UNDERSTANDING THE IMPLICATIONS 

AND CONSEQUENCES OF THE PROPOSED 

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UNDERSTANDING THE IMPLICATIONS AND CONSEQUENCES OF THE 

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UNDERSTANDING THE IMPLICATIONS 

AND CONSEQUENCES OF THE PROPOSED 

RULE ON RISK RETENTION 

HEARING 

BEFORE THE

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OF THE

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U.S. HOUSE OF REPRESENTATIVES 

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FIRST SESSION 

APRIL 14, 2011 

Printed for the use of the Committee on Financial Services 

Serial No. 112–27 

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(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

LARRY C. LAVENDER, Chief of Staff 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

DAVID SCHWEIKERT, Arizona, Vice 

Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

JUDY BIGGERT, Illinois 

JEB HENSARLING, Texas 

RANDY NEUGEBAUER, Texas 

JOHN CAMPBELL, California 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

NAN A. S. HAYWORTH, New York 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

MAXINE WATERS, California, Ranking 

Member 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

CAROLYN B. MALONEY, New York 

GWEN MOORE, Wisconsin 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

AL GREEN, Texas 

KEITH ELLISON, Minnesota 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

April 14, 2011 ................................................................................................... 1 

Appendix: 

April 14, 2011 ................................................................................................... 61 

WITNESSES 

THURSDAY, APRIL 14, 2011 

Alvarez, Scott G., General Counsel, Board of Governors of the Federal Reserve System ......................................................................................................... 9 

Cross, Meredith, Director, Division of Corporation Finance, U.S. Securities 

and Exchange Commission (SEC) ....................................................................... 10 

Cunningham, Henry V., Jr., CMB, President, Cunningham and Company, 

on behalf of the Mortgage Bankers Association (MBA) .................................... 34 

Deutsch, Tom, Executive Director, American Securitization Forum (ASF) ........ 36 

Harnick, Ellen, Senior Policy Counsel, Center for Responsible Lending (CRL) . 43 

Hoeffel, J. Christopher, Managing Director, Investcorp International, Inc., 

on behalf of the CRE Finance Council ............................................................... 38 

Krimminger, Michael H., General Counsel, Federal Deposit Insurance Corporation (FDIC) .................................................................................................... 11 

Lawler, Patrick J., Chief Economist and Associate Director, Office of Policy 

Analysis and Research, Federal Housing Finance Agency (FHFA) ................. 17 

Ryan, Bob, Acting Assistant Secretary for Housing and FHA Commissioner, 

Federal Housing Administration (FHA), U.S. Department of Housing and 

Urban Development (HUD) ................................................................................. 15 

Schneider, Kevin, President and CEO, U.S. Mortgage Insurance of Genworth 

Financial, on behalf of the Mortgage Insurance Companies of America 

(MICA) .................................................................................................................. 40 

Smith, Bram, Executive Director, Loan Syndications and Trading Association 

(LSTA) ................................................................................................................... 41 

Williams, Julie, First Senior Deputy Comptroller and Chief Counsel, Office 

of the Comptroller of the Currency (OCC) ......................................................... 13 

APPENDIX 

Prepared statements: 

Alvarez, Scott G. ............................................................................................... 62 

Cross, Meredith ................................................................................................ 77 

Cunningham, Henry V., Jr. ............................................................................. 86 

Deutsch, Tom .................................................................................................... 103 

Harnick, Ellen ................................................................................................... 208 

Hoeffel, J. Christopher ..................................................................................... 231 

Krimminger, Michael H. .................................................................................. 250 

Lawler, Patrick ................................................................................................. 263 

Ryan, Bob .......................................................................................................... 294 

Schneider, Kevin ............................................................................................... 298 

Smith, Bram ...................................................................................................... 309 

Williams, Julie .................................................................................................. 326 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Garrett, Hon. Scott: 

Written statement of the American Bankers Association (ABA) ................. 345 

Written statement of the Education Finance Council ................................... 349 

Page

VI 

Garrett, Hon. Scott—Continued 

Written statement of HVP Inc. ....................................................................... 351 

Hinojosa, Hon. Ruben: 

Letter from various undersigned organizations ............................................. 355 

Posey, Hon. Bill: 

Written responses to questions submitted to Scott G. Alvarez .................... 357 

Written responses to questions submitted to Meredith Cross ...................... 359 

Written responses to questions submitted to Michael H. Krimminger ........ 362 

Written responses to questions submitted to Julie Williams ....................... 364 

Schneider, Kevin: 

Chart entitled, ‘‘Qualified Insured Loan Performance’’ submitted in response to a question from Representative Biggert ..................................... 365 

(1) 

UNDERSTANDING THE IMPLICATIONS 

AND CONSEQUENCES OF THE PROPOSED 

RULE ON RISK RETENTION 

Thursday, April 14, 2011 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 2:02 p.m., in room 

2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. 

Members present: Representatives Garrett, Schweikert, Manzullo, Biggert, Hensarling, Neugebauer, Campbell, Pearce, Posey, 

Hayworth, Hurt, Grimm, Stivers; Sherman, Hinojosa, Lynch, Miller 

of North Carolina, Maloney, Perlmutter, Carson, Himes, Peters, 

Green, and Ellison. 

Ex officio present: Representatives Bachus and Frank. 

Also present: Representative Renacci. 

Chairman GARRETT. Good afternoon. This hearing of the Subcommittee on Capital Markets and Government Sponsored Enterprises will come to order. And without objection, all members’ opening statements will be made a part of the complete record. 

At this time, I yield to myself for the first 5 minutes. 

Today, we will be examining the ongoing rules and rule-writing 

of Section 941 of the Dodd-Frank Act. Section 941 of Dodd-Frank 

mandates that our financial regulators craft rules requiring entities involved in the securitization to retain a certain level of risk 

of the assets being securitized. 

The intent of this was to better align the incentives among the 

chain of originators, the securitizers, and the investors. I have stated numerous times that risk retention, if it is done correctly, in 

theory can be a constructive addition. But I do have significant concerns with the rules as currently written and the many unanswered questions that they raise. 

Some of my main concerns are not only with the policy implications of the rules but also, quite frankly, with the process and the 

manner in which some of the policies were included, and the explicit disregard, quite frankly, of congressional intent. Section 

941(b) of the Dodd-Frank Act creates section 15G of the Securities 

Exchange Act, which specifically exempts all assets which are insured or guaranteed by the United States or an agency of the 

2 

United States. The rest of the section specifically says that Fannie 

Mae and Freddie Mac are not agencies of the U.S. Government. 

With that said, it is hard for me to see how much more explicit 

this Congress could have been. It was not the intent to have the 

GSEs exempted from the risk retention requirement, yet the rule 

before us today allows for the GSEs to be exempted and it does so 

by claiming that their guarantee functionally acts as a formal type 

of risk retention. Quite frankly, this will severely hinder ongoing 

efforts by the Administration and Congress to encourage more private capital in our mortgage market and reduce taxpayer risk. 

By a 34–0 unanimous vote last week in this committee, we 

passed legislation that I introduced which would attempt to ensure 

that the government and the private sector are treated equally 

with regard to risk retention. As most of you know if you know this 

committee, over the last several years there have not been a lot of 

committee pieces of legislation that have passed out of this committee in a completely unanimous vote like this did. 

So in this case, this should be a clear intention to you that Congress believes that you need to alter your rule and follow the clear 

intention of Dodd-Frank on this topic. I look forward to working 

with each of you on this to ensure the final draft is structured in 

a way that does not put the private market at a disadvantage in 

the government. 

Another one of my main concerns is the addition of servicing 

standards to the rule. While I agree that there are a number of 

problems that have occurred in the servicing sector, I do not believe 

that unelected bureaucrats, if you will, should be attaching unauthorized policy goals on the next train leaving town. 

As you all know, I was on the Dodd-Frank conference committee. 

Over 6 days of discussion during the conference, I don’t remember 

any time when servicing standards were contemplated, much less 

discussed during that time. 

I certainly cannot find anything in Section 941 authorizing the 

regulators to include servicing standards in the rule. So it is Congress’ role to examine the issues in the servicing industry and 

make specific policy proposals, not the regulators. 

So these two instances—the exemptions of the GSEs and the inclusion of servicing standards—highlight my overreaching concerns 

about the manner in which this rule was drafted. In one instance, 

you have Congress specifically directing the regulators to do something and they did the opposite; in another instance, Congress 

didn’t provide any authority or authorization to do something but 

they did anyway. 

So I hope that you and the heads of the various agencies will reverse course on these issues and actually follow the letter of the 

law and the intention of Congress. This is just a microcosm of the 

absurdity, I guess, of trying to delegate over 300 rules affecting literally millions of people and businesses, not to mention the entire 

U.S. economy, to dozens of agencies and then mandating that it is 

all done in a year. I understand that. 

Finally, in addition to this, there are many other important 

issues that Members need to learn about today, like the specific ongoing underwriting standards of QRM, how private mortgage insurance should factor into the criteria, and also the premium capture 

3 

cash reserve accounts requirements and its possible tremendous 

negative effects on the residential and commercial securitization 

market. 

With that, the rule has a broad impact on so many people, our 

economy, and the recovery, it is critical that we get this right. So 

I hope today’s hearing can begin to move us all in that direction. 

And with that I yield now to—there he is—the gentleman from 

Massachusetts for— 

Mr. FRANK. Thank you. Let me just say preliminarily, the ranking member of the subcommittee, the gentlewoman from California, 

Ms. Waters, is at a full committee markup of the Judiciary Committee right now on patent reform. That is also where Mr. Watt is, 

so that is a very significant issue and they will not be able to be 

with us because of that. 

I want to talk just a little bit about the context of risk retention. 

The risk retention context is a very important one. 

I believe that one of the most important factors that led to the 

crisis was the ability of people to make loans without bearing the 

risk of nonpayment of that loan; that was transformative in both 

a good way and a bad way. Thirty years ago, we had a situation 

where people who borrowed money were paying back the lender, 

and lenders frisked people pretty good before lending them their 

money. And then, because of liquidity outside of the banking system from a variety of sources and because of the ability to 

securitize through computers and other ways, we lost that discipline. 

So it is very important that we put it back in the bill. I think 

it is one of the most important things in the legislation. And I 

should note that it does not simply apply to residential mortgages; 

it applies to commercial, to all manner of lending. 

And this policy of people making loans without regard for the 

ability of the borrower to repay was a serious problem. So we have 

this legislation, and we did say that with regard to residential 

mortgages we would make an exemption if we could have other assurances that these were good loans—that is, the fundamental 

mechanism for making sure that loans are made prudently is the 

loss that a lender will suffer if the borrower can’t pay it back, and 

that is the market discipline on the lender. 

To the extent that securitization either evolved into this or severely attenuates that, we want some substitute. The Qualified 

Residential Mortgage is a substitute for that market discipline. 

I want to make a couple of points. First of all, I disagree with 

those who are acting as if all residential loans in the future are 

going to have to come under that Qualified Residential Mortgage 

exception. It no doubt seems that way now. Change is hard for people to grasp. 

We have smaller financial institutions that have made mortgage 

loans and kept them in portfolio because they didn’t want to take 

the loss that comes when you go and securitize. We have some entities—Wells Fargo—that said they will make these loans and 

securitize them with risk retention. 

Risk retention is not meant to stop securitization; it is meant to 

make it more responsible. And a 5 percent number ought not to be 

deterring anybody with responsible policies. 

4 

And there is the FHA. I agree, as the vote made clear last week, 

that we should not be exempting Fannie Mae and Freddie Mac 

through risk retention. I do believe that we have a very solid set 

of safeguards in the FHA, and that we should continue to work on, 

and I hope we will be further legislating on, those safeguards, but 

there is an argument for not having the risk retention apply there 

and I think you can do that in the FHA without it. 

But there are, I hope going forward, going to be loans made outside of the Qualified Residential Mortgage. Having said that, I do 

believe that the Qualified Residential Mortgage, especially in this 

period when people need it, it is going to be very important. 

And I am persuaded by a number of people that 20 percent is 

too high a number. What we are looking for—and we have to look 

at the statistics as to what experience has been, and I think it is 

a very good argument that you don’t have to get to 20 percent. 

It is also the case that there are qualitative things you can do 

with regard to mortgages, some of which we have done, to prevent 

bad mortgages. And that, I think, further gives us some assurance. 

I will say, of those things that have been suggested as for the 

safeguards, private mortgage insurance does not seem to me to be 

one of those that can be a relevant factor here. I don’t think that 

is going to discourage the bad loans. Insuring people against having made bad loan decisions does not seem to me to discourage 

them from making bad loan decisions. 

So I am very pleased with the framework we have created. I 

think it is essential to reintroducing a healthy respect for risk into 

the lending system, not just in mortgages, but elsewhere; but I also 

believe that the arguments that 20 percent is too high a number 

are very persuasive and I look forward to further work on that. 

Chairman GARRETT. I thank the gentleman. 

To the chairman of the full committee, the gentleman from Alabama, for 2 minutes? 

Chairman BACHUS. I thank the chairman for convening the hearing on credit risk retention as mandated by Dodd-Frank. 

Securitization has both benefits and risk. While securitization of 

assets increases liquidity and lowers the cost of credit to homeowners, students, consumers, and businesses seeking financing, 

securitization can also create moral hazards by allowing originators 

and securitizers of assets to pass the risk of underlying assets on 

to investors. And of course, we certainly saw that in 2008 in a big 

way. 

Section 941 of Dodd-Frank sought to reduce that moral hazard 

by better aligning the interests of sellers and buyers of assetbacked securities, which is a worthy goal. Proponents of this approach advocate or are advanced at requiring securitizers to retain 

some skin in the game, which will encourage them to take more 

care in selecting high-quality assets. 

For risk retention to be successful, however, the standard must 

not stifle the securitization of loan products, thereby raising costs 

to consumers and cutting down on the availability of credit. The 

proposed release by the regulators on March 31st, I think recognizes the differences between asset classes, collateral, and financing structures and provides needed flexibility for securitizers to determine the most appropriate form of risk retention. 

5 

I particularly applaud the testimony of the Federal Reserve and 

the OCC, and there is a lot to associate myself with in your testimony. 

But as with any proposal that runs several hundred pages, there 

are aspects of the rule that I think raise questions and concerns. 

For example, the regulators have chosen to address extraneous 

issues, which, in my opinion, are beyond the scope of Dodd-Frank, 

including mortgage servicing standards as part of the risk retention requirements. Also, the broad exemption provided to loans 

purchased by Fannie and Freddie, I think is problematic. 

And I will close by saying this: I would associate myself with 

page seven of the Fed’s testimony, where you say, ‘‘However, unlike 

the various other types of risk retention discussed earlier, which all 

involve the acquisition of an asset by the sponsor, the GSE’s risk 

exposure is generally in the form of an unfunded guarantee, which 

would not satisfy the risk retention requirements of the proposed 

rules.’’ 

It really seems to be contrary to the intent and would, in my 

mind, unlevel a level playing field. And I know the intent of the 

Treasury, which has been announced, is to crowd in private investment in a crowded market, but I think that would work in the opposite direction. 

I appreciate your testimony, and I appreciate your thoughts on 

this in approaching today’s hearing. 

Chairman GARRETT. Does the gentleman yield back? 

Chairman BACHUS. Yes. 

Chairman GARRETT. Mr. Hinojosa for a liberal 2 minutes? 

Mr. HINOJOSA. Chairman Garrett, I ask unanimous consent to 

submit for today’s record a letter from several civil rights groups 

opposing the 20 percent downpayment proposed in the risk retention rule, including the National Council of La Raza, the NAACP, 

Americans for Financial Reform, and others. 

Chairman GARRETT. Without objection, it is so ordered. 

Mr. HINOJOSA. I ask unanimous consent. Thank you. 

Mr. Chairman, I appreciate you holding this important and timely hearing. 

I want to welcome the witnesses to the subcommittee and I look 

forward to a continued dialogue with your agencies on the importance of homeownership to my constituents in South Texas along 

the Texas-Mexico border. 

Mr. Chairman, I am concerned about the risk retention proposal 

we are addressing here today. We must restore sound practices in 

lending, securitization, and loan servicing without shutting out 

creditworthy borrowers. 

However, requiring a minimum 20 percent downpayment for 

Qualified Residential Mortgages might have a negative impact on 

the ability of minority and first-time homebuyers to obtain an affordable mortgage and attain the American dream of homeownership. Furthermore, additional requirements mandating specific 

loan-to-value ratios might do more harm than good by unduly 

disadvantaging well-qualified borrowers who lack the resources 

necessary for large downpayments. 

Mr. Chairman, whatever we do to address risk retention and the 

definition of Qualified Residential Mortgages, we should not allow 

6 

a proposal by any agency or agencies to move forward that would 

subject minority and first-time homebuyers to the same predatory 

lending that contributed substantially to the recent economic crisis. 

Requiring a 20 percent downpayment might have that effect. I 

hope that today’s witnesses have taken this concern into consideration as they drafted the proposal on credit risk retention. 

Again, I welcome the witnesses, and I yield back the remainder 

of my time. 

Chairman GARRETT. The gentleman yields back. 

The gentleman from Arizona, for 1 minute? 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. And I know I have 

only 60 seconds here. 

I have actually been looking forward to this hearing. I have dozens and dozens of questions and I am sure our panel here will hit 

every single one of them. 

One has to do with the servicing ending up as part of the discussion. Being someone who has a great interest in impairment servicing, should that be dealt with separately? Is the June 10th deadline for particularly comments—is that still on target or should 

that be extended? 

And one of my greatest concerns here in regards to risk retention 

is, ultimately, what are we trying to accomplish? Is 20 percent the 

magic number? Is it 10 percent down with private mortgage insurance? 

Is it some mechanic within, a strip on the bond, if the securitizer 

is willing to hold certain of the risk? What ultimately defines up 

and down through the market that additional guarantee for the 

final product, particularly on the bond side, that we are trying to 

protect? 

Thank you, Mr. Chairman. 

Chairman GARRETT. And the gentleman yields back. 

Mr. Himes for 2 minutes? 

Mr. HIMES. Thank you, Mr. Chairman. 

And let me thank the panel for joining us today for what I think 

is a really interesting and important conversation. As I reflect on 

Dodd-Frank, I think the risk retention provision was an example 

of—as a matter of principle—smart public policy. This government 

could have faced a choice of trying to be blunt about what securities were too risky to be contemplated, and which were not—how 

the spectrum of risk might—how different securities might fall on 

a spectrum of risk, but we didn’t. 

We chose instead to do something very smart, which was to say, 

‘‘Go out and invent some securitized product that we perhaps don’t 

understand, but you will retain some exposure to whatever that 

beast is that you have created. You will eat your own cooking, to 

some extent.’’ And that is a very smart principle within regulation. 

The challenge, of course, is that these beasts have very, very different profiles. Some of them are extraordinarily risky, as we 

learned; some of them are not. Some of them are composed of U.S. 

Treasury debt. 

And so the challenge, of course, for you is to figure out what the 

right level of retention is for different instruments. Dodd-Frank 

contemplated a 5 percent level with some flexibility. 

7 

It is really critical, I think, as you undertake your work—and 

you know this, of course—that risk retention not require capital 

levels so high that liquidity will be compromised. And that is a 

very real risk. 

These securities are complicated. They have different profiles. 

Many of the securities under contemplation here were far removed 

from the problems that we watched in the last 3 or 4 years. 

So I thank you for the work you are doing, and urge you to bear 

in mind that particularly now, in this economy, liquidity is essential. I point, in particular, to the CLO market, which the Federal 

Reserve indicated was perhaps a product that didn’t require 5 percent retention, in which liquidity could be damaged if a 5 percent 

number were used. 

Obviously, there are many, many other examples of this. I appreciate the complexity of your task. But as I stand for the principle 

of retention, which I think is absolutely right, I urge you to be very 

mindful that the process not damage liquidity, particularly in those 

instruments which were far removed from the problems that this 

country experienced in the last several years. 

And with that, I yield back the balance of my time. 

Chairman GARRETT. The gentleman yields back. 

The gentleman from Texas, for 2 minutes? 

Mr. HENSARLING. Thank you, Mr. Chairman. I know votes are 

imminent, so I will attempt not to take up the full 2 minutes. 

We all know that the world works off of incentives, and I like to 

have incentives properly aligned, so on the chalkboard, the whole 

risk retention rule certainly has an appeal to it. However, a prescriptive rule is not one I have a high level of enthusiasm for, and 

this one in specific I have great, great concern for. 

I think it could impede private capital from coming back into the 

market. I fear it does not serve as a caution light but perhaps as 

an absolute stop sign. I am afraid this may be one more of the unintended consequences that we find in the Dodd-Frank legislation. 

I must admit, as I was peeking and reading some of the testimony and some of the documents that have come across my desk, 

any time you get the mortgage bankers, the mortgage insurers, the 

Center for Responsible Lending, and the Congressional Black Caucus to agree on something, maybe this committee ought to pay a 

little bit of attention. So certainly, that is what I observed, Mr. 

Chairman. 

Again, they are sounding the alarm and we need to pay attention. And I, again, fear that something that looked good on the 

drawing board may not prove so good in practice. And I personally 

am going to be laser-focused on removing all the barriers necessary 

to get private capital to come back into our mortgage markets. 

I yield back to the chairman. 

Chairman GARRETT. The gentleman from Texas yields back. 

The gentleman from Texas referenced votes. I think we are going 

to try to—the recommendation is to plow right through this, but 

before we do that, we will hear from the gentleman, Mr. Lynch, for 

2 minutes. 

Mr. LYNCH. Thank you, Mr. Chairman. 

I would like to thank our witnesses as well for appearing before 

us and helping the committee with this work. The risk retention 

8 

rule in Section 941(b), if properly designed and administered, will 

play a critical role for the mortgage industry and will be incredibly 

important to the members of this committee and to regulators to 

get right in order to avoid the recklessness that we saw in the last 

financial crisis as well as to try to balance out the need for greater 

credit availability. 

The joint rule on the securitization of asset-backed security, 

which we all know played a central role in the recent financial crisis—Dodd-Frank requires banks or securitizers to keep some skin 

in the game for the loans that they are originating and bundling 

and selling to investors. Under the proposed rules, securitizers 

must retain a 5 percent portion of the credit risk for assets that 

they decide to sell to investors. 

There is an important exemption, of course, and the regulators 

are able to determine what the exemption looks like. Now, my 

friend, the gentleman from Texas, has talked about the proposed 

rule to include a requirement of a 20 percent downpayment and the 

impact that that might have on credit availability to people in his 

district and mine as well, and there is also a provision here that 

it would require anyone from qualifying—excuse me. It would prohibit someone from qualifying if they had any delinquency or late 

payment over 60 days in the last 2 years. 

That would probably eliminate a large portion of people who 

might otherwise qualify for a mortgage. And I think with the abundance of information we have on credit history, we should be able 

to come up with a more fine-tuned approach than simply saying 

someone missed a—was late on a cable bill or a utility bill for 60 

days and therefore are ineligible for credit. 

I am concerned about how this might affect the affordability of 

a 30-year mortgage. Congress has gone to great lengths to promote 

mortgage finance over the greater part of the last century. The 

GSEs were created because additional liquidity was needed in 

order to—for the market to provide long-term fixed-rate mortgages, 

and a 30-year fixed-rate mortgage was not affordable even to families with stable incomes. 

As the rule is currently written, however, I am not sure the 30- 

year fixed-rate mortgage, an essential and valued product to the 

American homebuyer, will still be available except to the very 

wealthy. I look forward to hearing from our witnesses and I yield 

back the balance of my time. 

Thank you, Mr. Chairman. 

Chairman GARRETT. The gentleman yields back. 

Mr. Stivers, for 1 minute? 

Mr. STIVERS. Thank you, Mr. Chairman, for calling this hearing 

on the proposed risk retention rules. And obviously, we all agree 

with the concept of risk retention. I think skin in the game makes 

a lot of sense. 

I do have a lot of folks in my district who are related to the automobile industry. I have a Honda plant in my district that employs 

about 4,000 people and they rely on the asset-backed securities 

market for critical access to capital and ensuring that they can 

produce and sell cars. And I am a little concerned about the narrow 

crafting of the qualified automobile loan as well, and I would like 

to ask some questions about that a little later. 

9 

I think there have been a lot of questions about the QRM that 

I am anxious to ask some questions about going forward. 

I look forward to hearing from all the witnesses. I want to thank 

the chairman for allowing me a little time, and I yield back the balance of my time. 

Chairman GARRETT. The gentleman yields back. 

And with that, we have just been advised of a slightly different 

vote sequence following this, so we will begin the sequence of panelists. 

Without objection, all of your written statements will be made a 

part of the formal record, and you are now recognized for 5 minutes. 

Mr. Alvarez? 

STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, 

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. ALVAREZ. Thank you, Mr. Chairman. 

Thank you, Chairman Garret, Ranking Member Frank, and 

members of the subcommittee. I appreciate the opportunity to discuss the implementation of the risk retention requirements of Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

This statutory provision generally requires securitizers to retain 

some of the credit risk of the assets they securitize, often referred 

to as ‘‘keeping some skin in the game.’’ The concept behind risk retention and securitization is that it promotes incentives for loan 

securitizers and originators to maintain appropriate underwriting 

standards and to monitor the credit quality of assets that they 

securitize. 

By better aligning the incentives of securitizers with the incentives of investors in this way, risk retention requirements foster 

more liquid markets for loans, which increases the availability of 

credit to consumers and businesses and lowers the cost to borrowers. The Federal Reserve has joined with the other Federal 

agencies here today to invite the public to comment on a proposed 

rule that would implement the risk retention requirements of the 

Dodd-Frank Act. 

In developing the proposal, the Federal Reserve and the other 

agencies carefully considered best market practices for risk retention used for various types of assets and various types of 

securitization structures. We also took into account how well these 

forms of risk retention performed during the recent market crisis. 

The proposal includes a menu of options for retaining risk that 

allows securitizers to tailor securitization transactions according to 

market practice while at the same time meeting the statutory requirements to retain risk. This should encourage securitizers to 

closely screen and control the credit quality of the assets they 

securitize without unduly disrupting markets. 

As provided in the Dodd-Frank Act, the agency proposal includes 

an exemption from the risk retention requirement for the 

securitization of ‘‘Qualified Residential Mortgages,’’ or ‘‘QRMs.’’ In 

keeping with the statute, the proposal is based on standards that 

are most associated with lower risk of default on residential mortgages, including conservative debt-to-income ratios, strong credit 

10 

history, and a significant downpayment requirement for purchase 

loans. 

The statute contemplates that strong underwriting standards offset allowing the securitization to proceed without any risk retention requirement on the sponsor or originator. In addition to lowering the default risk, this approach is designed to improve access 

to and lower the cost of credit for creditworthy consumers. 

A narrow QRM definition should improve access to credit and 

lower borrower cost by encouraging a deep and liquid market for 

residential mortgages that do not meet the definition of a QRM and 

fostering securitization of those loans. On the other hand, a broader definition of QRM that encompasses a much larger portion of the 

residential mortgage market could diminish access to credit for 

creditworthy borrowers because the small segment of the market 

left outside a broad definition of QRM may not be able to attract 

sufficient funding from the markets to make it practical for lenders 

to make the loans and for those loans to be securitized. 

The risk retention requirements of the Dodd-Frank Act raise important and complex issues. The Federal Reserve and the other 

agencies here today look forward to receiving comments on the proposed risk retention rules from consumers, borrowers, lenders, 

securitizers, and all others who are interested in the proposal. We 

will weigh those comments carefully before acting on the final rule. 

I thank you very much for your attention and am happy to answer any questions. 

[The prepared statement of Mr. Alvarez can be found on page 62 

of the appendix.] 

Chairman GARRETT. And I thank you. 

Ms. Cross? 

STATEMENT OF MEREDITH CROSS, DIRECTOR, DIVISION OF 

CORPORATION FINANCE, U.S. SECURITIES AND EXCHANGE 

COMMISSION (SEC) 

Ms. CROSS. Chairman Garrett, Ranking Member Frank, and 

members of the subcommittee, I am pleased to testify on behalf of 

the Commission on the topic of risk retention and securitization. 

On March 30, 2011, the Commission joined its fellow regulators in 

issuing proposals to implement the risk retention requirements in 

Section 941(b) of the Dodd-Frank Act. 

The proposal would permit a sponsor to choose from a menu of 

four risk retention options and also includes transaction-specific options for three asset classes. A sponsor also would be required to 

establish a cash reserve account in certain cases. 

The proposal would permit the 100 percent guarantee provided 

by Fannie Mae or Freddie Mac to satisfy their risk retention obligations, but only while they are operating under conservatorship or 

receivership with capital support from the United States. The proposal provides an exemption for ABS backed by Qualified Residential Mortgages as well as for ABS backed by commercial loans, 

commercial mortgages, or automobile loans that meet certain underwriting standards. It also would exempt certain other 

securitizations consistent with the Act. 

The proposal comes from many months of collaboration and cooperation. The agencies have included numerous requests for comVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
11 

ment and we look forward to considering the comments as we work 

together to finalize the rules. 

In addition to risk retention, the Dodd-Frank Act has other provisions that require Commission rulemaking for ABS and I would 

like to mention them briefly today. For example, Section 943 requires the Commission to adopt disclosure rules on the use of representations and warranties, which the Commission finalized in 

January. Also in January, the Commission adopted rules implementing Section 945, requiring ABS issuers in registered transactions to review the assets underlying the ABS and disclose the 

nature of the review. 

Further, Section 942(a) eliminated the provision that allowed 

ABS issuers to automatically stop reporting under the Exchange 

Act and granted the Commission authority to issue rules allowing 

ABS issuers to stop reporting. In January, the Commission proposed rules to permit suspension of reporting in certain limited 

cases. 

In addition to these Dodd-Frank Act ABS rulemakings, in April 

2010, prior to passage of the Act, the Commission proposed substantial enhancements to the Commission’s ABS rules. Importantly, the Commission’s April 2010 proposal would change the test 

that ABS issuers must satisfy to qualify for shelf registration, 

which currently requires an investment-grade rating. 

Two of the proposed new requirements—a 5 percent risk retention requirement and an undertaking to continue reporting—are 

covered by the Dodd-Frank Act. Before finalizing that part of the 

April 2010 proposal the staff will develop recommendations designed to harmonize the rules with rules adopted under the Act. 

The proposal also would require disclosure of asset level data for 

ABS. Section 942(b) directs the Commission to require asset level 

data so the staff is considering this requirement as we prepare recommendations for the Commission. 

Other important aspects of the proposal include providing investors more time to consider important information about the particular ABS offering, requiring issuers to file a computer program 

of the cash flow waterfall provisions, and requiring issuers to undertake to provide information to investors in certain exempt offerings. We are reviewing the comments received on the April 2010 

proposal, and as I noted, we will work to harmonize the rules with 

the ABS rules required by the Dodd-Frank Act. 

Thank you for inviting me to appear before you today. I would 

be happy to answer any questions. 

[The prepared statement of Ms. Cross can be found on page 77 

of the appendix.] 

Chairman GARRETT. I thank you very much. 

Mr. Krimminger? 

STATEMENT OF MICHAEL H. KRIMMINGER, GENERAL COUNSEL, FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC) 

Mr. KRIMMINGER. Chairman Garrett, Ranking Member Frank, 

and members of the subcommittee, I appreciate the opportunity to 

testify on behalf of the Federal Deposit Insurance Corporation on 

the interagency proposal to implement the risk retention requirements of Section 941 of the Dodd-Frank Act. The goal of the interVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
12 

agency proposal is to reestablish a sustainable private 

securitization market that will once again be an important source 

of liquidity for affordable credit. 

In fashioning new rules for the securitization market, the FDIC 

and the other agencies seek to incorporate the lessons learned from 

the financial crisis. The proposed rule implemented in Section 941 

addresses a key driver of the financial crisis, the misaligned economic incentives within the securitization process. 

Just over 2 weeks ago, the FDIC and the other designated agencies approved for publication a notice of proposed rulemaking to 

implement Section 941. As specified in the Dodd-Frank Act, the 

proposal requires, as a general rule, that securitizers retain not 

less than 5 percent of the credit risk of the securitized assets. 

Requiring securitizers to have real skin in the game will align 

their interests with the interests of investors, encourage better underwriting, and promote long-term sustainable lending. We believe 

that a strong and vibrant securitization market utilizing a 5 percent risk retention requirement will best promote sustainable market financing. 

Under the proposal, securitizers will be able to pick from a number of options to achieve this 5 percent risk exposure. These options 

reflect existing market practices and are designed to provide a 

large degree of flexibility to market participants in structuring 

transactions. 

At the same time, the proposal will prevent securitizers from 

gaming the risk retention requirement by taking all of their profits 

up front. To prevent this they will be required to hold their upfront 

profits in a premium capture reserve account which will be used 

to pay for asset losses before the losses are allocated to the other 

investors in the transaction. The premium capture reserve account 

complements risk retention by ensuring that a securitizer’s interests remain aligned with the underlying performance and quality 

of assets. 

Section 941 directs the agencies to create an exemption for certain high-quality home mortgages, known as Qualified Residential 

Mortgages or QRMs. The law requires the agencies to base their 

standards for QRMs on historical loan performance data. 

To meet this requirement, the proposed rule includes underwriting and product features which, from the data available to the 

agencies, demonstrated a strong record for reducing the risk of default. Those features include verification and documentation of income, past borrower performance, a prudent debt-to-income ratio, 

elimination of payment shock features, maximum loan-to-value ratios, a minimum downpayment requirement, and mortgage servicing standards. Many of these features were ignored during the 

housing boom and the consequences were high delinquency rates 

and declining house prices. 

Many people have expressed concern about the impact of the 

QRM standard on access to affordable mortgages, particularly for 

low- and moderate-income borrowers. The FDIC shares these concerns. 

The FDIC and the other agencies want to strike the right balance in the rule to ensure that low- and moderate-income borrowers have access to affordable mortgage credit. We look forward 

13 

to receiving comments on the impact of the QRM standards on 

these borrowers. We would also welcome comments on whether the 

unique needs of low- and moderate-income borrowers can be met 

through FHA programs and downpayment assistance programs. 

It is important to note that the QRM standards are designed to 

facilitate a vibrant and liquid secondary market for non-QRM mortgages. The agencies anticipate that non-QRM mortgages will constitute a substantial majority of all mortgages. This should facilitate a deep and liquid competitive market that makes credit available for non-QRM borrowers at reasonable pricing. 

Moreover, because risk retention was already built into most 

securitizations, the agencies believe any cost increase associated 

with the new risk retention requirements will be nominal. 

Continued turmoil in the housing market caused by inadequate 

and poor quality servicing underscores the need to make sure that 

future securitization agreements include incentives for servicers to 

mitigate losses when loans become distressed. Servicing standards 

must also provide for a proper alignment of servicing incentives 

with the interests of investors and must address conflicts of interest. 

The servicing standards in the QRM proposal address many of 

the most significant servicing issues. For example, the servicing 

standards require that there will be financial incentives for 

servicers to consider options other than foreclosure when those options preserve homeownership and maximize value for investors. 

Thank you again for the opportunity to testify. I will be happy 

to answer your questions. 

[The prepared statement of Mr. Krimminger can be found on 

page 250 of the appendix.] 

Chairman GARRETT. I thank you. 

And I think we have time for one more witness and then the 

votes have been called. I would just advise the rest of the members 

of the committee that after your testimony we will take a recess, 

vote on the two bills that we have, and then come right back for 

the last two. 

Ms. Williams? 

STATEMENT OF JULIE WILLIAMS, FIRST SENIOR DEPUTY 

COMPTROLLER AND CHIEF COUNSEL, OFFICE OF THE 

COMPTROLLER OF THE CURRENCY (OCC) 

Ms. WILLIAMS. Chairman Garrett, Ranking Member Frank, and 

members of the subcommittee, I appreciate the opportunity to testify on behalf of the Office of the Comptroller of the Currency this 

afternoon regarding the interagency proposal to implement Section 

941 of the Dodd-Frank Act on risk retention in asset-backed 

securitization. 

The agencies’ risk retention proposal is designed to carry out the 

congressional direction in Section 941 that securitizers have, in effect, skin in the game to incent them to exercise diligence regarding the quality of the loans that they securitize. Reflecting that 

premise, the exemptions from risk retention that are provided by 

the proposal are conservative and focus on demonstrably high-quality loans. 

14 

In order to facilitate robust securitization markets that would include risk retention, the proposal provides flexibility with several 

options for how the risk retention requirement may be satisfied. 

We are very cognizant that implementing the statutory risk retention requirements presents complex issues with multiple public policy implications for competition, credit quality, credit access, and 

credit costs. Achieving the right balance will be very challenging. 

For that reason, the OCC has stressed the importance of the 

comment process to help the agencies get that balance right. My 

written testimony summarized the terms and features of the proposed rule and highlights three particular issues of note, which I 

will touch on here. 

The first issue concerns the proposed criteria for Qualified Residential Mortgages, QRMs, that are exempt from any risk retention 

requirements. The agencies have proposed conservative underwriting standards to define QRMs. These standards were developed 

through evaluation of available historical loan performance data as 

directed by the statute. 

The preamble discusses several possible alternatives to this approach, however. One would be to permit the use of private mortgage insurance for loans with LTVs higher than the 80 percent 

level specified in the proposed rule. 

The due diligence procedures and underwriting standards imposed by private mortgage insurers could be viewed as consistent 

with the goals of Section 941 to incent careful underwriting of 

securitized assets. However, to include private mortgage insurance 

in the QRM criteria, Congress required the agencies to determine 

that the presence of private mortgage insurance lowers the risk of 

default, not that it reduces the ultimate amount of loss. Thus, we 

will be interested in the data that commenters can provide that addresses that point. 

The second issue I note is the question of whether the QRM criteria should include mortgage servicing standards. The proposed 

rule requires inclusion of terms in the mortgage transaction documents under which the creditor commits to have specified servicing 

policies and procedures designed to mitigate the risk of default. 

The agencies have included numerous requests for comment about 

the approach to servicing standards contained in the proposed rule. 

We believe there is a need for comprehensive and uniform mortgage servicing standards that apply not just to high-quality 

securitized loans but to all facets of servicing, from loan closing to 

payoff or foreclosure. In our view, mortgage servicing standards 

should apply uniformly to all mortgage servicers and provide the 

same standards for consumers regardless of whether a mortgage 

has been securitized. 

To further this effort and discussion, the OCC developed a framework for comprehensive mortgage servicing standards. Other agencies have contributed their ideas and there is now under way an 

interagency effort to develop a set of comprehensive nationally applicable mortgage servicing standards. 

The third issue I note is the treatment of Fannie Mae and 

Freddie Mac and the agencies’ proposal to recognize as a permissible form of risk retention the Enterprises’ 100 percent guarantee 

of principal and interest payments on the MBS sponsored by the 

15 

Enterprises for such time as the Enterprises are in their current 

conservatorship. Through this guarantee, the Enterprises effectively retain 100 percent of the credit risk in the transaction. 

Treatment of the Enterprises presents a very difficult combination of issues. Imposition of a risk retention requirement under the 

regulation could produce results that seem contrary to current U.S. 

Government policies to shrink the assets of the Enterprises and 

manage the risk. On the other hand, absence of a risk retention requirement contributes to their distinct status. 

Congress has begun to consider fundamental questions about 

that status and the future structure and role of the Enterprises, 

and the agencies have committed to revisit and change the retention approach for the Enterprises as appropriate when those 

changes occur. I appreciate the opportunity to appear before the 

subcommittee this afternoon, and I look forward to addressing your 

questions. Thank you. 

[The prepared statement of Ms. Williams can be found on page 

326 of the appendix.] 

Chairman GARRETT. Thank you, Ms. Williams. 

And Mr. Ryan and Mr. Lawler, we will have to wait for your testimony. 

The committee will stand in recess. We will come back right after 

the second vote, which should be fairly shortly. 

[recess] 

Chairman GARRETT. The hearing will come back to order. If we 

can close the two back doors, that would be great. 

And we will start where we left off. Now, we just gave you an 

extra 30 minutes to go over your notes, if you wanted to make any 

other changes, Mr. Ryan, and— 

Mr. RYAN. I am going to change it on the fly here. Don’t worry. 

Chairman GARRETT. There you go. The gentleman is recognized. 

Mr. RYAN. Thank you. 

Chairman GARRETT. Thank you. 

STATEMENT OF BOB RYAN, ACTING ASSISTANT SECRETARY 

FOR HOUSING AND FHA COMMISSIONER, FEDERAL HOUSING ADMINISTRATION (FHA), U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT (HUD) 

Mr. RYAN. Chairman Garrett, Ranking Member Frank, and 

members of the subcommittee, thank you for the opportunity to testify today. As this committee knows, during the economic crisis, 

bundling and packaging mortgages to sell on Wall Street not only 

fed the housing boom but also led to the erosion of lending standards that deepened the housing bust. 

In response, the Dodd-Frank Wall Street Reform law required 

that securitizers and originators have skin in the game, to retain 

at least 5 percent of the credit risk. That is the goal of this rule. 

Today, I am here to speak to the part of the rule, QRM, that 

seeks to define the safe mortgage which would not be subject to 

risk retention requirements because the risk of default is low. Getting this definition right is critical. Too wide a definition could impede the rule’s ability to build market confidence in securitization; 

too narrow a definition could significantly raise the cost of mortgage credit and reduce its availability to American families. 

16 

As such, with this proposed rule we sought to balance the need 

for strong, clear underwriting standards and the continuing need 

to provide sustainable homeownership opportunities for responsible 

families. Indeed, we only need to look at this economic crisis to understand that good underwriting is absolutely essential—that is, 

taking into account the borrower’s capacity to repay a loan, their 

credit experience, the value of the property being financed, and the 

type of mortgage products that they are purchasing. Each of these 

components is critical to ensuring that responsible borrowers receive sustainable mortgages. 

Mark Zandi, of Moody’s Analytics, recently did a comparison of 

subprime loans originated at the height of the housing bubble to 

30-year fixed-rates, fully amortizing with full documentation on 

owner-occupied properties whose borrowers have prime credit 

scores. He found that subprime loans performed 2 or 3 times worse. 

Stated income documentation loans performed 3 times worse. And 

negatively- amortizing ARMs performed 3 to 4 times worse than 

mortgages with stronger underwriting standards. 

And at FHA we stuck to the basics during the housing boom, 

with 30-year fixed-rates, traditional products, and strong underwriting requirements. At the same time, FHA has a long, successful history of loans with low downpayments. 

This is not to suggest that FHA was immune to the pain that 

this housing crisis caused. This is why we have pressed forward 

with the most sweeping combination of reforms to credit policy, to 

risk management, to lender enforcement, to consumer protection in 

the agency’s history. 

As stated, the proposed rule is designed to create a class of loans 

with a lower likelihood of default. Much of the debate has focused 

on the appropriate LTV ratio. While there is no question that larger downpayment correlates with better loan performance, downpayment alone tell part of the story, as indicated by both Zandi’s findings and FHA’s experience. 

That is why the proposed rule includes, among other things, two 

alternatives. The first would require a 20 percent downpayment, 

while the alternative considers a 10 percent downpayment with the 

inclusion of credit enhancements. 

Because the 10 percent alternative in this rule has the potential 

to minimize risk while enabling a large share of those who would 

otherwise be unable to access homeownership to do so in a safe and 

responsible way, we believe it deserves serious consideration and 

we look forward to those analyses. Toward that end, the proposed 

rule includes a number of questions. We look forward to receiving 

feedback on these issues. 

Answering these challenging questions will help us to strike the 

right balance between strong underwriting and ensuring that responsible borrowers have access to affordable products. Determining the appropriate balance is at the heart of our efforts, not 

only at the FHA and HUD but across the Administration. 

Thank you for the opportunity to testify today and I look forward 

to your questions. 

[The prepared statement of Mr. Ryan can be found on page 294 

of the appendix.] 

Chairman GARRETT. Thank you, Mr. Ryan. 

17 

Mr. Lawler, please? 

STATEMENT OF PATRICK J. LAWLER, CHIEF ECONOMIST AND 

ASSOCIATE DIRECTOR, OFFICE OF POLICY ANALYSIS AND 

RESEARCH, FEDERAL HOUSING FINANCE AGENCY (FHFA) 

Mr. LAWLER. Thank you very much, Mr. Chairman, Ranking 

Member Frank, and members of the subcommittee. Thanks for the 

opportunity to testify on this rule. 

I am going to focus on two areas that received a lot of attention 

by the agencies and have also been the subject of early public commentary: one, the tightness of the underwriting standards for the 

QRM exemption, especially the required downpayment; and two, 

the special risk retention rules proposed for Fannie Mae and 

Freddie Mac. 

For the QRM definition, the Act directs the agencies to take into 

consideration those underwriting and product features that historical loan performance data indicates results in a lower risk of default. We did. 

FHFA contributed by examining Fannie Mae and Freddie Mac 

acquisitions that were originated from 1997 to 2009. The evidence 

from these data and a host of other sources shows that LTV is one 

of the best indicators of risk. 

We are proposing that the QRM definition include home purchase loans with at least 20 percent downpayment. Lowering that 

to 10 percent would have increased the share of qualifying Enterprise loans originated in 2009 by just 5 percentage points, from 27 

percent to 32 percent. 

The additional loans would be much riskier, though. Their serious delinquency rates were consistently 2 to 21⁄2 times higher than 

the rates for QRM loans. Because these are Enterprise loans, virtually loans of LTVs above 80 percent had mortgage insurance, so 

allowing higher LTV loans only if they had mortgage insurance 

would not have improved the results. 

Concerns have been raised about the impact this standard would 

have on the availability or cost of finance for homebuyers who are 

unable to put 20 percent of the purchase price down. We are going 

to receive a lot of comments on this and we will consider them 

carefully. 

But I want to be clear that the proposed rule was not designed 

to prohibit high LTV loans. It is designed to encourage the production of good quality rather than bad quality high LTV loans. The 

rule could affect interest rates on non-QRM loans, but only to the 

extent they are not eligible for GSE or Ginnie Mae securities, and 

only to the extent that the rules retention requirements exceed 

what securities investors will require anyway. 

In evaluating the potential impact of risk retention it is important to distinguish between the effect of existing risk-based pricing 

and the effects that might be caused by risk retention. Significant 

differences in rates based on credit risk already exist today. 

In considering how much risk retention might add to borrowers’ 

costs, it is well to keep in mind that interest rates on jumbo loans, 

which do not currently have any serious securitization options, 

QRM or non-QRM, available—those rates have been about 60 basis 

points above those on the largest loans available for securitization 

18 

through Fannie Mae or Freddie Mac. In effect, that spread is currently the cost of not being able to securitize any portion of those 

loans. It seems reasonable to anticipate that in a market environment that is receptive to private label securities, the effect of risk 

retention on mortgage rates would be much smaller than 60 basis 

points because risk retention would only prevent lenders from 

securitizing 5 percent of their loans. 

Although the Act authorizes the agencies to make exemptions 

separate and apart from the statutory exemption that applies to 

Ginnie Mae securities, the NPR does not exempt the Enterprises 

from the risk retention requirements. Rather, it recognizes that the 

Enterprises currently retain 100 percent of the credit risk on their 

guaranteed MBS, which is the maximum possible and far exceed 

the 5 percent retention required by Section 941. Therefore, the proposed rule would deem the Enterprises’ security guarantees to 

qualify as a satisfactory form of risk retention. 

Retention of 5 percent of the securities issued would not result 

in a greater alignment of Enterprise interests with those of investors, and it would be inconsistent with the Enterprises’ agreements 

with Treasury that require a 10 percent per year wind-down in 

mortgage assets held for investment. Simply excluding assets held 

for the purpose of meeting the risk retention rule from calculations 

to determine whether the Enterprises have met their portfolio reduction requirements would prevent forced sales of other assets or 

violations of the agreements but it would not address the purpose 

of these asset reduction provisions that are in the agreements with 

Treasury. 

And the purpose of those was to reduce the interest rate and 

operational risks associated with these portfolios for the benefit of 

taxpayers. Nor does it seem likely that requiring the Enterprises 

to hold 5 percent of their newly issued securities would encourage 

any private capital to enter the market to any significant degree. 

The added Enterprise costs would only be a few basis points. 

There are more efficient and effective means to reduce the market share of the Enterprises without unnecessarily increasing taxpayer risk. Congress, the Administration, and FHFA have been 

considering a number of these. 

In conservatorship, the Enterprises’ underwriting standards have 

been strengthened and several price increases have helped to better align pricing with risk. FHFA will continue to review further 

changes along these lines and we hope to continue to work with 

Congress on evaluating legislative approaches to encourage greater 

private sector participation. 

Thank you, and I would be happy to answer questions. 

[The prepared statement of Mr. Lawler can be found on page 263 

of the appendix.] 

Chairman GARRETT. I thank you, Mr. Lawler. 

And I thank the entire panel for their testimony as well. So I will 

begin with questioning, and maybe I will take it from where Mr. 

Lawler left off, but I will open this up to the entire panel. 

With regard to the QRM, if you have a security that falls outside 

of the purview of a QRM, then you have to have retained the 5 percent risk. And if you retain the additional 5 percent risk, what has 

19 

to happen if you are a company, is then you have to post additional 

capital. 

What you are alluding to here, and Director DeMarco was saying 

as well, was that if you do that, that is an added cost to a company 

to retain that capital. Your solution in the proposed rule to do this 

is that the GSEs do not have to retain that, and the idea here, as 

I understand what you are saying, is that the fact that it is guaranteed by all of us, the taxpayers, that basically is enough to cover 

the 5 percent retention or the capital requirement there. 

Now, you heard my comments before that we have a problem 

with that because we see that potentially, it would have the effect 

of at least pushing some—perhaps, Mr. Lawler will disagree as to 

the percentage—but it would provide an impediment to the private 

market coming back into the marketplace. Why? Because if I have 

to retain 5 percent over here, why should I do that if I know the 

GSEs don’t have to do that? So, it is easier just to still go into the 

GSEs. 

So there is the rub, right? There is the problem with this. 

We had the legislation that we talked about—or I talked about 

earlier in order to try to address that, basically to do what the 

original congressional intent was, which would say no exemption 

for it, but I understand the problem here. This is what Mr. 

DeMarco was also saying, that effectively you could put a burden 

on the other cross purpose, which is to wind down the portfolios. 

I will digress on there for just 10 seconds as—maybe because if 

the portfolios are this big now and they have to continuously 

shrink down over a period of time, a segment of that market could 

be segmented out and said, this is the segment that is going to be 

ideally for the 5 percent retention requirements. Now, I understand 

that—I guess, Mr. Lawler, maybe you said this, that may then 

force a sale of some assets that you don’t want to sell right now 

because the portfolio has to come down, so that is one problem. 

So if that is not the solution to it—and I know what you are saying as far as some of the other underwriting criteria that you are 

already trying to do over there—are there additional solutions to 

this problem that we haven’t thought of, raising other costs, raising 

G fees, or something else on top of this? Would that be a solution 

to try to proverbial—set the proverbial level playing field that we 

are always trying to get to, which we never get to? 

I guess I will start with Mr. Lawler, but I would appreciate everyone’s two cents on this. 

Mr. LAWLER. I definitely think there are alternative means. The 

risk retention rule is designed to align the interests of investors 

and originators and securitizers so that they are all concerned 

about making loans that are too risky since there is skin in the 

game. The Enterprises already have those interests aligned in that 

they are taking all of the risks, and we can’t improve on that. 

But the concern that you have about the private sector getting 

a chance to move in is a concern that we share. It is not unique 

to the risk retention rule. If the risk retention rules will add a few 

basis points of cost the difference in cost for Fannie and Freddie 

as opposed to private—potential private entrance is much bigger 

than that. 

20 

And to address that, we need to consider some of the other 

means that I know that you are considering, which include pricing, 

could include other underwriting standards for Fannie Mae and 

Freddie Mac, could include loan limits, could include risk sharing. 

There is quite a wide variety of things we could do that would 

shrink the GSEs’ share over time, so I think we had better address 

that. 

Chairman GARRETT. Okay. 

My time is going quickly and I have a bunch more questions on 

this. Can you just run down the panel? 

Mr. RYAN. Let me add, I think this is a very challenging situation. There is no question that there are a couple of purposes. On 

the risk retention, they do put their security on the balance sheets. 

You are not changing the credit risk; you are just adding interest 

rate risk. That doesn’t necessarily accomplish the objective. 

I think that they are separable. We can address the shrinkage 

of the GSE footprint. We have said so in the Administration’s work 

plan, housing reform plan. We can certainly go after greater credit 

enhancement through either the mortgage insurance companies, 

through other securitization exercises to reduce the exposure to the 

credit risk that the GSEs have. You do have the loan limits as well 

to start to get at that. 

But it is definitely a complex and challenging issue and that we 

are, again—I think all of them will be looking forward to comment 

on. 

Ms. WILLIAMS. Mr. Chairman, I think there would be options 

along the lines of what has been described. The thing that is very 

tricky here is the unintended consequences of some of the compensating options that might be suggested. So I think you have raised 

some good questions for us to be thinking about. 

Chairman GARRETT. Thank you. 

Mr. Krimminger? 

Mr. KRIMMINGER. Mr. Chairman, we certainly share some of the 

concerns that have been expressed. So we primarily, in looking at 

this from an interagency working group, were seeking, giving the 

fragility of the housing market, to essentially not try to impair, if 

you will, the current GSE housing market and just basically leave 

the situation unchanged to defer to Congress on how Congress 

would wish to deal with the GSEs going forward. That was the primary motivation. 

Chairman GARRETT. Okay. We would just argue that they didn’t 

because we didn’t want the exemption there, but— 

Ms. CROSS. We at the Commission shared your concerns about 

the treatment of the GSEs. I would note from the SEC’s special 

mandate here, which is investor protection, there isn’t additional 

investor protection that would come above the 100 percent guarantee from some more risk retention, so from that standpoint, it 

is—we were fine with this approach but were concerned about the 

impact of the special treatment. 

Chairman GARRETT. Mr. Alvarez? 

Mr. ALVAREZ. The Federal Reserve has long had concerns about 

the GSEs and their place in the market, but the advantages GSEs 

have in the market I don’t think will come from a QRM definition, 

whether they are in or out of QRM; they come from their special 

21 

status, and that is something Congress will have to address and we 

will revisit and change our rules in accordance to that. 

Chairman GARRETT. The gentleman from Massachusetts? 

Mr. FRANK. I want to begin by reference to the servicing requirements, because I am all for, and I know there has been an argument that this somehow violates the intent of Congress. And people 

will argue about the intent of Congress. I would say people have 

a right, obviously, to vote however they want, but people who consistently vote against a bill are rarely considered the most authoritative interpreters of its intent since they wished it had never been 

anything. 

I don’t recall that there was any particular intent in Congress 

one way or the other. We spent a considerable amount of time on 

this. I have checked; we didn’t discuss the servicing one way or the 

other. 

I do agree, for instance, with the Center for Responsible Lending 

that the problems with servicing have contributed to the problem 

and I think it is entirely appropriate to put good servicing standards in here. I think they do help keep the loan from defaulting 

if done properly, and I hope that this will be done, that servicing 

standards will be applied everywhere we can, including in ways 

that will get to the non-banks. 

So I am all for including the servicing standards here, and people 

can be for that or against it, but invoking a nonexistent congressional intent on the issue I don’t think makes a great deal of sense. 

Second, on the GSEs—and I don’t want the GSE issues to overcome the most important question today, which is, is 20 percent too 

high, and if it is, what is the right number? I would say this to Mr. 

Lawler, here congressional intent was very clear: We ought to be 

covered. The only argument I see against it is that it will make it 

harder for you to reduce the portfolio, and the answer is we can 

deal with that with exemptions. 

I have to say, I did—I think your argument is a little inconsistent when you say on page 9, if we retain the 5 percent this 

would not address the purpose, which was to reduce the size of the 

Enterprises’ retained portfolios to limit taxpayer risks. Well, you 

can’t tell me that you are already at 100 percent risk on the one 

hand but that the 5 percent would limit your—would further increase your risk. 

It has to be one or the other. If you are already covered, then 

the 5 percent can’t—how does that add to your risk? 

Mr. LAWLER. The reference there was to the agreements with the 

Treasury. 

Mr. FRANK. I understand that, but purpose, you said, was—all 

right. We will ask Treasury to— 

Mr. LAWLER. The purpose of— 

Mr. FRANK. Let me ask you this: If Treasury said it was okay, 

would you be all right with it? Is that your problem? We will talk 

to Treasury— 

Mr. LAWLER. We shared the Treasury’s interest— 

Mr. FRANK. Okay, then don’t use them. If you want to independently make the argument, don’t hide behind them. 

Let me just say that we have had a serious set of issues about 

Fannie and Freddie. I think we have various views on it. 

22 

If Congress acts soon—and I don’t know whether we are going 

to pass 1 bill, or 8 bills, or 16 bills, or 24 bills, or whatever the Majority strategy is—but if we act, you are going to get covered and 

I—there is a lot of concern about special treatment of Fannie and 

Freddie. Please give it up. 

There is no real harm here. It almost becomes a matter of turf. 

The SEC thinks it would be a good idea. It can’t add to the taxpayer risk if you are already 100 percent at risk. 

I would just urge you to go along with the risk retention. It does 

not seem to me to make a great deal of difference one way or the 

other. It may be more a matter of the optic, but the optics are important. 

But I really want to get to the central issue that we should be 

getting to here: 20 percent. Let me start with FHA. You had some 

experiences. Twenty percent is way higher—the FHA objected 

when we talked about going to 10 percent. I agreed with that. 

I know it is different in the FHA. Does 20 percent strike you as 

the right number? Do you think we could get the same bang for 

the buck in terms of good loans at 20 percent—at 10 percent or 8 

percent? 

Mr. RYAN. Congressman, we— 

Mr. FRANK. That is a pretty specific question, so focus. 

Mr. RYAN. We are concerned about 20 percent and the impact— 

Mr. FRANK. It might be too high? 

Mr. RYAN. Too high, yes. We are definitely concerned. And we 

are seeking feedback and comment— 

Mr. FRANK. Okay. 

Mr. RYAN. —on what are the performance benefits that come 

with taking it from a 10 percent down to a 20 percent down relative— 

Mr. FRANK. I have been skeptical of the homeownership push, 

and critical of it in some ways, but 20 percent does seem very high. 

To what extent are there tradeoffs? I will say this: I am skeptical 

that private mortgage insurance does it. Private mortgage insurance has its uses; I don’t think it is—you are going to look at the 

history. I don’t see that as being a substitute. 

And I have run into this problem: We are in some socially sensitive areas here. Delegating to the private mortgage insurance 

companies the right to decide who gets to buy a house and not 

seems to me problematic. I want to have tough standards but I 

worry about that through the delegation. 

But let me ask Mr. Alvarez, what is your sense about a tradeoff 

between a lower downpayment percentage but tougher standards 

and enforcement of the qualitative standards? 

Mr. ALVAREZ. That is actually what most lenders do. They trade 

off these different standards. 

And that is a very intelligent thing to do but it is very sophisticated, it requires judgment, it requires experience in the market 

that you are dealing with. We didn’t feel we were in a good position 

as regulators here to make those tradeoffs on behalf of— 

Mr. FRANK. Can I ask just one more—let me ask, I guess this 

is the key question we are having: We would all agree, ideally if 

those qualitative standards were well administered they would be 

a substitute, you could bring down the downpayment. Is there a 

23 

problem—and I guess this is—is there a way for you, the collective 

regulators, to supervise the qualitative standards? The nice thing 

about 20 percent is it is a number, or 10 percent, so it is easy; it 

is yes or no. 

I guess the issue would be—and you can’t all answer it now— 

do we have the regulatory capacity to enforce qualitative standards 

as the way to protect against bad loans as opposed to the simpler 

number? I guess that is the issue, and I would ask you all to let 

me know in writing. I don’t want to take any more time now. 

What would we have to do to develop the capacity to be able to 

use—we would all agree that if you could do that, it would be better than an unduly high standard, and I would be interested in 

your views on that. 

Thank you, Mr. Chairman, for the time. 

Chairman GARRETT. And I thank you. 

The gentleman from Arizona? 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. Actually, the ranking member sort of sparked part of this thought. 

In regards to drafting the QRM, was the goal when you were 

doing sort of the rulemaking or the writing of the proposal—was 

it purely looking at the statutory request to do this or was there 

a look back saying, ‘‘Here is what the bond markets are. Here is 

what the securitizers would be able to buy things. This will be a 

triple A paper,’’ or was it also looking at the other side saying, 

‘‘Look here, we are able to see where delinquency rates and defaults would happen?’’ 

What drove the decision-making? Was it on this side of the equation, so it is the default side? Was it the statutory? Where is there 

a market? 

Whomever wants to share? 

Ms. WILLIAMS. I can start. We obviously have to start with the 

language of the statute that has been enacted, but it is against the 

backdrop of the experience that we have witnessed over the course 

of the last 5 or 6 years. And so those market factors—the different 

tradeoffs, the different objectives that the agencies want to accomplish going forward—they are all in the mix of the discussions and 

that is why I said there is a lot of balancing of a lot of important 

and complex issues that go into what will finally be adopted by the 

agency. 

Mr. SCHWEIKERT. Mr. Chairman, is it Ms. Williams? And forgive 

me. I am embarrassed; I am not wearing my glasses so I can’t even 

read those nameplates from here. 

But in that case, it might be 10 percent down if I had someone 

with a very high FICO score or vice-versa. You start to see this 

scaling. Was that part of the formula, looking at where—if I am 

looking at the statutory things, I am more concerned about what 

is my risk of default. Do you end up with a formula design? 

Ms. WILLIAMS. The statutory standard specifically refers to historical loan performance data that indicates a lower risk of default, 

and so there were a variety of factors—I might defer to Pat to talk 

more about this—that were looked at by the agencies in this process, and some were more telling than others about risk of default. 

Mr. SCHWEIKERT. And as you are also speaking, can I throw sort 

of one other quirky thing, because I often have a concern over here 

24 

that if—many of us were passionate about making sure there is liquidity again, the ability to move money back into our mortgage 

markets but also have good quality paper. If I was saying, these 

are the mortgages I am going to buy, I would want title insurance 

built in there as part of my checklist. 

I know mortgage insurance, PMI, is on the default side, but yet 

if I am the bond holder, or on this side the investor, I am probably 

okay with that even though it may not have helped me on this side 

of the equation. Am I wrong in what I was looking for? 

Mr. LAWLER. I don’t think so, if I understood you correctly. We 

assume that we would—the markets would thrive in both QRM 

and non-QRM if we made enough loans, made it reasonable and 

enough good quality loans fit both categories. If you designed the 

QRM so it covered almost any loan that people would be willing to 

have anything to do with then those loans that were outside of that 

area would find it very difficult to find a home, and the rates on 

those loans would go up a lot more. 

Mr. SCHWEIKERT. And I may take one step sideways on you. 

Okay, QRM loans—back into the definition of what is secure, ultimately, as you put this package—kind of what the QRM loan—is 

it always 20 percent, or is it someone with 10 percent but happens 

to have over here mortgage insurance? Is it someone with 10 percent but incredibly high credit quality? What ultimately becomes 

the matrix to provide as much options and velocity of sales? 

Mr. LAWLER. We read the statute to suggest that QRM loans 

should be especially good loans that didn’t need any risk retention, 

that risk retention should be the norm but here is a group of loans 

that simply, without knowing anything more about them, would 

not need risk retention. And so we thought about more complicated 

classifications of combinations of credit scores and LTVs, for example, and many other— 

Mr. SCHWEIKERT. So would you end up looking on something like 

a mortgage insurance product as being an alternative to the risk 

retention instead of the definition of the QRM? 

Mr. LAWLER. We did look at what the effect of mortgage insurance was. We tried to find data of loans without mortgage insurance but it was hard to find useful data. What we did find is most 

of the loans with mortgage insurance have high LTVs. Even with 

mortgage insurance they were a lot riskier. 

Mr. SCHWEIKERT. Yes. 

Mr. LAWLER. So we kept it down low and we tried to keep the 

definition simple. It still took a couple hundred pages. We tried to 

keep this simple so that it would be manageable and that we 

weren’t trying to define all of the good loans, but a simple group 

of loans that we were confident were good enough that they 

wouldn’t need risk retention. 

Mr. SCHWEIKERT. Okay. Thank you. 

And thank you, Mr. Chairman. But something is wrong in our 

life when ‘‘simple’’ is a couple hundred pages. 

Chairman GARRETT. It strikes me the same way too, yes. 

The gentleman from California for 5 minutes? 

Mr. SHERMAN. I am an old tax lawyer. I am here to say simple 

is a couple hundred pages. 

[laughter] 

25 

I think I have discovered a new law, which I don’t want to take 

responsibility for, so I am going to call it ‘‘Hank Paulson’s Law,’’ 

and that is that no crisis is so dire that those who caused it cannot 

become its ultimate beneficiaries. And I am interested in how the 

regulations before us and other regulatory actions will affect the 

five big banks, the largest financial institutions that were at the 

heart of this problem in late 2008. 

There are two interlocking boards of regulators. One has the responsibility to determine which entities that are too-big-to-fail 

should be broken up, and so far that regulatory body has decided, 

‘‘None. They are all our buddies. We love these guys. They like 

being big.’’ And more important, they have the lowest cost of funds 

because they are bigger than they have ever been and they are, indeed, too-big-to-fail. 

So by not breaking them up, by letting them get big, by living 

with us through the 2008 process we have already shown the country that they will get bailed out if they are so big they could drag 

the entire economy down with us. One board of regulators has 

made sure that they have the lowest cost of funds. 

We have regulations before us from this body of regulators that 

will allow them to parlay that lowest cost of funds into total dominance of real estate finance because we now have definitions of 

QRMs that are so restricted that the vast bulk of real estate lending will be under the iron grip of those with the lowest cost of 

funds who, did I mention before, are too-big-to-fail and the ones 

that caused the crisis to begin with. 

And so I would like to address this to Mr. Alvarez. Have you considered the impact of the proposed QRM definitions on smaller 

banks and financial institutions? 

It seems to me the larger banks would have the capacity to make 

and securitize non-QRM loans while the community banks, with a 

higher cost of funds, will not be able to do so at a cost-effective and 

competitive rate. In fact, one of the consequences of a narrow QRM 

standard might be to force smaller banks to become merely agents 

or supplicants to the larger institutions whose low cost of funds 

would allow them to retain any interest. 

So have you considered the effect of these rules on the smaller 

financial institutions and would it be a bad thing if the effect of 

these rules just made the too-big-to-fail much, much, much bigger 

than they are now? 

Mr. ALVAREZ. We have thought about this. We actually think 

small banks will be fine under this proposal for a variety of reasons. 

Mr. SHERMAN. Can you pull your microphone up again a little 

closer? 

Mr. ALVAREZ. Sorry. 

Mr. SHERMAN. Do you know of any small banks who think that 

way too, or you just think this about them? 

Mr. ALVAREZ. We have put our proposal out for comment, so if 

I am wrong about this, I will certainly hear quite a lot about it. 

Mr. SHERMAN. You are hearing about it. I represent quite a number of— 

Mr. ALVAREZ. If I could explain how it works, I think with the 

small banks—first, keep in mind a lot of small banks do mortgages 

26 

in their local area and keep those loans on their balance sheets. 

They are not affected by this at all. 

To the extent that they want to securitize, small banks often generate loans that are in the GSE space, so they would be insured 

by the— 

Mr. SHERMAN. But you know the GSE space is about to shrink. 

The chairman, perhaps, would like to see that more quickly. And 

so these rules that you are working with have to be designed to 

deal with not only the world as it is but as the chairman would 

like it to be. 

Mr. ALVAREZ. So that will be your decision and we have committed that— 

Mr. SHERMAN. But you didn’t draft these rules thinking, ‘‘Well, 

these rules will crush local financial institutions, but only after the 

chairman gets his way with regard to GSEs.’’ 

Mr. ALVAREZ. We have committed that after Congress addresses 

the GSE issue, we will adjust these rules to take all that into account. We must take the GSEs as they are today. That is the only 

option that we have. 

And so to the extent a small bank is generating loans that can 

be in the GSE space, they will be as they are today. Also— 

Mr. SHERMAN. If I can interrupt, if you were serious about that 

you would have—and I realize this would lengthen your document, 

much to the consternation of one of my colleagues—you would already have that in the rules. You would say, once under 40 percent 

of the loans in this country are FHA or GSE, then we are going 

to have these rules apply. 

But to tell me, ‘‘Oh, the small banks have nothing to worry about 

because the authors of the regulations that will doom them will 

ride to their rescue just as soon as the GSEs are smaller entities,’’ 

without that being self-effectuating, with that being just a glint in 

the eye of those who are currently serving, I—if you get any favorable comments from small banks, please share them with me. 

Mr. ALVAREZ. The other two points I would ask you to consider 

are that the small banks can generate loans that meet the QRM 

definition, and those that do not meet the QRM definition would 

be securitized under the same discipline of the 5 percent risk retention that would apply to any other bank. There is no distinction in 

the requirement between large and small banks. 

Mr. SHERMAN. These rules, with their restrictions, are going to 

drive the small banks out. They know it; the big banks know it; 

and you regulators would be more savvy if you understood it as 

well. 

I yield back. 

Chairman GARRETT. Thank you. The gentleman yields back. 

And I am very much encouraged by the gentleman’s confidence 

in my ability to get done what I want to do with regard to GSEs. 

Mr. Hurt, for 5 minutes? 

Mr. HURT. Thank you, Mr. Chairman. 

I thank the witnesses for being here. 

I wanted to follow up on what Mr. Sherman was talking about. 

I represent a rural district in south side, Virginia. Of course, small 

banks, medium-sized banks make up a large part of those who put 

capital on the street and I think are responsible for the economic 

27 

recovery that we are seeing and are a vital part of the future economic recovery that we all want. 

And I just wanted to follow up with Mr. Alvarez about, do you 

believe that this proposed QRM definition will have a negative effect on small banks, and does it favor large banks to their detriment? I would like to see if we could get a direct answer on that 

question, and then I would like it, if possible, to have Mr. 

Krimminger maybe address the same question? 

And Ms. Williams, if you could also address the question? 

Mr. ALVAREZ. As I mentioned to Congressman Sherman, the 

rules apply equally in all respects to small banks and large banks. 

There isn’t a distinction here or an incorporated advantage to one 

over the other in how the QRM definition works, how the GSE exception—or framework works, or any other part of the risk retention rules. 

We have asked the small banks and others for their comments 

on this. We are very interested in that. There is a lot in the DoddFrank Act that imposes burdens on small banks in that they have 

to worry about compliance. The idea of compliance is itself a burden on the small banks and we are working to try to ease that compliance burden wherever possible. 

But the risk retention requirement itself does not deviate depending on the size of the bank. 

Mr. HURT. And do you think that it should, in light of the disadvantages that it may impose upon those smaller entities that 

cannot absorb the costs of compliance? 

Mr. ALVAREZ. I don’t think in the risk retention area that an exception for small banks makes sense. 

Mr. HURT. Can you say why? 

Mr. ALVAREZ. Because they are generating mortgage loans and 

then the question is, when those are securitized, sold to investors, 

is there assurance to investors about the quality of the loans? One 

way that the Congress has chosen to ensure that there is discipline 

around the quality of the loan is to have the securitizer, who is not 

the small bank that originated the loan, but the securitizer who is 

putting the packages together to sell into the market, retains some 

of the interest in the loans so that they are clear that these loans 

meet good standards or meet the standards they have disclosed to 

their investors that they should meet. 

In the crisis, the advantage the securitizers had about the quality of the loans gave them an advantage over the investor as they 

knew what the quality was; the investor did not know what the 

quality of the loans and the securitizations were. There was nothing to keep the securitizer disciplined about keeping the quality of 

the loans high because they could—even where they took on risk 

retention pieces—they were able to lay that off, hedge it or sell it 

for counterbalances. 

That is all taken away by this risk retention proposal, but that 

is at the securitizer level. I think the originators will still be able 

to originate as they have. 

Mr. HURT. Mr. Chairman, I would like for Mr. Krimminger and 

Ms. Williams, if they could, to address the same line of questioning. 

Mr. KRIMMINGER. Yes, Congressman. I think one of the things 

that Mr. Alvarez pointed out is really key. The congressional statVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
28 

ute and the rule was really focused on the role of the securitizer, 

which is the larger bank that aggregates loans from smaller institutions, by and large, and then does the securitization. 

Part of the rule, though, does make a specific provision that will 

help small banks in this marketplace. That part of the rule simply 

says that in order for the securitizer to pass the risk retention requirement down to the lender or originator, the originator has to 

have originated 20 percent of the pool of mortgages that is being 

securitized. Most of the small institutions that are selling loans for 

aggregation and securitization do not originate 20 percent of an individual pool, so in most cases all of this risk retention will be held 

at the securitizer level or the larger bank level, not the smaller or 

community bank. 

So in conclusion, we do not think that the risk retention rules 

disadvantage the smaller institutions because there is that particular provision that will help protect them from having to bear 

the risk retention that the securitizer should be bearing. 

Mr. HURT. Thank you. 

Ms. WILLIAMS. I agree with what has been said. The business 

model of the community banks, their retention and portfolio or 

their use of the GSEs, put them in a position where they are not 

advantaged by this proposal, the way it is structured. 

Mr. HURT. Thank you, Mr. Chairman. 

Chairman GARRETT. The gentleman yields back. 

The gentleman from Massachusetts? 

Mr. LYNCH. I thank the chairman. 

One sort of simple question: With respect to the definition of a 

Qualified Residential Mortgage, I noticed you have some limitations here regarding the qualifications of the purchaser. I could understand a loan-to-value ratio, the debt-income ratio. On credit history, however, it says here that if any borrower has any current 

debt due past 30 days or if they had a—any debt obligation more 

than 60 days past due they are immediately disqualified from 

qualifying as a QRM. 

I am just curious—that would seem to be rather harsh. If someone falls behind on a cable bill or a telephone bill, it might be more 

reflective of bad bookkeeping or forgetfulness than a lack of creditworthiness. And I am just curious, as a representative of a government that has a current year deficit of $1.65 trillion, I think it 

might be a little bit hypocritical to say we are going to put a rule 

down that if you fall more than 60 days behind on a bill, you are 

not going to be able to get a Qualified Residential Mortgage. 

And I am just curious if there is some thinking out there that 

supports having such a bright line and a rather harsh requirement. 

Mr. LAWLER. It was difficult to try and put together a list of— 

Mr. LYNCH. I bet. 

Mr. LAWLER. —characteristics like that. Normally, underwriters 

use credit scores. We were uncomfortable with tying our rules to 

credit scores that are produced by specific private companies. 

Mr. LYNCH. Yes. Mr. Lawler, I don’t want to spend all my time 

on this, but I just want to suggest something. 

Look, with today’s technology we have an abundance of information on every individual borrower. We really have an abundance of 

knowledge and we might be able to fashion some better line of deVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
29 

marcation for judging their creditworthiness than just saying, okay, 

you went 60 days behind on your cable bill or a hospital bill, that 

are notorious for going back and forth. My own hospital, I owe them $8 one month and they owe me $3 

the next month and it goes back and forth so I can see how somebody could fall into a trap on that. I am just concerned about that 

because it is a 2-year penalty. Once you fall behind 60 days, you 

are disqualified for the next 2 years from qualifying as a Qualified 

Residential Mortgage. 

The other piece I have is I want to go back to risk retention. And 

while I understand we are going back and forth about the amount 

of that, I want to talk about the form of that risk retention. I know 

you have some very clear models out here—the vertical slice where 

the securitizer retains 5 percent of each tranche right down the 

line, which is easy to understand and it is reasonable; or the horizontal slice, where the securitizer retains a first-loss position equal 

to 5 percent of the probable value of all the asset-backed security 

interests; and the securitization, I can understand that. 

But the bottom one here is sort of a catch-all, and it says a representative sample. The securitizer retains a randomly selected 

pool of assets materially similar—key phrase—to the assets and 

the asset-backed securities. 

I am curious, would materially similar—would that include a 

synthetic instrument that tracked a real mortgage? So that is not 

in there. And materially similar—I understand, you know—help 

me with this. 

I think your microphone is off. I am not sure. 

Mr. LAWLER. —and then you take—do statistical tests to see that 

the ones that you pulled out randomly really do reflect generally 

the characteristics of the broader pool. 

Mr. LYNCH. Okay. Would the triple A tranche of property in 

Maine be materially similar to a tranche of property in Arizona? 

Is that— 

Mr. LAWLER. No, no. So you go— 

Mr. LYNCH. Is that laid out somewhere, because I know it is a 

common term in securities law but this gives light to some variance 

that I am not exactly comfortable with. 

Mr. LAWLER. We gave as much specificity as we thought we had 

to. It is something we can revisit. But it is meant to be inclusive 

of relevant risk factors and location is certainly an important risk 

factor. 

Mr. LYNCH. Okay. Are we just going to import the commercial or 

securities definition of materially similar, and we are going to be 

good with that, or are we going to try to draft something that is 

more— 

Chairman GARRETT. The gentleman will answer and then your 

time will be over. 

Mr. LAWLER. We did try to draft something that was a little more 

complicated, again, at the risk of trying to add another 30 pages 

to the rule. We tried to keep it brief, but it is something we can 

explore, whether it is adequate. 

Mr. LYNCH. All right. 

I thank the chairman. Thanks for your indulgence. 

Chairman GARRETT. Thank you. 

30 

The gentleman from Ohio? 

Mr. STIVERS. Thank you, Mr. Chairman. 

My first question is for Mr. Lawler. I was looking through your 

statistics in your analysis that you put together, and it is unclear 

to me—it looks like you did an analysis with individual criteria and 

then you did an analysis with all the criteria and removed one at 

a time. Is that how you performed this? 

Mr. LAWLER. Yes. 

Mr. STIVERS. So you didn’t do some kind of regression analysis 

of multiple characteristics to see which multiple characteristics 

work in tandem the best? Because if you had done that, you might 

be able to tell us a little more effectively. I know you removed loanto-value individually so you can tell us what it does to both loan— 

I was just looking at that—what it does to both the loan volume 

and the delinquencies, but you can’t really tell us what the impact 

of multiple criteria without that one is, or can you? Thank you. 

Mr. LAWLER. —held everything at the QRM definitions and just 

moved that to see what the effect was. 

Mr. STIVERS. So obviously the volumes went up slightly—not as 

much as they would have on the debt-to-income and payment-toincome. The volume of loans actually would have increased the 

most on those, but the delinquencies also look like they increased 

a decent amount on those and looks like delinquencies got worse 

when you removed the FICO scores or some type of, I guess it was 

FICO scores, and the loan-to-value was somewhere in the middle 

between those two. Is that about right? 

Mr. LAWLER. Yes. 

Mr. STIVERS. And the reason I am asking, obviously, is all of us 

are concerned about access and 20 percent down is a lot of money. 

What FHA talked about earlier, they have continued to offer loans 

that have lower percent downpayments and they have not seen as 

many problems because they had real underwriting criteria, and 

they didn’t take stated income loans, and so they haven’t seen the 

same kind of problems that folks who didn’t have real underwriting 

had. 

My grandfather was a banker and he made loans on loan-tovalue. My father was a banker; he started making loans on cash 

flow. And as your analysis shows, cash flow is the best determinant 

of whether somebody is going to pay their loan or not. 

I don’t know if you could go back and help us figure out, because 

I think we all want to try to find the middle ground here on access 

to the American dream, but maybe some of the folks who did your 

analysis could go back—and this is helpful data, but really helping 

us see how much of this could be made up by some other factor. 

Obviously, all of these loans had mortgage insurance so mortgage 

insurance doesn’t change these numbers. Is that right? 

Mr. LAWLER. The high LTV loans— 

Mr. STIVERS. Yes, the ones that weren’t 20 percent. 

Mr. LAWLER. That is right. 

Mr. STIVERS. It would be really helpful to me. I think your data 

is great and it helps us see what we are trying to do here, the way 

forward, but if you could help us as we are trying to all figure out 

how to deal with loan-to-value as a constraint to access to homeownership, we would love your help. 

31 

Mr. LAWLER. And we certainly will be considering all the comments and evaluating all the data we can. We don’t mean it to be 

a constraint to access to mortgage credit. 

I don’t think any of the agencies here think a 90 percent LTV 

loan is a bad loan, per se. It was simply to try and segregate out 

what would not need any risk retention at all and the predicate for 

that is that risk retention would not make loans impossible to get 

or even extraordinarily more expensive. 

Mr. STIVERS. But they would make them more expensive? 

Mr. LAWLER. Perhaps a little bit. 

Mr. STIVERS. Obviously, they would. 

Mr. LAWLER. Not necessarily, because if you tried to put together 

a security today with non-QRM loans the market would require 

more than 5 percent risk retention. 

Mr. STIVERS. Did any of you look at overcollateralization as an 

option for the risk retention, that we make other people do 

overcollateralization of things. Is that an option? 

Mr. LAWLER. We were looking at a particular kind of security— 

asset-backed securities—that don’t have overcollateralization— 

Mr. STIVERS. No, I understand that. But I am asking if anybody 

has looked at it as an option. 

Mr. LAWLER. Not in this exercise, but it is certainly an important 

possible funding—method of funding— 

Mr. STIVERS. Thank you. 

My final question is to the entire panel, and it deals with my 

concern for many of the other asset-backed securities that have 

been caught up in this regulation. 

Chairman GARRETT. I will let the panel get that answer back to 

you in writing, if you want to state the question to them. 

Mr. STIVERS. Sorry. Thank you. I didn’t realize I was out of time. 

I don’t have my glasses on. Sorry, Mr. Chairman. 

I yield back my nonexistent time. 

Chairman GARRETT. There we go. 

The gentlelady is recognized. 

Mrs. MALONEY. I want to thank the panelists. It is a very busy 

time for us with all the budget, and so I was not able to hear all 

of your questions. But what I am hearing from my constituents, 

and even Members of Congress, is before the crisis we were over 

here with very lax standards. The joke in New York was, if you 

can’t pay your rent, go out and buy a house. They didn’t require 

any documents. Nothing. 

Now, we have gone over here where it has become very, very difficult to get a loan. And I had two constituents tell me that they 

required so much paperwork—they required their cancelled checks 

for 2 years, they required their divorce settlement to review it, they 

required just—said it took 2 or 3 months just to get the paperwork 

together to get the loan. And then, of course, many people are questioning the 20 percent down in the draft rule. 

So I just would like anyone who would like to comment on, have 

we gone too far in the other direction? There is a lot of discussion 

now about the difficulty of getting the housing market moving and 

we know that the housing, according to Zandi and other economists, is 25 percent of our economy. If we are not going to be generVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
32 

ating a lot of activity in the housing, it is going to be a drag on 

the economy. 

So specifically, I just wanted to know if you think we have swung 

too far in the other direction, and your draft rule requires a 20 percent downpayment in order for the Qualified Residential Mortgage 

and exempt from risk retention. Could you give me or describe the 

research you did regarding what percentage of home purchasers 

this would preclude comparing to a lower standard of either 10 percent or 5 percent and also describe what research you did regarding the relative difference in loan default and losses from a 20 percent standard compared to, say, a 10 percent or a 5 percent standard, assuming that all other QRM requirements were kept in 

place? 

And I would like to also hear some comments on the contrast between the private sector financing these loans and FHA. Does FHA 

also have the 10 percent down requirement? And if it doesn’t, if 

they are not equal then you are giving—now it is more difficult to 

get the private sector back on their feet and—which many people 

would like to see happening, or maybe they can’t. But why is there 

a difference between an FHA and a private sector QRM downpayment percentage? 

And I just open it to anyone and everyone to respond. 

Mr. LAWLER. I will start on a couple of items. We looked at what 

volume of Fannie Mae and Freddie Mac loans would have met the 

20 percent downpayment and the other QRM conditions, and for 

2009, the latest year we looked at, 27 percent of homebuyers would 

have met it; for all loans 31 percent would have met it. 

This rule would take effect 1 year after it was promulgated. In 

the meantime, and perhaps after that, depending on what Congress 

does, we have Fannie Mae and Freddie Mac who buy loans with 

more than 80 percent down, certainly. 

FHA is a very important source of—you talked in the beginning 

about very tough underwriting standards. FHA has increasingly 

tough underwriting standards but not nearly as tough as those you 

described, I would guess, and that is an important outlet for people. 

And so there are other sources, and again, when designing this, 

we didn’t mean for non-QRM loans to be unavailable, only that 

they would require risk retention when used in securities. 

Mrs. MALONEY. Would anyone else like to comment? 

Mr. RYAN. Congresswoman, I will add that the macroeconomic effects of the various choices on downpayment and the underwriting 

criteria are an important consideration. We need that input; we 

need to understand kind of the implications there. 

There is no doubt we need to make sure we have tight, strong 

underwriting guidelines, that we are managing that credit risk, but 

we absolutely need to make sure that we don’t overcorrect. It is a 

natural tendency, kind of after a large event like that. 

We need to go back, and as the colleagues here have done, and 

we need to continue to look at the data. We need more data about 

those loans that have had a long history of low downpayments and 

how they have performed and whether that adequately meets our 

consideration about the quality underwriting and the performance, 

33 

and what are the implications on the volumes of loans that are 

being eliminated by imposing overly strict underwriting standards? 

Dr. HAYWORTH. [presiding.] Would the gentlelady care to submit 

the remainder of her questions in writing to the panel? 

Mrs. MALONEY. Sure. 

Dr. HAYWORTH. Thank you. 

And the Chair yields herself 5 minutes or however fewer than 

that may be needed in view of the time constraints we are under. 

A question for Mr. Lawler: Was a 10 percent figure—10 percent 

loan-to-value figure—ever considered when you were working on 

the downpayment issue? 

Mr. LAWLER. Yes, we did. We considered quite a range of possibilities, including 10 percent. We even considered the possibility of 

having a 5 percent risk retention bucket, a zero, a QRM, and something in between. 

And we asked a lot of questions in the rules for comment on 

those. 

Dr. HAYWORTH. Okay. 

Mr. LAWLER. And the 10 percent—we observed that the 10 percent downpayment had a lot more defaults associated with it than 

20 percent. 

Dr. HAYWORTH. So this was a statistical analysis that you optimized at 20 percent, essentially? 

Mr. LAWLER. As best we could. There was a big difference between loans that did and did not have 20 percent— 

Dr. HAYWORTH. That was where you found a step off, so to 

speak? 

Mr. Alvarez, this question probably is best directed toward you, 

but for the panel: Title 14 of Dodd-Frank also, of course, has the 

qualified mortgage safe harbor. Those rules are also being promulgated currently. I realize that rules on QRMs are behind. This 

clearly is a very challenging issue to resolve on a number of levels. 

But will there be any effort to harmonize these definitions? 

Mr. ALVAREZ. Yes, absolutely. In fact, the statute requires that 

the QRM definition not be broader than the qualified mortgage definition. The qualified mortgage definition, of course, is under the 

Truth in Lending Act. It has a few different kinds of focuses. 

We expect that that we will make a proposal about a Q.M. definition shortly and of course it will have to be finalized, so it is on 

a slightly behind track, but a similar track. And then we will harmonize the two definitions. 

Dr. HAYWORTH. Okay. That would seem to be a very important 

coordination to pursue. 

How much more time do you think you are going to need with 

these rulemakings, just out of curiosity, as the industry waits with 

bated breath? I am not trying to put you on the spot, but I am 

just— 

Mr. ALVAREZ. No, no. This one is out for comment until the beginning part of June, so we will need at least that much time and 

then some bit of time afterwards depending on how the comments 

come through, and how many we get, and what the complexity is. 

This is a very important rule. We want to make sure we get this 

right. 

34 

We are putting a lot of resources into it. All the agencies have 

worked very hard on this one. So we are going to try to do the best 

we can as quickly as we can. We are behind the schedule that Congress set for us but we are going to try to do it as quickly and as 

well as we can. 

Dr. HAYWORTH. Very well. And I appreciate very much your answer, sir, and the participation of the entire panel. 

In deference to the need for us to vote, at this time, with thanks, 

we will dismiss the panel. And as the Chair, I want to note that 

some of our members may wish to submit questions in writing to 

the panel and the record will remain open for 30 days in order for 

members to submit questions to you and to place your responses 

in the record. 

This hearing is now in recess and it will return following votes. 

The second panel will begin when we return. 

And thank you, again, for your time. 

[recess] 

Chairman GARRETT. Welcome back, everyone. 

I appreciate this next panel’s forbearance. And so without objection, your written testimony will be made a part of the record, and 

you will each be recognized for 5 minutes. 

Mr. Cunningham is recognized for 5 minutes. 

STATEMENT OF HENRY V. CUNNINGHAM, JR., CMB, PRESIDENT, CUNNINGHAM AND COMPANY, ON BEHALF OF THE 

MORTGAGE BANKERS ASSOCIATION (MBA) 

Mr. CUNNINGHAM. Thank you, Chairman Garrett. 

It is no exaggeration to say that the rule we are examining today 

will have profound effects on our housing and commercial real estate recovery and determine who can and cannot buy a home for 

years to come. If finalized in its current form, the result will be 

much higher costs for the vast majority of consumers and diminished access to credit for many others. 

Let me speak first to the most controversial part of the rule, the 

Qualified Residential Mortgage exemption. Recognizing that loans 

subject to risk retention would carry higher costs, Congress wisely 

instructed regulators to exempt safer products from the requirement. While Congress left some of the key decisions to regulators, 

your intent was clear: to require sound underwriting and proper 

documentation while excluding nontraditional risky ventures. 

Yet, regulators took this authority and opted to exclude most 

mortgage products, making QRMs the exception instead of the rule. 

FHFA reports that less than one-third of the loans purchased by 

Fannie and Freddie in 2009 would have met these requirements. 

This is all the more notable because 2009 was the most cautiously 

underwritten market in generations. 

Let me bring this home to you. I am an independent mortgage 

banker operating in North Carolina, hardly the epicenter of the 

housing crisis. 

I ran an analysis on our 2010 book of business, and 58 percent 

of our purchase loans and 74 percent of our refinance loans would 

not have met the QRM standards. That is astonishing because 97 

percent of that same book of business in 2010 were fixed-rate mortgages. 

35 

Mr. Chairman, I have been in the mortgage business for 37 

years. During that time, I have found that underwriting is an art, 

not a science. 

No one borrower characteristic will predict whether a loan will 

default, yet this rule hardwires some of the least flexible underwriting standards any of us has ever seen. The hardest hit would 

be first-time homebuyers, minorities, and middle class families, for 

whom the downpayment requirement would be nearly insurmountable. 

The ommission of mortgage insurance, which Congress specifically asked regulators to consider, is also troubling. And the debtto-income ratios may exclude even more qualified borrowers than 

the downpayment requirement. 

The proposal raises several other major concerns. For instance, 

it is not clear that the regulators reflect a relationship between the 

QRM and FHA’s significantly lower 3.5 percent downpayment requirement. 

The Administration’s recent GSE White Paper professed a preference for reducing the government’s footprint in housing finance 

and paving the way for a robust private mortgage market. The obvious contradiction between the QRM and FHA’s requirement will 

force more borrowers to seek FHA loans and takes us in the opposite direction. 

Another controversial piece of the rule is the national servicing 

standards. If ever there was a regulatory overreach, this is it. 

Never in the year-long debate over risk retention were servicing 

standards proposed or discussed. Congressional intent couldn’t 

have been more clear and directed to origination practices, not 

servicing. 

Moreover, servicing standards are currently being developed 

through separate regulations and will include requirements well 

beyond those contained in this rule. Respectfully, this is neither the 

time nor the place to insert these provisions. 

MBA is also concerned that risk retention would apply for the 

life of the mortgage. Underwriting deficiencies typically emerge 

shortly after a loan is originated. Any requirements beyond this 

time will further constrain funds and increase cost to borrowers. 

On the commercial side, MBA believes regulators have worked 

diligently to propose rules that would support a responsible and vibrant CMBS market. However, some elements of the proposed rule, 

such as the premium capture cash reserve account, are unworkable. MBA will seek clarification and modification to ensure workable rules are in place that will not hamstring the CMBS market. 

So where do we go from here, Mr. Chairman? Considering the 

gravity of the rule, the many concerns it raises, and the nearly 200 

questions embedded in it, MBA believes the comment period should 

be extended to permit a full discussion of the rule’s profound implications. We also strongly urge this rulemaking to be synchronized 

with Dodd-Frank’s qualified mortgage safe harbor. 

Finally, we urge Congress to call on the regulators to recognize 

the enormous restraints the risk retention rule would put on homebuyers, especially the steep downpayment and DTI requirements, 

and to come back with a more flexible approach to underwriting. 

36 

We thank you for your interest in this important topic and look forward to answering questions. 

[The prepared statement of Mr. Cunningham can be found on 

page 86 of the appendix.] 

Chairman GARRETT. Mr. Deutsch? 

STATEMENT OF TOM DEUTSCH, EXECUTIVE DIRECTOR, 

AMERICAN SECURITIZATION FORUM (ASF) 

Mr. DEUTSCH. Thank you, Congressman Garrett. My name is 

Tom Deutsch. I am the executive director of the American 

Securitization Forum, which represents over 330 member institutions that serve as both issuers, investors, and broker-dealers in 

the securitization marketplace representing all forms of asset classes in the securitized marketplace, which includes residential mortgages and commercial mortgages as well as auto loans, credit 

cards, student loans, asset-backed commercial paper, as well as lots 

of emerging and esoteric asset classes—rail cars, different types of 

timeshares. There is an extensive array of securitizations that are 

affected by this rule that are well beyond the mortgage debate that 

I will discuss in some detail today in my testimony. 

We are here today to not only applaud the regulators for parts 

of their rules, but we are also here to point out many of the areas 

where they didn’t seem to accept many of the comments that we 

provided in November and December of 2010. We requested a lot 

more specificity related to these different asset classes, and in particular, I will discuss three key areas in the auto sector, assetbacked commercial paper, as well as the student loan market, before I get back to the mortgage-related issues. 

But first, let me be very clear: ASF, our investor, and our issuer 

members are very supportive of the goals of aligning incentives between issuers and investors. We also support targeted solutions in 

certain asset classes where better alignment can be made. 

But we strongly oppose efforts to try to create unhelpful retention in asset classes that demonstrated very strong performance in 

the recent credit downturn, and that is where investors in particular don’t believe there are any misalignment of incentives in 

those asset classes. 

In particular, I would note that in these other asset classes, in 

these other areas, would force keeping additional capital on the 

books both of banks and depository institutions as well as captive 

auto finance companies, student loan lenders, etc., that are not in 

the business of retaining capital and credit but are in the business 

of originating them to be able to provide credit to consumers. 

Moreover, FAS 166 and FAS 167 accounting considerations, 

which can force consolidation of securitizations for risk-based capital purposes—these can lead to absurd results if a bank holds only 

5 percent of a first loss position and also services the loan but yet 

requires them to reserve capital for 100 percent of the risk for the 

transaction even though they had sold off 95 percent of the risk. 

So there are important regulatory capital, accounting, and legal 

considerations that have to be addressed throughout these rules 

that have not been fully addressed currently. 

So let me provide a couple of examples of areas where we found 

that there are significant rationale where the regulators did not 

37 

necessarily get it right in certain asset classes. Let me start with 

asset-backed commercial paper. This is a market right now that has $379 billion of outstandings 

currently. This is a key hub of middle market funding for businesses throughout America—for residential mortgage loans, credit 

cards, lots of trade receivables, student loans, etc. 

The sponsors of these types of vehicles provide credit support vehicles and that create more than—well more than the 5 percent of 

risk retention that is required by the Act. Investors, in particular, 

in this asset class strongly believe that issuers’ and investors’ interests are currently well-aligned in this aspect, yet we were shocked 

that the regulators didn’t propose that these credit support facilities that investors strongly support are not eligible to be a part of 

the requirement to meet the risk retention rules. This omission 

must be addressed or substantial middle market funding in this 

$378 billion asset class will be lost. 

Second, prime auto loans: There was an exemption that was created for auto loans within the securitization transaction—within 

the proposed rules. Unfortunately, those would provide zero relief 

to this asset class. That is, not a single auto securitization in the 

history of the securitization market would currently be eligible for 

that exemption. 

It appears as if someone who was a mortgage specialist wrote 

these rules because they created things like a 20 percent minimum 

downpayment on a car loan. I am not very sure how many people 

actually put 20 percent down on a car loan prior to purchasing 

them. 

Finally, on FFELP student loans, which are currently 97 percent 

government guaranteed, yet they are still required to maintain a 

5 percent risk retention by the issuer. It seems very odd to me 

that—and makes no sense that unless the government is threatening or possibly could ultimately not stand behind their obligations on these student loans why you would have to retain a 5 percent risk retention when there is only 3 percent credit risk associated with these products. 

Finally, let me agree with Mr. Cunningham. Many of the areas 

related to servicing standards should not be included in the proposed rules. 

But moreover, let me turn to the premium cash reserve account 

that will be discussed in many of these rules. Let me make very 

clear, although we have heard that there are some differences between the regulators on this premium cash reserve account as to 

the appropriate meaning of it, the way that it is currently written 

effectively would put the RMBS and the CMBS markets in a deep 

freezer out on the back porch. It simply would shut down these 

markets because of the way that these rules are written. 

We understand that the regulators believe that they may have 

miswrote part of those rules, but we look forward to getting clarification and correction of that because otherwise the impacts on the 

RMBS and the CMBS markets will be significant. 

I thank you very much for the time here and look forward to 

questions. 

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

103 of the appendix.] 

38 

Chairman GARRETT. And I thank you. 

Mr. Hoeffel, please, for 5 minutes? 

STATEMENT OF J. CHRISTOPHER HOEFFEL, MANAGING DIRECTOR, INVESTCORP INTERNATIONAL, INC., ON BEHALF 

OF THE CRE FINANCE COUNCIL 

Mr. HOEFFEL. I thank you, Chairman Garrett, and members of 

the subcommittee. My name is Christopher Hoeffel. 

I am managing director at Investcorp International and I am 

here representing the Commercial Real Estate Finance Council. 

The Council is unique in that it represents all of the constituents 

in the commercial real estate capital market, including lenders, 

issuers, investors, and servicers, among others. 

Before I highlight some of our concerns about the proposed regulations, I would like to frame what is at stake. There is approximately $7 trillion of commercial real estate in the United States. 

Prior to the economic crisis, CMBS provided each year as much as 

50 percent of debt capital for commercial real estate. 

Between now and 2014, more than $1 trillion of commercial real 

estate loans will mature and will require refinancing. Without 

CMBS, there is simply not enough capital capacity through traditional portfolio lenders to satisfy this credit demand. It is for that 

reason that Treasury Secretary Geithner and other policymakers 

agree that no economic recovery will be successful unless the 

securitization markets are revived and healthy. 

Although CMBS markets have reemerged with approximately 

$30 billion to $50 billion of new issue expected this year, we are 

still walking on eggshells. Financial regulatory reform and the implementation of Dodd-Frank could have the effect of shutting down 

the flow of capital completely and permanently. 

The impact of these rules is, understandably, a matter of great 

concern for property owners and borrowers. We are therefore grateful to have the opportunity to highlight some of the potentially serious issues with the regulations as proposed. 

However, at this point we have far more questions than we have 

answers. Several elements have sparked extensive internal debate. 

First, the proposal includes a new concept called a premium capture cash reserve account that, as drafted, appears to eliminate the 

economic incentives for issuers to securitize loans. At a minimum, 

the creation of this wholly new requirement will dramatically 

change deal economics and potentially securitization structures. 

Second, for CMBS specifically, we appreciate the regulators creating a special B-piece buyer retention option. In our space the traditional structure has included a B-piece buyer that purchases the 

first loss bond position, re-underwrites every loan included in the 

bond pool, and negotiates the right to remove loans from the bond 

pool that they deem unacceptable. 

The proposal would require, however, that an operating advisor 

participate in any transaction in which the B-piece buyer is also— 

has special servicing rights for troubled loans, which is generally 

the case. The servicer would have to consult the advisor prior to 

making any major loan-related decisions and the advisor would 

have the unilateral power to replace the servicer if, in the operVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
39 

ating advisor’s opinion, the servicer is not meeting its contractual 

duties. 

Recent CMBS transactions have included variations of this type 

of operating advisor construct and we are pleased to see that the 

regulators embraced a concept that has evolved in the free market 

since the liquidity crisis. However, the regulatory proposal would 

go further than the market has and would vest the operating advisor with a much stronger all-or-nothing servicer replacement 

power. 

Although many CMBS investors are supportive of the inclusion 

of an operating advisor function there is a concern that the function as proposed under the regulation would both dissuade some Bpiece buyers from investing in CMBS altogether, due to insufficient 

controls over their first loss position, and add a layer of scrutiny 

that might lead to a ‘‘too many cooks in the kitchen’’ scenario under 

which loan servicing and decision making are inefficient to the detriment of both investors and borrowers. 

A third concern is that the proposal requires permanent retention by either sponsors or B-piece buyers. This type of permanent 

investment constraint is unprecedented and could severely limit 

the universe of institutions that could function as retainers. Many 

of our industry participants have begun to discuss whether it might 

be advisable to limit the duration to a finite number of years and 

then limit subsequent buyers of the retained interest to qualified 

transferees whose attributes could be defined in the regulations. 

Fourth, the proposed regulations include a commercial real estate specific retention exemption for loan pools composed exclusively of qualifying commercial real estate loans that satisfy certain 

underwriting conditions. It does not appear, however, that this exemption, as currently drafted, would bring any benefit, as essentially no commercial real estate loans would satisfy these requirements. 

As I hope I have demonstrated, the stakes here are enormous 

and the questions are many. The regulators have been under pressure to issue the proposal in accordance with the Dodd-Frank stipulated schedule and we are now under a 60-day clock to fully 

evaluate and respond to these proposals. 

Given that the final rules will not be effective until 2013 for commercial real estate, and given that these rules will also be implemented in conjunction with other accounting and regulatory reform, we urge you to consider allowing the regulators to extend the 

comment period to enable all of us to get these regulations right. 

We can still keep the final effective dates the same. 

If we don’t draft the regulations correctly, the consequences 

would mean significant drying up of capital that could reverse the 

still fledgling economic recovery. Thank you. 

[The prepared statement of Mr. Hoeffel can be found on page 231 

of the appendix.] 

Chairman GARRETT. And I thank you. 

Mr. Schneider, for 5 minutes? 

40 

STATEMENT OF KEVIN SCHNEIDER, PRESIDENT AND CEO, U.S. 

MORTGAGE INSURANCE OF GENWORTH FINANCIAL, ON BEHALF OF THE MORTGAGE INSURANCE COMPANIES OF 

AMERICA (MICA) 

Mr. SCHNEIDER. Thank you, Mr. Chairman. I am Kevin Schneider, president of Genworth’s mortgage insurance business, and I 

also represent MICA, the Mortgage Insurance Companies of America. I will focus my remarks today on changes that will take place 

as a result of the proposed risk retention rule, and specifically the 

provisions related to Qualified Residential Mortgages, or QRMs. 

As the committee knows, the concept of QRMs in Dodd-Frank is 

intended to accomplish three key objectives: provide market-based 

incentives to strengthen the underwriting standards; stabilize the 

housing markets by promoting sound non-government lending; and 

reboot the mortgage securitization market by creating a robust, liquid QRM mortgage asset class. 

Unfortunately, by failing to include low downpayment loans with 

mortgage insurance, the current QRM proposal misses the mark on 

what the bipartisan sponsors intended when the offered the QRM 

exemption. As the sponsors have stated on numerous occasions, 

they considered, and deliberately rejected, including a minimum 

downpayment as part of QRMs. 

Private mortgage insurance, by definition, provides real risk retention backed by hard capital and has been doing so for over 50 

years. Mortgage insurance minimizes defaults and lowers losses 

when borrowers do get into trouble. 

Getting the rule wrong will have a devastating effect on markets, 

communities, and families. For decades, millions of creditworthy 

Americans, perhaps including many of the people in this room, 

have been able to purchase homes with downpayments of as little 

as 3 percent to 5 percent thanks to private mortgage insurance. 

Most have never missed a single payment. 

But the draft QRM rule effectively says these Americans are no 

longer a good credit risk. The rule penalizes those with unvarnished credit but only modest savings. 

As a consequence, the housing market recovery will continue to 

stagnate, and let me explain why. Last year, the median price of 

an existing home was $153,000. If the 20 percent rule was in effect, 

a first-time homebuyer would need to save $30,600 for a downpayment. It would take a family earning $50,000 annually nearly 11 

years to save this amount even in the best of times. 

In 2009, half of all homebuyers made a downpayment of less 

than 20 percent. The 20 percent downpayment requirement could 

have kept more than 16 million borrowers out of the market or 

forced them to pay substantially higher mortgage rates. 

Even a 10 percent downpayment would have harmed nearly 9 

million borrowers. And the data show that there is no good reason 

to keep these borrowers out of the market for sustainable low 

downpayment mortgages. 

I have provided comparative data for the record which show that 

loans with mortgage insurance perform better than those without 

M.I. In fact, with all other characteristics being equal, insured 

mortgages become delinquent 32 percent less frequently than comparable uninsured loans. 

41 

The facts are clear. Quality underwriting drives good loan performance. 

Since 1957, the Nation’s mortgage insurers have helped 25 million Americans buy or refinance their homes with low downpayment mortgages. The M.I. industry currently has enough private 

capital to insure $700 billion in new mortgages, enough to support 

nearly 4 million of new low downpayment loans over the next several years. 

Mortgage insurers acknowledge the important role that FHA 

plays in serving the low downpayment market. However, every day 

our private capital competes with FHA to serve first-time and lowincome homebuyers. Without parity for private mortgage insurers, 

this proposed rule will shift virtually all low downpayment lending 

to the FHA, whose market share already has risen from 5 percent 

of the overall market in 2007 to 20 percent today. 

Additional business to the FHA means American taxpayers will 

continue to bear 100 percent of the risk for all low downpayment 

loans. By incorporating mortgage insurance into a final QRM rule, 

we can continue the type of safe low downpayment lending that for 

decades has allowed millions of Americans to achieve the dream of 

homeownership. 

On behalf of Genworth Financial and the Mortgage Insurance 

Companies of America, I thank you for the opportunity to testify 

before this committee. 

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

298 of the appendix.] 

Mr. SCHWEIKERT. [presiding.] Thank you, Mr. Schneider. 

Mr. Smith? 

STATEMENT OF BRAM SMITH, EXECUTIVE DIRECTOR, LOAN 

SYNDICATIONS AND TRADING ASSOCIATION (LSTA) 

Mr. SMITH. Good afternoon, Chairman Schweikert. My name is 

Bram Smith and I am the executive director of the Loan Syndication and Trading Association, or the LSTA. 

The LSTA has more than 300 member firms which consist of all 

types of participants in the syndicated commercial loan market. 

These include large and regional U.S. banks, foreign banks, insurance companies, fund managers, and other institutional lenders. 

The LSTA undertakes a wide variety of activities to foster the development of policies and market practices in the loan market. 

The U.S. commercial loan market is critical to the success of 

American businesses. There are $1.2 trillion of outstanding funded 

syndicated commercial loans to U.S. companies. 

Institutional lenders such as insurance companies, mutual funds, and CLOs provided $500 billion to these syndicated commercial 

loans. CLOs alone provided $250 billion. 

My testimony today will focus on one aspect of commercial loan 

lending—CLOs. While the LSTA represents the interests of all loan 

market participants, not just CLOs, we appreciate the opportunity 

to offer our views on how the recently proposed risk retention rules 

under the Dodd-Frank Act would impact the CLO market. 

Unfortunately, attempting to apply the risk retention rules to 

CLOs is like trying to fit a square peg into a round hole. They simply do not fit. 

42 

The current proposal would have a profoundly negative impact 

on the formation of CLOs. This could significantly reduce lending 

to American corporations and impact their ability to expand and 

create jobs. 

Why won’t the proposed rules work for CLOs? As the regulators 

have noted, fundamentally this rule is about reforming the originate-to-distribute model for securitization and realigning the interests in structured finance. 

However, CLOs are not originate-to-distribute securitization. 

CLOs differ from originate-to-distribute securitizations in a number 

of ways. 

First, CLOs are a way for asset managers like Invesco or Eaton 

Vance to create investment pools of syndicated loans. These independent third party asset managers have a fiduciary responsibility 

to their investors. They seek out and purchase pieces of individual 

loans they believe are good investments, just like they would for a 

mutual fund. 

They buy a limited number of corporate loans, each of which is 

rated and priced daily. They research and analyze them individually. 

They then actively manage the portfolio to minimize losses and 

maximize returns. This is very different from typical ABS, which 

are static pools with no asset manager. 

In addition, the interests of the CLO manager and its investors 

are already aligned. The CLO manager is not paid an upfront fee. 

The only money it makes is from successfully managing this portfolio of corporate loans. If the CLO does not perform, the manager 

is not paid the vast majority of its fee. 

It is important also to note that CLOs performed remarkably 

well through the global financial crisis. CLOs suffered practically 

no defaults and investors in CLO notes suffered virtually no losses. 

The Dodd-Frank Act mandated a Federal Reserve study of risk 

retention. The study concluded that, ‘‘CLOs are different from most 

asset classes.’’ It recommended that the rule makers consider, 

among other things, the economics of different asset classes and 

securitization structures in designing retention requirements. 

Unfortunately, by lumping actively managed CLOs together with 

static originate-to-distribute securitization structures, the proposed 

rules do not take into account the unique characteristics of CLOs. 

Indeed, we are faced with a retention structure that threatens the 

very viability of CLOs. While we appreciate the agencies’ efforts to 

write many risk retention options, for the reasons described in detail in our written testimony none of them is workable for CLOs. 

The proposed rule requires retention of 5 percent of the par value 

of all CLO securities rather than 5 percent of its credit risk. The 

horizontal first loss retention option is the only one even marginally feasible for CLOs, but the credit risk in this option is approximately 18 times greater than what was required by Dodd-Frank. 

This level of risk retention is unwarranted and unworkable for 

CLOs. 

Finally, the qualified commercial loan exemption is written so 

narrowly that even loans to some of the strongest companies in 

America, such as AT&T, John Deere, and PepsiCo, would not qualify, thereby rendering the exemption unusable. 

43 

In conclusion, CLOs are not static originate-to-distribute ABS. 

Therefore, CLOs do not fit within the spirit of the risk retention 

provisions of the Dodd-Frank Act and we believe it is appropriate 

and prudent to expressly exclude them. But if the agencies nevertheless see fit to include CLOs, it is important to consider ways to 

optimize the alignment of interests without shuttering this important source of financing to U.S. companies. 

We appreciate the opportunity to testify and we look forward to 

working constructively to help produce the best possible final rule. 

Thank you. 

[The prepared statement of Mr. Smith can be found on page 309 

of the appendix.] 

Mr. SCHWEIKERT. Thank you, Mr. Smith. 

Ms. Harnick? 

STATEMENT OF ELLEN HARNICK, SENIOR POLICY COUNSEL, 

CENTER FOR RESPONSIBLE LENDING (CRL) 

Ms. HARNICK. Good afternoon, Mr. Schweikert. 

I will focus my remarks also on the impact of the proposed rule 

on the market for home mortgages. We agree with the agencies 

that Qualified Residential Mortgages should consist only of loans 

that have responsible and sustainable terms and that are underwritten to ensure the borrower’s ability to repay based on documented income. 

Where we disagree with the agencies is in our strong belief that 

these high-quality loans should be broadly available to creditworthy families. They should be the loans of choice for most borrowers. 

The proposed rule would do exactly the opposite of what we here 

suggest. It would create a category of responsible mortgages but 

would make them available only to a small proportion of creditworthy families. 

Those lacking sufficient wealth to make a 20 percent downpay- ment would be excluded. Twenty percent down means $34,000 

down for a home at the median sale price nationwide, and $80,000 

in places like Staten Island, or Oakland, California, where many 

working families live. 

This would leave out most families, including the majority of the 

middle class, regardless of whether they currently own or rent. 

This will take many qualified homebuyers out of the market. 

Shrinking the pool of homebuyers would hurt current homeowners whose homes would therefore be harder to sell. So what 

will these current homeowners do if they can’t sell the home? 

Will a family whose adjustable rate mortgage is about to have a 

rate increase be able to refinance the loan? Not easily. The proposed rule requires even larger downpayments for refinanced loans. 

Nationwide, more than half of current mortgage holders could 

not meet these new requirements. The problem is exacerbated by 

the rule’s debt-to-income requirements and a ban on families who 

are 60 days late on any bills. These restrictions are too rigid and 

are more restricted than necessary to ensure the family can responsibly sustain homeownership. 

All of this, of course, will take an even greater toll on families 

of color and those with low to moderate incomes who otherwise 

44 

could have successfully purchased a modest home. This is bad for 

our economic recovery and we think contrary to congressional intent. 

In codifying the list of criteria to be considered and defined in 

the QRM, Congress did not include downpayments, an item that 

was specifically considered. And Congress was wise not to include 

a downpayment requirement. 

While I would not claim that downpayments bear no relationship 

to default risks, the data show that for loans that are responsibly 

structured and underwritten, low downpayments are not a substantial driver of default. Certainly, the amount by which large 

downpayments reduce defaults is too small to justify the large proportion of American families who would be excluded. 

Some might say that families excluded from the Qualified Residential Mortgage should get a mortgage that doesn’t meet QRM 

standards. But a key point of these reforms is to make sure that 

the safest mortgages become the norm. The idea was not to relegate a large part of the population to second-tier credit, nor should 

FHA become the primary source of credit for American families. 

While it helps in this regard that Fannie Mae and Freddie Mac 

would still be able to securitize loans to families excluded from 

Qualified Residential Mortgages this does not solve the problem. 

The proposed rule would put the government’s stamp of approval 

on the idea that loans with less than 20 percent down are substandard. 

Bank examiners and lenders will consider non-QRM loans to be 

less safe and sound. This will make them more expensive and 

harder to come by. 

When lending was done the old-fashioned way lenders stayed 

with the borrower until the loan was repaid. They had strong incentives to ensure that the borrower could afford the loan, that any 

features that could produce payment shock were appropriate for 

the borrower, and to work with the borrower through periods of 

short-term crisis to avert unnecessary foreclosure. 

In this way the underwriting structure and servicing of the loans 

all minimized the risk of default. These three features should define a Qualified Residential Mortgage, and such mortgages should 

be available to all creditworthy families. 

I am happy to answer your questions. 

[The prepared statement of Ms. Harnick can be found on page 

208 of the appendix.] 

Mr. SCHWEIKERT. Thank you, Ms. Harnick. 

Mrs. Biggert? 

Mrs. BIGGERT. Thank you, Mr. Chairman. 

And I thank all the witnesses for being here. It has been quite 

a long day with our votes. 

My first question is for Mr. Schneider. Does mortgage insurance 

reduce the risk of default? 

Mr. SCHNEIDER. Yes. As a practical matter, the relevant comparison when you are trying to compare mortgage insurance and how 

it does against default is mortgage insurance against piggyback 

loans, which is really the only other alternative to low downpayment loans. 

45 

One can think of a piggyback loan literally almost like risk retention because those loans were done in lieu of mortgage insurance 

for low downpayment lending and those loans were kept on balance 

sheets. You could also think of mortgage insurance the same way 

because in mortgage insurance there is a significant loss position 

taken by the mortgage insurer, so also risk retention. 

When you compare the performance of those two, a study was 

done of the CoreLogic servicer database on over 5 million loans 

that were originated from 2002 through 2007, really the height of 

the crisis. Controlling for origination year, documentation, loan 

purpose, combined loan-to-value, FICO, and geography, when you 

looked at all those attributes being equal, insured loans compared 

to those piggyback loans outperformed the piggyback loans consistently. 

They became delinquent 32 percent less of the time. When they 

did become delinquent, they were cured through the support of the 

servicer and the mortgage insurer 54 percent more often and ultimately defaulted 40 percent less than the piggyback loan, so— 

Mrs. BIGGERT. So could you say that the mortgage insurance reduces the severity of loss instead of the actual risk of default? 

Mr. SCHNEIDER. No. I would say that it does both. 

What I just described was both a reduction in the actual incident 

of default and—as well as the severity given a loan default. When 

a loan ultimately does go to claim, the mortgage insurance pays in 

the first loss position, so unequivocally it reduces the severity of 

the— 

Mrs. BIGGERT. Thank you. 

Mr. Cunningham, does the rule proposal maintain or worsen the 

playing field between the GSEs and the private securitizers? 

Mr. CUNNINGHAM. The rule, as it is currently proposed, would 

allow for those GSEs to be exempt from QRM, so therefore it 

would, in my opinion, worsen the position of private capital. 

Mrs. BIGGERT. Ms. Harnick, do you believe that there should be 

any downpayment requirement? And if so, how much? 

Ms. HARNICK. We believe certainly for mortgage lending there 

should be some money down, but we don’t believe that there should 

be a requirement set out in the QRM rules. The amount—as I said 

in my prepared statement, it is not that the size of the downpayment has no relationship to default; it is that the number of families excluded is not justified by the relatively limited amount of default reduction you get when other factors are in place to make 

sure the loan is responsible. 

Mrs. BIGGERT. Why is it that you wouldn’t tie it to the QRM? 

Ms. HARNICK. The reason I wouldn’t tie it to the QRM is that the 

downpayment requirement really is a wealth-based restriction, and 

so it is the sort of restriction that should be put in place only if 

it significantly improves the performance of the loans relative to 

the people excluded, and it just doesn’t do that. And I can say from 

the lending experience of our sister organization, Self-Help Credit 

Union, for example, we found that for some families, $500 or 

$1,000 is enough skin in the game to keep them paying well and 

for other families, a large downpayment isn’t enough to keep them 

paying well. But the best drivers are these other factors. 

Mrs. BIGGERT. Thank you. 

46 

Mr. Deutsch, how will the proposed rule impact the smaller 

banks and financial institutions? Will they have more trouble with 

or be out of game compared to the larger banks? 

Mr. DEUTSCH. I think all the banks will have a much harder 

time being able to originate loans. I think there will be some disproportionate impact on the smaller banks in particular because 

private label securitizations will have a more difficult time coming 

back, as Mr. Krimminger outlined in the previous panel. Having 

aggregator transactions by reducing the ability for those to get off 

the ground, there will be less ability for the capital markets to purchase them through the smaller banks and will create more limited 

capital that they will be able to originate. 

Mrs. BIGGERT. Thank you. 

My time has expired. I yield back. 

Mr. SCHWEIKERT. Thank you, Chairwoman Biggert. 

Mr. Manzullo? 

Mr. MANZULLO. I would like the record to note that none of the 

people who voted for this bill are present at this second panel. 

They should be here to answer to you and so you can give them 

the reasons why this horrible piece of legislation is going to further 

stifle credit. 

Let me ask a general question here. States such as, I believe, 

California and possibly Nevada do not have requirements for deficiency judgment. The State of Illinois does, which—you guys are already shaking your heads and you know what the question is. 

Do you believe that the States that don’t have a deficiency payment, whereby a person can simply walk away from his house and 

not be slapped with a judgment of the difference between the 

amount of the note and the sales price, does that increase, in your 

opinion, the default rates? Does it serve as an incentive not to stick 

it out and work it out on your house? Anybody? 

Mr. DEUTSCH. I will take a first shot at— 

Mr. MANZULLO. Yes, sir. 

Mr. DEUTSCH. Absolutely. We would be supportive of more recourse back to the borrowers for taking out loans that they ultimately have to pay back. Creating these walk-away borrowers has 

been a significant problem, I think, for mortgage lenders and institutional investors who purchase mortgage-backed securities. 

By not having recourse, a borrower can just sort of simply walk 

away, turn their keys in, it does create very significant challenge 

in being able to price the risk, particularly in a housing market 

downturn. 

Mr. MANZULLO. Do you have any idea of the number of States 

that don’t require deficiencies judgments? Anybody? 

Kevin, do you have any idea how— 

Mr. SCHNEIDER. I don’t know offhand what the number is. 

Mr. MANZULLO. Okay. Because what is interesting is that the 

people who took out the loans, who signed the documents in the 

States where there is no deficiency, are now going to be required 

to go to a bank, and so if they default, the bank holds the bag but 

the consumer walks away with no liability. Does anybody think 

that makes sense? 

I thought that you were going to volunteer to give an answer 

down there? 

47 

Ms. HARNICK. I was reaching—it is beyond the topic I was prepared to testify on, but I am just sitting here thinking, in the commercial mortgage space, I haven’t heard anyone object to the idea 

that a borrower on the commercial loan, for example, can go to 

bankruptcy court and get released on the mortgage, and it is effectively a similar concept. The note holder gets the value of the mortgage—the value of the property in connection with the bankruptcy 

sales but no more. 

Mr. MANZULLO. But so can the homeowner in the States that 

have a deficiency judgment—bankruptcy. 

Ms. HARNICK. That is correct. But I am saying we haven’t heard 

much objection to this in the commercial mortgage space, and for 

most families, at least in our lending experience, most families do 

not walk away from the home if they have any way to save it. And 

so the effort to go after the family for the value of the personal 

property home and whatever else can be extracted seems a very 

poor social outcome and probably not financially— 

Mr. MANZULLO. It is a financial obligation. If you sign a note for 

$100,000 and you default on your loan, and the assets sell for 

$60,000 and you still owe $30,000, to me that is a moral obligation 

that attaches to that, and sometimes what I have seen taking place 

here—I haven’t been able to go through all the testimony—is that 

the people who come in here from the government agencies talk 

about having all new types of loans and new consumer product divisions and new regulations, and yet it wasn’t until October 1st of 

2009 that the Fed required written documentation of a person’s 

earnings. And it took a year. It took a solid year for the Fed to 

come out with that regulation. 

Maybe I look at this thing too simply, but people were allowed 

to buy homes who couldn’t even make the first payment and they 

were actually called ‘‘liar loans.’’ And I am not even talking about 

subprime, but there is still a market for subprime where somebody 

who has a good job and doesn’t have a large downpayment can buy 

a house, and therefore there is another reason for mortgage insurance on it. 

But it just amazes me that something that could have been fixed 

that simply wasn’t done. And now they want to have all these rules 

which would really mess up securitization, especially on the commercial end, with regard to your family. 

Mr. SCHWEIKERT. Thank you, Mr. Manzullo. 

Mr. Sherman? 

Mr. SHERMAN. Mr. Cunningham, what is the Mortgage Bankers 

Association’s view on this 20 percent downpayment requirement? 

How is that going to affect home prices in a world where the GSEs 

are playing a diminished role, as so many of my colleagues—well 

I would say, I guess, colleagues to my left—could be. Sort of creepy 

that way, isn’t it? 

Mr. CUNNINGHAM. The mortgage bankers certainly believe that 

a 20 percent downpayment is too stringent a requirement. We 

think that it will increase the cost of credit to borrowers, and decrease the availability of credit to borrowers. Ultimately, fewer borrowers would result, and in the end, prices will have a harder time 

stabilizing. 

48 

Mr. SHERMAN. There is a different price elasticity for different 

products. At my local pizzeria, they don’t cut the price if they have 

fewer buyers that day; they just make fewer pizzas. The amount 

of housing stock we have in this country could go up but it isn’t 

coming down, and even a 5 percent or 10 percent decline in effective demand from people who can get a mortgage—could see a tremendous decline in price. 

Now, I would like to turn to the role of private mortgage insurance, either Mr. Cunningham or Mr. Deutsch. Private mortgage insurers have been shown to mitigate and cure loan deficiencies—or 

reduce loan deficiencies—because you have a second set of eyes. 

But also, the entire concept of retained interest is that we want 

somebody in the private sector who really knows what is going on 

to be on the hook. And it occurs to me that mortgage insurers 

might be just as smart—they are certainly just as private and they 

are certainly on the hook to the same degree as would a lender who 

retains an interest. 

Shouldn’t the downpayment of loans that are—that qualify reflect the private mortgage insurance involved, or should we require 

just as high a downpayment even if there is private mortgage insurance? 

Mr. CUNNINGHAM. I think that a smaller downpayment would be 

justified with a credit enhancement or private mortgage insurance. 

Mr. SHERMAN. And if the purpose of this retained interest is to 

say somebody in the private sector who understands the loan—may 

not have made the loan but understands it, because it is my understanding that the securitizer doesn’t have to be the entity making 

the loan; you could have small banks making the loans, selling 

them and getting a little shafted on the price when they sell them 

to the big banks who could then retain the interest. 

So the law is structured so that somebody in the private sector 

has to be on the hook and that has to be the securitizer. Securitizer 

doesn’t make you—there is no magic with that. The securitizer, 

though, is knowledgeable as to the portfolio, has skin in the game, 

is in the private sector. 

Should we simply regard the mortgage insurance company being 

on the hook as the same as a retained interest by the securitizer? 

Should we view the entire team of private sector folks involved in 

securitization and say, looking at the team, are they on the hook? 

Mr. CUNNINGHAM. First of all, I don’t think that the exemption 

for Qualified Residential Mortgage loans excluded low downpayment mortgages. It specifically considered it and decided not to exclude low downpayment mortgages but left it up to the regulators 

for consideration. 

Regulators have chosen to come back and require 20 percent 

downpayment. I think further consideration of lower downpayment 

mortgages is certainly a worthwhile conversation and I think lower 

downpayment mortgages—well underwritten, well qualified— 

Mr. SHERMAN. Let me try and squeeze in one more question. 

Mr. CUNNINGHAM. Yes. 

Mr. SHERMAN. Going back to life as we hope to see it again, what 

percentage of first-time homebuyers are able to come up with 20 

percent down, back when you could—say in 2007, 2006, the world 

we hope to restore? 

49 

Mr. CUNNINGHAM. Mr. Schneider may have better information on 

this than I do, but I think that in 2009, probably of the buyers who 

purchased in 2009, close to 47 percent or so put down less than 10 

percent. 

Mr. SHERMAN. Less than 10 percent? So even in 2009, with higher underwriting standards, half of the effective demand is from 

those who don’t even have 10 percent? 

Mr. CUNNINGHAM. Remember, when I say that, that includes 

FHA mortgages in addition— 

Mr. SHERMAN. Right. 

Mr. CUNNINGHAM. —to conventional mortgages, so it is inclusive. 

Mr. SHERMAN. I yield back. 

Mr. SCHWEIKERT. And to my friend to the right, actually on that 

same track as you were actually—great question. 

Mr. Scheneider, could you also—because I would like to hear 

your response to— 

Mr. SCHNEIDER. It is dead on, Congressman. I represent the 

mortgage insurance industry and we believe the congressional intent in the QRM definition was absolutely to include something— 

credit enhancements such as private mortgage insurance that did 

provide significant capital to get significant private equity in a first 

loss position that could be the equivalent of the risk retention that 

is suggested in the bill. 

Private mortgage insurance—you could think about it as an independent set of underwriting standards that provides the appropriate friction in the system to make sure the originator is really 

kept honest. And when you have your own private capital at risk 

and you are in a first loss position after the borrower’s equity, 

which is exactly what the private mortgage insurance industry 

does, we have demonstrated that it does reduce both the incidence 

and severity of loss for low downpayment lending and can certainly 

support a much lower level than a 20 percent down requirement 

as proposed in the bill. 

Mr. SHERMAN. May I ask the indulgence of the Chair to ask— 

Mr. SCHWEIKERT. Yes. Let me yield you a minute of my time. 

Mr. SHERMAN. —one more question, and that is, the risk reten- tion that the big banks plan to have is if they make a $100 loan 

and it drops in value to $50, the folks retaining the interest are on 

the hook for 5 percent of that $50 loss—$2.50, if I calculated that 

correctly. In contrast, if you have private mortgage insurance on a 

mortgage that was $100 but now it is worth only $50, how much 

are you on the hook for? 

Mr. SCHNEIDER. The private mortgage insurance industry generally provides 25 percent to 30 percent mortgage coverage on the 

unpaid principal balance of the loan, so it would be 25— 

Mr. SHERMAN. So if for some reason— 

Mr. SCHNEIDER. —percent riskier— 

Mr. SHERMAN. —they lent $100 and it had to go to foreclosure 

and they only realized $50 you would be on the hook for $25? 

Mr. SCHNEIDER. $25— 

Mr. SHERMAN. Which is 10 times the risk the big banks would 

pay with—if they retained a 5 percent— 

Mr. SCHNEIDER. That is our loss position. 

Mr. SHERMAN. Yes. 

50 

I yield back. 

Mr. SCHWEIKERT. Thank you. And in many ways, you asked the 

question I was going to head toward. 

I am elated to have you but I also—I have so many questions. 

Many of you, you don’t mind not going home tonight, do you? 

[laughter] 

Is it pronounced Mr. ‘‘Hoeffel?’’ 

Mr. HOEFFEL. ‘‘Hoeffel.’’ 

Mr. SCHWEIKERT. ‘‘Hoeffel.’’ Help me work through the reserve 

account—the premium reserve account. Mechanically, how do you 

see that actually working? 

Mr. HOEFFEL. The way it has been drafted is that any excess 

spread that is monetized needs to be retained in the structure of 

securitization through the term. Now, the reason people aggregate 

pools of loans and bundle them into securitizations and sell them 

is clearly they hope to be able to sell the transaction for more than 

the cost of putting the bundled transaction together, much like 

having a sandwich shop. You want to sell the sandwich for more 

than it costs to put the bread and the ingredients together. 

But what this is doing is saying any profit you make—because 

the profit in the securitization generally comes from excess 

spread—needs to stay in the transaction as additional credit support for the bond. 

That might be good for investors but then there is really no reason for the industry to exist because banks and loan aggregators, 

if they are not going to make any money or even, in this case, in 

the most extreme case, cover the cost of their personnel and their 

loan funding— 

Mr. SCHWEIKERT. You are beating me, almost, to where I was 

going. So where would the premium or fee for the securitizing of 

bringing the debt instrument to market come from? 

Mr. HOEFFEL. Where does it come from? 

Mr. SCHWEIKERT. If the capture was held aside? 

Mr. HOEFFEL. Say you bundle a portfolio of loans that all have 

an interest rate of 8 percent and then you create a security so that 

the securities have the benefit of diversification so it is not just one 

8 percent loan; it is a portfolio of 300 loans at 8 percent, so you 

have some credit diversification. The hope is that you would sell 

the securities for a blended coupon of something less than 8 percent—say it is 7— 

Mr. SCHWEIKERT. No, I am very comfortable with the— 

Mr. HOEFFEL. In effect, the bondholders are paying you more 

than par value for the loan because they are paying you a price 

that yields a lower yield on the sum total of the bonds than the 

face amount. So you are basically selling for more than the face 

amount of the bonds, and that is where the excess comes from. 

Mr. SCHWEIKERT. But if you have the premium recapture account— 

Mr. HOEFFEL. That excess, that 1 percent or 2 percent that is in 

there stays in the transaction so— 

Mr. SCHWEIKERT. So then I will—my question again. So you are 

putting the package together. How are you paid? 

Mr. HOEFFEL. With the premium capture account? You are not 

paid. 

51 

Mr. SCHWEIKERT. Okay. That is sort of where I was sort of heading, the long way around. I am sorry. Maybe I did a very poor job. 

In my last 6 or 7 seconds, Mr. Schneider, and maybe I am working on the conceptual problem here because I see us talking about 

the QRM and then I talk about over here, the 5 percent. In many 

ways, I think we are having a conversation we are talking around 

each other. 

Okay, qualifying loan over here, the 20 percent, this is the credit 

quality. It is a nice, safe instrument. But when we talk about 

PMIs, the mortgage insurance, it is not necessarily about this instrument; it is about my threatened risk to the purchasers on the 

other end of that instrument. 

And so over here, I have my qualifying mortgage, which I 

wouldn’t have to have a reserve account for. But over here, if I had 

somehow insured the pool—the individuals—I could actually be offering loans with less than 20 percent down but it is not the insurance on that individual loan, in many ways; it is the fact that it 

is another way to insure it so it is not a risk out to the market. 

Is anyone else with me that we may be talking around each 

other on two different sort of subjects here? Let me see if I am 

making sense. 

QRM—it is just about the individual loan, and we can accept 

that. 

Mr. SCHNEIDER. The underwriting quality of an individual loan. 

Mr. SCHWEIKERT. Mortgage insurance comes into effect when it 

is already in default. 

Mr. SCHNEIDER. Mortgage insurance is provided potentially on a 

loan at the point of origination and the discussion about mortgage 

insurance vis-a-vis QRMs is, does that allow a lower downpayment—a low downpayment mortgage to qualify as a QRM? 

Mr. SCHWEIKERT. In some of the discussion we had in the earlier 

panel—and I know I am way over my time and I am going to yield 

myself about another 20 seconds, but in the panel we had before 

the discussion was, well, we don’t want to discuss mortgage insurance because that is after it goes into default we gain the enhanced 

credit quality and— 

Mr. SCHNEIDER. And you reduce the amount of loss associated 

with this because— 

Mr. SCHWEIKERT. Yes, but that happens to be after the loan goes. 

And the QRM was on this side, saying we are trying to find those 

loans that won’t. And my fear is by creating that type of box we 

are going to lock out a lot of families from being able to get a home. 

Mr. SCHNEIDER. I couldn’t agree with you more. By not allowing 

lower downpayment lending through the support of the credit enhancement the private mortgage insurance provides I think we are 

dramatically trading off an opportunity to have more creditworthy 

borrowers be able to participate in the market and help us take 

some of this inventory off— 

Mr. SCHWEIKERT. Forgive me. I am way over my time. 

Mrs. Biggert? 

Mrs. BIGGERT. It seems like the QRM appears to ignore or dismiss several matrix—full documentation of loans, mortgage insurance, and others—of prudent mortgage underwriting, and in fact 

QRM seems to set up an arbitrary box of standards for a limited 

52 

number of borrowers. And so I have heard from several non-government individuals and groups that the analysis is a mysterious 

data set that Federal regulators used and it does not reflect other 

market data on sound mortgage underwriting. 

Would you agree with that? And maybe start with Mr. Smith, because I don’t think we have heard from you. 

Mr. SMITH. I would love to comment but that is not our field. 

Where we specialize is really on corporate loans and CLOs, so I 

will defer to my fellow panelists. 

Mrs. BIGGERT. Then, I will go to Mr. Schneider. 

Mr. SCHNEIDER. Yes, Congresswoman, I would say that as described this morning, in the earlier panel—the comparison that 

was made on the data analysis was between a below 80 LTV loan 

and above 80 LTV loan. There is no doubt an above 80 LTV loan 

is a riskier product. 

The discussion needs to be, when you do an above 80 LTV loan 

is there a way to do it safely? Is there a way to do it that reduces 

both the incidence and severity of default? And that is what our 

data has proven and I would like to submit formally for the record 

a chart I have that we did not submit earlier that illustrates that 

performance differential that I talked about earlier in my testimony. 

Mr. SCHWEIKERT. Okay. Without objection, we would be happy to 

have it. 

Mrs. BIGGERT. Would anyone else like to comment on that? 

Mr. DEUTSCH. Yes, if I might address it. I think one of the key 

aspects of this is if you—if these metrics prove that these loans 

outside of what the proposed QRM are so unsafe or unwieldy it 

really begs the question of the statistics that they did include in 

their release that said only one out of five loans right now that the 

GSEs—ultimately the American taxpayer—are guaranteeing—only 

one out of five of those loans would qualify as a QRM right now, 

which says that the other 80 percent of those loans that the American taxpayer are on the hook for right now are ‘‘unsafe or less safe 

than the QRM.’’ 

I think it really begs the question of, why isn’t the QRM defined 

substantially similar to what a current conforming loan looks like 

that the American taxpayer is on the hook for? 

Mr. HOEFFEL. I would say that underwriting mortgages can be 

very complex, and certainly on the commercial side we have been 

trying to outline all the different considerations that are made for 

mortgage loans, so I think it is also similar for residential loans, 

that using just one or two metrics like LTV can be misleading because you can have a low LTV loan that has bad characteristics or 

you can have a high LTV loan that has very strong characteristics 

and they may have vastly different default probability. So it really 

needs to be a layered analysis on the definition of a high-risk or 

a low-risk loan. 

Mrs. BIGGERT. Okay. And then just one more quick question, if 

I may. 

We are trying, I think, to get less government—get government 

out of the mortgage finance business and encourage the private 

sector to replace the taxpayer-backed government financing, so I 

am concerned that the GSE reform and a narrow QRM more borVerDate Nov 24 2008 18:03 Nov 02, 2011 Jkt 066865 PO 00000 Frm 00060 Fmt 6633 Sfmt 6633 K:\DOCS\66865.TXT TERRIE
53 

rowers will try to utilize FHA versus the private sector and then 

the taxpayer-backed FHA program will be especially attractive if 

FHA permits a 3.5 percent downpayment. How should Congress 

address this problem and should FHA serve a more limited role? 

Mr. Schneider? 

Mr. SCHNEIDER. Congresswoman, I would like to respond to that. 

As I mentioned and outlined in my testimony, I think one of the 

things that is very critical right now is there is some form of parity 

between what is the allowed requirements in the private sector and 

what is going on in the FHA. 

The FHA provides 100 percent coverage on any loans that go into 

default. That means the taxpayer is on the hook for 100 percent 

of those loans. 

That is the stated intent of the Administration through the 

White Paper, we are going to start ratcheting that down, and as 

we think going forward specifically about QRMs and we don’t have 

some type of parity between the private sector and what is allowed 

in the FHA, you are absolutely right. Business will continue to run 

to the FHA. The American taxpayer will continue to be on the 

hook. And private capital will not be allowed to come back into the 

sector. 

Mrs. BIGGERT. Thank you. 

Mr. CUNNINGHAM. One of the other considerations is the downpayment. As you pointed out, the disparity between a 20 percent 

downpayment, as proposed, versus 3.5 percent would obviously 

push borrowers towards an FHA loan. Making that downpayment 

requirement less would provide more parity in the marketplace and 

encourage more private capital. 

Mrs. BIGGERT. Thank you. 

Ms. HARNICK. I would simply agree that FHA should be serving 

the pool of borrowers who either are first-time homebuyers or who 

need help affording reasonable credit, but that in general, borrowers who are creditworthy should be able to go and get mortgages in the first tier of the market. This idea of having two tiers 

is unhelpful, I think, economically and for the taxpayers. 

And I would simply note some of the data that Moody’s Analytics 

has released showing that even 3 percent downpayment loans perform well if properly underwritten and the other respects we have 

been talking about, that should not be forced to FHA. 

Mrs. BIGGERT. Thank you. 

I yield back. 

Mr. SCHWEIKERT. Thank you, Chairwoman Biggert. 

Mr. Sherman? 

Mr. SHERMAN. Ms. Harnick, if we had a 20 percent downpayment 

requirement, what effect would that have on minority homeownership? 

Ms. HARNICK. On minority homeowners, the effect would be even 

more devastating than on white families because most families in 

America have most of their wealth in their homes. That is just a 

fact of the way our economy is structured. But for families of color, 

overwhelmingly the home is the primary place that they build 

wealth. 

And I should say, among, for example, renters, who are largely 

the pool of available first-time homebuyers, only the wealthiest 25 

54 

percent of minority renters have an excess of, I think it is something like $3,000 or $5,000 in cash flow. 

Mr. SHERMAN. And I believe that renters in our society in total 

averaging negative net worth. Is that true? 

Either Mr. Cunningham or Mr. Deutsch, if you could explain to 

me whether—what is the cost of funds of the Big Five banks as 

compared to everyone else who might retain a 5 percent interest 

in a mortgage? 

Mr. CUNNINGHAM. I think it is fair to say that the cost of funds 

for the Big Five banks is probably less than it is for smaller community lenders. 

Mr. SHERMAN. And as I have editorialized before, the reason for 

that is—a huge reason for that is the too-big-to-fail syndrome, 

where we see smaller financial institutions every decade go under 

and uninsured depositors are—or those with more than the amount 

covered by FDIC insurance—are out of luck, whereas there is a 

general perception that if that happened to one of the Big Five, it 

would be the taxpayers, not the investors. That is why they have 

a lower cost to fund. 

I yield back. 

Mr. SCHWEIKERT. Thank you, Mr. Sherman. 

Mr. Manzullo? 

Mr. MANZULLO. I understand that it is about $1.2 trillion in 

loans secured by commercial real estate that are going to be coming 

due within the next 5 years, and that it is a very common practice 

to take monthly appraisals as the value of these real estate holdings go down then to go to an institution and say, ‘‘I would like to 

refinance,’’ and they say, ‘‘Well, you owe more than what this shopping center/commercial building, etc., is worth.’’ 

Notwithstanding that minor problem, my concern—and, Mr. 

Smith, if you could help me on this because from my understanding 

of CLOs is that you work in a participation agreement with a lender, and based upon your testimony, your CLOs performed extraordinarily well and yet you are being blamed by these rules applying 

to you when in fact they should not. And so my question—and actually the answer to it appears on pages three and four—but you 

didn’t have the opportunity to give all the testimony—is to explain 

here why the CLOs performed well and therefore why you should 

be exempt from risk retention requirements. Do you like that question? 

Mr. SMITH. Yes. Thank you. 

Mr. MANZULLO. Okay. 

Mr. SMITH. And before I start, I was noticing all the questions 

being focused on mortgages and commercial mortgage so I am glad 

to have a chance here to talk about this small but extremely vital 

market, even though it only totals $250 billion. 

Mr. MANZULLO. That is a lot of money. 

Mr. SMITH. For most people it is, but when you compare it to the 

securitization market, which is 10 or 12 or however it is defined 

now we can understand—I can understand, I think, a little bit how 

the agencies perhaps—I don’t want to use the word ‘‘overlooked’’ it, 

but didn’t concentrate on it and figure out the nuances and why 

it is different. 

55 

So as I mentioned before, I would feel very strongly that it is not 

an originate-to-distribute model, which most of the other 

securitizations that we have discussed this afternoon are. So why 

has it performed better? 

There are many reasons. Some of the major ones are is what 

comprises a CLO, and these are corporate senior secured loans that 

are secured by all the assets or nearly all of the assets in the company. And those loans go through a rigorous process not only by 

the bank syndicates but by the individual buyers of the loan, the 

CLOs, in this case; so many eyes get to look on these. 

Number two, it is the structure of the CLO which allows and provides for managers to go ahead and individually select these loans 

on a one-off basis, an independent third party basis. They are paid 

to do this. They are very similar to asset fund managers and they 

use all the information that is available. 

When I think about what is available out there in terms of transparency, it starts all the way at the beginning. A lot of information 

about each individual loan provided by the borrower, provided by 

the banks, provided by the syndicator. 

On the other side, what does the investor get? The investor who 

invests in the CLO—they get a phonebook in terms of volume of 

information every quarter about each individual loan, how it is performing, what is its price stat, and any other issues that have come 

up. 

And what makes it interesting is that there are only 150 to 250 

individual loans in each of these CLOs, so it is very manageable. 

The CLO manager, who is an investment advisor and covered—and 

has fiduciary responsibility to his investors, has a lot of other 

transparencies that help out. These are all rated; these are all 

priced every day. 

There is a vibrant, robust secondary market in secondary loans 

that he uses for indications of how loans are performing and where 

the value is. He takes advantage of that secondary market to balance his portfolio, sell some loans perhaps to avoid losses and to 

buy other loans to maximize returns. 

And lastly, and perhaps key, is that the incentives that have 

been set up in CLOs—the over 630 CLOs that are out there 

today—align the interests, we think, I think, of the investors with 

the asset managers. 

And so why do I say this? I say this because they get a very 

small fee—the senior fee—annually to operate and manage these 

funds. The second fee, the subordinate fee, which can comprise as 

much as 80 percent—as much as 80 percent of the total annual fee 

he gets, he only receives that if interest is paid to all the other 

tranches in the securitization. 

And actually, I forgot the most important thing. The CLO manager gets no money when the CLO is closed. He only gets his 

money on an ongoing basis, an annual fee. 

And then there is an extra fee that may or may not occur well 

down in the life of the CLO—5, 6, or 7 years—more of a profit 

sharing. If the CLO has generated for the equity holder a return 

or an amount of money over a certain agreed to level then he gets 

to share in that. 

56 

So we think all the alignments are—make sure that the asset 

manager is thinking about what the right moves are and to perform well for his investors. So I guess that was a long answer, but 

I think that— 

Mr. MANZULLO. —but I would like to ask, if possible, a followup question, because this is really important at this point. Assuming the regulation kicks in, based upon what you have just stated, 

tell me how that would interweave, or destroy, or the actual impact 

on the CLO. 

Mr. SMITH. Sure. The risk retention, as contemplated now, has 

five options and none of them really work for CLOs. The one that 

has been talked about the most is the 5 percent vertical, so I will 

approach this in two vote—it two facets. 

Number one, 5 percent is a lot of money for these CLO managers. Remember, they are not originating this because they are 

not banks; they are buying. It is very similar to what a mutual 

fund manager is, and nobody is thinking of asking mutual fund 

managers to have 5 percent risk retentions on anything they buy. 

And so 5 percent is a large number. 

We have conducted a survey, terminated back in November— 

only 13 percent of our members said that they could come up with 

5 percent on a vertical slice to hold as risk retention. Of those 13 

percent, many of them said just because they could probably 

wouldn’t because the return on that 5 percent—because you would 

be taking 5 percent of the triple A’s, 5 percent of the double A’s, 

all the way down to the equity—that wouldn’t—they probably 

wouldn’t meet their return hurdles because capital is scarce in all 

of these companies. So we don’t think that will work. 

Now, another alternative suggested, and we think it is just mathematically wrong, is take that 5 percent vertical and turn it into 

a 5 percent horizontal, so you are the first loss. You are the first 

loss. 

And remember, Dodd-Frank says you should take 5 percent of 

the asset risk here, and this is 5 percent—really taking 5 percent 

of the entire portfolio and making that the first loss. We don’t 

think any of our members will, if that is the way it goes, will put 

that money down. 

However, we think we can work with the agencies and demonstrate that their proposal is much more excessive than what 

Dodd-Frank calls for. We have done some calculations. It looks like 

it could be as much as 18 times as much. 

So if there is a first risk position that was much lower than 5 

percent that might work for some. My big challenge here is that 

one of the recommendations that the Federal Reserve study said on 

risk retention was, what would be the impact on risk retention for 

all types of managers, so small, medium, and large? We think almost any risk retention will have a detrimental effect on the 

small—detrimental effect on the small and medium-sized managers. They just don’t have the money. 

Mr. MANZULLO. I know the hour is late. I do have a quick question of the witness, Ms. Harnick. Would I— 

Mr. SCHWEIKERT. I will yield to—actually, this has become sort 

of an open discussion— 

Mr. MANZULLO. I appreciate that. 

57 

In your testimony, Ms. Harnick, on page two you state, ‘‘Almost 

4 years ago our organization released a report warning that the 

reckless and abusive lending practices in the previous 2 decades 

would lead to approximately 2 million subprime foreclosures.’’ Now, 

you don’t wear the hat of a prophet, and what was going on back 

then didn’t require a prescient mind, but there were members here 

going back as far as 2000, when the first GSE reform bill was introduced, that were concerned about it. 

It came up again in 2005. In 2005, we had another bill and there 

was something called the Rice amendment that would have tightened up these lending requirements. And many of us were just 

really, really upset looking to any agency to step in and say, ‘‘You 

simply cannot keep on lending to people without good proof of their 

ability to repay.’’ 

Tell us what you were saying 4 years ago? 

Ms. HARNICK. So first of all, what I wanted to say when I heard 

you speaking earlier about how it was amazing that it took as long 

as it did to require documented ability to repay, you would think 

that would have been a first principle. But I must tell you that we 

were among the people pushing for that and the resistance was extremely strong from people who said basically, ‘‘Lenders know their 

business. Why do you, Ellen Harnick, think you know what is better for a lender than a lender? They can protect their own interests 

and if these loans really were risky they wouldn’t make them because the market would correct.’’ 

What made us in 2006 draw the conclusion we did was that we 

looked at the structure of the subprime loans and we figured out 

that they were dependent, really, on ever-appreciating home prices 

because the loans after 2 years would explode and the borrowers— 

the lenders were only establishing ability to repay for the first 2 

years. And so it was clear that the homebuyer had to refinance before the 2 years were up because they couldn’t afford the new payments. 

But to accomplish that, they paid a prepayment penalty of something like 300 to 350 basis points, which they could only accomplish by taking a bigger loan in their refinance. And they could, of 

course, only do that if the home appreciated enough to support the 

bigger loans. 

So what we did then was we looked at the pace of home price 

appreciation and saw that it was slowing. See, even before home 

prices began to decline we looked at the pace—the slowing pace of 

appreciation and just thought, ‘‘This simply can’t continue.’’ And so 

we did the math and came up with an estimate that turned out to 

be unfortunately conservative. 

But our real concern all along has been some of the points you 

yourself have emphasized today. And I will say, the tragedy for us 

was that for many of the borrowers who got these ridiculous exploding 2/28 ARMs qualified for a 30-year fixed-rate loan at a very 

small increase on the initial payment, and those people would— 

many of those people would be in those homes today. 

Mr. SCHWEIKERT. Thank you, Mr. Manzullo. 

And I appreciate everyone’s tolerance. I know we are not paying 

much attention to the clock but at least we are getting the information and discussion. And with only three of us up here, why not? 

58 

Mr. Deutsch, talk to me about what is working right now in the 

securitization market. Because your organization, you cover all 

types of securitization. What is working, what is frozen right now? 

Mr. DEUTSCH. First, let me say I am jealous of many of my counterparts here on the panel who have one or two asset classes to 

focus on; I have about six or eight just in my testimony today. 

I think what is working normally right now is, for example, auto 

securitization. At this point, it is my view that we have an absolutely normal functioning auto securitization market. 

There is somewhere around $40 billion annually that is being 

issued. It is certainly down from the peak, but obviously in America right now you are not—Americans aren’t buying as many pickup trucks or cars as they were 2 or 3 years ago because they have 

a less optimistic perspective. 

Mr. SCHWEIKERT. On the consumption of auto securitization, is 

the securitization market consuming the paper that is available? 

Mr. DEUTSCH. There is actually a very high demand right now 

from the investor community for auto paper. It is, you know— 

Mr. SCHWEIKERT. And if these rates go—as you understand them 

to be, if they were implemented what would that do to that type 

of securitization? 

Mr. DEUTSCH. It would significantly reduce it. And one of the key 

factors for that is that the originators of most auto loans in America are not banks; they are auto captive, auto finance companies. 

They are not necessarily in the business to make loans. They are 

fundamentally in the business to sell—to make and sell cars and 

have a captive auto finance company that goes along with it. 

Those companies are not built to take risk retention. They are 

not built to hold capital as part of those captive auto finance companies. 

Now, certain of them can and they do as part of those 

securitizations. They have built this in over the course of the last 

20 years in the auto securitization so that they do retain certain 

amount of risk which is not eligible under these rules. 

Mr. SCHWEIKERT. But are they retaining part of that risk as part 

of their income and their business model? 

Mr. DEUTSCH. They are retaining that risk because investors demand it. They say, ‘‘I want you to retain some risk and I will buy 

this securitization.’’ And that market is functioning now— 

Mr. SCHWEIKERT. Does securitization sell at a premium because 

they are holding a risk? 

Mr. DEUTSCH. They don’t sell at a premium. And fundamentally 

these investors—if you have $40 billion coming into the market 

from these institutional investors they are clearly signaling—they 

think their interests are aligned with those of those who are selling. If those interests are already aligned why add new capital requirement that ultimately will reduce that availability not only for 

investors to buy but also for consumers to take out those loans? 

Mr. SCHWEIKERT. Okay. 

Mr. HOEFFEL. If I might, Mr. Schweikert, one thing—one area 

that is also performing is the commercial mortgage side. We are 

starting to see a growth in CMBS issuance that has evolved without government intervention. The industry itself has created best 

59 

practices, better disclosure. It has brought investors back into the 

market— 

Mr. SCHWEIKERT. Any particular category of underlying asset 

that is working now? 

Mr. HOEFFEL. It is all commercial asset types. They tend to be 

larger assets in core markets more than in smaller markets. I 

think that is more a function of just the general economic health 

of the regions where the properties are located more than from investor appetite. 

Mr. SCHWEIKERT. I would yield my time, but why would I start 

doing that now? And Chairwoman Biggert has been very, very patient with a freshman at the Chair. 

Same question, though, on your markets: If these rules went into 

effect what would that do to the commercial mortgage-backed security market? 

Mr. HOEFFEL. Risk retention itself would have some effect on 

cost, potentially, because we would have to force a 5 percent retention where one doesn’t exist now. But we have always had some 

form of risk retention through the B-piece buyer, so we don’t think 

risk retention in a vacuum would stop the industry, it would just 

increase the cost of borrowing and create some additional frictional 

costs. 

But with this premium recapture, if that is part of the risk retention regulations that would, as you mentioned— 

Mr. SCHWEIKERT. I remember, you and I have been through that 

one. 

Mr. HOEFFEL. Yes. 

Mr. SCHWEIKERT. All right. Thank you. 

Chairwoman Biggert? 

Mrs. BIGGERT. I have no further questions. 

Mr. SCHWEIKERT. Anyone else? 

I think you may be very blessed to be rid of us. And thank you 

for also being willing to be so flexible because doing a little more 

open process at least allowed us—because some of you had some 

great answers, and just letting it flow instead of cutting you off 

when the little red light popped up. 

Without objection, the following statements will be added to the 

record: the Education Finance Council; HVP Inc.; and the American Bankers Association. 

And the Chair notes that some of the members may have additional questions for the panel which they may wish to submit in 

writing. Without objection—I wonder if I can object to my own motion—the hearing record will remain open for 30 days for members 

to submit written questions to these witnesses and to place their 

responses in the record. 

And with that, this hearing is adjourned. 

[Whereupon, at 6:20 p.m., the hearing was adjourned.] 

(61) 

A P P E N D I X 

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