a

properly risk priced government supported market.

I would also point out, though, that there were, and I agree with

Ms. Ratcliffe in terms of capital is a big piece of the answer, and

would also remind you that a lot of the problems that we saw, sort

of secondary and side effect problems that we saw, were arbitrages

on the difference between regulatory capital requirements of various parties. If you remember, the insurance regulators had much

lower capital level requirements than the Federal regulators, and

that became an opportunity to arbitrage or theoretically transfer

risk to insurers who weren’t capitalized enough to hold those risks.

Mr. MCHENRY. All right, Ms. Ratcliffe, I want to give you an opportunity to followup or respond to that, if you would like. And

then I realize Mr. DeMarco has had to leave, so we have one final

question for the whole panel. But I do want to give you an opportunity to comment.

Ms. RATCLIFFE. Yes. I want to just say that I think the transparency and risk retention accomplish sort of complementary, but

different, things, and the other thing that together that they can

help do is just reduce the overall amount of risk that the system

takes on. These are, really, the natural market mechanisms that

ought to dampen the willingness of all parties along the spectrum

to take on risks so they wouldn’t necessarily take on the same magnitude of risks they took on back in 2004 to 2006. So in that case

I would argue strongly that the net effect of both of those would

be overall reduction in systemic risk.

Mr. MCHENRY. OK. OK. Obviously there is some disagreement

on that from the panel, but my final question, and we will start

with you, Ms. Ratcliffe, and go right down the line, final question,

I promise: Do you think that the most powerful tool to address this

challenge, to address this problem, the most powerful tool, marketbased tool would be transparency?

Ms. RATCLIFFE. And the challenge is, sir?

Mr. MCHENRY. Well, the challenge is—I don’t know if you have

been—this question of securitization, private sector—OK, let me

give you context. In light of Fannie and Freddie and the government being 90 percent of the mortgage market, with Mr. DeMarco

having the largest housing portfolio in the world under his control,

and I would say we realize you do not seek such. This is not part

of ambition, we understand; we realize you have one of the most

challenging jobs in Washington. But in light of that, is transparency the most powerful tool to make sure that we can have a

private sector market for mortgages?

Ms. RATCLIFFE. I think it is——

Mr. MCHENRY. Yes or no? I mean, if you think no, it is fine, and

we can keep rolling here.

Ms. RATCLIFFE. I will say that I think there are some better

tools.

Mr. MCHENRY. Such as?

Ms. RATCLIFFE. Capital, regulatory capital, level regulatory capital playing field.

Mr. MCHENRY. So 5 percent is good?

Ms. RATCLIFFE. That is not adequate necessarily for systemic

capital.

57

Mr. MCHENRY. Ten?

Ms. RATCLIFFE. It depends on the types of risk the system takes

on.

Mr. MCHENRY. Twenty?

Ms. RATCLIFFE. That would depend entirely on the risk profile of

the loans that were made. I would suggest that would represent a

fairly high risk market that we wouldn’t want to return to, that

level of inherent risk.

Mr. MCHENRY. Mr. Rosner.

Mr. ROSNER. If you are talking about to solve the problems of the

securitization market itself and the risk transfer, yes, transparency

in a standardized, manageable format with corresponding standardization of contract and representation and warranties I think

are the best solution.

Mr. MCHENRY. Can that be done in the private sector?

Mr. ROSNER. It absolutely can be. Unfortunately, I think that

task has been led not with investors’ interests at core, but with

issuers’ interests at core. So I think that we need to see that paradigm changed or regulators need to get more involved to foster an

environment where that is being created on behalf of the investor

community.

Mr. MCHENRY. Dr. Sanders.

Mr. SANDERS. I would say transparency absolutely is the most

important one. And again I am just going to say one last time I

think for those households that have credit impairment after the

housing bubble crash, I think risk retention rules are going to work

in the exact opposite direction; it will cutoff credit to households

that really want it, and that really scares me.

Mr. MCHENRY. Mr. DeMarco.

Mr. DEMARCO. To have private at-risk capital invested in assetbased security undertaking that credit risk, having transparency is

essential. But if I may go further, it is essential that there be full

and appropriate and high-quality data there. To some of Mr.

Rosner’s points, there does need to be attention to standardization,

to terms of contracts. There may be a role for government in doing

that because the government can take a look at all the stakeholders, not just one party. But one might argue as well that would

be executed by private groups doing it.

But I do think that transparency, it is not just being transparent,

but what is it we are being transparent about? There has to be the

right data properly and timely disclosed and understandable to the

investors. That is the full definition of transparency that would be

essential for private risk capital to really return to investing in

mortgage-backed securities where they are undertaking the actual

mortgage credit risk.

Mr. MCHENRY. Well, thank you. I appreciate your time.

I am sorry. Yes, I recognize the ranking member.

Mr. CUMMINGS. I have been patiently waiting.

Mr. MCHENRY. And I would say to the gentleman that Mr.

DeMarco’s time, we have pushed him beyond his time, so if you

start with him and let him go, he would probably appreciate it.

Mr. CUMMINGS. Oh, sure. I certainly will do that.

Mr. MCHENRY. I recognize the ranking member.

58

Mr. CUMMINGS. I want to understand, Mr. DeMarco, when you

say transparency and then I hear Mr. Rosner say some people that

I would expect to understand the stuff that is transparent don’t understand it. I am confused. You just said a moment ago that I

think you said the investment bankers. I don’t know, I can’t remember who you said. The question was asked who would understand. In other words, if that information was available, would

folks understand it, and you can correct me if I am wrong, I could

have sworn you said there are certain people that would not. No?

Mr. DEMARCO. I don’t think I said that.

Mr. CUMMINGS. OK. So if we had transparency—let me go to you,

Ms. Ratcliffe, and then I will come back to you, Mr. DeMarco. The

transparency, who would benefit from that, Ms. Ratcliffe?

Ms. RATCLIFFE. We have talked a lot about transparency to investors.

Mr. CUMMINGS. Right.

Ms. RATCLIFFE. But I have also, in my comments, addressed the

importance of transparency to borrowers. I think you need to have

both. Transparency should be to the benefit of both ends of it. I

still believe that accountability is critically important to the equation, and transparency without accountability may not get us anywhere.

Mr. CUMMINGS. When I talk to my community banks, they have

skin in the game, and the community banks in my district that I

talk to said that their problem was not mortgages. The problem

was mortgages from the standpoint that maybe people couldn’t pay

them back, but their problem was other things like people losing

their jobs and unable to make the car payments and all that kind

of stuff.

So when a lot of people think about skin in the game, they think

about their community banks, and the community banks had an interest; they serviced their loans, they made sure that they didn’t

give no-doc loans, and they knew that they would be out of business if they gave enough loans that were toxic. So to the layperson

it seems like it would make sense for somebody to have some risk

here.

And then, Mr. Sanders, you were talking about people who want

to come back into the game. Well, a lot of people I am talking about

won’t be in a position to get back into the game, period, maybe

even in a lifetime. So I am trying to figure out—and then I think

about the fact of all these people who have lost so much, and I still

don’t think that a lot of folks get how significant this foreclosure

problem is. Sometimes I wonder whether there is a disconnect with

the people out there who are losing their houses and basically that

is all they had.

So I am trying to figure out why don’t we err on the side of making sure, again, going back to the community bank thing, making

sure that these folks have some kind of incentive to do the right

thing and due diligence and all that kind of stuff, and have layers

of protection, layers of different sets of eyes. You follow me? Am I

missing something?

I will start with you, Mr. DeMarco, since you have to go. You

look like you are straining to understand what I am trying to say.

Mr. DEMARCO. No, sir.

59

Mr. CUMMINGS. OK, good.

Mr. DEMARCO. I believe I understand what you said, and I would

echo several things. I think that there has been a real damage to

thousands of families across this country as a result of many difficulties and problems in the way our finance system was working

earlier this decade. And I think the toll on American families and

on their communities, on their neighbors and so forth, has really

been stunning, and there are some communities that are going to

take many years to recover from this. And I think that is something we all should be very concerned about, and certainly for our

agency we are doing our best with foreclosure alternatives to try

to help as many people stay in their homes as they can.

Second, with respect to community banks, if I could make a larger point that I think may resonate with some of the concerns you

are raising, when I look at the mortgage market today and the way

it is structured, I see tremendous concentration. I see concentration

in mortgage origination, I see tremendous concentration in mortgage servicing, and it does make me wonder where is, as we contemplate changes to the country’s housing finance system, that we

go about that in a way in which the role of the community bank,

the community lender is not shut out and, in fact, we think about

ways to better foster the involvement of community lenders in not

just making loans, but continuing to service loans in their community. They have the direct touch with the borrower and they are

in a good position to be able to understand the borrowers’ needs

and help them before they get into trouble.

So I think about some of the things we have done, sometimes

meaning to be prudential in our actions, has led to a concentration

that is actually causing or could be said to be causing harm in our

communities, and I think as we go forward and think about housing finance reform, what is going to be the role of government in

housing finance, what is the post-Fannie, Freddie world look like,

I think we should be very mindful of the role of community lending

institutions and that we don’t, in an effort to tighten things down

everywhere, create an environment in which community institutions cannot participate and be robust and constructive participants, whether it is in housing finance or other parts of consumer

finance.

I hope that is responsive.

Mr. CUMMINGS. Yes. It is very helpful. So they are the ultimate

skin in the game folks, right? Am I right, Ms. Ratcliffe?

Ms. RATCLIFFE. One of the——

Mr. CUMMINGS. Mr. DeMarco, I don’t want to hold you up. My

time has run out anyway, but——

Mr. MCHENRY. I would say to the ranking member if we could

dismiss Mr. DeMarco.

Mr. CUMMINGS. Yes, of course.

Mr. MCHENRY. I want to thank you for your service to your government. I appreciate your testimony today. Thank you for dealing

with the schedule as well, and we apologize for that. Thank you.

Mr. DEMARCO. Well, thank you very much, Mr. Chairman and

Mr. Cummings. I appreciate being excused, but my staff and I are

fully prepared to followup in whatever way would be helpful to the

subcommittee.

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Mr. CUMMINGS. Thank you very much.

Mr. DEMARCO. Thank you so much.

Mr. MCHENRY. With that——

Mr. CUMMINGS. You were getting ready to answer my question,

Ms. Ratcliffe?

Ms. RATCLIFFE. Yes. Certainly to the extent that if community

banks are willing to take the 5 percent risk or hold the loans on

portfolio and take 100 percent of the risk, they are the ultimate

skin in the game. And I think this speaks to one of the points we

haven’t addressed much here today is the alignment on the servicer

side that there is also some provisions for in the risk retention

rules, that there is evidence that lenders who are servicing their

own loans in their own portfolio tend to be more likely to pursue

remedies that keep the borrowers in their home and minimize

losses all around than those who are servicing for others. So that

is another one of the alignment of interest problems that risk retention could seek to address that really full information doesn’t

get at.

Mr. CUMMINGS. Just one last question. Going back to what you

just said, 5 percent seems like a little bit compared to what a community bank would be dealing with. So I am just wondering if you

are going to have a retention, do you think 5 percent is sufficient?

In other words, to do the things that you just said, what you just

said, about them servicing and try to keep the borrower in the

house and all that kind of stuff, it seems like the bigger the bank,

the less—it seems like they are much further away. And I just base

this on what I see in my community. They are much further away

from the borrower, so you don’t have those relationships. So I am

just saying 5 percent, I wonder if that even does it. You follow me?

Ms. RATCLIFFE. Of course, it is hard to know, but I believe that

relatively modest amounts of risk retention are effective, especially

when structured right, and the regs have a number of different alternatives for looking at the structure, are enough to begin to get

at some of the principal-agent problems. They are not necessarily

going to be enough to protect the entire financial system, and that

is sort of a different objective, is having enough capital systemwide

to pay for the losses than just the behavioral aspects of a risk retention model.

I would also add that small institutions can participate in the

mortgage market by holding loans in portfolio, potentially provided.

We will see how the regs come out, maybe by keeping some of the

risks in securities. They can also participate by selling loans to

Fannie and Freddie, and those agencies right now, and hopefully

some kind of successor function, would allow smaller institutions to

continue to offer the same kinds of products in communities around

the country that the large banks can offer competitively.

Mr. CUMMINGS. Mr. Rosner, you had something?

Mr. ROSNER. Yes. The community bank, I think, has been a very

different type of player and, yes, they do retain the risk. Not only

do they know their customer, they know the customer’s company,

usually; they know the local economics of the market in which they

are lending; they have a lot more information with which to assess

risk and, therefore, for many reasons have much more comfort in

holding that risk.

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The large firms, when you have, as we saw, an increasing concentration of loans that are being made by a handful of players

such that, as of now, last quarter, 56 percent of originations were

done by three players, if you think that a lender in California

knows anything of substance about a borrower in New York or any

other community, he really doesn’t, it is just a number. And when

you have firms that are inherently too big to fail, they know that

even if they are forced to retain 5 percent, it is not their 5 percent,

it is the taxpayers’ 5 percent.

So we haven’t addressed that. And the risk retention, as I said

before, I fear is almost a false sense of comfort because, as we saw

even in the FCIC report, a lot of the senior-most managers of many

of the firms did not even understand or know, and weren’t apprised

of the risk that their firms retained as it was, in many cases risks

that ultimately sunk those firms. So I think, as Mr. DeMarco pointed out, we do have to figure out a way to get deconcentration of

lending, deconcentration of servicing. And I am just not sure that

in a world where we already have institutions that have extraordinary benefits and think of themselves as too big to fail, that giving them the right or almost the responsibility to hold more and

more risk, holding the taxpayer more and more hostage, is the

right answer.

Mr. CUMMINGS. Mr. Chairman, you have been quite lenient, but

I have to say this. First of all, I want to thank all of you for your

testimony; it has been very helpful.

I just hate the idea of, Mr. Rosner, kind of throwing up our

hands and saying, you know, we cannot control this. That is what

it seems like. And it just seems to me that in a Nation where we

can send somebody to the moon, it seems like we ought to be able

to straighten out this mess so that it doesn’t happen again and so

that it makes sense so that little people or regular just everyday

people are not crushed. I mean crushed. And as I say to my constituents, I think what I am seeing right now probably is the greatest transfer of wealth in my lifetime from middle class to upper

class. There is a tremendous transfer of wealth and it is really kind

of sad, and it has come in so many forms, and foreclosures is one.

Thank you very much.

Mr. MCHENRY. And I appreciate the ranking member. If the

Members do want to make a comment about the gentleman’s statements, I am happy to hear it. Mr. Chairman, I have just been interested in the questions and good feedback, and I think we have

had a good panel, and it is a good question. I mean, is that sort

of the idea, Dr. Sanders, Mr. Rosner, Ms. Ratcliffe, just throwing

up your hands and just say we can’t do it, or what is that answer?

Mr. SANDERS. I will try this first. I moved here from Phoenix, Arizona, so about foreclosures, I am painfully aware of what it does

to the community and how households suffer when that happens,

and I have seen community banks out there just go away; and that

is bad, because I am a big supporter of community banks for all

the reasons Mr. Rosner said, which is very good.

But again I get back to the point that there really is something

that we can do; it is strengthen representations and warranties,

which is, by the way, the ultimate skin in the game, it is not 5 percent. Because what happens is if a bank such as Wells Fargo or

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one of their subsidiaries misleads investors, investors then file, and

there are tons of these suits lined up in court and they will in some

cases collect the money back.

And again, to go back to Mr. Cummings’ question, you were saying, well, that is after the fact they will collect money. Well, going

forward, if you strengthen these and make it clear that we will enforce these laws, we will enforce these regulations that are on the

books and have transparency, we will see a lot different market

going forward, but we really have to have those things. And that

is not waving my hand; I want to move forward. I am just concerned that risk retention gets focused on and it doesn’t achieve

what we think it is going to do.

Mr. ROSNER. Many of the underlying problems that brought us

to where we were were illegal activities, both on behalf at times of

borrowers and at times of lenders. It seems that they exist in the

servicing world as well. We have seen no enforcement, which I find

to be astonishing. I have spent most of my, since leaving the traditional sale side, have spent my entire career highlighting and

warning of exactly the issues that we have come to live with and

doing analysis on that.

I am not at all throwing up my hands. What I am suggesting is

that we have to avoid the false sense of solving something that we

are not solving, and the closest we get is make sure that the information out there is so clear, so standardized and so manageable

that you can’t hide reality from either borrower or from investor.

Mr. MCHENRY. Ms. Ratcliffe.

Ms. RATCLIFFE. I agree with all that. I think that it is quite possible that if all we did was increase transparency for investors and

let them run all these tapes and fields, records through their models, that too could potentially create a false sense of security. I

mean, to your earlier point, I think the saddest thing about this

situation is that it didn’t really have to happen.

Why didn’t the market ask for the reps and warrants then? Why

didn’t the private investors get those? Why didn’t they get more information then? Mr. Rosner saw it coming. It seems like private investors could have used what information they had; they had

enough information to be able to anticipate some of these events.

You did.

Mr. ROSNER. They didn’t really have the information, i.e., the information that we are talking about, the loan level information.

And, unfortunately, I am not here to make excuses for the investor

community, but the reality is you have a broad and very diffuse investor community, 10,000 or so firms who, to get them to even offer

comment letters on rulemaking processes or accounting rules to

which they are extremely exposed is almost impossible.

So you have that relative to a handful of firms who are ultimately making the rules, and there has been no regulatory intervention on behalf of the investor, who, by the way, harms—you

have to remember that a lot of those people who have lost their

houses have been doubly harmed because they have lost their pension assets, they have lost other investment assets. They have been

harmed all along the way. They are investors. Most investors, most

professional investors are managing money for many of those same

people.

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Ms. RATCLIFFE. So I agree with everything Mr. Rosner said. I

just wanted to say that this is not rocket science. I think the mortgage finance system, for a number of years, really has worked fairly well for a lot of people and we do know what it is going to take

to get it right. These are, in a lot of ways, common sense things,

and this either/or discussion is a little misleading. We need the

transparency; we need the risk retention; we need the skin in the

game; we need the capital; we need transparency in markets. We

know what we need here.

Mr. CUMMINGS. Thank you all very much.

Mr. MCHENRY. All right, thank you for your testimony. I appreciate the ranking member’s questions as well.

I would just say, in closing, thank you for staying for an extended period of time. I certainly appreciate your candor in answering these questions. It is a highly important issue. And let’s make

no mistake about it, there is skin in the game, as there always has

been with securitization, at all levels. The question is what can we

do to foster more transparency in this marketplace.

Clearly, Dodd-Frank doesn’t address this. I think the takeaway

from today is that more transparency would not be a harmful thing

to my constituents who seek a mortgage; it wouldn’t be a harmful

thing to investors, because they would at least have greater certainty in the products they are purchasing. I think those are some

enormous takeaways that we can agree to in a wider array, so I

certainly appreciate you addressing those issues.

It certainly is an important issue not simply here in Washington

or on Wall Street, but for Main Street, for average Americans and

average homeowners, even those that are paying their mortgage.

But we want to make sure we get this right, and that is what this

hearing is about, and I certainly appreciate your information, informing us as public policymakers about that.

Thank you, and the hearing stands adjourned.

[Whereupon, at 5:12 p.m., the subcommittee was adjourned.]

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