U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

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

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

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

53–987—PDF 2007

S. HRG. 110–968

THE HOUSING DECLINE: EXTENT OF THE

PROBLEM AND POTENTIAL REMEDIES

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

DECEMBER 13, 2007

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

DEBBIE STABENOW, Michigan

MARIA CANTWELL, Washington

KEN SALAZAR, Colorado

CHUCK GRASSLEY, Iowa

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAT ROBERTS, Kansas

JOHN ENSIGN, Nevada

RUSSELL SULLIVAN, Staff Director

KOLAN DAVIS, Republican Staff Director and Chief Counsel

(II)

C O N T E N T S

OPENING STATEMENT

Page

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

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

WITNESSES

Kemp, Hon. Jack, principal, Kemp Partners, Washington, DC ........................... 3

Davis, Prof. Morris A., assistant professor in real estate and urban land

economics, School of Business, University of Wisconsin–Madison, Madison,

WI .......................................................................................................................... 5

Geier, Prof. Deborah A., Leon M. and Gloria Plevin professor of law, Cleveland-Marshall College of Law, Cleveland State University, Cleveland, OH ... 7

Decker, Michael, senior managing director, research and public policy, The

Securities Industry and Financial Markets Association, Washington, DC ..... 9

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

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

Prepared statement .......................................................................................... 23

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 25

Davis, Prof. Morris A.:

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

Prepared statement .......................................................................................... 26

Decker, Michael:

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

Prepared statement .......................................................................................... 32

Geier, Prof. Deborah A.:

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

Prepared statement .......................................................................................... 38

Kemp, Hon. Jack:

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

Prepared statement with attachment ............................................................. 48

Salazar, Hon. Ken:

Prepared statement .......................................................................................... 54

COMMUNICATION

National Association of Home Builders ................................................................. 57

(III)

(1)

THE HOUSING DECLINE: EXTENT OF THE

PROBLEM AND POTENTIAL REMEDIES

THURSDAY, DECEMBER 13, 2007

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

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

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

(chairman of the committee) presiding.

Present: Senators Bingaman, Stabenow, Salazar, Bunning, and

Crapo.

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

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. The hearing will come to order.

In the 1940 film, ‘‘The Grapes of Wrath,’’ Ma Joad explained how

life had changed. She said, ‘‘I’ve never had my house pushed over

before, never had my family stuck out on the road, never had to

lose everything I had in life.’’ But that’s the threat hanging over

millions of Americans today. The fear that their lives are about to

fall over. They fear that they will be stuck out on the road. They

fear that they may lose everything that they have in life.

According to the Center for Responsible Lending, 2 million Americans will go to bed tonight in fear of losing their homes because

their mortgage payments are about to jump. I am talking about

people like Luke and Jennifer St. Claire. Luke and Jennifer are a

hardworking couple, raising a family in Missoula, MT. They have

three kids and number four is on the way. Luke has been blessed.

He works as a union bricklayer and earns $23 an hour. That is

twice what they call a ‘‘living wage’’ in Missoula. It ought to be

enough to raise a family.

But in 2 months, Luke and Jennifer’s mortgage will reset. Their monthly payment will jump from $1,400 a month to $1,800 a

month, a 29-percent increase. At the same time, everyday expenses

like food, gas, and utilities are also on the rise. Over the last 4

years, the cost of living in Montana has increased twice as fast as

wages.

Good, hardworking people are in danger of being thrown out of

their homes, and we need to do everything that we can to prevent

it. Owning one’s home is a foundation of the American dream.

Home ownership builds wealth. Homeowners feel connected to

their communities. But if home ownership is a sure sign of success,

what happened this last year? Home ownership rates were the

2

highest in our Nation’s history, and housing prices were increasing

at the highest rate in our Nation’s history.

It turns out that the housing boom was built on a foundation of

low interest rates and exotic mortgages. Falling housing prices exposed the underlying weaknesses of the loans themselves, and then

the housing market collapsed. Many homeowners who purchased

exotic mortgages will see a 30-percent increase in payments, and

low teaser rates are adjusting upwards and most of these borrowers cannot afford that kind of an increase.

The housing market makes up 5 percent of the American econ- omy. The housing market is worth $13 trillion. Holders of mortgage-based assets are looking at losses of $100 to $400 billion.

Today the overall economy is still strong, but housing troubles have

spilled over into the financial markets. Combined with high oil

prices, these disruptions could bring a recession. Experts believe

that the problem will get worse before it gets better; therefore, we

need to find out how to help people keep their homes.

One step that we can take is to address the unexpected tax consequences triggered by foreclosures and loan modifications. The tax

code treats forgiven debt as taxable income. The tax code does not

tax loan proceeds as income because the borrower pays the loan

back. But when the borrower does not pay back the loan, the

money looks more like income. In those cases, the code treats it

like income. That is sound tax policy. But when so many homeowners are losing their homes and face a large tax bill to boot, it

is time for us to provide temporary relief.

Home ownership is the number-one asset class and the numberone wealth builder for Americans. It is the bedrock of the American

dream. So let me begin this hearing by asking everyone to work together to achieve the goal of helping Luke and Jennifer St. Claire

and the 2 million people like them keep their homes. Let us find

ways to keep their house from being pushed over, let us find ways

to keep them from being stuck out on the road, let us find ways

to help them hold onto whatever they have in life.

Before we turn to the witnesses, I want to take a moment to note

that if and when we get a quorum—clearly we do not have one

now—we will interrupt to report out four nominations, and they

will be Christopher Padilla, to be Under Secretary of Commerce for

International Trade; Benjamin Sasse, to be Assistant Secretary of

HHS for Planning and Evaluation; Christina Pearson, to be Assistant Secretary of HHS for Public Affairs; and Charles Millard, to be

Director of the Pension Benefit Guaranty Corporation.

I have a longer statement on these nominations and ask consent

that it be placed in the record at this point. Without objection, it

will be included.

[The prepared statement of Chairman Baucus appears in the appendix.]

The CHAIRMAN. I say to all Senators and witnesses, you are on

notice that, if and when we get a quorum, that would be 11 Senators, then we will interrupt to report out those nominees.

I would now like to introduce the panel. The first witness is no

stranger to this committee or to this city, Secretary Jack Kemp. He

is former Housing and Urban Development Secretary in the first

Bush administration. I look forward to your views, Mr. Secretary,

3

and the insight that you will have on the housing markets, and I’m

sure you will offer some ideas to address the problem based upon

your prior service, and also your experience.

We will also hear from Michael Decker, Senior Managing Director for Research and Public Policy at The Securities Industry and

Financial Markets Association, otherwise known as SIFMA, which

represents interests of security firms, banks, and asset managers.

We will then hear from Dr. Morris Davis. Dr. Davis joins us from

Wisconsin, where he is an assistant professor in the Department of

Real Estate, School of Business. From 2002 to 2006, he worked as

an economist at the Federal Reserve Board.

Finally, we will hear from Ms. Deborah Geier, a tax professor at

Cleveland-Marshall College of Law, Cleveland State University.

She has written extensively on tax issues, including forgiveness of

debt income, depreciation deductions, estate tax, and property

transfers between spouses.

Thank you all for coming. I know you have written statements,

and they will automatically be included in the record. I encourage

you to keep your oral testimony to 5 minutes.

Mr. Secretary?

STATEMENT OF HON. JACK KEMP, PRINCIPAL,

KEMP PARTNERS, WASHINGTON, DC

Secretary KEMP. Thank you. Well, at the risk of damaging your

Democratic credentials, Mr. Chairman, let me say that Jack Kemp,

publicly and privately, agrees with everything you said about Luke

and Jennifer St. Claire and the low rates that helped cause the

problem, including those exotic mortgages. So, thank you for holding the hearing. Thanks to Chuck Grassley, your ranking minority

member. I applaud this effort to bring a perspective on this issue,

this crisis, really, before the U.S. Congress and the American people.

This is going to be a historic occasion, because Jack Kemp is

going to stick to the 5-minute rule. [Laughter.] I could go 10 minutes without using a verb, Mr. Chairman. [Laughter.]

I very much appreciate you and—I almost said Congressman—

Senator Grassley. This is a very serious condition for our American

economy and the housing industry. The credit crunch is a great

threat to the economy. It certainly is slowing it down. But far from

devastating, there are some positive signs in our robust national

economy. But nonetheless, it is a crisis if you are about ready to

lose a home or you have lost your home through foreclosure.

The subprime mortgage meltdown and the credit crunch, in my

opinion, Mr. Chairman, exist because there was, as you said, an

over-abundance of liquidity. The Federal Reserve Board, through

the FOMC, the Federal Open Market Committee, kept the funds

rated 1 percent for far too long.

Now all of a sudden a lurch to 5.25 in 2006 caused, in my opinion, a correlation between the Fed funds rate that was low and the

easing of liquidity, and then all of a sudden raising those shortterm rates has led to a severe problem, and particularly among adjustable rate mortgage holders in the subprime market, as you

pointed out, and also in the private mortgage market.

4

There were ill-advised subprime loans, particularly, as I suggested, among the ARMs. Along with prime ARMs and subprime

ARMs, that represents about 60 percent of the foreclosures.

The impact of the subprime mortgage—I call it a crisis. And incidentally, I think it’s interesting that in China the word ‘‘crisis’’ is

the juxtaposition of two Chinese characters, one signaling danger

and the other signaling opportunity. Yes, there is a danger, but

there might be an opportunity to keep Jennifer and Luke in their

home. I appreciate the fact that you have suggested that the

amount forgiven on a mortgage that, say, has come down from

$200 to $150, that should not be taxed as ordinary income. So I

strongly support that legislation and believe it is something that

both sides of the aisle can support.

The impact of the subprime mortgage contraction is very clear.

Lending standards are tightening. Subprime lenders are going out

of business or, like Countrywide, refuse to even make loans in the

subprime area. The large investment banks have suffered significant losses, and in some cases have gone to the Middle East or to

Asia to get infusions of capital investment—witness Citicorp going

to Abu Dhabi and UBS going to Singapore.

Most importantly, as you point out, Mr. Chairman, hardworking

American families and homes are in jeopardy, because the value of

their home in many cases is less than the mortgage.

What can the government do? You pointed out one thing the government can do. I am suggesting that that be included in a 3-

pronged approach. Number one, provide mortgage tax relief on a

temporary basis so people do not get taxed on loan forgiveness. You

stated it quite perfectly. The administration has also proposed allowing cities and States to issue tax-exempt mortgage bonds to refinance existing loans and, under current law, cities and States cannot issue those tax-exempt bonds to finance new mortgages. I think

that is a very important step.

We should resist, in my opinion, Mr. Chairman, long-term tinkering with the tax code to address a short-term problem. Our

economy is fundamentally strong, although challenges, as I pointed

out, are on the horizon. We should not overreact with over-regulation or increasing the tax burden on working and investing Americans. To the contrary. The Federal Reserve Board, in my opinion,

needs to continue to value a strong U.S. dollar, but at the same

time provide the liquidity to our markets. I was pleased that on

December 11 they brought the Fed funds rate down to 4.25 percent.

I would have preferred 4.0, because the 10-year rate is 4.1 percent

this a.m. I think they should have come down 50 basis points at

least.

Second, a limited change to our bankruptcy laws, Mr. Chairman,

to help provide relief for distressed homeowners. The House Judiciary Committee passed, yesterday, some important legislation to let

bankruptcy judges give the same relief on home mortgages that are

already available on commercial real estate loans, vacation home

loans, car loans, and other secured debt.

The industry opposes it because they say somehow this will raise

interest rates or make credit more expensive, but for decades, Mr.

Chairman, bankruptcy courts have been modifying mortgage loans

on family farms in chapter 12, commercial real estate in chapter

5

11, the vacation homes and investor properties in chapter 13, and

this has resulted in no ill effects on credit in those submarkets. In

my opinion, the bill passed by the Judiciary Committee in the

House should now be passed by the full House—the Emergency

Home Ownership and Mortgage Equity Protection Act of 2007.

There has to be better scrutiny of lending practices in the rating

agencies themselves. I think both were exotic, beyond exotic, in

some cases unscrupulous. I applaud the White House and Treasury

Secretary Paulson’s efforts to encourage mortgage servicers to modify their existing loans for a limited number of borrowers, but we

can do more.

I want to get through this. In closing, Mr. Chairman, I think you

stated the absolute most pressing need is to help those 2.2 million

families avoid losing their homes. We need to keep people in their

homes, as I suggested we could do it with some very modest, yet

progressive, proactive efforts by the Congress, the Fed, and the

White House.

Home ownership is the American dream, but it is also the dream

universal. We have had a huge expansion of home ownership opportunities for low-income people. I think 49 percent of people of

color have enjoyed home ownership. We need to expand it, not contract it, if we are to remove this gap between those Anglos and people of color in this country. So I thank you for your attention.

Thank you for the invitation. I appreciate the opportunity to talk

about this issue.

The CHAIRMAN. Thank you, Secretary Kemp.

[The prepared statement of Secretary Kemp appears in the appendix.]

The CHAIRMAN. Dr. Davis, go ahead.

STATEMENT OF PROF. MORRIS A. DAVIS, ASSISTANT PROFESSOR IN REAL ESTATE AND URBAN LAND ECONOMICS,

SCHOOL OF BUSINESS, UNIVERSITY OF WISCONSIN–

MADISON, MADISON, WI

Prof. DAVIS. Chairman Baucus, Ranking Member Grassley, and

members of the committee, thank you for inviting me. I will be referring to the three exhibits at the end of this testimony.

The top panel of Exhibit 1 shows the history of the price of

owner-occupied housing, on average, in the United States since

1975. Prior to 1997, after smoothing through the booms and busts,

real inflation-adjusted house prices——

The CHAIRMAN. You are on Exhibit 1, is that right?

Prof. DAVIS. Yes. I am sorry.

The CHAIRMAN. Real house prices. Exhibit 1.

Prof. DAVIS. Exhibit 1.

The top panel of Exhibit 1 shows the history of the price of

owner-occupied housing, on average, in the United States since

1975. Prior to 1997, after smoothing through the booms and busts,

real inflation-adjusted house prices increased by about 0.6 percent

per year. From 1997 through mid-year 2006, real house prices increased by 5.7 percent per year. Since 2006, real house prices have

been flat.

So, can we explain the recent housing boom? For house prices to

rise over time, something about housing must be hard to manufacVerDate 11-MAY-2000 16:32 Jan 14, 2010 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 53987.000 SFIN1 PsN: SFIN1
6

ture. For this reason, it makes sense to visualize a house as a

physical structure on some land. Physical structures are like manufactured goods, and so the price of structures should show little upward trend, like the price of most manufactured goods. The dotted

line in the bottom panel of your exhibit shows that, in fact, the real

price of structures has increased by only 35 percent since 1975.

In contrast, land is not manufacturable and this implies that

changes to the demand for housing should be directly reflected in

changes to the price of land. Shown by the solid line, the real price

of residential land has increased by more than 250 percent since

1975. Viewed in this context, the housing boom experienced over

the 1997 to 2006 period was a land boom. Over this period, the real

price of land increased by 10 percent per year. A simple statistical

model can explain most, but not all, of the recent boom to the price

of land, which is the subject of the top panel of your next exhibit.

For most of the sample period, real per capita income, interest

rates, and the inflation rate have jointly explained the trend and

cycles to the real price of land. To predict the price of land based

on these three variables, the dotted line, closely hugs the actual

land data, the solid line, until mid-2004, at which point the lines

diverge. By last quarter, the actual price of land was 26 percent

higher than its predicted price. A 26 percent over-valuation in the

price of land currently translates to 12 percent over-valuation in

house prices.

The bottom panel of Exhibit 2 lists two possible explanations for

why the actual price of land has outpaced the predicted price over

the last 3 years. The first explanation is that there is a bubble.

There might be some merit to this story, but I would rather focus

on the second reason, which is that underwriting standards may

have eased in 2004.

A change of this sort is sufficient to cause a surge in the price

of land. The reason is that there is a fixed supply of good locations.

At any given price level, the number of potential buyers that can

afford to live in any given location increases if credit becomes

cheaper or more people have access to mortgages. In this case, the

price of land must rise to clear the market.

Recently, however, underwriting standards may have become

more strict. Thus, at current price levels, the number of potential

buyers that can afford to live in any location has fallen. The price

of land and housing must fall to clear the market for land. Assuming that underwriting standards have returned to pre-2004 levels,

we might expect the price of land and housing to fall by 26 and 12

percent, respectively.

In the final exhibit, I make the case that the decline in house

prices will be accompanied by a slow-down in residential investment and GDP. The top panel compares growth in real house

prices, the solid line, with the share of GDP accounted for by residential investment, the dotted line.

The correlation of these two series is 86 percent. Thus, if house

prices fall, the odds are that residential investment will weaken. In

the bottom panel, the solid line shows the percent deviation of real

GDP from its trend, and the dotted line shows the percent deviation of real residential investment from its trend. The historical

correlation of these two series is 74 percent.

7

Summing up, given that (A) residential investment is currently

below trend; (B) we expect residential investment to fall further as

house prices fall; and (C) cycles of residential investment and GDP

are highly correlated, from a statistical point of view it seems highly likely that GDP growth will slow.

This concludes my prepared remarks.

The CHAIRMAN. Thank you, Dr. Davis.

[The prepared statement of Professor Davis appears in the appendix.]

The CHAIRMAN. Ms. Geier?

STATEMENT OF PROF. DEBORAH A. GEIER, LEON M. AND

GLORIA PLEVIN PROFESSOR OF LAW, CLEVELANDMARSHALL COLLEGE OF LAW, CLEVELAND STATE UNIVERSITY, CLEVELAND, OH

Prof. GEIER. Good morning. I am pleased to have the opportunity

to discuss with you the tax consequences that arise on debt foreclosure or workout pertaining to a principal residence. I will take

only a few minutes to highlight my submitted written testimony,

and I will be glad to answer any questions that you have for me.

My bottom line thoughts, to summarize right up front, though,

are that I believe that the relief provided in the Mortgage Forgiveness Debt Relief Act of 2007, H.R. 3648, passed by the House of

Representatives, is justifiable, except that I believe that, at least

from a normative or conceptual point of view, the relief should be

temporary. Moreover, it would be conceptually defensible to dispense with the basis reduction required by H.R. 3648, though

whether or not basis reduction occurs would likely have few realworld tax consequences.

Finally, as a conceptual matter, at least, there is no reason to

limit the amount of debt discharge income that could be excluded

to $2 million. Let me explain. I think the easiest way to explain

is to use a simple hypothetical that I think reflects common facts

occurring in our current market situation.

Let us suppose that Tom purchased a primary residence for

$5,000 in cash and $195,000 in debt in 2005, resulting in a

$200,000 cost basis. When the unpaid principal balance remains

$195,000 on his interest-only loan, Tom discovers that the fair market value of his home has been reduced to $170,000 in 2007. He

defaults on the debt and the lender forecloses, taking title to the

property.

Now, in most instances, for tax purposes Tom’s transaction is bifurcated into two component parts. First, Tom is deemed to sell the

property for its $170,000 current value, and then, second, he is

deemed to use that $170,000 of proceeds to settle the $195,000 outstanding debt.

The first part, the deemed sale, results in a $30,000 loss for tax

purposes, but, because a personal residence is deemed a personal

use asset, that loss is not deductible for tax purposes.

In the second part of the transaction, the deemed debt settlement

will result in $25,000 of debt discharge income if the lender discharges the shortfall—$195,000 debt less the $170,000 repayment—which is excludable under current law only if Tom is insolvent or the discharge occurs in bankruptcy court.

8

Alternatively, assume the same facts, except that the lender does not foreclose but rather reduces the outstanding $195,000 debt in

a workout to $170,000 to reflect its current value. Because there

is no property transfer there is no loss calculation, but as before,

Tom nevertheless realizes $25,000 of debt discharge income that

would be excludable only if Tom is insolvent or in bankruptcy

court.

While many taxpayers like Tom are not in fact legally insolvent

because of retirement savings that cannot be accessed without stiff

tax penalties, they may be functionally insolvent with credit card

and mortgage debt exceeding the reduced value of the home and

other assets outside of retirement accounts. But they are not legally insolvent and thus they gain no protection from the current

insolvency exclusion. These are the taxpayers that would be protected by H.R. 3648.

Now, under H.R. 3648, the solvent taxpayer would be permitted

to exclude debt discharge income realized on or after January 1,

2007 with respect to the taxpayer’s primary residence, to the extent

of $2 million, so long as the discharged debt satisfied the definition

of acquisition indebtedness within the meaning of the code provision pertaining to the home mortgage interest deduction. Acquisition indebtedness is debt that is secured by a personal residence

and was incurred to acquire, construct, or substantively improve a

home, or was debt used to refinance such debt.

Now, H.R. 3648 provides that the amount excluded would reduce

the basis of the personal residence only and not any of the other

tax attributes listed under current law, such as net operating loss

carry-overs and capital loss carry-overs that are reduced if debt is

discharged in bankruptcy or insolvency.

But I believe that this basis reduction would not usually result

in any actual tax consequences in the future. It would either reduce the amount of non-deductible loss that I described above or,

if the debt was discharged in a workout without a transfer, it could

conceivably produce gain on a later sale if the home began to regain value over time.

That gain, however, would likely itself be excluded from gross income unrealized under section 121 of the code, which generally allows exclusion of up to $250,000 of realized gain, $500,000 for a

married couple filing jointly on home sale gains, so long as the taxpayers owned and resided in the home for at least 2 of the last 5

years.

Now, because H.R. 3648 applies primarily to solvent taxpayers,

the real central question here is whether a solvent taxpayer is deserving of any relief. The key to understanding this analysis, in

turn, is the treatment of the loss on a deemed sale in the first part

of the analysis that I described above. The problem arises here

chiefly because personal residences are categorized for tax purposes

entirely as personal use assets providing personal consumption.

Wealth used in consumption should not, as a normative matter,

at least, reduce the tax base under income tax principles, so losses

on sale are not deductible. In contrast, if Tom had bought stock instead of a personal residence with that debt, his $30,000 loss would

be deductible because it would represent a wealth reduction that

does not reflect personal consumption by him.

9

Now, in a more normal market for personal residences, this categorization of personal residences as personal use assets that cannot produce deductible losses is generally a good rule. If a home

loses value in such a market when most homes at least maintain

nominal value, if not appreciate, the reason is usually because the

owner failed to maintain the home or made idiosyncratic changes

that she liked, but which the market abhorred. That is to say, the

value loss is usually due to personal consumption of the taxpayer,

just as use of a personal use car which reduces its value reflects

personal consumption of the driver.

In that case, the value lost reflects personal consumption and

should remain in the taxpayer’s tax base. Application of the usual

rule results in this treatment. The loss is non-deductible, and the

debt, which effectively paid for this personal consumption, results

in includable gross income if the debt is discharged and the taxpayer is solvent.

But, in the current unusual market conditions, the value loss of

the personal residence does not likely reflect personal consumption

of the taxpayer.

The CHAIRMAN. Ms. Geier, I am going to have to ask you to summarize if you could, please.

Prof. GEIER. All right. In an ideal world, I think that we would

try to identify those value losses resulting from personal consumption and tax that discharge income arising from them. But, because

I do not think that is administratively feasible, I think that the

best approach would be to make relief temporary.

These value losses are unusual. When a more normal market returns and most homes maintain value, any loss in value of the

home would likely be due to personal consumption of the taxpayer.

Thank you.

The CHAIRMAN. Thanks, Ms. Geier, very much. Thank you.

[The prepared statement of Professor Geier appears in the appendix.]

The CHAIRMAN. Mr. Decker?

STATEMENT OF MICHAEL DECKER, SENIOR MANAGING DIRECTOR, RESEARCH AND PUBLIC POLICY, THE SECURITIES

INDUSTRY AND FINANCIAL MARKETS ASSOCIATION, WASHINGTON, DC

Mr. DECKER. Good morning, Chairman Baucus and other members of the committee. Thank you for the opportunity to testify

today about the mortgage securities market and tax proposals to

provide relief to homeowners in need. We appreciate the opportunity to work with you and the committee on these issues, just as

we continue to work with Banking Committee Chairman Dodd,

who introduced comprehensive legislation this week, and Ranking

Member Shelby on subprime mortgage reform legislation and related housing matters.

The U.S. system of supplying credit for home buyers has undergone a fundamental transformation over the last 20 years. Mortgage lending has gone from a business dominated by thrifts and

other portfolio investors to one dominated by securitization. This

transformation has reaped numerous benefits for home buyers, investors, and the economy as a whole. Securitization is responsible

10

for supplying more mortgage credit at a lower cost for U.S. families

than would have ever been possible under the old originate-andhold model.

While millions of families have been able to purchase homes as

a result of subprime mortgages and mortgage-backed securities, it

has become clear that underwriting standards were at times too

loose at the peak of the housing boom. Subprime loans that should

not have been made were made.

This happened as a result of a combination of a period of historically low interest rates, overly optimistic assumptions, fraud or

abuse on the part of both lenders and borrowers, speculation, and

an under-pricing of credit risk brought about by a glut of investment capital from around the world seeking attractive rates of return.

As it became apparent earlier this year that defaults and foreclosures in the subprime mortgage sector were spiking, the market

for securities backed by subprime loans changed direction very

quickly. Today, the securitization market for new subprime loans

has shut down. Virtually no subprime mortgages are being originated, and the values of outstanding securities backed by subprime

mortgages have dropped dramatically. Market liquidity, or the ability to seamlessly trade securities in the secondary market, has

dried up.

From the perspective of market practices, the downturns in the

subprime mortgage market and the credit markets more broadly

have raised some challenging questions. For example, how can

thinly traded securities—in some cases securities that were never

designed to be traded at all—be valued in difficult market conditions? Or how can the market ensure that investors and others

have adequate access to information on the structured securities

they hold?

SIFMA members and other market participants take these questions seriously, and we are working on solutions that will improve

market practices without threatening the benefits of securitization

for consumers and the economy as a whole.

From the perspective of public policy, Treasury Secretary Paulson announced last week a multi-pronged plan designed to assist

struggling homeowners who will face a mortgage reset with a rising interest rate. A key element of this plan is expanding the use

of tax-exempt mortgage revenue bonds to help such homeowners

refinance their subprime loans.

Tax-exempt mortgage revenue bonds issued by State and local

governments are an important tool to finance low-cost mortgages

for low- and moderate-income families. Under current law, MRBs

can be used to finance new mortgages for first-time homeowners for

owner-occupied single-family homes. Treasury’s proposal would

allow State and local governments to issue tax-exempt MRBs to refinance existing subprime loans.

As members of this committee explore efficient and flexible solutions for distressed homeowners, tax-exempt bonds can help accomplish that goal. The refinancing of existing loans at lower interest

rates remains a preferable outcome for troubled borrowers. We

urge the committee’s adoption of this proposal.

11

While policy and market practice responses to the housing decline are important, the fundamental issues of over-supply and

over-pricing of residential housing can only resolve themselves

through market adjustments. Reducing the inventory of new and

existing homes for sale is key to an overall turnaround in housing.

Home prices will need to continue to adjust to draw buyers to the

market and reduce supply.

At the same time, a de-leveraging and recognition of losses, already begun at banks and securities firms, investment funds, and

others affected by the credit downturn, will help alleviate constraints in the supply of credit, as will continued actions by the Fed

and other central banks.

The evolution of mortgage securitization has been one of the

most remarkable developments in the financial markets over the

last 25 years. The mortgage securities market, now the largest sector of the U.S. bond market, has brought benefits to home buyers

and has reduced risks for banks, thrifts, and others engaged in

home lending. Despite the downturn in the subprime mortgage

market and the broader real estate sector, securitization will continue to provide a ready supply of capital for consumers and others.

Thank you again for the opportunity to be here. I look forward

to your questions.

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

The CHAIRMAN. Thank you all very much.

I would like to focus a little bit more on this committee’s jurisdiction, that is, on the tax side. I would like the entire panel’s reaction

to the House proposal that allows homeowners to exclude cancellation of debt income resulting from either foreclosure or refinancing.

So, just quickly.

Secretary KEMP. I strongly supported it in my testimony, Mr.

Chairman. I believe it is absolutely essential. I congratulate Senator Stabenow for introducing it in the Senate. I know there is Republican and Democratic support. So I think it should be done,

along with one other act that could be passed. That is, reinstating

the mortgage insurance tax deduction. It expires December 31,

2007. I think it should be continued as an existing tax deduction

for mortgage insurance.

The CHAIRMAN. All right. Dr. Davis? Would you modify the $2 million limit, for example, so it is indefinite in duration? What

do you think of it, and would you modify it? That is to Dr. Davis.

Prof. DAVIS. I think, in spirit, it sounds like a good idea. I have

not thought about the details, so I am not prepared to give an answer as to all the details and whether or not it makes sense in its

current form, or should be modified. But it is good. I think it is the

right thing to do.

The CHAIRMAN. Ms. Geier?

Prof. GEIER. I support it. I do think that some changes would be

conceptually defensible. Three, really. Number one, this exclusion

really does stand on a different footing from the bankruptcy and

insolvency exclusions. Those exclusions are in the code because it

is thought to properly measure income, but we do not want to tax

that income now.

We want to defer taxation until the future when the taxpayer is

on a more financially sound footing. So the exclusion is immediate,

12

but the taxpayer must reduce valuable tax attributes in an equal

amount so that the idea is that the taxpayer’s future income will

be increased by precisely the same amount that was excluded this

year. So the bankruptcy and insolvency exclusions are not properly

thought of as tax forgiveness provisions, they are properly thought

of as deferral provisions.

The CHAIRMAN. Right. But I am talking about this one.

Prof. GEIER. So this one, I think, therefore, the House bill has

structured it the same way. It requires a basis reduction in the

home under the same kind of normative structure as for the bankruptcy and insolvency exclusions, which can require a basis reduction in property which can increase future gain, and therefore future income.

The CHAIRMAN. My real question is, how would you change it?

Very, very briefly, because my time is about to be up.

Prof. GEIER. All right. Very briefly, I would make it temporary.

The CHAIRMAN. How temporary?

Prof. GEIER. That is beyond a tax expertise. It is an empirical

question. It should be, to the extent we believe the bubble has not

burst yet, to the extent we believe home values will——

The CHAIRMAN. All right. Make it temporary.

What else?

Prof. GEIER. I would not require a basis reduction in the principal residence.

The CHAIRMAN. What about the $2 million limit?

Prof. GEIER. The $2 million is not conceptually justifiable. For

revenue needs, it may be necessary, but, as a matter of properly

measuring income, this should not be thought of as real income. So,

therefore, regardless of the amount, it should not be taxed.

The CHAIRMAN. Any limit to owner-occupied, or to a taxpayer

who lives in the home, not to investors?

Prof. GEIER. Yes. I do believe that H.R. 3648 is limited to the

taxpayer’s primary residence.

The CHAIRMAN. Right.

Prof. GEIER. And it also does not allow exclusion of home equity

debt, to the extent that it was used in a way other than to permanently improve the home. I think that is correct as well.

The CHAIRMAN. Mr. Decker, your thoughts?

Mr. DECKER. We think that the concept of excusing forgiven

mortgage debt from taxation is a good one and will help servicers

and lenders keep families in homes. With respect to the House bill

specifically, I think that the permanence of the House provision is

probably not appropriate in the context of the current market conditions. Sunsetting the provision after 2 years, maybe, would give

Congress the chance to revisit the proposal in the context of whatever market or mortgage conditions were prevailing at the time.

The CHAIRMAN. I have another question, and that is the degree

to which the seizing up of the credit markets is having a separate

effect, maybe adverse effect, on homeowners. We have been looking

at the subprime problem with the administration’s proposal and

other refinancing, and so forth, to help the home buyers, to help

homeowners as we are in discussing this legislation, but in addition—I am just curious of your reaction—the degree to which tightening up of the credit markets—today’s papers, for example, cenVerDate 11-MAY-2000 16:32 Jan 14, 2010 Jkt 000000 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 53987.000 SFIN1 PsN: SFIN1
13

tral banks are trying to get more money in banks so they start to

trust each other more. The banks trust each other more and start

lending to each other a little more. To the degree they are not

doing that, how much of an adverse effect does that have on my

Montana St. Claires? If it is having an adverse effect, what should

we do about that as a Congress? Mr. Secretary?

Secretary KEMP. Well, I pointed out in my testimony, Mr. Chairman, that the Congress is proactive. The administration is

proactive, albeit in a very modest fashion. I think the Fed has to

be more proactive. I have called for a 50 basis point reduction to

4 percent. The 10-year T-bill is 4.1. There is an inverse yield curve.

I think that has to be resolved, and it can only be resolved by lowering the Fed funds rate to 4.

Now, in my opinion, there is a correlation—maybe not a perfect

correlation—but I think Chairman Greenspan kept the Fed funds

rate too low for too long. It was too much liquidity, it had a huge

impact on housing values and real estate values, and all of a sudden to go from a 1-percent Fed funds rate set by the FOMC to 5.25,

it affected adversely all those ARMs, both in the subprime market

and in the prime adjustable rate mortgage market.

The CHAIRMAN. Thank you.

Senator Bingaman, you are next.

Senator BINGAMAN. Thank you very much.

Let me ask you, Dr. Davis. As I understand your testimony, you

are saying that residential investment is going to continue to fall

as housing prices continue to fall and that that will result in a lowering of Gross Domestic Product going forward.

Prof. DAVIS. Yes. There are two pieces to that. I had another exhibit prepared for the committee, but in the interest of keeping to

the 5 minutes I did not show it. So there are two pieces. The first

is, there is an arithmetic lowering. Residential investment is a

component of GDP, so, to the extent that there is a reduction in

residential investment, there is an arithmetic reduction in GDP.

Recently the slow-down in residential investment has arithmetically caused a 1-percent reduction in what we would have seen

to GDP, and that data is available at the Bureau of Economic Analysis.

So that residential investment has an arithmetic pull on GDP,

and then there are the economic forces at work. So the economic

link between house prices and GDP is through this consumer

spending channel called the ‘‘wealth effect.’’ What the wealth effect

says, briefly, is that when people are less wealthy they spend less

on consumption.

Typical estimates are that, for every dollar reduction that households’ balance sheets fall, for every dollar, consumer spending falls

between 3.5 and 5.5 cents to the dollar. So in Exhibit 3, you saw

a statistical link between residential investment, house prices, and

GDP. What I have just presented to you now is an economic link:

house prices fall, people are less wealthy, they spend less on consumption. As residential investment falls, arithmetically that pulls

down GDP.

Senator BINGAMAN. Are you able to look ahead? We are beginning 2008 here in a few weeks. Are you able to look ahead and say

what the time frame for some of this will be? I have heard preVerDate 11-MAY-2000 16:32 Jan 14, 2010 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 53987.000 SFIN1 PsN: SFIN1
14

dictions that the price of housing is likely to bottom out in 2009

sometime. Are we looking at a continued decline in GDP until that

time or do you think that there is no way to predict?

Prof. DAVIS. There are two parts to this answer. Let me first

refer you to Exhibit 1, if you would not mind. In the past, the

downturns in house prices—and you would know there was a

downturn by looking at the black line, and when the black line falls

there is a downturn—have lasted about 4 years. So if we were to

think that going forward will look like the past, we might expect

another 2 to 3 years of house price declines.

The impact that will have on GDP. In the minutes of the Federal

Open Market Committee, it looks like the economists in the central

bank and the branch banks think that, if I am reading the forecasts accurately, there will certainly be a slow-down in 2008, a

slow-down relative to GDP’s normal rate of growth, which is 3 percent. So, the forecast in the FOMC minutes is between 1.8 and 2.5

percent. In 2009, there might also be a slow-down as well.

Senator BINGAMAN. A further slow-down from 1.8?

Prof. DAVIS. No, no. From trend. So if trend is 3 percent, 2008

might be 2 percent, 2009 might be 2.3, 2.5 percent.

Senator BINGAMAN. All right.

Prof. DAVIS. So house prices 4 years, GDP, 1 to 2 years.

Senator BINGAMAN. Let me ask Mr. Decker, what about the secondary market for new home mortgages? Does that come back?

Mr. DECKER. There are elements of it that never really slowed

much. The market for conforming loans, loans that are eligible to

be bought by Fannie Mae, Freddie Mac, and Ginnie Mae, is still

robust and has been robust through the downturn. The market for

non-conforming loans, including subprime loans, slowed considerably earlier this year.

There is now credit available for non-conforming prime loans—

so, loans that are not eligible for Fannie Mae or Freddie Mac purchase, but where the borrower has good credit or there are low

loan-to-value ratios. There is practically no subprime lending taking place right now.

Senator BINGAMAN. But those non-conforming prime loans, are

those being securitized?

Mr. DECKER. In some cases they are. In some cases they are

being held in portfolio.

Senator BINGAMAN. What about this problem of the larger loans

that are above $417,000? What about that? Is there a secondary

market for those loans?

Mr. DECKER. There is a secondary market. It is not as liquid or

robust as it was even 6 months ago. The best indication is the difference in mortgage rates between conforming loans and nonconforming prime loans, which is now something like a percentage

point, which is much wider than it typically is in normal market

conditions.

Senator BINGAMAN. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

Professor Davis, in your testimony you assume that underwriting

standards have returned to the pre-2004 level. But is it not more

15

likely that underwriting standards will become even more strict

than in 2003 to reflect the added risk that banks and investors now

appreciate better?

According to your analysis, that seems to increase the risk of a

recession even further. Would you say that the Federal Reserve,

under former Chairman Greenspan, should have intervened sooner

to tighten underwriting standards? Alan was trying to get all of us

here at the table to take ARMs at the time. He thought that would

be a good buy for everybody who was purchasing homes at the

time. Would we be here today if the Fed had intervened earlier?

Prof. DAVIS. Let me address both parts of that question separately. The first is, I did not mean to be optimistic or pessimistic

in my testimony. I just said if underwriting standards revert to

pre-2004 levels, then here is a forecast for how much house prices

will fall. Certainly if credit conditions become more strict prior to

2004, then it is reasonable to assume house prices will fall by even

more.

Then with respect to what the Federal Reserve should or should

not do, there is one statistic that I find telling. This is in the GAO

report on, I think, October 16 to the House committee. In 2006, of

the top 25 originators of subprime and Alt-A, which is 90 percent

of volume, 21 were non-bank.

Senator BUNNING. But that did not make any difference because

the Federal Reserve had control over banks and non-banks.

Prof. DAVIS. All right. Then there is the other quote from Mr.

Bernanke that, according to Home Mortgage Disclosure Act data,

‘‘lenders not subject to oversight by Federal banking agencies originated just under half of higher-priced conventional first-time mortgage loans in 2006.’’

Senator BUNNING. Yes, sir. I understood that. I questioned Chairman Bernanke when he was before our committee about that.

Prof. DAVIS. So the Federal Reserve—I do not want to criticize

what they did because I——

Senator BUNNING. I sure do.

Prof. DAVIS. Their mandate is to follow unemployment and inflation.

Senator BUNNING. Thank you very much.

Secretary Kemp, you said in your testimony that Congress

should provide relief so that people do not get taxed on loan forgiveness. But later on in your testimony you refer to this idea as

‘‘tinkering.’’

Secretary KEMP. I do not think I did.

Senator BUNNING. Well, I am pretty good at——

Secretary KEMP. I am sure I did not mean to.

Senator BUNNING. It is in your written testimony.

Secretary KEMP. It may be, but I apologize if it is in there. It

should not be. I summarized and I made it very clear that I support the legislation to provide mortgage relief from ordinary income.

Senator BUNNING. All right. Let me just follow up then. If it is

good policy today, why not make it permanent?

Secretary KEMP. It may be that you should. I did not talk about

that. I supported the Stabenow bill. There should perhaps be a

sunset restriction.

16

Senator BUNNING. I happen to agree with that. I happen to agree

that there should be a sunset provision.

Secretary KEMP. All right. Good. Then we are agreed.

Senator BUNNING. Back to Professor Davis. You used the ‘‘wealth

effect’’ in your testimony also. Chairman Greenspan used the

‘‘wealth effect’’ to pop the bubble on the tech bubble that he talked

about quite a while back. He talked about the wealth effect and

people having more money to spend, and therefore we were going

to have this huge bubble. He never, ever mentioned it during the

housing bubble, which happened to be popped after he had left it

on the table for Chairman Bernanke.

Prof. DAVIS. Right.

Senator BUNNING. I just wanted you to know that was the case.

I had another question for Professor Geier, but I do not know if

I have enough time. I happen to think that H.R. 3648, on a temporary basis, would be a fine start. I also happen to think that the

administration is a little timid in their approach. But that is not

unusual. They want to get things started and obviously let us carry

the ball. That is usually their way of doing things.

I think it is a temporary change that should be made, as you do.

Most of the panel, I believe, thinks it should be temporary. We

hope that Senator Stabenow’s legislation will be considered by this

committee as we go down the pike.

Thank you very much.

The CHAIRMAN. Thank you, Senator.

Senator Salazar?

Senator SALAZAR. Thank you very much, Chairman Baucus, for

holding this hearing on this very important issue this morning. In

Denver, CO, Denver wakes up to yet another headline which I

think is typical for the rest of the country. The headline in this

morning’s Denver Post is, ‘‘Colorado Foreclosures Set Record.’’ The

first line—I will not read it all—is ‘‘More Colorado homeowners

have gone into foreclosure in the first 9 months of this year than

in all of 2006, which was a record year.’’

In conversations that I have had with home builders and others

who are interested in this issue in my State of Colorado, not only

do they see us as being one of the top five States that is being affected by the home foreclosure problem, but they also do not think

we have yet seen the worst of it, that the worst of it is coming. We

will see that as the ARMs on mortgages are adjusted in the year

ahead. So the next couple of years, I think, are still seen as being

very problematical from the point of view of people whom I have

talked to.

Mr. Chairman, I have a longer statement for the record that I

would just submit for the record, if there is no objection.

The CHAIRMAN. Without objection.

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

Senator SALAZAR. Now I have two questions, or maybe three

questions. The first one I think you have answered in terms of answering Chairman Baucus’s questions relative to loan forgiveness

and how we would deal with that in terms of the tax consequences

of that. I do hope, Chairman Baucus, that we are able to move forward with some proposal, whether it is Senator Stabenow’s proVerDate 11-MAY-2000 16:32 Jan 14, 2010 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 53987.000 SFIN1 PsN: SFIN1
17

posal or ideas that you might have, because I think that is one avenue in which we can be helpful.

The second—and here I want some of you with expertise on this

to respond back—some have suggested that we do something with

private activity bonds. The White House has suggested that we do

something with respect to private activity bonds in the mortgage

market. What I would like to do is get your thoughts on what it

is specifically that we have to do with respect to private activity

bonds for mortgages.

Secretary Kemp, I can start with you and we can just come this

way. If you will keep your answers relatively short, we will make

it all the way to this end before my 5 minutes are up.

Secretary KEMP. Well, Senator, thank you for the question. I

agree with you, it should be both private and public. The more we

can have MRBs, tax-exempt mortgage bonds, both public and private, the better off we would be in this very troubling and vexatious moment in the history of the housing market.

Senator SALAZAR. Do you have a suggestion as to how much of

a private activity bond increase we ought to make to deal with the

problem?

Secretary KEMP. No, I really would not. I usually have an answer

for everything, but not that.

Senator SALAZAR. All right.

Dr. Davis?

Prof. DAVIS. I am sorry. I do not have anything useful to add.

Senator Salazar.

Professor Geier?

Prof. GEIER. I think our colleague here is the one who is going

to have the most relevant answer to that. But the tax consequences

on the back end are not going to help all of the homeowners now

who are going to see those rate increases. As I understand it, the

private activity bonds or mortgage refinancing bond proceeds could

be used to help refinance those taxpayers’ loans to keep them out

of ever having to seek relief under the tax provisions that the committee is considering.

Senator SALAZAR. All right.

Prof. GEIER. So, I think it is a good idea.

Senator SALAZAR. Mr. Decker, they are not mutually exclusive

approaches to dealing with the issue?

Mr. DECKER. No, not at all. The Treasury proposal is a smart

idea. Mortgage revenue bonds provide below-market rate financing

for low- and middle-income home buyers, but right now State and

local governments can only use them for new home purchases.

So allowing those bonds to be used for refinancings of subprime

borrowers who are in trouble would give them another opportunity

to potentially stay in their homes. The one issue that comes up

when you talk about expanding mortgage revenue bonds is the existing volume cap that applies to all private activity bonds, which

might constrain the use of the Treasury proposal. So, that is one

amendment you might want to think about.

Senator SALAZAR. So it would be something that we would have

to consider here in this committee if we are going to move forward

with that.

18

To whoever wants to take this question, I have about a minute

left. Is there a difference in terms of how this home foreclosure

problem is affecting rural America versus the urban parts of America, or is it the same in both places?

Secretary KEMP. I am sure there is an answer to that. I do not

have a geographical distribution of the problem. I alluded earlier

in my testimony to the fact that over 60 percent of all the foreclosures are in the ARMs, the adjustable rate mortgages, both in

the subprime and in the prime market. About 45 percent of it is

in the subprime, about 15 to 20 in the prime market. So I am sure

it affects rural and urban America probably in a parallel fashion.

It is a threat to both sides of this distribution of our income.

Senator SALAZAR. Does anybody else have any other information

on that question? [No response]. All right.

Thank you very much, Chairman Baucus.

The CHAIRMAN. Thank you, Senator.

Senator Stabenow?

Senator STABENOW. Thank you very much, Mr. Chairman, for

this hearing. This is such an important topic. Thank you to all of

you. It is good to see you.

We are all looking, on our committee and the Banking Committee, working with the administration as well, at what we can

do.

I guess the first question that I would have relates to what you

have been talking about in terms of the mortgage tax cancellation

legislation which I have introduced with Senator Voinovich and a

bipartisan group, and there is a bill that has passed the House, as

you know. The House bill is permanent. Those of us in the Senate

would like to make it temporary. We may be in a situation, with

the interest of time now, to get something on the books and clarify

it as we go forward.

But would you agree that it is critically important to get something in place for this year? I mean, I am certainly hearing at

home—I think I am asked about this almost as much as anything

now in terms of people who are in a situation of foreclosure, short

sale, refinancing, but find themselves not only having a hardship,

maybe losing their home, but maybe having a new tax bill. So

would you agree with the sense of urgency that we address this

this year?

Secretary KEMP. Absolutely. I think the Chairman began, Senator, by alluding to your bill. I think all of us, to one degree or another, agree that it should be passed as immediately as possible.

It passed the House. I think it should be sunsetted, but that would

be up to the wisdom of the Senate and the House conference.

Prof. GEIER. One thing that I did not get a chance to mention,

but is in my written testimony, is that the effective date of H.R.

3648 is for debt forgiveness income that arises after January 1,

2007. One of the things I mentioned in my written testimony is

that I do think that, if in fact there were substantial foreclosures

due to falling home prices in 2006, that it would be justifiable to

even make it retroactive before then. If this is not conceptually income, it should not be taxed whenever it rises.

Senator STABENOW. Right. Thank you.

19

Thank you, Mr. Chairman, for mentioning the bill. I know you

are leading our efforts to address this.

On a little different topic, in the sense of what we ought to be

doing, I know that the administration has preferred a 1-800 number, I know the mortgage bankers—we were at a U.S. Conference

of Mayors meeting where I participated on this issue a couple of

weeks ago in Detroit, and indicated they are putting forward resources, and also a database on their website so that people can

find out who actually holds the loan, since these days it is not just

going back to your lender, you are trying to figure out who you

talked to, who holds the loan.

But we also have dollars in the budget, $200 million, that we

have passed for counseling to be able to help people sort through

these things. Is that an important piece? I may have missed this.

I apologize if I was not in the room.

Has anyone mentioned the extent to which individually, now,

being able to help people sort out who has their mortgage, what are

the options, do they fit under what the President announced or

not? Unfortunately, most folks in Michigan do not because they are

not current on their payments and are not in a situation to take

advantage of it. But we want people to be able to be helped and

not be placed into a situation where, in fact, they go into foreclosure.

Secretary KEMP. I alluded to that in my testimony, Madam Senator. The Chairman alluded to it earlier as well. I also mentioned

a limited change to our bankruptcy laws to provide relief for distressed homeowners. We provide that type of relief for real estate

loans, vacation home loans, car loans, and other secured debt, so

I think it should be also—it passed yesterday in the House Judiciary Committee. It seems to me it would be a limited change to our

bankruptcy laws that would be quite progressive.

The CHAIRMAN. I might ask, if the Senator would yield.

Senator STABENOW. Yes.

The CHAIRMAN. I could never understand why there is that distinction in the law.

Secretary KEMP. It was changed in 1978. I was in the Congress.

I went back and looked at it and it passed by voice vote. So how

did I vote? It passed by a voice vote. I do not even remember what

I did. I wish I had spoken up then because I think it is a

ridiculous——

The CHAIRMAN. I did, too. I just wondered about the origin of all

that, and I was just curious as to if you knew.

Sorry, Senator. Go ahead.

Secretary KEMP. One last point, Mr. Chairman, to Senator

Stabenow. I mentioned also the mortgage insurance tax deduction

expires.

Senator STABENOW. Yes.

Secretary KEMP. I would like to see that renewed. I want to submit for the record, I was watching Kudlow and Company on—I forget. I had better be careful here, with the battle between the cable

shows. But Kudlow had a very interesting chart on where the problem is among the ARMs, prime and subprime, and the Fed funds

rate from 2002 and 2005, and suddenly going from 1 percent to

5.25 percent and what that did to those ARMs.

20

Senator STABENOW. Right. Right.

Secretary KEMP. And 60 percent of the foreclosures are in the

prime and subprime ARM market. I would just like to submit it to

the Chairman’s staff for the record.

The CHAIRMAN. Without objection.

[The information appears in the appendix on p. 52.]

Senator STABENOW. Thank you.

Just in closing, I would say what we know also from testimony

is that most of those are coming due, those resets are. We have not

even seen all of them, or begun to see them yet, so we have a lot

to do on it. I know we are working on FHA reform and the tax

piece, and bonding authority, and a number of things, but it should

have, certainly, our highest urgency.

Mr. Chairman, thank you for that.

The CHAIRMAN. Thank you, Senator, very much. I appreciate

your legislation.

I am just curious. At what point will confidence come back? That

is, when will we hit bottom? What is it going to take? Does it take

policymakers to show greater recognition of the problem and being

more candid about it and being recognized realistically, the excess

underwriting standards, maybe purchasers? Perhaps we are a little

bit too forward-leaning in getting our mortgages in the first place,

plus all the SIVs, the CDOs, and all the securitization and so forth.

But I am just curious as to your thoughts. I am sure it is on the

mind of most every American here: when are we going to get out

of this mess, what is it going to take, and what are some indicators

and what needs to be done so we know we are starting to go forward?

Secretary KEMP. Let me take a stab at it. I have to leave, and

I apologize to your fellow committee members and you, Mr. Chairman, for having to leave. I did not realize that we would go beyond

11 o’clock. But just a stab from a 60,000-foot view.

The CHAIRMAN. Sure.

Secretary KEMP. I think the fact that there is a proactive Congress, legislation we discussed, including counseling, a proactive

administration, albeit it is modest, as the Senator from Kentucky

pointed out, and a proactive Fed. The Fed is more proactive. I criticized it earlier for not going down a full 50 basis points. The spread

between overnight money in 10 years is ridiculously inverted. You

can borrow 10 years at 10.1, and overnight at 4.25. So, I thought

it should have come down to 4.

I think, in order to keep the dollar strong—this would be Jack

Kemp saying this; I do not speak for anybody else—I think we

should cut the corporate income tax rate. We have the highest in

the world. It would increase the demand for the dollar, thus it

would help strengthen this move by the Fed that some would suggest might set off incipient stages of inflation.

So a proactive Fed, a proactive Congress, and a proactive administration are steps in the right direction. I do not foresee a recession. I think there will be a slow-down. I think we should take

steps to forestall any fear of recession by bringing those tax rates

down, and interest rates.

The CHAIRMAN. Other comments? I have only about 21⁄2 minutes

left. Do other panelists have a reaction to that? Mr. Decker?

21

Secretary KEMP. Thank you, Mr. Chairman.

The CHAIRMAN. Yes. Thank you, Mr. Secretary, for coming. We

deeply appreciate you taking the time. Thank you.

Mr. DECKER. Ultimately, what it will take for the crisis to abate

is a repricing of assets. That means a repricing of homes. Home

prices will need to continue to fall in order to work through the excess inventory and bring buyers back into the market, and a repricing of financial assets. You see investors and banks and securities

firms taking very large write-downs, very large charges against income to mark their portfolios to market. Some investors are more

able or willing to do that than others, but eventually, across the

board in the capital markets, investors will need to de-leverage,

recognize that they have taken losses on their books, and there will

be an opportunity for more——

The CHAIRMAN. Let me ask another question. Let us take the

public sector. The public sector response, do you think, is about

right, or too much, or too little? Secretary Paulson has presented

his proposal, his HOPE proposal, for example. He also suggested

that States be able to issue revenue bonds. There is talk in the

house of FHA and so forth. I frankly think Freddie Mac and Fannie

Mae can do more than they are doing. They are talking at the Fed

of easing credit up a little bit. Now we in the Congress, here in this

committee, are going to help with the cancellation of debt, and so

forth.

Do you think, given the moral hazard question, is it about right?

Have we gone far enough generally? Too far? Your sense.

Mr. DECKER. I think that the issues that you have raised this

morning and that are before this committee, the cancellation of

debt proposal and the mortgage revenue bond proposal, are just the

kinds of solutions that Congress should be thinking about in the

current context. I think the market has welcomed the Fed response

for the most part, the change in direction of Fed policy.

Some have argued that it should be more aggressive or faster

than it is, but overall the Fed is on a clear path towards easing,

which is welcomed by the market. Overall, I think fundamentally

for the crisis to resolve itself, it requires more of a market adjustment than a policy adjustment.

The CHAIRMAN. Then in answer to my question, I infer from

what you said that you think the public response, the government

response, is about right. Or would you change it or modify it in

some way while we are waiting for the over-priced houses to start

working their way through?

Mr. DECKER. Well, I think that we——

The CHAIRMAN. Do we help people more or not?

Mr. DECKER. I think that, like you said, you run the risk, if you

start thinking in terms of bail-out type policy, you run the risk of

a moral hazard. I do not think, from a capital markets perspective,

anyone is looking for or expecting that kind of response from the

public sector.

The CHAIRMAN. What do you say to those people who are losing

their homes?

Mr. DECKER. Well, I think that, between the public sector response so far and the securitization of the mortgage industry, some

of the steps that have been taken—our affiliate organization, the

22

American Securitization Forum, has taken very aggressive steps to

create a standardized framework for mortgage servicers to be able

to sort through the very large volume of loans that are going to be

reset in the next 2 years and find ways to process those as quickly

as possible; refinance the ones that are possible to refinance, modify the ones that are are possible to modify, to keep as many families in their homes as possible.

Senator STABENOW. Mr. Chairman, might I just insert, you had

mentioned Fannie Mae and Freddie Mac. And I could not agree

more with the idea, as quasi-governmental entities that were set

up just to address these kinds of issues, to be there, to be able to

support the housing market, that they could do more. But they are

saying they would do more if we allowed them to do that, to be able

to raise their limit so they could place more capital into the marketplace.

I would be interested in your reaction to having them be able to

participate more. It seems to make a whole lot of sense to me that

we would look to them. They are willing to do it. They have a track

record, and obviously the expertise to be able to more aggressively

help.

Mr. DECKER. Raising the conforming loan limit is one of the

issues that has been on the table with respect to Fannie Mae and

Freddie Mac, and I think that there are certainly some positives

associated with doing that. I think that the conforming mortgage

market, the Fannie, Freddie, and Ginnie Mae eligible part of the

market, like I said, has remained robust and has remained liquid

through the crisis.

The other side of the argument is that the mortgage agencies

have a competitive advantage relative to private participants in the

market and that expanding their scope creates a disadvantage for

private market participants. So I think you have to weigh those

kinds of concerns.

Senator STABENOW. Thank you.

The CHAIRMAN. Thank you all very much. Thank you for taking

the time to come here.

This will conclude the hearing portion of this session. As for the

nominations markup, we have been unable to achieve a quorum of

11 Senators, so the committee will stand in recess until the next

vote on the floor of the Senate. We will reconvene off the floor to

vote on those nominees. So, in the meantime, thank you again to

all witnesses for coming today. I thank the Senators again today.

We are also going to move either the Stabenow bill or something

similar to it and try to get that moved very quickly, perhaps today

or tomorrow, because people need some help, and we are going to

try to do what we can do to accomplish that result.

The committee is in recess until the next vote.

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

(23)

A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

(57)

COMMUNICATION

58

59

60

61

62

63

64

Æ