Segment 2 Of 2 Previous Hearing Segment(1)
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H.R. 3703—HOUSING FINANCE REGULATORY IMPROVEMENT ACT—PART 1
TUESDAY, MAY 16, 2000
U.S. House of Representatives,
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises,
Committee on Banking and Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 9:30 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.
Present: Chairman Baker; Representatives Leach, ex officio, Manzullo, Ryan, Sweeney, Biggert, Terry, Toomey, Roukema, Royce, Paul, Cook, Riley, Kanjorski, LaFalce, ex officio, Bentsen, Sandlin, Waters, C. Maloney of New York, J. Maloney of Connecticut, Hooley, Mascara, and Jones.
Also Present: Representatives Watt and Clyburn.
Chairman BAKER. The hearing will come to order. I want to facilitate the progress of the hearing this morning. I do not want to unnecessarily keep our witnesses here all day, as I know there are many questions.
Despite what my staff told me, I always knew that a good, robust discussion of systemic risk would be a crowd-pleaser, and I am glad to see so many of you here. I would like to outline the process. I consulted with Mr. LaFalce about limiting opening statements to three minutes. We will adhere strictly to the five-minute rule. And on our side, I will recognize Members by the order of arrival to the subcommittee.
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I would look to Mr. Kanjorski, who I understand is on his way momentarily, to give the order of recognition on his side. And it is without any objection; that will be our process for the hearing this morning.
And the opening statement time is three minutes, so you can start the clock on me if you like.
This is a very important hearing. It literally is a battle over huge fortunes. And I do not mean FM Watch v. GSE Shareholders. I speak to the potential liability of taxpayers if everything is not run perfectly. The potential for systemic risk is enormous.
Circumstances today appear great for the GSEs. They are well managed, extremely profitable, all is well. But it is my responsibility, and I do believe that of Congress, to ensure that adverse business conditions do not bring on circumstances that could result in economic loss.
In 1992, when Congress created OFHEO, the agencies were large and complex. Today, they are very large and very complex, yet OFHEO is still pursuing implementation of the stress test to gauge agency capital adequacy. Should we wait another decade to initiate sound regulatory oversight? What are we to say to our grandchildren and those who follow when GSE paper has replaced Treasuries as the benchmark for financial transactions, when every bank and pension fund has enormous investment in securities, and housing demand goes down while interest rates go up?
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No Government Sponsored Enterprise should be above examination. To have suggested that holding a hearing was to result in 206,000 families being denied home ownership is about as reckless as it gets in my opinion. I wonder how many hundreds of thousands Chairman Greenspan will impact with his expected announcement this afternoon? And should we expect the same criticism to be leveled at the Federal Reserve? I don't think so.
This is an important process, and I emphasize ''process.'' There will be more hearings. Everyone that wants to be heard will be heard, and we will be in no rush to judgment. Many responsible voices have already supported this legislative effort. I want to express my appreciation to the Home Loan Bank system for their constructive approach and willingness to support legislation with appropriate modifications. I want to also express appreciation to the management of Freddie Mac, who have engaged in discussions over the past weeks and have given concrete suggestions that could lead to consideration of legislation.
I also want to express my appreciation to HUD and the Treasury, both of whom found elements of the bill worthy of support, but again, with modification. These opinions were issued also under very harsh criticism.
This is a process, a process that will result in legislation, legislation that will ensure stability over the long haul for the secondary market. But most importantly, the legislation should do all that is possible to minimize potential of systemic risk. At all costs, I do not want a Fannie benchmark or a Freddie security to go the route of an LTCM investment. It is a far more important issue than shareholder return. If one of these big guys stumbles, they will crush us all.
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Chairman BAKER. Mr. LaFalce.
Mr. LAFALCE. I thank you, Mr. Chairman. I am only an ex-officio Member of the subcommittee, and I appreciate the opportunity to make a few remarks at the opening of the hearing.
Two out of three Americans own their home today. That is a record home ownership rate. And this tremendous success story is in no small measure a result of governmental initiative in fostering strong mortgage markets through the creation and maturity of FHA, Fannie Mae and Freddie Mac, and the Federal Home Loan Bank system.
As we discuss legislation that proposes to fundamentally reform our Federal regulation of GSEs, specifically Fannie Mae, Freddie Mac, and the Home Loan Bank system, I believe it is critical that we do not either intentionally or inadvertently harm our very successful mortgage markets which are the envy of the world. We are barely into the new regulatory regime we put in place in the 1992 GSE Act, and the GSEs have been both successful and effective.
Clearly, nowhere near a consensus exists with respect to the issues raised by H.R. 3703. I think it would be inappropriate and unwarranted for Congress to take any action this year. I think that the hearings are important, but they should not be followed by a rush to judgment and any quick markup.
At the same time, I believe it is always appropriate for our subcommittee to discuss the vitally important issues attendant to GSEs. In spite of the most explicit Federal warning, the GSE debt is not backed by the full faith and credit of the Federal Government. We have an obligation to continuously assess any potential risk that these institutions take, balancing any proposals to reduce risk with any potential negative impact on consumers.
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Fannie Mae and Freddie Mac are a demonstrable source of affordable fixed-rate mortgage loans in the conventional market. The Federal Home Loan Bank system provides liquidity and reduces interest rate risks to enable our financial institutions to make affordable fixed-rate loans. Combined, they provide reassurance that mortgage credit will be readily available through good economic times and bad, through both strong and weak credit markets.
There are a number of issues for consideration as we ponder this in the future. First, what is the best regulatory structure? The bill before us would envision a fundamental alteration in our regulatory structure. Without prejudging this issue, I would simply say that our public policy objective should be to have the most professional regulatory staff, as free as possible from political inference and influence, including not being subject to the annual appropriations process and committed first and foremost to protecting the taxpayer.
The second issue relates to the controversy swirling around the so-called ''implied guarantee.'' Again, without getting into the pros and cons of this issue, there is an explicit statement in the law and in every offering made by the GSEs that there is no guarantee, and I believe our primary responsibility should be to ensure strong regulation so that the issue of the Federal Government ever having to step in is moot, remote indeed.
And finally, there is no escaping the fact that there is an emerging concern on the part of competitors over the scope and activities that GSEs, and Fannie and Freddie in particular, are engaging in. We need to balance the concerns of these competitors against the benefits to the consumers of GSE involvement.
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I will confess a prejudgment on this. I am sympathetic to Fannie Mae and Freddie Mac involvement, for example, in the subprime market, provided their risks are quantifiable and done in a safe and sound manner and there are proper capital reserves.
As predatory lending abuses proliferate, and as some of us in Congress have initiated legislation to curb these abuses, I believe there is great potential for Fannie Mae and Freddie Mac to provide affordable mortgage credit to families and individuals with blemishes on their credit record. It is arguably better to have these lenders, who promise to adhere to non-abusive lending guidelines, making loans to consumers than to have more questionable lenders do so.
So I look forward to today's and other hearings on the GSEs, but I urge our subcommittee to tread most cautiously before reaching any conclusions or before even considering legislative action.
I thank the Chair very much.
Chairman BAKER. Thank you, Mr. LaFalce.
I would restate the rule for the purpose of the hearing today, since Members have arrived after we started. There was agreement to limit opening statements to three minutes. We will abide by the five-minute rule, and Members will be recognized on both sides by the order of arrival at the hearing.
Mr. Kanjorski has agreed to that for recognition on his side as well.
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I would like to recognize at this time cosponsor of the legislation, H.R. 3703, and Chairman of the full committee, Jim Leach.
Mr. Chairman.
Mr. LEACH. Thank you, Mr. Chairman. I appreciate your leadership on this issue.
Let me just stress that from a congressional perspective, it is clear that caution has to be the watchword. But there can never be intransigence if it is the status quo that is precipitating radical change in the marketplace. I think we are all going to have to be cognizant of the fact that GSEs were set up to serve and complement the market and not become the marketplace itself; and for that reason, I personally think Congress is going to have to be very vigilant to assure that Fannie and Freddie stick exclusively to the home mortgage market, that the Farm Credit system and Farmer Mac stick exclusively to agriculture, and that the Federal Home Loan Banks make advances to member institutions, rather than loans or equivalents in their own right.
I have three very precise concerns this morning. One relates, again, to the arbitrage activities of all of our GSEs, and particularly Freddie Mac and Farmer Mac, as well as the totality of the Federal Home Loan Bank system. And the argument for liquidity is not a very powerful argument in the case of the volume that is currently taking place in arbitrage activities in these institutions, which I believe is an abuse of public powers.
Second, I am very concerned about the Federal Home Loan Bank system and the movement to reduce capital. Now is a time to be concerned for adequacy of capital, not to reduce it to 3 percent. The fact that Fannie Mae and Freddie Mac have weaker capital standards than commercial banks is no excuse for the Federal Home Loan Bank system to weaken its capital; and in some regards the movement is to a weaker standard than Fannie and Freddie, which I think is very, very dangerous at this time.
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And, finally, I would stress within the Federal Home Loan Bank system that the new draft rules on stock tradability lack any restraint on concentration. And what is prospective with these new draft rules is the prospect or the possibility that a single entity could come to control a Federal Home Loan Bank, which I think would be highly undesirable. This could take a cooperative system and make it the captive of a single institution, whether it be a bank, an S&L, or a division of an investment bank or an insurance company. Even though it is not contemplated by statute, I guess conceivably Fannie or Freddie could buy a Federal Home Loan Bank; and I would stress the frightfulness of that prospect, because Federal Home Loan Banks don't pay Federal tax, Fannie and Freddie do not pay State taxes, both of which are presumptive and powerful circumstances. And if you could balance the two, it would be a real tax umbrage, let alone power play, in the marketplace.
So with regard to stock tradability, in the strongest possible way I would call upon the system to think very carefully about putting limits on what entities can control, or if any entity can control more than a very modest percentage of stock.
I thank you very much, Mr. Chairman.
Chairman BAKER. Thank you, Mr. Chairman.
Mr. Kanjorski.
Mr. KANJORSKI. Thank you very much. Thank you for the opportunity to speak briefly before we begin the second hearing on H.R. 3703, the Housing Finance Regulatory Improvement Act.
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In our last meeting in March on this legislation, we heard from the present regulators for the housing Goverment Sponsored Enterprises, or GSEs, as well as the U.S. Department of the Treasury. During my opening remarks at this hearing, I noted that we should move forward cautiously in considering this bill. This will ensure that we maintain the delicate balance that has led to 67 percent of U.S. families owning their homes.
Another issue that I raised in my March statement was consideration of the effect on the marketplace of these hearings. As noted in the Wall Street Journal and other news sources, our capital markets experienced disruptions in which the cost of funds for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks increased in the days following our initial hearing. According to these accounts, the spread, or the difference in yields between GSE debt and ten-year Treasuries, increased by as much as 14 basis points. Spreads on mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac also grew wider.
As we proceed today, we must renew our efforts to ensure that we do not accidentally raise home ownership costs.
Mr. Chairman, as I indicated in my letter of March 31 to you, we should not move precipitously on this complex and important set of policy issues by attempting to legislate in the 106th Congress. We should instead continue to use H.R. 3703 as a focus for our oversight activities.
In the weeks following our last hearing I have also had the opportunity to meet with many of the parties affected by this legislation, including those who support, those who oppose, and those who remain neutral on the bill. During these discussions, I have heard many reasons for and against moving ahead. Many of the arguments for and against the bill appear credible when made on their own merits or without someone testing their basis. In my opening remarks at our last hearing, I suggested that we should convene a roundtable discussion with the interested parties. This will allow us to better understand the need for and the implications of this legislation on our housing finance system.
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I still believe that a roundtable discussion is the most appropriate forum for our consideration of this issue. A roundtable discussion would force the participants to challenge each other's assumptions and assertions in an open environment. It would also provide us with greater insights than would testimony that has been vetted and sterilized through the clearance process.
A roundtable debate would further allow us more fully to educate Members about the substantive issues involved in this debate. In addition, it would address the real effects this legislation would have on the housing and finance marketplace.
In closing, I hope that as we continue to consider these important issues, you will join me in working to lower home ownership costs. I also hope that for our next hearing you will invite all interested parties to participate in a roundtable debate. That way, we can have a free, fair, and vigorous deliberation on the future role of GSEs in our housing finance system.
Chairman BAKER. Thank you, Mr. Kanjorski.
Does any other Member desire—Mr. Ryan.
Excuse me; I am going to break my own rule. It ought to be Mr. Riley first and then you.
Mr. Riley.
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Mr. RILEY. Mr. Chairman, in the interest of time, and I think we have got a lot of people who would like to ask questions today. I will save my comments for later. Thank you.
Chairman BAKER. Thank you, Mr. Riley.
Mrs. Maloney.
Mrs. MALONEY. Thank you, Mr. Chairman, for calling this subcommittee to meet to review issues relating to the U.S. mortgage finance system, the most successful of its kind in the world.
At our last hearing in March, FHFB Chairman Bruce Morrison made the important point that other countries have had great difficulty in attempting to duplicate the success of a United States mortgage finance system. Outside the U.S., fixed-rate, long-term mortgages are a rarity. In the United Kingdom down payments of 20 percent are required and interest rates vary as lenders' borrowing costs change. Lenders in France routinely require 30 to 40 percent down on fixed-rate loans. Japanese loans are made at subsidized rates with down payment requirements of 40 percent.
I believe the goal of this subcommittee should be to make further improvements in the U.S. mortgage market and build on the success of the housing GSEs. I would like to see Fannie and Freddie have the authority to buy child care loans. This is an area where there is a market failure similar to that that Fannie and Freddie solved in housing.
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We really must tread carefully to avoid any unintended consequences. Unfortunately, it would appear that certain comments from the subcommittee's March hearing had the effect of increasing spreads between Treasuries and GSE debts. It is vitally important that markets be reassured that we are moving slowly and thoughtfully.
This is not to say that the home mortgage market could not be improved. Certainly efforts to combat predatory lending are worthy topics for the subcommittee. We should also be working to increase minority home ownership rates.
At an appearance last week at the National Press Club, one of our witnesses, Fannie Mae Chairman Franklin Raines, acknowledged that red-lining sometimes still occurs, saying that it is a result of too few lenders competing for business in minority communities. When the chairman of Fannie Mae, whose company benefits from buying loans, says there are too few competitors in a potential market, I believe the Banking Committee should investigate the reason for this market disconnect.
Mr. Chairman, our mortgage market is far from perfect, but we must be very careful not to make changes where it works very well unless we can be certain that there is a real problem with a workable solution that does not generate negative unintended consequences. Thank you very much.
Chairman BAKER. Thank you.
Mr. Ryan.
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Mr. RYAN. Mr. Chairman, I first would like to say how much I appreciate your holding this series of hearings. Addressing the tough questions raised by Government Sponsored Enterprises has not been an easy task, and you have done this Congress a great service, I believe, by treading where very few have been willing to go.
In my view, these issues we are discussing today are probably the most important issues we in the Banking Committee will be addressing the remainder of this Congress and most likely in future Congresses. We find ourselves at a turning point in the financial markets. The volume of U.S. Treasury debt in capital markets is falling, and the volume of debt issued by Fannie Mae and the Freddie Mac and the Federal Home Loan Bank has increased to the point where Treasury Under Secretary Gensler stated to this subcommittee that: ''GSE involvement in the credit market is approaching the size of the Treasury market.'' The Treasury now testifies that GSE debt may surpass publicly-held marketable Treasury debt in the next three years.
When Congress created these GSEs decades ago, I doubt that anyone thought that they would reach the point of matching the U.S. Treasury debt in the markets. It is now the responsibility of Congress in 2000 to determine what this means for our country and the future obligation of taxpayers.
In our view, the GSE issue is a very complex one. Fannie Mae, Freddie Mac and the Federal Home Loan Banks have played a vital role in creating the housing market from which all of our constituents have clearly benefited. All of us support a vibrant housing finance system for working families. In fact, I think it is very important at the outset to say that just because some questions have been raised as to some aspect of GSE operations, it does not mean that they are against home ownership or want to raise its cost. Likewise, we should not assume that anyone wants or plans a taxpayer bailout of a GSE. Let us all assume that everybody in this debate is acting in good faith and with the best interest of home buyers and taxpayers equally at heart.
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The reason I think these hearings are so important is that the issues involved do not lend themselves to simple or easy answers. In Fannie Mae and Freddie Mac, we have giant, shareholder-owned companies that are now, the two of them alone, bigger than the entire thrift industry. The Federal Home Loan Banks are cooperatives, but their members are private companies too. As these agencies issue more and more debt, we need to be asking serious questions about the benefits they receive, the benefits they pass on to home buyers, and the risks they pose to taxpayers.
I do not know yet what Congress should do, if anything, but the one thing I do know is that this is an important issue with serious implications for home buyers and taxpayers alike. I think the Chairman's bill has properly put this issue on the agenda, and I look forward to a careful and comprehensive review of GSEs today and into the future.
Thank you, Mr. Chairman.
Chairman BAKER. Thank you very much, Mr. Ryan.
Mr. Watt, did you choose to make a statement?
Mr. WATT. No. I thank you, Mr. Chairman. I am not a Member of the subcommittee. I just came to listen. So I do not have any comments.
Chairman BAKER. Thank you very much, sir.
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Any other Member desire—Mrs. Jones.
Mrs. JONES. Thank you, Mr. Chairman. Good morning, Chairman Baker, Ranking Member Kanjorski and Members of the subcommittee. I ask unanimous consent that this full statement be included in the record.
I would like to associate myself with the comments of my colleagues, Mr. LaFalce and Mr. Kanjorski. We are here this morning to discuss H.R. 3703. The sponsors of this bill suggest that it is designed to improve regulation and supervision of the housing GSEs. It is my hope this morning that we will be able to discuss the issues surrounding this legislation and the challenges that it presents, not singularly to GSEs, but to the ability of future home buyers to secure homes and for others to obtain affordable housing.
Housing, we know, is a key public policy concern. It was a concern in 1968 when GSEs were formed and it is a concern even today. In cities and suburbs nationwide, there is still an affordable housing crisis. There are citizens, including the ones in the 11th Congressional District of Ohio, which I represent, that are struggling with skyrocketing rents as well as inadequate housing stock. GSEs were established to address this problem.
And it is not as if Congress has not done anything since 1968 to regulate them. In 1992, we passed the Federal Housing Enterprises Financial Safety and Soundness Act that mandated Fannie Mae and Freddie Mac, I quote: ''to lead the mortgage finance industry in making credit available for low- and moderate-income families.'' From my understanding, they are fulfilling this mission; thus, I am glad that we have representatives from these three GSEs to be able to make their own case.
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I applaud the Members of this subcommittee for providing an opportunity for a balanced view of the issues surrounding this legislation.
Let me be clear. I need to correct the National Journal statement relative to my legislative position. I support affordable housing and increased home ownership, be it Fannie Mae, Freddie Mac, mortgage lenders, and so forth, and I want home ownership for all Americans.
I questioned at the hearing the last time we were here one agency's questioning another with regard to the effect they have on home ownership in America. I am proud to be an African-American, but every time I open my mouth, I do not just speak for African-Americans. I represent a congressional district that is very diverse, and everyone needs housing.
I realize that putting a family into a home is much more than originating a mortgage, automated underwriting systems, or implicit or explicit relationships. Putting a family into a home provides a family with, in many instances, its first real asset or even provides a legacy for future generations. Home ownership, I believe, is one of the first key steps to true empowerment. Thus, we cannot take this process lightly or this legislation lightly.
As our Nation transforms itself from industrial base to an information technological power, we, as Members of the subcommittee, have championed public-private partnerships as well as market innovation; and I sense we have taken a different approach with respect to GSEs.
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I have a lot more that I would like to say. I will leave the rest for my questioning. Thank you.
Chairman BAKER. Mr. Sweeney.
Mr. SWEENEY. I will also seek to have my full statement entered into the record.
Let me just say this. I was not here for part of the past deliberations in 1992, when the charter revisions were last made; and I recognize, as I did at the last hearing in March, our need for oversight in this area, and I will reiterate that I am hesitant to conclude that congressional action or reforms are needed at this point in time.
But I want to thank the panelists for being here. I thank those on the panel who have worked with us since last March to begin to develop some constructive ideas, and I think we are developing some constructive ideas, and I look forward to your testimony. Thank you.
Chairman BAKER. Thank you very much, Mr. Sweeney.
Chairman BAKER. Ms. Waters.
Ms. WATERS. Thank you very much, Mr. Chairman and Members.
Well, I suppose it is usually in order to congratulate the Chair for holding a hearing. I cannot do that this morning. As a matter of fact, I am a little bit agitated about the fact that we are here.
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While I recognize that there are many, many problems that confront us that we must deal with as public policymakers, I do not take kindly to being basically used in a market share war, where all of us make pronouncements day in and day out about laissez-faire capitalism and allowing the marketplace to work. I am beginning to believe that most us do not really believe that, particularly as we pursue these hearings.
Let me just share with you what my agitation is about. A recent Wall Street Journal headline read, and I quote: ''Rates on Mortgages Behaving Strangely, Fail to Come Down.'' And the story is quite simple. Wall Street experts say that based on historical market conditions, interest rates in the past weeks, and I quote: ''should be significantly below 8 percent,'' but according to the Wall Street Journal: ''Again, the threat of legislation or some other governmental action in turn, has helped keep prices of mortgage-backed securities lower and yields higher.''
So I suppose what we have is one of the most respected financial publications in America confirming that the mere threat of this bill that is the subject of this hearing is keeping interest rates higher than they should be. In other words, the bill, Mr. Chairman, that you proposed, is already raising costs for American homeowners and keeping potential homeowners out of business.
Chairman BAKER. Would the gentlewoman yield briefly on that point? I will give you an extra 30 seconds, so I am not chewing up your time.
I think if we were to read the whole article, in its entirety, the reason cited for the inability of rates to drop was the repurchase of debt by the Treasury Department, not the committee hearing process. And I think that that document stated that.
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I thank the gentlewoman for yielding.
Ms. WATERS. Certainly, Mr. Chairman, but let me say that I have talked now with any number of people who are worried that precisely what was described in the Wall Street Journal article is true.
Now, let me just continue. Fannie Mae and Freddie Mac are two of the strongest companies in the country. Fannie Mae ranks 26th and Freddie Mac 62nd on the Fortune 500 list of top American companies. Currently, Fannie Mae holds more than $19 billion in capital. In its 1999 report to Congress, the Office of Federal Housing Enterprise Oversight, the congressionally appointed safety and soundness regulator for Fannie Mae and Freddie Mac, found both Enterprises to be financially sound and well managed. OFHEO also stated that Fannie Mae exceeds safety and soundness standards in every category.
In 1997, at the request of OFHEO, the rating agency Standard & Poor's evaluated Fannie Mae and assigned them an AA rating in terms of their risk to the Government, a rating only a handful of institutions meet. Additionally, in July 1999, Fortune Magazine named Fannie Mae the second-best company for employment in the country for Asian Americans, African Americans and Hispanic Americans.
Fannie Mae and Freddie Mac are Government Sponsored Enterprises, as we know. They are congressionally chartered, but shareholder-owned corporations. They enjoy federally granted benefits in support of their important public purpose which is to increase nationwide access to residential mortgages by developing and supporting a secondary mortgage market for housing finance. Fannie and Freddie pass their federally granted value on to mortgage borrowers in the form of lower interest rates.
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According to a June article in Money Magazine——
Chairman BAKER. I hate to ask you, but can you begin to wrap up?
Ms. WATERS. Unanimous consent for 60 seconds.
Chairman BAKER. Without objection, certainly.
Ms. WATERS. According to a June article in Money Magazine, American soaring home ownership rates and the reduction in down payment requirements are evidence of Fannie's and Freddie's benefits to American consumers. Similarly, in a 1996 Congressional Research Service report, stated that comparison of mortgage rates in conforming and non-conforming markets have led analysts to conclude that the presence of the GSEs has lowered mortgage rates between 25 and 50 basis points. Lower mortgage rates result in thousands of dollars saved for American consumers.
I cannot complete my statement, I don't have enough time, but I guess the question I am raising is, what is broken and what are we trying to fix? Why have we taken the argument of FM Watch, a group of subprime lenders who simply do not want to compete with Fannie and Freddie, and simply are concerned that they are going to bring new products for our consumers that will lower the cost of mortgages?
I do not like being in the middle of this fight. I do not think it is fair, Mr. Chairman; and I just must put that on the record.
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Chairman BAKER. Thank you, Ms. Waters.
Mrs. Roukema.
Mrs. ROUKEMA. Thank you, Mr. Chairman. I do want to commend you. Despite what the previous speaker, our colleague, said, I do want to commend you for this hearing. This is the second hearing, I believe, on this very important issue. I believe that it is important to all of us, and certainly all the homeowners that are out there. After all, what we are discussing is the ''American Dream,'' and we are not going to abandon that.
But I would like to make the point, Mr. Chairman, that we are not going to take precipitous action on your bill. I think you have confirmed to Members of the committee that you will move very slowly. It is a highly complex subject. I, for one, as well as others who have already spoken on this, have said that we have to examine it thoroughly and understand all the consequences; and it is absolutely essential that we understand the complexity of this and not take precipitous action.
So I am very pleased to hear what you said in your opening statement, Mr. Chairman. However, there are other issues that have already been outlined, but that I did not hear; and I want to stress—even if it has already been said, I do want to stress to the GSEs who are here today about the question of mission creep. As a general rule, they are not supposed to be competing with the private sector, except where explicitly authorized by Congress. I know there are real concerns about Freddie and Fannie expanding their lines of business. Just to state a couple of instances, some are suggesting that they are getting into real estate brokerage, consumer lending, mortgage insurance, and other areas which arguably are not part of their mission. I hope we could address those questions today, because they are central to the debate and review we are doing here.
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At the same time, I want to acknowledge that there is a potential liability to taxpayers if their actions are not well managed on the other side of the question.
So I am very pleased to be here today and to carry on as part of our obligation here in subcommittee to fully explore the pros and cons of this essential issue about how we assist homeowners in a safe and sound manner through the proper capital standards.
Thank you, Mr. Chairman.
Chairman BAKER. Thank you, very much Mrs. Roukema for your participation and your leadership on this and other issues.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman.
First of all, Mr. Chairman, even though you and I do not always agree, or we agree on some things and not others in the same legislation, I want to commend you for holding these hearings. I think—while I have some problems with your legislation—I think you have been thoughtful in the process. I would encourage my colleagues not to make up your minds quickly on this legislation. I think we need to look at the facts.
First of all, we also have to remember that Fannie Mae and Freddie Mac and the Federal Home Loan Bank system are not something that came about on their own. This is something that Congress created over time. We established the laws, we have had charter reviews, and now there are some who are saying what we have done may have been a mistake, or we have allowed the monster to grow too big. So let's be cautious in our approach.
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Second of all, I would say that I thought the previous hearing, and particularly the comments from the Under Secretary Gensler, were really quite stunning. And I would concur with Ms. Waters that it did create a market reaction, because regardless of how much disclosure Fannie or Freddie put on their documents with respect to Government guarantee, I strongly believe—and I had the opportunity to work both with and against Fannie Mae in the mortgage markets before coming to Congress—but, I strongly believe that the capital markets believe that there is some implicit guarantee on the part of the Federal Government.
Now, I know that both these gentlemen will tell us today that there is none, that they are adamant about it, and they are being correct in their statements, but the market believes otherwise. And as such, I think we should consider that going forward.
We cannot, on the one hand, or we should not on the one hand be taking something away that affects the value of these companies which have done a pretty good job, quite frankly, for the mortgage market, and at the same time be reigning them in. We will have to make a choice. If we choose to do anything at all, we will have to make a choice of either going one direction or the other, but you can't go both ways. And, unfortunately, I think the way the bill is currently drafted, it goes both ways.
And with that, I do commend the Chairman, my colleague from Louisiana, and I appreciate him holding these hearings.
Chairman BAKER. Thank you very much, Mr. Bentsen. I appreciate your remarks.
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Mr. Toomey, do you choose to make a statement?
Mr. TOOMEY. Thank you, Mr. Chairman.
Very briefly, I would just make the observation. I don't believe there is any question the market believes there is an implicit guarantee of the debt of the Government Sponsored Enterprises. And as such, I am reluctant to conclude that the market is completely wrong when it is virtually unanimous in its conclusion. I would believe that a guarantee has inherent value, and if there is inherent value in such a guarantee, then it seems to me that the value should be compensated; and the form of the compensation presumably is the value of improving access to home mortgages. But there is a cost to that, and the cost is this cost of the implied guarantee, and I think it is important to evaluate whether there is a proper return for that cost.
And so it is very useful to have this hearing today, I think, and I thank the Chairman for pursuing this so that we have an opportunity to discuss the various activities, how those activities relate to the profitability of the firms, but also how they relate to the mission of the Enterprises. Because it goes to the question of whether or not the cost borne by the taxpayer is properly being compensated.
So I want to thank the Chairman for conducting these hearings, and I look forward to the testimony of the witnesses. Thank you.
Chairman BAKER. Thank you Mr. Toomey.
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Does any other Member desire to make an opening statement? Let me get my list here. Mr. Terry is next by time of arrival, then Mrs. Biggert, and then Mr. Cook.
Mr. Terry.
OK, Mrs. Biggert.
Mrs. BIGGERT. Thank you, Mr. Chairman. I first want to commend you for holding another hearing on this very important issue.
The Government Sponsored Enterprises have helped make the American dream of owning a home a reality for hundreds of thousands of families throughout the country. For example, the Home Loan Bank of Chicago has invested over $32 million in housing loans in my district, while Fannie Mae has provided mortgages for some 60,000 families in the Illinois 13th Congressional District alone.
Despite this good work, I do have some concerns about the GSEs' large debt obligation, and wonder whether legislation may be necessary to protect taxpayers from another bailout crisis, should an economic downturn occur. On the other hand, I am not sure that the regulatory process contemplated in H.R. 3703 would allow the innovation that the GSEs will need to be able to adapt easily to the changing mortgage market of the future.
So, therefore, Mr. Chairman, I look forward to the testimony of the panelists and anticipate a very spirited and educational question-and-answer period. Thank you.
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Chairman BAKER. Does any Member on the Democratic side choose to make an opening statement?
If not, Dr. Paul you are next and then you, Mr. Cook.
Dr. PAUL. Thank you, Mr. Chairman. I want to thank you for holding these hearings.
These are certainly very important. This problem has been around for a good while. There are some in the financial media that have been talking about this for a long time, talking about a ticking time bomb. There are some others who think it might be a little too late to do much about it. But the implicit guarantee is obviously something that needs to be discussed and dealt with.
I am interested, though, in a little bit more than just the apparent debt that the GSEs have accumulated, but the relationship of this accumulation of debt through monetary policy.
For the GSEs to go out and borrow these huge sums of money, into the trillions, it could not be done without pushing up interest rates, without a generous Federal Reserve policy of keeping interest rates low, because when you subsidize something, you get more of it.
And, of course, it has been beneficial to the housing industry; we have had good times in housing. But it is also the substance of which bubbles are made. So there should be a concern about this. This huge obligation that we have will be met. I think it will be very difficult for us to walk away from it. I think it is implicit that something will be done if trouble hits, and that is bothersome to me.
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But it is also bothersome to me in the monetary policy sense that since last fall our Federal Reserve has decided not only to make credit generously available for the GSEs to borrow, they are literally monetizing this. They are buying up GSE papers and holding them as an asset which they can use as a collateral against Federal Reserve notes. And not only that, there has been an increase in foreign central banks' holding of this GSE paper as well.
So, first, we create a lot of credit to make these loans available, and then we literally turn around and buy them back at the Federal Reserve level, which has monetized them. So this is a huge bubble that we have built. And at the same time, we allow our banks to borrow these without any reserves set aside, which enhances their ability to increase their credit within the fractional reserve banking system.
That is the area that I have concern about, and I hope to address that in the question-and-answer session.
Thank you.
Chairman BAKER. Thank you, Dr. Paul.
Any Member on the Democrat side?
If not, Mr. Cook.
Mr. COOK. Thank you, Mr. Chairman. I would just like to make note that America's home ownership rate is at an all-time high of 68 percent. While the hard-working American public deserves the lion's share of credit for this, I would like to express my appreciation to the witnesses scheduled to appear today for the supporting role they have played in making all of this possible. The institutions they represent certainly have all played critical roles in the home ownership process and have all helped to make America's housing finance system the envy of the world.
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Mr. Chairman, I have no problem discussing the regulatory issues affecting Government Sponsored Enterprises. The manner in which GSEs are regulated is clearly within the purview and jurisdiction of this subcommittee. And I want to express my hope that we can carefully analyze the impacts that this legislation will have on the entire housing finance industry and the capital markets.
But I am very troubled and not sure of the intent of having GSEs publish the details of each new mortgage product they seek to produce in the Federal Register for public comment. I am not sure how hampering their ability to innovate would make a difference for homeowners.
Fannie Mae has opened a Utah partnership office in my district for the purpose of offering flexible and innovative mortgage products which lenders can offer on a neighborhood-to-neighborhood-basis. I think clearing those new products through the layers of HUD bureaucracy in Washington is concerning to me.
We are well aware of how inefficient HUD can be at times, and with this in mind, it should give us cause for concern. With a healthy economy, high mortgage loan demand, and the current good management of the housing GSEs that are in sound operating condition, now is a good time to examine these entities and their position in our current financial system; and I commend you, Mr. Chairman, for holding this hearing to discuss the role of GSEs.
I will have a number of questions about the scope and intent of H.R. 3703, and I look forward to hearing the views of the witnesses on how consumers stand to benefit from this legislation.
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Chairman BAKER. Thank you, Mr. Cook. If no further Members desire to give an opening statement, I would proceed to our witnesses.
I would like to first call on the CEO of Fannie Mae, Mr. Franklin Raines, who of course was the former Director of OMB in the Clinton Administration, a very accomplished individual.
And let me assure you, Mr. Raines, that all my comments and discussions concerning future issues with regard to Fannie are in no way intended to reflect on your management or your competency in your role as the chief operating officer. In fact, my concerns are aimed some years down the road—when there is no longer a Franklin Raines; and I would bet some would say, ''I hope that is when Baker is not in Congress too''—that there might be problem on the horizon that neither one of us would choose to see, nor can we forecast.
But inevitably, business cycles are that. So it is with that perspective of containing systemic risk that I have made my remarks and proposed H.R. 3703; and I have appreciated your willingness to come by the office and talk about the issue. I look forward to working with you.
We would be pleased to hear your testimony.
STATEMENT OF FRANKLIN D. RAINES, CHAIRMAN AND CEO, FANNIE MAE
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Mr. RAINES. Thank you very much Mr. Chairman. Thank you for that kind introduction. And let me also thank the Members of the subcommittee for this opportunity to meet with you here today.
I have submitted extensive written testimony which I would ask be included in the record.
Chairman BAKER. Our witnesses' testimony is included in part of the official record, without objection.
Mr. RAINES. So I will just summarize that more lengthy testimony in my oral statement.
Before I begin, let me——
Chairman BAKER. I am sorry, Mr. Raines, I apologize. I meant to say, I said it long ago, but to the extent possible, can your testimony be under ten minutes, as a goal?
Mr. RAINES. Yes, I will try to make it as quick as possible. I will shoot for that as a goal.
Let me say that the housing finance system today is very strong. It is vibrant, it is safe and sound, and it serves consumers better than ever. And this is due in no small part to the careful scrutiny, sound judgment and constructive action that Congress has taken over many years.
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The outcome of Congress' long-standing commitment to home ownership is that millions of families have achieved the American dream. The benefits of the astounding growth of home ownership have rippled out to improve the wealth of average families, the health of communities and the strength of the U.S. economy. We all want to keep this success going, so it is entirely appropriate for Congress to have oversight hearings on the safety and soundness of the secondary mortgage market today, and Fannie Mae welcomes this oversight.
I am pleased to be here, Mr. Chairman, because there is a good story that deserves to be told. The U.S. housing finance system is the best in the world, the most efficient and effective ever devised. The American Dream of home ownership is more alive and achievable and inclusive than ever. The national home ownership rate has just set a new record of over 67 percent. The housing market is robust. The housing industry is strong, and for consumers, it has never been easier or more possible to buy a home.
Behind this success story is the secondary mortgage market. What this market does is to attract billions of dollars of private capital from all over the world to provide mortgage lenders with a steady flow of funds to lend to all communities, under all economic conditions, at the lowest rates in the market with zero risk to the Government. The secondary market ensures that a home buyer will never hear her lender say, ''I'm sorry, we are out of money to lend.''
Keeping the supply of mortgage funds up also keeps the cost of mortgage funds down, which means more families can afford to qualify for a home loan.
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The secondary market also makes consumer-friendly mortgages possible. In America, we take the long-term, fixed-rate mortgage for granted, with down payments as low as 5 and 3 percent. Last year, 66 percent of all conforming mortgages originated in the United States were thirty-year fixed-rate loans. Outside our country, this kind of mortgage is a rarity.
In Canada, they have the rollover mortgage where the rate is fixed during the first one to five years with a prepayment penalty equal to three months of interest. The fixed term in Spain is usually one year. In France, 80 percent of all mortgages have variable rates. In Germany, you can get a fixed rate for five to fifteen years, but you cannot refinance during this period without paying a huge penalty. And in Germany, the down payment is typically 30 to 40 percent. In Japan, you have to put down effectively 50 to 60 percent in order to buy a home.
There is a simple reason why the low down payment, long-term, fixed-rate mortgage is so common here and uncommon elsewhere. Most countries do not have a secondary market to buy or guarantee loans that lenders originate, so the lender requires the consumer to pay more up front and more each month if mortgage interest rates rise. Overseas, the U.S. secondary mortgage market is considered some kind of miracle.
Fannie Mae is proud of that, but we know where the credit belongs. It was Congress that created the secondary mortgage market. It was Congress that chartered Fannie Mae and later Freddie Mac as private shareholder-owned corporations, so Congress deserves the lion's share of the credit for the successes of the secondary market and the housing finance system today.
What Congress did turned out to be absolutely brilliant. It created a system that harnesses private enterprise and private capital to deliver the public benefit of home ownership. And it maximizes this public benefit while minimizing the public risk, and without spending a nickel of public funds.
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Then in 1992, Congress improved on its work. After the thrift and banking crises and reforms, Congress wanted to make sure that Fannie Mae and Freddie Mac were fulfilling their housing mission in a way that was financially safe and sound. After two years of hearings, several Government studies and much discussion, Congress passed a 140-page bill called the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. In effect, Congress strengthened both sides of our equation. The 1992 Act increased the public benefit we provide, and it decreased the possibility of public risk even more.
Let's look at increased public benefit. The 1992 Act gave Fannie Mae and Freddie Mac the toughest affordable housing goals in the financial services industry. Under our housing goals set by HUD, we have to meet specific percentage of business goals. For example, starting next year, we have to devote at least 50 percent of our business to families living at or below their area median income. That is up from 30 percent when the law took effect in 1993.
But Fannie Mae has always viewed our HUD goals within our own more dramatic goals. In 1994, Fannie Mae pledged to provide $1 trillion of financing to 10 million underserved families by the end of the year 2000. We met that goal last month, and immediately pledged to provide $2 trillion to 18 million families before this decade is over. We call this new pledge our ''American Dream Commitment.''
These efforts have transformed Fannie Mae. We exceed our HUD goals every year. We have increased our lending to low-income families by 28 percent, to African American families by 31 percent, and to minorities as a whole by 16 percent. Last year, we provided $46 billion in financing to over 400,000 minority families.
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Fannie Mae is now the Nation's largest affordable housing company. We lead or match the primary market in serving low-income or minority families even though we do not originate a single mortgage. We rely on lenders to originate the loans, so we help lenders reach these consumers and get them approved.
Reaching these new markets, if not done right, could be more risky. But Congress in 1992 gave us a new structure to reduce our risk. First, Congress gave us our own specialized safety and soundness regulator, the Office of Federal Housing Enterprise Oversight, known as OFHEO. OFHEO conducts regular on-site safety and soundness exams. They have an office in our building and a lot of regulators on the job. OFHEO has 26 examiners for two companies—a 13-to-1 ratio. In comparison, the FDIC has one-third of one examiner for each bank that it regulates. And our financial regulator is the only one that discloses the results of our exams to the public.
In our most recent exam, it reported and I quote: ''In all categories, Fannie Mae exceeds safety and soundness standards.'' These safety and soundness standards, also found in the 1992 Act, are the most rigorous in the financial services industry. Unlike the simple leverage standard that banks use, where they hold a ratio of capital to assets, Fannie Mae and Freddie Mac have a risk-based capital standard with a stress test. It requires us to hold enough capital to actually survive a worst-case scenario. Now, let me explain, because this test is unusual.
The stress test assumes that interest rates either rise or fall by up to 600 basis points and stay there for ten years. Then it takes the worst credit losses that the United States has suffered in the past twenty years in residential mortgages, which was a portion of the oil patch in the 1980's, and then this devastating scenario is applied nationwide and assumed to go on for ten years.
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But we are still not done. We then have to add 30 percent of capital for management risk. So we must hold 130 percent of the capital necessary to survive this ten-year test.
Now, how tough is this standard? According to one study, if the devastating stress-test scenario in our capital requirements ever came to pass, thrifts would deplete their capital base in five to seven years and become insolvent. By year ten, Fannie Mae and Freddie Mac might be the only major holders of mortgage assets in America still standing. Fannie Mae's charter confers certain benefits that help us meet our Federal requirements to be in all markets under all conditions. But also Federal bank charters confer certain benefits to banks such as access to the Fed window, and direct, not implied, Government backing through the Federal guarantee of deposits.
We can also measure how Fannie Mae passes its benefits to consumers every day. All you have to do is look in the Saturday Washington Post, in the real estate section, at the mortgage rate charts and compare the left column, the conventional conforming rate, with the right column, the jumbo rate. The left column is the mortgages that we back, which are always cheaper than the column on the right.
Right now, a Fannie Mae-backed mortgage is about $19,000 cheaper over the term than a jumbo loan that is $1 over our loan limit. And we also have a loan for borrowers with slightly impaired credit that is about $20,000 cheaper than the loan they might get in the subprime market. And what is even more surprising is that a Fannie Mae-backed mortgage is even about $21,000 cheaper than a Government-backed FHA or VA loan.
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During the 1990's, we estimate that we directly saved consumers at least $20 billion by lowering mortgage rates, and that is counting the market impact we have on jumbo and other loans bought by others by driving down conventional rates. The way Fannie Mae is regulated and the business that we are in makes our company uniquely safe and sound.
Chairman BAKER. Can you begin to wrap up, Mr. Raines?
Mr. RAINES. I will, Mr. Chairman.
Our asset, the mortgage, is one of the safest. We only invest in one type of asset, mortgages. We do not buy commercial real estate. We do not buy junk bonds. We do not buy Danish bonds. Just one homely asset. And we have one job and that is to manage risk. Last year, we paid out one-half of our gross revenue, $6.4 billion, to manage risk. And it is worth it.
During the thrift crisis, we kept our credit losses at 5 basis points, 5 cents for every hundred dollars, while banks paid out 86 cents for every hundred dollars. And right now our losses are as low as 1 basis point, one cent for every hundred dollars.
Over the last twenty years, there have been financial difficulties for fifteen industries, the mortgage insurance industry, the banking industry, the thrift industry. The savings and loan industry cost $125 billion. The banking industry cost their insurance fund $36 billion. Fannie Mae suffered losses in the 1980's, though it never became insolvent. It righted itself without costing the Government one penny.
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Mr. Chairman, let me summarize by saying just a couple of words about the subcommittee's actions with regards to the proposed legislation. The question before the subcommittee is whether the 1992 Act should be modified. And we welcome this question. As I said, congressional oversight has helped to create the strong system we have today. But as for the legislation that has been proposed, we have submitted in our written statement a section-by-section analysis, and we would be delighted to answer any questions about that analysis. In our view, however, there is no part of the bill, as proposed, that improves the system or improves upon what Congress achieved in the 1992 Act.
Let me emphasize that our concern is not with congressional oversight, the hearings of this subcommittee or proposals to improve the housing finance system. Our concern is with any actual change in the law that would weaken our charter or impose regulatory burdens that would raise our costs of providing capital to the housing finance system.
Thank you, Mr. Chairman and Members of the subcommittee. I look forward to discussing these issues with all of you.
Chairman BAKER. Thank you, Mr. Raines.
The next witness is the Chairman and Chief Executive Officer of Freddie Mac, Mr. Leland Brendsel.
And let me say for the record, Mr. Brendsel, over the past weeks I have been working with some of your senior management folks, getting concrete suggestions for modifications that possibly could lead us to legislation that the organization may not strenuously object to, and I just—whether the outcome of that is productive or not, I simply want to say thank you for those efforts.
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And we welcome your remarks.
STATEMENT OF LELAND C. BRENDSEL, CHAIRMAN AND CEO, FREDDIE MAC
Mr. BRENDSEL. Thank you, Mr. Chairman. And good morning, Congressman Kanjorski, Members of the subcommittee. Thank you for inviting me to be here today. I welcome the opportunity to talk to you about Freddie Mac and the tremendous benefits and the work that we have done and we are doing for America's families, home buyers and renters.
Congress created Freddie Mac in 1970 with a special purpose and a vital role. And I think that the dramatic improvements for home buyers since then is a great success story and a great testament to that vision for Freddie Mac in 1970.
I believe our ability to continue meeting our mission rests on maintaining the confidence of the markets and of the Members of this subcommittee and the United States Congress. And I certainly want to work with this subcommittee on achieve this objective.
Freddie Mac's role is, and always has been, to link families in the Nation's communities with the global capital markets. The mortgages we buy are mortgages on people's homes, and obviously they are high-quality, low-risk assets, because they are backed by people's homes. And the securities we issue attract investors worldwide to finance America's housing.
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For thirty years, Freddie Mac has been at the forefront of innovation. From the standardization of mortgage documents, now accepted, which occurred in the 1970's, to the development of automated underwriting systems, new technology of the 1990's, we have reduced the time, we have reduced the costs, and we have increased the availability of mortgage loans.
Freddie Mac's single-handed creation of the market for conventional mortgage securities back in the 1970's and the development of a global investor base for our debt securities today is further reducing mortgage costs and expanding housing opportunities.
Freddie Mac has opened doors to home ownership and housing for low-income families and for minority families. In fact, we have now financed homes for more than 25 million families in America since our beginning. The result, as already said, is the Nation's highest home ownership rate ever, and a housing finance system, as said by Chairman Raines, that is the envy of the world. And by any measure, our success is evident, whether you look back in history or you look at parts of the market we do not serve today, or you look at other countries. Any way you look at it, the market we serve does a far better job for home buyers than the market we do not.
Now, I think it is appropriate for Congress and for this subcommittee to examine Freddie Mac and Fannie Mae and the Federal Home Loan Bank systems, and to ensure that future generations of home buyers, as well, enjoy these benefits. Indeed, over the next decade, America's families will need another $6 trillion to finance their homes, including more than $2 trillion for first-time home buyers.
Some of Freddie Mac's competitors think this can be accomplished without a vibrant, without a growing secondary market. They bear the burden of proof, I think, that uprooting this tremendous housing finance system would benefit America's home buyers and renters. But there is no way that they can meet this standard, so instead, they distort the record.
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I would like—in my brief minutes that remain, I would like to set the record straight on three points. First, it has been suggested that Freddie Mac can continue to meet our public mission without issuing debt securities. The reality is that debt financing is essential to meeting our mission and is becoming even more important as the number of new home owners grows. Our use of both mortgage-backed and debt securities has enabled us to build a diverse investor base, first, within the United States and now internationally. The benefit is lower costs for home buyers and tremendous stability for the mortgage market.
Indeed, the fall of 1998, most recently, is a prime example, when capital markets were in turmoil, but the mortgage market that Freddie Mac and Fannie Mae serve worked flawlessly. There was no disruption whatsoever.
And by funding mortgage purchases with both our mortgage-backed and debt securities, we save millions of dollars in interest, and American families can count on the availability of mortgage credit whenever and wherever they need it.
Now, the second distortion is that we represent another thrift crisis in the making. The reality is that Freddie Mac and Fannie Mae are specialists in the management of the risk of making or purchasing and funding home mortgage loans. And Freddie Mac is one of the strongest financial institutions in the country. We pioneered the development of automated tools that enable us to accurately assess mortgage credit risk and help families avoid foreclosures. We pioneered the development of mortgage securities, callable debt and the use of other financial instruments that enable us to match the maturities of our assets and liabilities.
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Not only is Freddie Mac highly skilled at managing risk, we are extremely well capitalized for the risk we take. We hold enough capital to withstand ten years of severe adverse economic conditions, much like the Great Depression. The difference between Freddie Mac and the thrift industry could not be more stark. As you know, thrifts in the 1980's were funding long-term mortgages with short-term deposits and then took on more and other kinds of credit risks. And even today, the thrift industry is nowhere near the capital strength of Freddie Mac. We commissioned a recent study by industry experts that calculated that the thrift industry would have to triple its capital to meet our risk-based capital standard as proposed.
Now, we also asked another expert, one probably well known to you, Bill Seidman, former Chairman of the FDIC. We asked him to review our risk-based capital standard, and he concluded that if it were applied to other financial institutions, it would be, and I quote: ''devastatingly stringent.'' I ask that both reports be placed in the record of this hearing. Thank you.
Chairman BAKER. Without objection.
Mr. BRENDSEL. The fact is, if thrifts held as much capital relative to risk as Freddie Mac does, there would never have been a thrift crisis.
The third distortion about Freddie Mac is that we engage in activities that are beyond our charter. What are we accused of? We are accused of using the latest technology to reduce the time and cost of getting a mortgage loan made by lenders, our customers. We are accused of responding to lenders who want to sell mortgages over the internet. And we are accused of trying to improve the practices in the subprime sector.
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All these activities make mortgages more affordable, streamline the mortgage process, and open doors to home ownership, and all these activities are squarely within our charter, support our public purpose, and have tangible benefits to consumers, home buyers and renters.
Finally, I would like to say a few words about your desire to ensure a strong, independent and effective safety and soundness regulation for Freddie Mac. We share this objective, but we do not think H.R. 3703, as introduced, is the way to achieve it.
So let me again express my desire for the Congress to have confidence that Freddie Mac is meeting our very important mission in a safe and sound manner. Again, we would be happy to work with you to achieve this important objective. We are committed to making the world's best housing finance system even better for America's families.
Again, thank you for the opportunity to appear today, and I welcome any questions that the subcommittee may have.
Chairman BAKER. Thank you, Mr. Brendsel, for your remarks and for your willingness to work with us in the days ahead.
Our last witness is the Chairman of the Council of Federal Home Loan Banks, Mr. Curtis Hage.
Welcome. It is a pleasure to have you with us.
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STATEMENT OF CURTIS L. HAGE, CHAIRMAN, COUNCIL OF FEDERAL HOME LOAN BANKS
Mr. HAGE. Good morning, Chairman Baker, Congressman Kanjorski and Members of the subcommittee. My name is Curtis Hage; my bank is Home Federal Savings Bank of Sioux Falls, South Dakota. It is one of the 7,400 owner banks in the Federal Home Loan Bank system.
For disclosure purposes, I should mention that I wear several hats. I am a member of the board of directors of the Federal Home Loan Bank of Des Moines. I am the Second Vice Chair of America's Community Bankers, and I currently serve as Chair of the Council of Federal Home Loan Banks. I am here today on behalf of the Council.
I am here to tell you that partnership with the Federal Home Loan Bank of Des Moines is very important to our bank's success. Moreover, our success is important to the twenty communities, small and large, that we serve in South Dakota.
Mr. Chairman, and Congressman Kanjorski, I would like to take this opportunity to thank you both for the extraordinary efforts you put forth to enact legislation to modernize the Federal Home Loan Bank system. Without your leadership and efforts, the Federal Home Loan Bank System Modernization Act of 1999 would not have come to fruition. This is an important Act.
First, the legislation decentralized management of the Federal Home Loan Banks, local governance decisions are most effective if made at the local level;
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Second, leveling the playing field of membership status was an important and appreciated change;
Third, the addition of small business and farm loans as eligible collateral for smaller community financial institutions provides needed access to more funding; and
Finally, thanks to this legislation, the capital structure of the Federal Home Loan Bank system is being revised for the first time in sixty-eight years. This is an extremely important and dramatic revision. If carefully crafted with coordination and support from the Federal Home Loan Bank members, it can improve an already strong system.
Again, Mr. Chairman, we want to emphasize how constructive you were in the legislative process over the last several years, and we know that your intentions with H.R. 3703 are constructive as well.
Your staff has remained in communication with our offices relative to our issues of concern. In fact, modifications suggested by your staff would significantly alter our areas of concern. If such modifications are adopted, I believe the Council of Federal Home Loan Banks would not have objection to favorable consideration of H.R. 3703. With that as the context, I would like to make three key points this morning and ask the subcommittee to reference my written testimony on the specifics of H.R. 3703.
The first point is that the Federal Home Loan Bank system is unique. It is a child of the Depression, designed to partner with local financial institutions starved for liquidity and, thus, unable to lend. The Federal Home Loan Banks' liquidity mandate is no less important today than it was seventy years ago. But now, in addition to being vital tools for housing finance liquidity, they are also vital community lending and development tools. In fact, Federal Home Loan Banks, through their members, build communities.
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Because of this important function, and because our members' funding needs are growing, the Federal Home Loan Banks are growing. The 1990's saw the mutual fund industry explode to over $7 trillion. A great deal of that growth came from deposits in local banks.
In spite of this massive deposit drain, banks and thrifts continue to provide credit to their communities through the advances provided by the Federal Home Loan Banks. This dependable, low-cost source of funds supports the continued lending role of community banks.
We note with great concern that after the last hearing you held on this subject, the rate spreads on GSE debt jumped substantially and our fund costs increased. Clearly, the Treasury line of credit needs to be handled cautiously.
A second key point is that the Federal Home Loan Banks operate in a very safe and sound manner. We are subject to annual safety and soundness exams. We have, by regulation and practice, an extremely low tolerance for credit- and interest-rate risk. In fact, the system has never experienced a credit loss. Two reasons for that great track record are that the Federal Home Loan Bank advances are fully collateralized and we have statutory lien protections for that collateral.
H.R. 3703 proposes removing this protection in Section 138. In our view, that removal would be problematic and serve no purpose.
Current law requires the Federal Home Loan Banks to secure their loans with specified collateral. Rather than identifying, assigning, or perfecting that collateral, which would be a costly and time-consuming process, well-capitalized community banks and other portfolio lenders may use a blanket lien to cover their entire portfolio of eligible collateral. This is a practical and efficient way to hold down the costs of advances and the administrative burdens for the community bank, the consumer, and the Federal Home Loan Bank.
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Furthermore, in the event of a loss by a financial institution, the super lien, like a perfected lien, would have first claim on the failed bank's assets. Removing the super lien would not, as some purport, place the Federal Deposit Insurance Corporation in a better position in the event of a bank failure. Without the super lien, the Federal Home Loan Banks would perfect their security interests and, thus, have a first claim on the assets.
Finally, the third point I wanted to make today, is that the biggest job facing the Federal Home Loan Bank system is the daunting task of capital restructuring. The sweeping capital changes brought by the Modernization Act require Federal Home Loan Banks to prepare and implement a new capital structure. Many complex issues and decisions need to be made and broadly understood to create a sound, new, permanent capital structure.
Therefore, with all due respect, changing the regulator of the Federal Home Loan Bank at this time would be most problematic. We are also concerned about the limitations Section 111 of H.R. 3703 would impose. We prefer assurances that limitations would not be arbitrary or counter to good, safe and sound balance sheet management. The Federal Home Loan Banks' loss-free record is due in great part to the flexibility that management has had historically to manage their balance sheets in difficult times.
The housing finance market is cyclical, which means our advance business is also cyclical. Mortgage-backed securities are a financial management tool that is a low-risk and readily tradable commodity used by our members every day. The finance board currently limits our purchase of MBSs to three times capital. We believe that limitation is sufficient to focus the Federal Home Loan Banks on their mission.
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We believe that the legislation should respect the need for flexibility, allowing MBS as a mission-consistent tool to ensure safe and sound business management. Without a safe and sound balance sheet, no advances will be made, no affordable housing grants will be made and no members will join the system.
As we restructure our capital to provide for a strong and flexible home loan bank system, we envision a capital structure that will allow the banks to meet the lending needs of the communities and customers that we serve.
Mr. Chairman, this concludes my statement, and I would be happy to address any questions the subcommittee may have.
Chairman BAKER. Thank you very much Mr. Hage. And I do appreciate the staff's willingness to converse with us on substantive modifications to the proposal that might wind up in a legislative approach which you would find acceptable, and I do appreciate that very much.
Mr. Raines, it has been stated here several times already this morning, but would you confirm the view that the securities issued by Fannie Mae are not backed by the full faith and credit? This is stamped on the face of the security; is that correct?
Mr. RAINES. It's stamped on the face of all of our offering documents, as required by law, that they are not backed by the full faith and credit of the United States and they are solely the obligations of Fannie Mae.
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Chairman BAKER. And if down a distant road you are no longer CEO and I am not in Congress, circumstances develop where we have a soft housing market, interest rates have skewed up, difficult circumstances, let's say as in the 1980's, net worth insolvency is imminent, in the workout of that difficulty, would you expect investors of securities to take a haircut in the workout before you get to the taxpayer?
Mr. RAINES. Well, Mr. Chairman, the circumstances in which Fannie Mae would reach any kind of insolvency are such that the country would be in a devastated condition. All the thrift industry would be gone. The banking industry would be gone, and so we are talking about a very extraordinary circumstance.
Chairman BAKER. Sure.
Mr. RAINES. But what I can say is, as you know, if that were to occur, we would expect that our regulator would implement the provisions that are included in the 1992 Act. The 1992 Act provides the procedures by which, if Fannie Mae were to have impaired capital, the regulator would step in and begin to take actions, including putting the company into conservatorship. And given the liquidity of our assets, we would expect that we would see an orderly elimination of the problem as our assets were sold off, given their great liquidity. One of the big differences between Fannie Mae and Freddie Mac and a thrift or a bank is that we invest in highly liquid assets that are easily sold into the marketplace. So as long as liquidity in the general marketplace exists, then Fannie Mae would be able to adjust its book position to whatever capital it had.
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But I want to stress, it would take very devastating circumstances for that to occur. And that is exactly what our capital standard does; it says you must be protected even if these devastating circumstances occur.
Chairman BAKER. Sure. But the question was, would investors be required to take a haircut in such insurmountable, unlikely, impossible circumstances? Would that be the logical order before we get to the taxpayer in trying to understand what is the implicit guarantee worth and when do we get to the taxpayer's pocketbook?
Mr. RAINES. Well, Mr. Chairman, I don't believe you ever get to the taxpayer's pocketbook. I believe our current regulatory structure and capital structure protects taxpayers in all conceivable events. Our investors are protected by the assets that we have. They are protected by the extraordinary equity in American homes. They are protected by the billions of dollars of mortgage insurance that we have purchased. And then they are protected by our capital.
Chairman BAKER. I do not dispute that today. But this is going back to 1979-1983 kind of conditions, when it did happen. There was an insolvency technically, and forbearance of the Congress did enable a workout to occur.
Mr. RAINES. There was never an insolvency of Fannie Mae. Fannie Mae has never been insolvent. Not once.
Fannie Mae suffered losses in the early 1980's. They were significant losses. Fannie Mae righted itself without any assistance from the Federal Government. Fannie Mae was able to modify its business activities and to right itself.
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But the 1992 Act is what ensures that the early 1980's won't occur, because our capitalization is so much higher.
Chairman BAKER. I am going to stick to the five-minute rule and try to apply it to myself as well.
Since Fannie Mae is so well capitalized, so well managed and so profitable, wouldn't the repeal of the line of credit be purely symbolic and that is all? It does not equal one week's trading. Why is the repeal of the line of credit such a big deal to you?
Mr. RAINES. It is not a question of whether it is a big deal to us; it is a question of investors. And I agree with you that it is symbolic, but symbols are very important.
Investors look to see whether there are certain entities in the United States that qualify to issue debt in what we call the agency market. And the agency market in the U.S. is not made up of Government agencies. It is made up of privately owned companies who have been asked to serve a public purpose. And so that is the vast majority of entities who issue in that market. And investors look for the indicia of, are you or are you not eligible to issue in this market. And this market is between Government securities and ordinary corporate securities, a lot closer to the ordinary corporate than it is to Government.
If you begin to take away indicia of eligibility in that market, you can undermine your ability to sell into that market. And the whole array of criteria that we have, and indicia that we have, are like a woven cloth. Can you take out one thread? Well, certainly. Does it have the potential of beginning to unravel the entire cloth? Absolutely.
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So that is the issue. It is symbolic and if it has no cost to the Government, the question we would raise is, why take the risk? Why take the risk that investors would begin to see that something has fundamentally changed in the relationship of all of these issuers and the entity that chartered them?
Chairman BAKER. One financial question just on product expansion. I understand the pursuit of home ownership helping to facilitate for individuals who otherwise would be excluded from the process. But to enter into a pilot project basically with Home Depot to finance jacuzzi purchases and sun room expansions does not really facilitate home ownership. That is, at best, at the fringe of home equity lending. Why would Fannie want to engage in that type of market activity?
Mr. RAINES. We don't.
Chairman BAKER. You have a pilot program with Chevy Chase Bank that does that. Chevy is the one that extends credit; they in turn sell the paper to you. Is that right?
Mr. RAINES. No, that is not right. The Chevy Chase example is an excellent example where a small bank decided to compete with a giant company. Chevy Chase Bank, a local bank in Washington, wanted to compete with the General Electric Company for the business of Home Depot, and they came to Fannie Mae and said ''Would you be our partner in competing? And what we want to compete on is, Home Depot wants to help people remodel their homes. And what they would like to do is provide them not only materials, but also a contractor and the loan to help them finance improvements to their homes.''
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So they came to us and said, ''Will you help us compete?'' So little Chevy Chase Bank went and competed against GE and beat them. They provided lower interest rates and better service.
Chairman BAKER. Because they were partnered with you guys, though. Was that not somewhat a costing advantage?
Mr. RAINES. No, it was not a costing advantage. What was the real costing advantage was that the Chevy Chase turned out to be much more efficient than the giant corporation. They beat the giant corporation. The giant corporation was none too happy.
Chevy Chase never had an agreement with us to sell spa loans to us. It does not today. It was never part of any arrangement. It has always been on home remodeling.
There is a separate business, in that Chevy Chase competed with the giant corporation to provide those kinds of loans, which Chevy Chase would have kept in their own portfolio. There has never been any suggestion that they were selling those loans to us.
Chairman BAKER. But you do buy the home remodeling paper?
Mr. RAINES. We have bought second mortgages for thirty years.
Chairman BAKER. Right. In other words, stated differently, Chevy Chase extends the credit which they turn to you and sell the paper for home improvement. At question is, is the spa home improvement or is it aluminum siding? Is that how you break it out?
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Mr. RAINES. No, Mr. Chairman, I don't think anyone would say that putting in a jacuzzi would constitute something that you would put a mortgage on the house for.
What we are talking about is honest Americans who cannot afford to have big-time contractors come and do their home improvements, so they go to Home Depot where they can get the materials much less expensively, where they have someone to help them pick out an honest contractor; and what they want is to be able to get their loan in the same place. They do not want to have to go and find out that they cannot get a loan.
Here is a company trying to help the average family, because for most families this is how they improve their homes. They don't sell them and move off to a fancy neighborhood. They fix them up.
And I think what Chevy Chase Bank did was outstanding, the fact that they beat a giant multinational corporation. We should be proud of that. It showed great initiative on their part, and I think we did what we were supposed to do, which is to respond to the primary market; when they have a new idea and they come to us for help, we should help them.
Chairman BAKER. Excellent explanation. I still understand the principal operation is slightly different.
It reminds me of the television commercial where the actor is saying to the golfer, ''Pick a number between one and a billion.'' And he says, ''seven'' and he says, ''You're good; you're very, very good.''
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You are good, Mr. Raines, in explaining your position.
Mr. Kanjorski.
Mr. KANJORSKI. Thank you, Mr. Chairman.
My first question is, would you discuss—particularly Fannie Mae and Freddie Mac—the size of Fannie Mae and Freddie Mac debt relative to Treasury debt, and whether it is valid to compare the two?
Mr. Raines.
Mr. RAINES. Well, as you know, I spent a fair amount of time worrying about the Federal debt in recent years, and I consider it to be one of the major achievements of both the Administration and this Congress that we are now actually reducing the Federal debt.
But the comparison of our debt to the Federal debt is something I have never quite understood. Because if the Administration and Congress are successful in paying off all of the outstanding publicly-held debt, then every financial institution in America will have more debt outstanding than the Treasury, because the Treasury will have zero outstanding.
In reality, Fannie Mae and Freddie Mac do not create new debt. All we do is finance debt that is already outstanding. We can only buy a loan that has already been made. And when that loan was made, the lender borrowed short term to make that loan. When they sell the loan to us, all we can do is borrow long term. They pay off the debt they had, but we still have just that loan that is outstanding. So we do not add to the outstanding debt of the country at all.
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Comparing us to the outstanding Treasury debt, I assume, is an implication that our debt is guaranteed in some way, and therefore, that that is an additional obligation of the Government. I hope that my testimony, and I hope Leland Brendsel's testimony, made very clear, that any obligation of the Government—financial obligation to Fannie Mae's debt is tenuous at best. And in my time as the Budget Director, I never ran into the budget concept of an implied guarantee. There is noplace in the Federal budget where we charge for an implied guarantee. There is noplace that we count up implied guarantees. We charge for real guarantees.
And even if there were a real guarantee of Fannie Mae's debt, under existing budget accounting rules, the cost would be zero, because there is no conceivable default under the credit scoring rules that the Government uses for complete guarantees.
So, I have never understood this argument, other than it is to compare us to a big number and to say that our debt is a big number, which we admit. But we operate in a big market. There are $5 trillion of mortgages outstanding. The one thing we know is that even if the worst fears of our critics were realized, we could never have more than $5 trillion of debt outstanding, because that is all of the mortgages that exist.
Mr. KANJORSKI. Mr. Brendsel.
Mr. BRENDSEL. Congressman, if I could summarize this way, the decline of Treasury debt and the increase of Freddie Mac obligations, and Fannie Mae's, is good news. It is good news for the Nation. On the one hand, with the prosperity in the economy, with the sound fiscal management, Treasury debt is declining. On the other hand, with the sound economy, with the growing economy, home ownership rates are rising and, with that, mortgage loans that enable people to buy those homes are rising, and the business for Freddie Mac and Fannie Mae.
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After all, all of our obligations, really nearly all of our obligations, are mortgage loans on people's homes. And they are what is backing all of our securities that we issue in the form of mortgage-backed securities or in the form of our debt obligations outstanding. And behind that is equity on people's homes, their down payments, and the growing equity.
As a result, I think it is great news. It is apples and oranges to compare Treasury debt with Freddie Mac and Fannie Mae debt. And, indeed, as Chairman Raines has already said and I said in my opening remarks, frankly, we are one of the strongest financial institutions in the country, if not the world, because of the fact we are in this one line of business.
There is no risk of insolvency and loss to the taxpayers, and indeed there is no guarantee to the United States taxpayer surrounding any of our obligations.
So with that, I am not certain what else I could say, Mr. Chairman.
Mr. KANJORSKI. Mr. Hage, what would the effect on the housing financing marketplace be if the Federal Home Loan Bank system were not involved? What if the Federal Home Loan Bank system were chartered or commissioned to do something else, primarily economic and community development?
Mr. HAGE. I am not sure I heard all the question, Mr. Kanjorski.
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Mr. KANJORSKI. What kind of impact would occur on the housing finance marketplace in the United States if the mission of the Federal Home Loan Bank was redirected out of housing and toward economic and community development?
Mr. HAGE. The impact in some respects would probably be minimal, because community banks today are heavily engaged in economic development lending. We are the source of credit for Main Street businesses, farms, and other economic units of production in our local communities.
The increasing role and value of the Federal Home Loan Bank system, due in large measure to the expansion of eligible collateral in the bill just passed, allows and gives banks even greater power to continue to provide that source of economic lending in our communities, as well as continue our housing lending.
If the mission or the definition of mission were changed to be very narrowly defined and forced a focus on economic development at the expense of housing, that would be a mistake.
Chairman BAKER. Thank you, Mr. Kanjorski.
Mr. Riley, you are next.
Mr. RILEY. Thank you, Mr. Chairman. Thank you gentlemen. I enjoyed your opening statements.
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But I am somewhat concerned, especially, Mr. Raines, with some of the rather bold statements concerning both this bill and the testimony of Under Secretary of the Treasury Gary Gensler. On a number of occasions, Fannie has called this bill ''anti-housing'' and continues to state that the bill would increase mortgage rates. Fannie called Gary Gensler's testimony regarding the issue on this bill as ''inept, irresponsible, and unprofessional.''
We know that Fannie apologized for those remarks. However, a week later, Fannie said that Gensler's comments had cost 208,000 families a chance at home ownership.
I would like to point your attention to a chart, if you would, over here. I hope you can see it that far away. The chart tracks thirty-year fixed conventional mortgage rates for the period of February 25, 2000, through May 11, 2000.
This bill was introduced on February 29th of this year. The week before the bill's introduction, the average thirty-year fixed conventional mortgage rate was 8.31 percent. The week after the bill's introduction rates actually fell on average down to 8.27. One week after Gensler's testimony, rates had fallen by 1 basis point. In fact, rates either fell or leveled off until over three weeks ago when the financial world began to speculate that there would be an increase in the Fed funds rate.
I guess my question is, the Federal Reserve and Alan Greenspan have raised the Fed rate 165 basis points in the last year, and it is anticipated they will probably raise them again today a quarter to one-half a point. It would seem to me that those rate increases would have much more of a direct effect on your cost of funds than anything in this legislation.
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That being the case, would Fannie characterize the Fed as being antihousing or irresponsible? Does Fannie accuse the Fed of barring hundreds of thousands of Americans from home ownership? And if not, why are these comments reserved only for those that merely want to raise the issue of increased scrutiny for GSEs?
Mr. RAINES. Congressman, let me repeat what I said in my opening statement, that we do not find any objection to oversight activities. We believe what this subcommittee is doing is entirely appropriate and timely. We also have no objection to our regulators or other agencies exercising their responsibility to ask questions and make proposals. That has never been our concern.
Our concern is that if legislation is passed that actually changes our charter and causes our costs to go up, then that will have a negative impact on home buyers.
All of us have to deal with the circumstances of the markets as we find them. Rates may go up and rates may go down. The Fed may find, for good and sufficient reasons, that they have a need to slow down the economy or to speed up the economy. The question, though, is, should housing suffer an additional burden? Should rates be higher than they otherwise would have been?
So we do not ask that the monetary policy be directed solely to expanding home ownership. Monetary policy has to have a much broader purpose, but we shouldn't do anything that adds on top of that additional costs that otherwise wouldn't be there. And that is our only concern.
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Mr. RILEY. Well, there was certainly dialogue or rhetoric that was coming out of Fannie for the last two or three months that seemed to be directed specifically at this bill. And I think it is a little disingenuous on Fannie's part to say that this bill, or Secretary Gensler's testimony, had cost 200,000 Americans the opportunity or the ability to own a home, or to say that the basis of any increase in mortgage prices was because of some bill that we are only considering here. And I think that if there is going to be an attempt by this Congress to work with your organization to try to effect any kind of change, any kind of systemic risk change that we might think is appropriate, I believe Fannie is going to have to not only be a participant in the process, they are going to have to lower their rhetoric somewhat to the point that we are not accused of trying to damage home ownership in this country.
Mr. RAINES. Well, I don't think that there is any doubt that we need to have a very considered view of any proposal, such as the bill before the subcommittee today. And I don't believe we have ever accused this subcommittee, or any Member of this subcommittee, of trying to damage home ownership.
But, I think it is also important to remember that we are asking investors around the world every day to invest billions of dollars in American homes. And we are asking them to buy debt that will be outstanding for a long time. And we are asking them to do that on an understanding of what the arrangements are behind that debt. They have a right to have some stability in those arrangements. They have a right to know what they are getting themselves into.
So our concern, as I said, has to do with what is happening to the actual charter. If there is a proposed change to the charter that will change the arrangement in a way that is unfavorable to our ability to raise funds for home ownership, then we think we have an obligation to point that out. And it is a very fragile arrangement that exists in the marketplace and the capital markets now have many opportunities to invest their funds. They do not have to invest in home ownership in the United States. They could invest in home ownership in their own countries, but they have chosen to invest their dollars in home ownership in the United States; and we are simply saying that we need to exercise care in changing the arrangement that has worked so well that it has induced them to invest so much. And be sure that we are willing to assess the risk appropriately.
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Chairman BAKER. Your time has expired, Mr. Riley.
Mr. BRENDSEL. Congressman, Mr. Chairman, may I make a comment here?
Chairman BAKER. Please.
Mr. BRENDSEL. Freddie Mac happened to be in the markets the day of that hearing, marketing a debt security. And, indeed, we have experienced significant success over the last few years in expanding our investor base worldwide to foreign markets; approximately a third of our debt securities are now purchased by international investors.
And, indeed, when we were in the markets that day, I was in our trading room watching the offering, and I saw the impact on the market of our offering. It really did disrupt the market. It caused confusion, I would say ''uncertainty'' among investors—probably investors that do not know this system as well, do not know the entire process, the entire committee and legislative process.
And indeed, all I could say is that regardless of the specific reasons, I have no doubt that the uncertainty created by how some of those comments were handled really was concerning to investors.
I might also add that if you look at some other statistics, some other charts, they would show a somewhat different story, not in terms of conventional mortgage rates, but, for example, if you were to compare rates on Government—Treasury, Government-guaranteed, mortgage-backed securities, Ginnie Maes, compared to conventionals, you would see again the impact of recent events.
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Mr. RILEY. Mr. Chairman, will we have an opportunity to make a second round?
Chairman BAKER. Yes, sir. If you can stay, we will have a second round.
Mr. RILEY. Thank you.
Chairman BAKER. Mr. LaFalce. I'm sorry, he is not here.
Mrs. Maloney. Nope.
Mr. Watt, do you want to get in on this? No?
Mrs. Jones.
Mrs. JONES. I am not used to getting to ask questions this quickly. I was sitting back here.
Chairman BAKER. That is OK. You do not have to.
Mrs. JONES. No. I am going to ask some questions now. I want to start with Mr. Hage.
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Can you discuss for me the impact of having H.R. 3703 lump all three GSEs into one category in terms of regulation, and so forth?
Mr. HAGE. We believe there are distinct differences in terms of the Federal Home Loan Bank structure and the organization of Freddie and Fannie. The Federal Home Loan Bank is a cooperative organization, not a stock—privately funded like Freddie and Fannie. Membership functions in the Federal Home Loan Bank system by members having access to and using the product that we offer—the focus, I believe, is different. The mission is different, and the way we achieve it is different.
Mrs. JONES. So, therefore—short answers, because I only have five minutes, go ahead—do you oppose or support this lumping together?
Mr. HAGE. We would oppose lumping together.
Mrs. JONES. OK. That was a good short answer. Thanks.
Let me go now to Mr. Raines and Mr. Brendsel.
There has been a lot of discussion and debate about your automated underwriting system. Some entities have complained that your systems leave out potential homeowners. Could you respond? Short as you can, guys. Come on.
Mr. BRENDSEL. I, in fact, think that automated underwriting systems have had the benefit and will continue to have the benefit of further reducing costs, making the system fair, more objective; and indeed our experience has been that it expands the opportunities for home ownership when combined with the human judgments that go along with those automated underwriting systems.
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But there is no doubt it reduces costs and increases the availability of mortgage credit, particularly as you try to expand into low-income neighborhoods where the cost related to making a mortgage loan and financing it in the secondary market is so very important.
Mr. RAINES. There is no question that Fannie Mae's desktop underwriting system has expanded the range of loans that we purchase. We have found underwriters who will say that we had no idea Fannie Mae would purchase a particular loan.
But also we have introduced a whole series of products that we would not have felt comfortable introducing unless we had a Desktop Underwriter helping us to assess the risk. So we believe that automated underwriting has been a valuable tool for expanding availability of mortgage credit to many people who would otherwise not have qualified for it.
Mrs. JONES. Talk for a moment about a complaint by some of your detractors, or people in the industry, about mortgage insurance and the position of Fannie Mae that you have to have mortgage insurance in order for them to purchase or for you to purchase these loans.
Mr. RAINES. Well, as I mentioned before, mortgage insurers are key risk-sharing partners of ours. In 1994, in fact, when we expanded the range of loans that we would buy to include loans with as little as 3 percent down, in other words, to help to protect us against a relatively new risk for us, we expanded the requirement for mortgage insurance. We said you had to purchase more mortgage insurance for a loan such as that.
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When I became Chairman, after I came back from the Government, we had just completed a study that identified we did not need as much mortgage insurance as we had required in 1994; our experience base had grown and we did not need as much coverage. So we reduced that coverage.
When we increased the coverage, I don't remember there being any complaints from the mortgage insurance industry. But when we reduced the coverage, when we said you don't have to buy as much coverage, we got a lot of complaints from the mortgage insurance industry. They were disappointed that we were not requiring that their product be bought as frequently. And because 80 percent of the mortgage business product involves insuring either loans that Freddie Mac buys or Fannie Mae buys, this is a market of some importance to them. We are essentially their market, because we are required to use it in this part of our charter.
But the accusations of our trying to get into the mortgage insurance business are, of course, false. We don't intend to do mortgage insurance. We are their customer. We only want them to give us the best products that are available at the lowest possible costs to meet our risk-sharing needs.
Mrs. JONES. Can I go one more question?
Chairman BAKER. One more quick one.
Mrs. JONES. OK. Deal with, for a moment, the issue of mission creep.
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Mr. RAINES. I can do that very quickly if you put up chart number 20.
Mission creep appears to be a concept that I am not quite sure exactly what it means, since we have a charter that sets our mission and we have regulators who enforce the charter. But the best answer to mission creep with regard to Fannie Mae is to look where our assets are. And if you look to see what our assets are, they are exactly what you would expect of a secondary mortgage company. Eighty-eight percent of our assets are single family mortgages, 2 percent are multifamily mortgages, the remainder is cash and liquid assets which every financial institution is required to have, and that is about 8 percent of our assets. We do not have any mission creep assets that are on our books.
So I am not sure what it means, unless what they mean is that you used to buy only certain kinds of mortgages, and now you are buying other kinds of mortgages. We used to buy only mortgages with 20 percent down; that is true. We now buy mortgages with as low as 3 percent down. We used to require perfect credit; that is true. We now say you do not have to have perfect credit. We used to have most of our mortgages come from outside of central cities; that is true. We now have a lot coming from inside central cities.
If that is what they mean by mission creep that we are doing, then I would simply point them to the charter that this committee voted on in 1992, which mandates that we try to extend our service to all parts of the mortgage market.
Chairman BAKER. Can we wrap up here, please? If we can, we will do a second round. People have been here for so long, I hate to make them wait longer.
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Mr. Ryan.
Mr. RYAN. Thank you, Mr. Chairman. I enjoyed the testimony.
I had a different line of question planned, but I was intrigued with your line of questioning with Mr. Riley, my colleague, the fact that the introduction of this bill purportedly raised the cost of mortgages.
I think a representative of your company, Mr. Raines, at a conference in front of the mortgage bankers, said that the mere introduction of this bill has caused an increase in your cost of funds, which I understand is low relative to private entities, and caused an increase in the cost of home purchasing for average Americans.
In a recent National Journal article, it said that Fannie's and Freddie's return on equity in 1995 and 1999 was 24 percent compared to 15 percent for large banks, 12 percent for thrifts and insurers, and 17 percent for securities firms over the same period.
Now, this consistent earnings growth and return on equity is wonderful. I think you should be proud of that. That is a good thing. That is what private companies should be doing. But we are also assuming that then Fannie has been passing on the profits to its shareholders, regardless of the cost of borrowing funds, which is what an entity should be doing.
Getting to the point of whether or not the introduction of this bill, this kind of discussion, raises the cost of home buying, isn't the answer also included in whether or not you are interested in passing the costs on to the consumers to protect that 25 percent profit rate; or is it really fair to say that this legislation would make interest rates increase if you make the ultimate decision on either using your return on equity to keep rates low, passing them through to keep rates low, or enhancing shareholder wealth?
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Which comes first is the question.
In my opinion, from watching your give-and-take with Mr. Riley, it would seem that your mission and your capability is to offset any of these increases in the cost of funds by using more of your return on equity, or a greater percentage of your Government subsidies, keeping rates low rather than hitting that 25 percent target.
Mr. RAINES. Mr. Ryan, we do not believe that the mere introduction of this bill raised interest rates. We believe that the investor community had great concern that legislation such as this might be enacted. It is the enactment—not the introduction, not the discussion, the enactment of legislation is what investors are concerned about. Since they have to buy debt and hold it for a long time, they have to make their own calculation what are the chances it is going to be enacted. So it is the enactment that is the concern.
In terms of our income—and I think this is an important point; and I know you share the view that all additional costs, all taxes, all regulatory burdens on corporations are not paid for by the corporations, they are paid for by consumers—the important point here is, what is happening with our profits?
The assumption in your question was that we write a check to the shareholders for our profits. Indeed, 28 percent of our pretax profits last year went to Federal income taxes, 50 percent went to increases in our capital required to meet our strict capital requirement, 22 cents on the dollar actually went to shareholders. So our shareholders basically have taken the view, ''keep the money in the company, keep doing your job, keep serving your mission.''
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So it is not accurate that somehow we can translate profits into overcoming an impact in the market caused by the legislation.
The last thing I would simply say is that the cost of mortgages is not set by Fannie Mae, and it is not set by Freddie Mac; it is set by the markets. When lenders take our mortgage-backed securities, we do not sell them to the market, they do. So the price they get is given to them by the market. The price that we have when we buy out of the market is set by the market. And so all of us are having to ensure that the market works well, and we simply have to react to what the market gives us.
Mr. RYAN. Mr. Raines, I would like to switch now. I am interested in this debt issue and this debt debate we seem to be having.
We are in the middle of a big chart war, it seems, these days. I see in your testimony in chart 19 you talk about the debt that Freddie and Fannie have, and I would like to go to the issue of repurchasing your own mortgage-backed securities. I believe, in 1993, you started doing that with a fairly steady pace. Some critics of the GSEs argue that when Fannie Mae or Freddie Mac issues debt to repurchase its MBSs from the private sector, it is unnecessarily increasing the risk to taxpayers, that that is excess debt that does not go toward fulfilling your mission statement, and that it is debt that is unnecessarily borne by taxpayers with this implied credit that we obviously have various opinions on.
Isn't the issue not how much debt is outstanding in the economy, which is, I think, what your chart 19 shows. Isn't the issue how much GSE debt has been issued and whether that debt, the excess debt, whoever's measurement that may be, is needed to meet your GSE mission?
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So my question is, is the debt that you incur from repurchasing mortgage-backed securities above and beyond what you need to fulfill your mission? I don't think this panel is saying any GSE debt is bad. I think the panel is concerned about some GSE debt, on top of your critical mission debt, is an unnecessary risk posed to the taxpayer and goes beyond and above what your original mission fulfillment is.
Chairman BAKER. We will have to wrap up with—and let Mr. Raines answer fully, but I suggest that we have one vote. At the conclusion of Mr. Raines's remarks, we will briefly recess.
On the Democrat side, Mrs. Waters, you would be up next for a question if you can make it back after the vote, and we will just pick up at that tempo.
Mr. Raines.
Mr. RAINES. I can answer now?
Chairman BAKER. Yes.
Mr. RAINES. Put up number 2. I will do this quickly so you can go vote. It is an excellent question, and I think it is one that we need to have clearly understood if the functioning of the secondary market is to be understood.
First, we try to offer investors the kind of securities they most want, because if we offer them the kind of securities they most want, they will charge less money. And not all investors are created equal; some investors like to have all of the volatility along with the additional income you get from a mortgage-backed security. There is volatility, because people can repay that mortgage at any time, and therefore it is hard to decide what that is worth.
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And so some investors will want mortgage-backed securities, but there is a limited number of them.
There are other investors who say, I do not want all of that volatility. I am willing to take a little bit of what we call ''optionality'' in my debt, but I don't want a lot. And for them, we offer our callable debt. And others will say, I do not want any optionality; I want it paid back on a particular date exactly on that date. And for them we offer our bullet debt.
So we offer investors what it is they want, because if we do not offer what they want, they will charge us more money.
Mr. RYAN. How does that deal with you repurchasing your own mortgage-backed securities and whether or not that transforms into your reaching your mission statement?
Mr. RAINES. Excellent question, and that is the second chart.
Mr. RYAN. A lot of charts in this.
Mr. RAINES. Old habits.
This one shows what we believe to be our fundamental role. Our fundamental role is to transform the risks that are inherent in consumer mortgages into the kind of risk that investors want. And the question has come up, are we increasing the debt as we do that? And let me just walk you through the process, if you will; it will take me less than one minute.
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This shows an example of a lender originating a billion dollars in mortgages. So we have a billion dollars of debt that has now been created and that lender has gotten a short-term loan from their bank to pay for that. They swap those for mortgage-backed securities which is the predominant way it is done. They say Fannie Mae, here are the loans; you give me mortgage-backed securities.
They hold those securities or they sell them to Wall Street. Wall Street now takes out a short-term loan, pays the lender for the mortgages. That lender pays off their warehouse loan. The market still has that same billion dollars of debt outstanding, that same billion dollars financed by a billion dollars. Wall Street sells part of that to Fannie Mae and part of it to other investors. So we buy a part of it, and other investors buy a part of it, and then we issue debt to pay off Wall Street, and the other investors don't pay off Wall Street.
So here we are. There is still a billion dollars of loans outstanding. There is still a billion dollars of debt that has been used to invest in them. There is no new debt.
Mr. RYAN. I think that is a very accurate statement and I agree with what you just said.
I guess the question is, it is the difference between your owning your mortgage-backed securities at an implied taxpayer risk versus a private-sector holder of your mortgage-backed securities. I don't think the issue is increased total debt in the market.
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Does it increase your debt and, therefore, implied taxpayer risk?
Mr. RAINES. We guarantee the mortgage-backed securities just as we guarantee our debt. So it does not matter in terms of the risk to Fannie Mae whether or not it is in the form of a mortgage-backed security or debt. It is the same guarantee on both.
So if you believe there is a risk in there, it is the same risk no matter what form it is in. In fact, we would argue that Fannie Mae is a better holder of the mortgage risk, because we have so much more data, so much greater ability to hold it, that the risk to the system is actually reduced; because if these loans were being held by your local thrift or your local bank, who have lesser ability to manage them, there is more systemic risk than if they are held by Fannie Mae or Freddie Mac. And remember, those are institutions that have Federal guarantees, whereas we do not.
Mr. RYAN. I think the Federal guarantee—excuse me.
Mr. BRENDSEL. If I may comment, there are two other points I would make that relate to this. One is the natural investor for callable debt is sometimes different than the natural investor for a mortgage-backed security. Freddie Mac and Fannie Mae are always in the process of finding who is the most attractive investor for a particular kind of security.
Chairman BAKER. If I may interrupt, we are down to five minutes.
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Mr. BRENDSEL. The second issue would be whether or not this affects anything about the safety and soundness of Fannie Mae or Freddie Mac.
Chairman BAKER. We will come back to this explanation when we come back. We are down to five minutes on the vote. We will be right back. Thank you.
[Recess.]
Chairman BAKER. If I may ask individuals to please take seats, we will reconvene our hearing. Mr. Brendsel, when we suspended our activities here, Mr. Ryan was in an exchange. I think he would request the ability to restate his question and then have you respond from the start.
Mr. Ryan, you are recognized.
Mr. RYAN. I am sorry we cut you off before the vote happened. We wanted to make our vote.
The question is, and I saw——
Chairman BAKER. Excuse me. If I could get those back doors closed, it would help with the noise so that the witnesses are able to hear properly.
Mr. Ryan.
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Mr. RYAN. The question, and it is a very simple one—I think this is very fascinating. You had the chart that showed the callable, the bullet, and the mortgage-backed security debt. And tell me if I am misparaphrasing you, Mr. Raines; the riskiest debt was the mortgage-backed security debt, correct?
Mr. RAINES. I think it would generally be considered as having the greatest volatility and greatest optionality.
Mr. RYAN. The question is, does the issuance of mortgage-backed securities and the repurchasing of your mortgage-backed securities put another person into a home, period? Does that advance the goal of home ownership and put another person into a home? That is question number one.
Question number two is, if it does not put another person into a home, is that not excess debt above and beyond the debt that is needed to put people into homes or to fulfill the mission of the GSEs, the primary mission of which is the secondary market?
Mr. RAINES. An excellent question. And I think the answer is very clear that the operation of our portfolio is vital to our achieving the reduction in interest rates that we achieve in the marketplace. Because when we buy mortgage-backed securities, we are one of the investors who are adding to the demand for mortgage-backed securities. Without our buying the mortgage-backed security, interest rates would be higher, because the demand for mortgage-backed securities would be less.
And it was never shown so well as it was shown in the fall of 1998, when the number of people who wanted to own mortgage-backed securities disappeared, and billions and billions and billions of dollars of existing mortgage-backed securities came into the market.
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So, if you were trying to buy a home in October of 1998, if Fannie Mae and Freddie Mac had not had mortgage-backed portfolios, you would have seen interest rates in the United States soar, and it would have prevented people from getting a mortgage in October of 1998.
So the operation of our portfolios is vital in maintaining the flow of capital and achieving that 25- to 50-basis-point reduction in interest rates.
Mr. RYAN. I clearly understand that the operation of the portfolio is critical to that mission.
Is the operation in the portfolio specific to the issuance and repurchase of mortgage-backed securities in and of itself critical to fulfilling that mission, meaning putting another person in a home that otherwise would not be put into a home?
Mr. RAINES. Absolutely, because there is a distinction that some critics have made between our buying a whole loan and buying a mortgage-backed security. And they would say if you buy a whole loan, that is OK; but if you buy a mortgage-backed security, that is not OK.
It is a false distinction, because all mortgage-backed securities are groups of whole loans. So it is exactly the same activity when loans are put in mortgage-backed securities by lenders and sold to investors, that is, the vast majority of loans in our marketplace are put in mortgage-backed securities first.
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They are not sold to us as whole loans. The vast majority are put into mortgage-backed securities. And so when we buy them or anyone else buys mortgages, they are predominantly buying them in mortgage-backed securities, not as an individual loan.
Chairman BAKER. Mr. Ryan, can you wrap it up now?
Mr. RYAN. One more point, if I could, Mr. Chairman.
So you are saying, by the GSEs repurchasing mortgage-backed securities, that contributes to lowering interest rates as opposed to a private entity buying those mortgage-backed securities? Is that what you said?
Mr. RAINES. The key distinction, you said ''repurchase.'' The idea of repurchase implies that we would be the one who sold the mortgage-backed securities. But it is the lender who sells them; we only buy them essentially when other reinvestors do not want them.
Mr. RYAN. I think you mentioned $493 billion, everyone combined, in 1999. That $493 billion purchase of mortgage-backed securities are mortgage-backed securities that otherwise would not have been purchased by the private market; is that essentially what you are saying?
Mr. RAINES. No. What we are saying is, if you add the bid of Fannie Mae and Freddie Mac into that market, we make the value of that mortgage-backed security higher and the interest rate lower. The market would have cleared at some level, but it would have cleared at a much higher interest rate. By our buying them, we are clearing that market at a lower interest rate to the consumer.
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So the loans would have been bought by somebody.
Mr. RYAN. They would have been bought, but the effect would have been higher interest rates?
Mr. RAINES. The effect would have been higher interest rates.
Mr. RYAN. This is fascinating. I understand that I am out of time, but thank you.
Mr. BAKER. Ms. Waters would be next, but she is not present, so I recognize Mr. Sweeney.
Mr. SWEENEY. Thank you, Mr. Chairman.
I thank our guests for their testimony. I have a couple of questions I would like to address to the panel regarding just to get a sense of your position on oversight and risk management and what is proper, and I would like very brief answers, and then I would like to make a point before I conclude.
Mr. Hage, you mentioned in your testimony that the task of capital restructuring is going to be quite a daunting task, and it will indeed present the greatest challenge to you. Could you very briefly give me some of the key points?
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And you also mentioned the need to maintain flexibility, and I think it does go to the heart of the whole notion of whether we need to reform and in what particular areas we need to, whether it needs to be a macro or micro approach. Could you give some key points on flexibility, what your greatest concerns would be in terms of loss of flexibility if we were to move forward with this legislation?
Mr. HAGE. The Federal Home Loan Bank system historically has been a closed capital system. By that I mean, the member has to put capital into the system whether or not they use it. The new definitions of capital and the new requirements of capital under the financial modernization bill have changed that in a positive way, but also in a significant way. The challenge is to construct the capital in a way that is salable to its members, so they will in fact buy the capital, and yet achieve the flexibility of utilization of capital by members so that if they are not using the system, they are redeploying that capital.
Mr. SWEENEY. And it aids, as you said in your testimony, that the regulatory process currently provides enough protection to ensure that the Federal Home Loan Banks are sufficiently capitalized, correct?
Mr. HAGE. I believe it does, yes.
Mr. SWEENEY. OK.
Mr. Brendsel, I understand, and we have heard it a couple of times, that you have worked with the Chairman and his staff, and I am suspecting that we pretty much agree, or you pretty much agree that promoting great market discipline transparency is an overall goal that you would sign on to in support?
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Mr. BRENDSEL. Absolutely.
Mr. SWEENEY. And I want to thank you, because your staff has been very helpful.
Mr. BRENDSEL. Thank you.
If I could add to that, I have always supported a very strong safety and soundness regulator, independent and credible. I frankly do not believe that the bill as currently structured would enhance those basic principles.
With regard to the transparency and the availability of information to the market, to investors about our business and risk management practices, I would actually also like to mention something additional. In fact, I believe that Freddie Mac is a leader in transparency and disclosure about our business activities and risk management practices.
Indeed, we recently asked for an independent review by PricewaterhouseCoopers of our disclosures, and they have recently completed that review. I am in the process of obtaining a written copy of it, but I can give you the bottom line conclusion.
They took the top institutions, banking and financial institutions in the country, regarded for being best practices in disclosure; they compared our disclosures against those—to the marketplace, to investors—and they ranked us in the top third. Top three.
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Mr. SWEENEY. You also—Freddie Mac has also recently announced antipredatory lending practices. Maybe you could briefly give us some of that information and your rationale. And be brief, because I need get to Mr. Raines with some questions.
Mr. BRENDSEL. With regard to—I'm sorry?
Mr. SWEENEY. The antipredatory lending guidelines that you have just initiated.
Mr. BRENDSEL. Yes, we have explored the subprime sector, and in particular, in addition, lending activities in parts of that sector. Indeed, there are good parts and there are bad parts of that sector; and in fact, we became troubled with some of what we saw, and we commissioned—in fact, we conducted a thorough review of those practices. And we recently issued guidelines to our lenders, first of all, requiring credit reporting on all of their borrowings.
Mr. SWEENEY. I would like to stay with you, but I am running out of time.
Mr. Raines, I am hopeful that your people read the testimony or read the statement that I made at the March hearing and understand that my position has been very substantially one that I have been quite hesitant to move forward here, because I'm not certain that the system is broken and I do not want to try to fix something that isn't. But I need to make that point to you.
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You have said three times in your testimony that oversight is key to safety and soundness, and you said that you are concerned, not with these hearings, but with actual change. And yet my office has been barraged by constituent letters, mailgrams of this nature, e-mails. One such e-mail reads as follows: ''Last week I received a telephone call from an individual who stated that he was with the Fannie Mae Foundation, seeking my agreement to join the foundation in opposing H.R. 3703. I also have received substantial mail from those on the other side.''
I have a couple of questions. One is, I would like to know where you obtained the list that you solicited this kind of constituent mail. Second, to what Members did you do this? And thirdly, as a freshman Member of Congress, my office is often burdened beyond the norm. This certainly causes me great concern, and I am not one who was necessarily moving precipitously, if you felt Members were, and I do not quite understand your tactic.
Mrs. ROUKEMA. Will the gentleman yield?
Chairman BAKER. If I may, Mr. Sweeney, so he can see to respond, I ask that the boxes be moved.
Mr. SWEENEY. That is the problem I have now in my office with a lot of things I need to do, because I have to respond to those letters.
Mr. RYAN. Could I ask unanimous consent to move the boxes to the right, so we could see Mr. Raines as he gives his answer?
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Chairman BAKER. Mr. Sweeney, have your staff remove the boxes.
Mr. RAINES. I feel like the judge in ''Miracle on 34th Street'' when they brought in the letters to Santa Claus and put them on the judge's desk.
Mr. SWEENEY. Well, this is no miracle.
Mr. RAINES. Democracy is a wonderful thing.
Chairman BAKER. Mr. Raines, you have a moment or two to respond. Mr. Sweeney has expired his time.
Mr. RAINES. Mr. Sweeney, I am delighted to respond.
We have been absolutely thrilled anytime we have asked for support for Fannie Mae and our activities at the response we get throughout our industry and throughout the Nation. And we did, in fact, contact constituents in virtually all of the districts of Members of this subcommittee, and perhaps beyond this subcommittee, and asked them to express their support for us and their concern about this bill.
Mr. SWEENEY. Where were those lists obtained?
Mr. RAINES. We bought them from commercial houses who have lists of homeowners in yours and other districts. But the tone of these letters I think is exactly appropriate, and let me read just the first two paragraphs:
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''I wanted to rush you a quick note and let you know how much I appreciate all you are doing on behalf of homeowners and for home ownership in America today. Home ownership in America is at an all-time high, and that is due in large part to the policies that you and other Members in Congress have supported in recent years.''
Mr. SWEENEY. Reclaiming my time, let me make this final point. You made the statement earlier that ''We have never accused any Member of trying to damage home ownership'', yet in this letter you, as well, say, ''However, there is a bill today that has already had negative impact on mortgage costs.''
That directly contradicts what you have said to Mr. Riley and to Mr. Ryan and to other Members. And I, as a Member who I think was more in the middle on this than any other Member, that may feel that there is not a need of great change, am offended by that.
Mr. RAINES. Mr. Sweeney, I think this letter is very clear. It does not accuse any Member of trying to hurt home ownership. It does say that this bill can have that effect. And it is not just Fannie Mae that believes this bill can have that effect; there are many people in the housing industry—certainly, I cannot believe that you are saying that we cannot critique the bill.
Chairman BAKER. Mr. Sweeney, can we can wrap it up?
Mr. SWEENEY. Let me suggest this, that if there has been an adverse impact on the market, it may not simply have been the hearing or the testimony of any of the witnesses in March; it may also be as a result of the actions of Fannie Mae, and I caution that you go very slowly here.
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Mr. RAINES. With all due respect, I think that we are prepared to accept any criticism that we deserve. But just to be very clear on this letter, this letter does not criticize a witness; it does not criticize a Member.
The letter says very clearly, ''There is a bill, H.R. 3703, that has already had a negative effect.''
So we have tried to be very, very careful about the kinds of things that we say, and we try to be very, very careful here that our objection is to a bill that we hope will not be enacted. It is not to a hearing, not to a Member, not to a witness, not even to an idea; but it is to a bill.
Chairman BAKER. Mr. Raines, I do not want to arbitrarily conclude the discussion, but in fairness to Members we do need move on to others who have been waiting some time. And I think it is clear, the only persons to whom any correspondence may have reference would be myself and Chairman Leach as offerers of the bill. That would be it, as I have read the letter that has been transmitted.
So I understand the issue and I am comfortable with it.
Ms. Waters, you are next.
Ms. WATERS. Thank you very much, Mr. Chairman and Members.
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First, I would like to compliment both Mr. Raines and Mr. Brendsel for their testimony today. I think that you have, in the best way that I have ever witnessed in this subcommittee, explained who you are, what you do, how you do it; and many Members who are sitting here today are understanding for the first time some of the intricacies of how you work and why now we all, I am sure, understand, based on your testimony, that you are at no great risk.
But I do think there is one little thing needs to be cleared up, and I am going to ask you to do that so that we can put this question about whether or not there was an increase in interest rates to rest.
I am very clear that what you have said is that there was an increase in the cost of the money that you borrow. I think the previous chart that was put up by my colleague on the other side of the aisle tried to compare that to the interest rates in the market, rather than looking at the cost to you.
You need to explain, I think, that, yes, there was this increase in the cost of borrowing and that you did not pass it on in any way. But there is a difference between what they show and what the experience was that was described by both you and the Wall Street Journal and other publications.
Will you please illuminate on that and explain, so that the Members of the subcommittee understand the difference and we can all be clear about it?
Mr. BRENDSEL. Well, let me start on this, and as I said before in this hearing, this morning, we were in the market that day. We did see an increase in the cost of our borrowings, and in fact we saw an increase in the yields on our mortgage-backed securities relative, for example, to Government-guaranteed mortgage-backed securities. There is no doubt in my mind that that is reflected in mortgage rates.
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Now, there are other things that influence mortgage rates, the Federal Reserve actions that are influencing mortgage rates that you actually observe and record. In fact, I am not certain where this particular source of information came from.
Chairman BAKER. That is the Freddie Mac home page posting on Thursday.
Mr. BRENDSEL. But we do conduct a survey of mortgage lenders, and we study this a lot. And as everyone knows, there are a variety of influences on mortgage rates that cause them to change over time.
But it did increase our costs. It did increase yields on mortgage-backed securities and contributed. Otherwise, mortgage rates would have been lower would be a different way of saying it.
Ms. WATERS. Thank you very much. I would like to get this on the record.
I have been one of the greatest critics of Fannie Mae and Freddie Mac; and on more than one occasion, we have faced off about everything from ads to statements, studies, you name it. And I am going to continue to do that, so I don't want anybody to think that somehow I am going to support Fannie Mae or Freddie Mac in whatever they do.
I want you to put more money into my community. I want you to buy more of those loans in the secondary market. I want you to expand the way that you operate so—I mean, I want it to be understood that I think that it is incumbent upon all of us to make sure that we get the best that we can get for our constituencies. And for all of those who are involved in FM Watch, I would like to have the opportunity to interact with you and have you interact with my constituents in the same way that Fannie Mae and Freddie Mac have been doing.
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So even though today I support you 100 percent in saying that there is nothing wrong here, there is nothing that needs to be fixed, and that, yes, if there is an implied thought in the overall community that somehow you are Government-backed, and if that inures to all of our benefit, that is fine. But as you said, I cannot calculate any implications and that is that.
But let me just close by saying that I can tell you that you have done well here today and let me tell you what the measure should be. Not my simply saying so, but when the Chairman admits it. He does not admit that very easily and when he compliments you, you can take it to the bank.
Thank you very much.
Chairman BAKER. I think that was a compliment. Thank you.
Chairman Leach, you would be recognized.
Mr. LEACH. Thank you very much.
Mr. Hage, in the proposed rules that are circulated by the oversight board for the Federal Home Loan Bank system, a stock will be tradable in such a manner that a single entity will be able to control an individual Federal Home Loan Bank.
Do you think this is appropriate or inappropriate?
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Mr. HAGE. As the capital rules are being suggested and proposed and the notion of capital being more fluid than it has been in the past, there are serious questions that need to be addressed. It is of concern that—the notion that larger shareholders would have the power to control the system by the quantity of stock that they would own and be able to vote. It has also been a long-standing concern of those large members, who have had a large amount of stock, that have been denied the right to vote their stock. It is a matter that has merit on both sides and has concern on both sides.
Mr. LEACH. Let me stress to this subcommittee a couple of aspects about privilege, that this panel suggested we should maintain the status quo. One is that the Federal Home Loan Bank system is federally untaxed. Under the rules that are being promulgated within it today, an entity could take it over and therefore take advantage of its untaxed status. That is not the intent of anyone that I know of in the United States Congress, and it is an aspect that this subcommittee is obligated to comment upon.
Second, as Freddie Mac and Fannie Mae well know, both are exempt from the payment of State taxes. Fannie Mae is the most profitable institution per employee in the United States of America. Freddie Mac is the second most profitable institution in America of any kind. And yet you are privileged from the payment of State income taxes.
So let me ask, is that fair, Mr. Raines?
Mr. RAINES. The determination to exempt Fannie Mae from the payment of State income taxes is, I think, grounded in public policy and not meant to favor the companies. But, it was one of the things that Congress did to ensure that mortgage finance could flow at the least expense, but I think, more importantly, was a concern that if you allowed the State in which we were located to levy a tax on us, that that would simply be a way to export that tax around the country. Whatever State that was would be able to collect a tax on all mortgages in the United States without their own constituents feeling a proportionate share of the burden.
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So I believe, as a matter of public policy, that exemption was there to prevent that from occurring, to prevent one State from being able to collect taxes from around the whole country and bring them all into any one State.
From the standpoint of the company's activities, you know, we probably could engage in the same activities that other companies do to minimize taxation. Our effective tax rate is higher than that of most companies, because we cannot engage in the kind of activities, such as leasing and other things that can drive down your tax rate. So even with the exemption from paying State income taxes, our effective tax rate is higher than most of the tax rates of our critics. And I doubt that they would want to switch with us in terms of whose effective tax rate they would like to have.
Mr. LEACH. Let me ask a second question on arbitrage activities.
The Federal Home Loan Bank system leads the country in arbitrage. Fannie and Freddie are very high; Farmer Mac, on a percentage basis, is number one. So let me just ask your judgment on another GSE.
Do you think it is credible for Farmer Mac, a Government Sponsored Enterprise of approximately $50 million in capital, to have several billion dollars in arbitrage activity?
Mr. Brendsel, is that appropriate?
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Mr. BRENDSEL. I can't speak with regard to Farmer Mac knowledgeably. I can say that we do not engage in arbitrage activities.
Mr. LEACH. You have never engaged in arbitrage activities?
Mr. BRENDSEL. We have never engaged in arbitrage activities.
Mr. LEACH. Well, you may recall getting a letter from me a few years back in which it was pointed out that on an instantaneous basis, that is, within seconds, Freddie Mac had taken down a given amount of money on a multiyear Government basis and purchased a Philip Morris bond. Is that not arbitrage?
Mr. BRENDSEL. That is not arbitrage.
Mr. LEACH. What is it?
Mr. BRENDSEL. Let me explain. Put Philip Morris off to the side.
Clearly, that was an error in judgment about the particular name that one invests in, given the amount of, I think, discredit it brought to what we are doing. We do make investments that are non-mortgage—in non-mortgage assets. They are a very small, but essential part of our mission. They are used to manage the cash flow as well as to hold a small amount of capital in reserve to support——
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Mr. LEACH. How is that managing cash flow if you buy a bond, the same duration, at the exact same moment that you take down Government money? Your access to the Government borrowing capacity? Is that anything except your stockholders taking the differential, which in the general term of art is considered arbitrage, although maybe in your definition it is a good investment in the Philip Morris bond?
I mean, is buying a Philip Morris bond, is that part of your mandate as a Government Sponsored Enterprise in housing?
Mr. BRENDSEL. Holding a small amount of our assets in high-quality, low-risk investments——
Mr. LEACH. Long-term, this was a long-term bond.
Mr. BRENDSEL. I can't recall the particular maturity of that bond. A vast majority of the maturities of our non-mortgage investments are short-term, ninety days or less. They are high-quality, triple A rated. They are done for purposes of managing the cash flows of the corporation and holding a capital contingency in reserve so that we can liquidate that investment and step into the mortgage market. And indeed we have shown historically that is indeed what we do.
We will, when we need the capital, step in; if we cannot go out into the capital markets and raise it, we sell off an asset, this small contingent reserve, and go into the market to buy mortgages and mortgage-backed securities.
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Chairman BAKER. Mr. Chairman, I am reluctant to do this, but do you have one more to wrap up, sir?
Mr. LEACH. No, sir.
Chairman BAKER. Thank you, Mr. Chairman. I hope you do not remember that.
Mrs. Roukema, are you back? No.
Mr. Manzullo. I am sorry. I don't know what I am doing. I was looking at the wrong list.
Mrs. Maloney is next.
Mrs. MALONEY. Thank you, Mr. Chairman.
Some critics of GSEs have charged that you are not doing all you are capable of doing to increase minority home ownership. Some have argued that banks actually serve a higher percentage of minority borrowers than the GSEs. Is this true? Is this a result of the GSEs only being able to buy loans that originators choose to sell them?
And I ask anyone to comment.
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Mr. RAINES. I would love to start on this one.
Fannie Mae has had a policy over the last decade of ensuring that we focus on those who have not benefited from home ownership over this period. And we believe that we and the entire secondary market have been successful in beginning to make progress on the extraordinarily low home ownership rates that exist in the minority community in the United States. Virtually all minority communities in the United States have home ownership rates below 50 percent, whereas the white home ownership rate is around 73 percent. And we have made tremendous progress.
The chart that we have up here shows the actual change in our business mix over the period from 1993 to 1999 where you can see that our loans to African Americans are up 31 percent over that period; loans to all minorities up 16 percent. And loans to whites have actually declined in that period in our book of business. So we have made extraordinary progress over this time.
I have pledged over the next ten years that we are going to invest over $400 billion in moving up minority home ownership rates. We are committed to that as a company, and I believe that we will achieve that goal.
Mr. BRENDSEL. If we could leave that same chart up and I could talk to it for Freddie Mac at least.
Indeed, Congresswoman, as you said, we are in the secondary market. We do buy loans from originators; we do not make those loans directly. Nevertheless, that is not an excuse for any performance or lack thereof, and we are always trying to do better. In fact, I am very proud of Freddie Mac's record of service and particularly the progress in our record of service.
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We could always get into debates over statistics and numbers and trying to compare the performance of one market to another, and primary to a secondary, and there is a lot of misinformation out there. But let me just say that our focus is to reduce the costs of getting the mortgage loan, the down payment, the closing costs, mortgage rates; develop innovative new products, outreach, education for minority families, potential home buyers. And indeed the statistic that I remember from our own that stands out is that since 1993, our purchase of loans that were made to African American families have increased by over 50 percent since 1993.
Mrs. MALONEY. Thank you.
Would you like to comment?
Mr. HAGE. Thank you, Congresswoman.
The Federal Home Loan Banks, through their affordable housing program, are deeply involved in making loans and grants, actually, to low-income people of all neighborhoods and of all sections of our country. In 1998, we awarded $199 million. Over 230,000 units of housing were funded since 1989. We are the largest single contributor to Habitat for Humanity affiliates in helping them rebuild homes and put families in homes.
So affordable housing is indeed a very strong part of the Federal Home Loan Bank program enhanced by our AHP funding. We are also supported by the activities of our members in individual communities who make loans daily.
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Mrs. MALONEY. Thank you.
I would like to ask Fannie and Freddie, what are the ramifications of automated underwriting for minorities? Specifically, how do you ensure that automated underwriting is not so strict that borrowers with unorthodox credit histories are shut out?
Mr. RAINES. Well, one of the most important implications of automated underwriting for minorities is that, for the first time, we have a tool to eliminate explicit racial discrimination. The automated underwriting does not know what your race is, does not know what your accent is, does not know what where you live. It underwrites your application, based on criteria that in Desktop Underwriter we have validated as being racially neutral.
We have done an enormous number of tests to determine that the factors that we use are racially neutral; and indeed we have published the fourteen factors that we use in our system so that everyone can look at them and judge them. We also ensure that we are only looking at those things that predict default in mortgages and do that quite accurately.
But, we do not rely on automated underwriting solely. We always use automated underwriting to approve borrowers, but it can never disapprove someone. All it can do is refer them to a human underwriter. And we have a number of loan programs that explicitly take into account unorthodox credit histories where someone may not have the same credit cards and other things that would show up in the normal credit reporting, but they have diligently paid their rent and utility bills.
So we allow alternative underwriting standards to be used by human underwriters to be able to respond to the great diversity that we find out in the community.
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So automated underwriting really is a way to reduce discrimination, speed up the process, and indeed free up the human underwriters to work on the harder cases, because they do not have to work on the easier cases, because our system exists.
Mr. BRENDSEL. We began developing automated underwriting systems back in the early 1990's. We have a database of roughly twenty million mortgage loans that we have purchased. In addition, we got a lot of data from other sources and developed what I think is an outstanding automated underwriting system.
But we do not rely on that, in and of itself, exclusively. Like Fannie Mae, we combine that with human judgment, human review such that no one is ever turned down because of a simple score.
In addition, to add to that, some of the—clearly some families have impaired credit histories that an automated underwriting system may penalize them for. It is because of the ostensive predictability of it. But what we have done is develop some additional mortgage products and programs like—what we call Credit Works that enables a family to go through a credit counseling education program and at the same time get a loan at a prime rate and give the family the chance to demonstrate that they can manage their credit and make their mortgage payment; and we have been very pleased with that type of product.
And indeed, I might also add that it is those types of innovative products and programs that would be, I think, interfered with by this particular legislation. Because it would require prior approval of all those innovative mortgage products by a regulatory process that would only stifle innovation and increase costs.
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Chairman BAKER. Mr. Brendsel has exhausted your time, Mrs. Maloney, by a considerable amount.
Mr. Manzullo.
Mr. MANZULLO. Thank you.
On May 2, 4 and 9 my office also received anonymous boxes full of 500 envelope-sealed form letters expressing opposition to this bill. Two thousand letters in two weeks catches anyone's attention, but something did not smell right; so I had my staff call thirty of the people who had written in. The first nine people knew nothing about the letter.
I then came across several constituents who remembered receiving a telephone call about having their name placed on a petition to Congress about decreasing the cost of home ownership and having Congress lower interest rates. Three of those constituents did not recall who contacted them, but they thought it was a not-for-profit affordable housing group.
Many constituents clearly remembered who contacted them: Fannie Mae, the Fannie Mae Foundation, and the Coalition for Homeownership. Some constituents received a copy of the letter with their name on it from the Coalition for Homeownership, and three had explicitly told them not to send the letter, but they did anyway. Some received a copy of the letter and had never been contacted about anyone sending the letter. Finally, some persons said that the name on the letter was a relative who had never lived at that address and they could not figure out how the name got attached to the address.
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Most of my constituents were upset that their good name had been used by your company. I am upset also. No one knew that the letter was being sent on their behalf on a specific piece of legislation.
I have several questions, Mr. Raines, to ask you. What role has Fannie Mae's corporate headquarters played in this lobbying effort and exactly who makes up the Coalition for Homeownership?
Mr. RAINES. Congressman, we are quite direct about our involvement in contacts with Members here. We authorized the phone calls to be made. We asked people to authorize the sending of the letters. We were very explicit, and I can read to you the script that was used.
Mr. MANZULLO. Who is the ''we''?
Mr. RAINES. Fannie Mae.
Mr. MANZULLO. What about the Coalition for Homeownership?
Mr. RAINES. We expressly said that the Coalition is sponsored by Fannie Mae. There is no deception of anyone.
Mr. MANZULLO. I just called your headquarters before I came here. I asked to speak to somebody from the Coalition of Homeownership, and no one had any idea what that organization was.
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Mr. RAINES. Congressman, I am the Chairman of Fannie Mae. I am telling you we are the sponsor of the Coalition. You will be learning more about the Coalition as time goes on.
Mr. MANZULLO. I hope not the way that we did. I mean, did you contract with anybody to get commercial lists for this?
Mr. RAINES. Absolutely.
Mr. MANZULLO. With whom do you contract?
Mr. RAINES. I don't know the name of the contractor.
Mr. MANZULLO. How much did you spend?
Mr. RAINES. I don't know, Congressman.
Mr. MANZULLO. Could you give us that information before the day's end?
Mr. RAINES. I can get you that information, Congressman. But the implication you raise that there is anything wrong with a company seeking support and asking supporters to send letters to Congress.
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Mr. MANZULLO. You contacted my constituents, and three of them expressly told you not to use their names and you did. And you are telling me there is nothing wrong with that?
Mr. RAINES. Congressman, I would be very happy to go and check to see any cases where anyone's name was used, unauthorized.
Mr. MANZULLO. I want you to send letters to 2,000 of my constituents apologizing for using their good name. This is bogus lobbying.
Mr. RAINES. Congressman, I reject that notion thoroughly.
Mr. MANZULLO. You don't have to reject it. You are not the one being lobbied; I am. These are my constituents.
Mr. RAINES. You are also being lobbied by our opponents, who also have letters coming to you.
Mr. MANZULLO. We got letters from no one else. No one else.
Mr. RAINES. You may be the only Member of the subcommittee then who did not get letters from anybody else.
Mr. MANZULLO. Did the Foundation play any role in this?
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Mr. RAINES. Absolutely not. Absolutely not.
Mr. MANZULLO. So you see nothing wrong in using people's names without their permission?
Mr. RAINES. I do see something wrong with that. I say that in each and every one of these cases that I am aware of, we got their permission.
Now, that is not to say——
Mr. MANZULLO. I have 2,000 people in my congressional district and would like you to call every single one of them and get verification in writing that they authorized to you use their good name to lobby me on your behalf. Would you be willing to do that?
Mr. RAINES. We would be happy to go back——
Mr. MANZULLO. Every single one. And not at taxpayers' expense. At your own expense.
Mr. RAINES. Congressman, we would be happy to go back and contact each and every one of them to verify that they, in fact, have the position that they said over the telephone was their position. Each one of them was sent a copy of the letter that was sent to you. Each one of them has a copy of that letter. Each one of them was told exactly——
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Mr. MANZULLO. There are people who sent letters from addresses that do not even live there. I don't know where you got your commercial lists.
Mr. RAINES. Maybe you have got a better list than we have got.
Mr. MANZULLO. I do not appreciate that.
What I do appreciate is this. I represent 700,000 people. They do not like to have their names used wrongly for the purpose of a bogus lobbying effort. And I reject those 2,000 letters. Most of them have no idea what is going on with this bill, and you used their good names to try to have some grass-roots effort, and I am telling you it is not working.
Chairman BAKER. Mr. Manzullo, your time has expired. We do have a vote pending.
I would like to give Mr. Raines any opportunity he would like to respond further.
Mr. RAINES. Well, my response is simply this. We will ask for support from people in the United States to support the secondary market. We will ask them to contact their Members to express their point of view. If any letter came to you that was not an accurate expression of the views of a constituent, I'm sorry for that, and we will endeavor in the future to ensure that that does not occur.
The thing I cannot——
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Mr. MANZULLO. Then you are going to——
Mr. RAINES. Congressman, please, please, if I could just finish.
The thing we do reject is the idea that we can be attacked, that we can suffer these kinds of attacks and not call on support. You can reject the support; we do not say that you have to respond. But we do have a right to solicit people to come to our aid on a matter before the Congress, and that is what we have done.
Mr. MANZULLO. Then solicit it with integrity.
Mr. RAINES. And we tried to do that.
Mr. MANZULLO. Then you failed.
Mr. RAINES. That may be your view, Congressman. We believe we tried very hard to do this.
There is nothing secret about what we have done. We have been up-front in everything we have done, and we intend to continue to try to make our case in the best way we can.
Chairman BAKER. Mr. Raines, we do have a vote pending. I hate to ask your patience and long suffering. When we get back, Mr. Bentsen would be next up in the line of questions.
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We will recess and try to return as quickly as possible. Thank you.
[Recess.]
Chairman BAKER. I would like to call our hearing back to order again, and ask everyone if they would please take seats, and we will reconvene. Thank you.
When we recessed, Mr. Bentsen, you were next up, so please proceed. Sorry.
Mr. BENTSEN. Thank you, Mr. Chairman. It has been very interesting. I have a number of questions. I do want to make a couple of observations as well.
First of all, I want to remind my colleagues, none of whom are here, but I want to remind my colleagues with respect to this issue of Fannie or Freddie mortgage-backed securities and/or debt becoming a new store of value or interest rate of record as the Federal debt goes down, Members should not be too alarmed by that.
Chairman Greenspan testified before the full committee earlier this year, and I raised the question with him as to what would become the new debt instrument that we would look at to peg interest rates off of if, in fact, we paid down the national debt over the next thirteen-or-so years, and he said there would be other issues in the market that would be found. And the mortgage-backed security market clearly is a somewhat more stable entity. So it shouldn't come as a great surprise, I think, to Members that this may be one factor. Whether or not that has a nefarious impact on the rest of the market I think is highly questionable.
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I would ask both Mr. Raines and Mr. Brendsel if you could answer a few questions for me. One is, there has been a great deal of discussion with respect to your debt about the leverage and capital ratios as compared to commercial bank debt and to securities, SEC capital ratio requirements, and even derivative arbitrage operations.
My personal feeling is that you were talking a little about by apples and oranges, but I would like you to address that and what quality of the security is with the debt issues.
Second of all, there is a concern about imminent demand on the part of the GSEs; thus, as long as we are able to issue debt at favorable rates, because of the implicit Federal guarantee, therefore, you have money in search of assets to invest in. What is your opinion of that?
Mr. Raines made one comment that he thought the upper end of the market would be $5 trillion, assuming that you acquired every mortgage loan that was outstanding, if you could elaborate on that. If you could give me a breakdown in your asset base of single family mortgages versus home equity lending and home improvement lending, to what extent does this non-traditional product make up the part of your asset base? And then if you would add to that the question, following up on what Chairman Raines said, regarding non-mortgage-related investments, what percentage of your assets are non-mortgage-related investments and how liquid are they? Do you have a liquidity test for that?
Mr. RAINES. Let me take a crack at it first. We do not believe there is an unlimited market for our debt. Our debt resides between Government and corporate, and we do not possess an unlimited market. Indeed, as we try to issue more debt, the cost of that debt goes up, and as the cost of that debt goes up, we cannot afford to buy mortgages. So we are constantly working all the time, trying to expand the market for our debt. It is bought on its merits, and the market understands the merits of our debt compared to other debt; and we have to work as an issuer very hard to find expanding sources of funds to invest in our debt. So we, like any other issuer, are limited by the appetite of investors.
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In terms of the growth of Fannie Mae and its role in the marketplace, we have grown about 1 percent of market share a year over the last ten years. My goal is to grow another 1 percent a year over the next three-and-one-half years. Ultimately, we do not know what our share of the market will be, because we don't know how competitive other players in the market will be over time. Right now, for example, banks are very competitive, because the market has moved toward an adjustable rate mortgage market where they have the lion's share of that business. So in a given market, we may be more competitive or not competitive. So I have no idea what the ultimate position will be thirty, forty or fifty years from now, as the mortgage markets develop.
In terms of our non-traditional product, by far, thirty-year fixed rate mortgages is our largest product. But we have had second mortgages for many years. The percentage of those has gone up slightly in the last few years. We expect it to continue to rise slightly in coming years as second mortgages become more popular among homeowners who are seeking to improve their homes.
With relation to the liquid assets, I put up a chart earlier that showed that about 8 percent of our assets are liquid assets that are held as our liquidity portfolio. We have an internal limit set by our board of directors of 15 percent of our assets. We have, in fact, drawn down our percentage of liquid assets since 1998, as the demand in the marketplace for us to be out buying mortgages increased. So we have reduced our liquidity portfolio from what had been its peak now down to 8 percent. That is all very liquid assets, typically AAA, short-term securities where we could go and sell today, get the cash, and use that for buying mortgages immediately. So that is a very, very small percentage of our base, but one that any financial firm is required to have in terms of liquid assets.
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Mr. BRENDSEL. Let me take a crack at those three questions, Congressman. First, with regard to our debt, the size of its growth over time, the extent of its growth and so forth, we expect that the mortgage, talking about the total mortgage market in terms of mortgage debt outstanding, over the next few years our forecast is that total mortgage debt outstanding in the Nation, rising from the $5 trillion number, will grow in the neighborhood of 8 percent. Indeed it has been growing slightly higher than that within the last few years, but our anticipation is right around 8 percent.
I expect that Freddie Mac as a share of that or its own growth rate in terms of its holdings of mortgages, financed both by mortgage-backed securities and debt, will grow slightly more rapidly, maybe a couple of percentage points more. That would mean that, for example, as a percentage of total mortgage debt outstanding today, Freddie Mac is slightly smaller than Fannie Mae, we have about 17 percent of that share. We are likely to rise to 20 percent or so; in five years, 20 or 21 percent.
With regard to how the split occurs between mortgage-backed securities and debt financing, that depends on investor preferences and investor demand for the types of instruments they want to hold, it depends on, frankly, our success in developing a new international base for some of our securities, particularly for what we call our reference notes and bonds. I don't expect that——
Mr. BENTSEN. On that point quickly, this was raised earlier, the question of buying back MBSs for your account. Is that purely a pricing issue as to whether or not you hold the mortgages in your own portfolio backed by your corporate debt, versus buying the mortgage-backed security through the market?
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Mr. BRENDSEL. Yes, while it strictly depends on the cost of financing once you take any differences in risks into account. Indeed, as we approach this, we approach it in the way that——
Mr. BENTSEN. The risk difference is an interest rate risk, it is not a credit quality risk, right?
Mr. BRENDSEL. That is correct.
Mr. BENTSEN. I think that wasn't made clear earlier.
Mr. BRENDSEL. Indeed, the way we manage our debt finance portfolio, there is only modest differences with regard to interest rate risk between that and a pass-through financing, and it is all taken into account in terms of how closely we match our assets and liabilities and, ultimately, the amount of capital that is held against that. Indeed, when you go to the risk-based capital rule as proposed in the 1992 legislation that is currently under development in a proposal by OFHEO, it carefully considers how that portfolio will respond to changes in interest rates in the economy as with regard to credit risk, any change in credit risk as well.
As a result, the conclusion out of that is that we are highly capitalized, we are safe and sound, and as I said in my opening statement, the risk-based capital rules, as proposed by OFHEO, would subject us to a much more stringent capital standard to support both or all the risk of the business, including management operation risk, than that imposed on thrifts or, in fact, any other mortgage financial institution in the country.
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With regard to home equity, second mortgage loans and so forth, we have, like Fannie Mae, purchased second mortgage loans for years, going way back at least to the early 1980's. I don't have the precise number in front of me. I would be willing to provide it to you, but I could say that it is less than 2 percent of our total mortgage portfolios, second mortgages, and home equity at the current time.
Finally, with regard to non-mortgage investments, there was some discussion about that earlier; we hold—any of our assets, I might say, must meet the dual test. One is, in support of mission and the purpose for which Freddie Mac is chartered, legally authorized, and second of course, obviously being approved by—that investment policy being approved by the board of directors. Currently, any non-mortgage investments as a percentage of our total mortgage portfolio, asset portfolio, is roughly 3 percent, and that is really held for purposes of liquidity and capital contingency to enable us to step into the mortgage market at any time.
To maybe give you an idea on the liquidity, we are constantly in the process of collecting cash flow, cash payments from our mortgage servicer and moving them on through to investors, investors in mortgage-backed securities as well as our debt. In any given month, that number that flows through may be $15 billion or $20 billion, and obviously that has to be invested, even on a short-term basis, in highly marketable, highly liquid securities, and that is one of the purposes of our liquidity portfolio, in addition to capital contingency.
Chairman BAKER. The gentleman's time has expired.
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Next would be Mr. Toomey.
Mr. TOOMEY. Thank you, Mr. Chairman.
I had a series of questions for Mr. Raines, if I could. First let me thank the witnesses for joining us today. I guess I would like to discuss the issue of the implicit guarantee and specifically I guess I would start by asking, do you believe that there is an implicit guarantee of the financial performance of Fannie Mae on the part of the Federal Government?
Mr. RAINES. I don't believe that the Federal Government has entered into any such commitment to investors that there is a guarantee for investors of our debt. What investors expect is two things: one, that the Federal Government, having chartered us, will ensure that we are regulated in such a way that we will be able to meet our obligations in a timely way; two, they expect that we are such—having chartered us in the secondary mortgage market, that we are an important aspect of housing policy, and therefore, there will not be a matter of indifference to our continuing to operate in a safe and sound way. Therefore, we will continue to qualify to be in that agency market between Governments and corporates. I think that is what people expect. I think that is what most people mean when they say implicit guarantee. I don't mean that people really think that someone can walk up to the United States Congress with one of our bonds and say please pay it.
Mr. TOOMEY. No, no. Do you share the view that the market believes that there is an implicit guarantee, that the market believes that the Federal Government would not let Fannie Mae fail to perform on its financial obligations?
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Mr. RAINES. You just said two very different things. One is that there is a guarantee, and the other is that they would not permit us to fail to perform. I believe that the market believes the latter, that the Government would require us to perform and to be run in such a way as that we would perform in all but the most extreme circumstances.
Mr. TOOMEY. I am going a step further, saying I think that the market believes, in fact, that if all best efforts failed, the Federal Government would do whatever it took to make sure that investors, certainly at least in debt securities, were made whole, and I think that that is a rational conclusion that the market draws from a series of benefits that Fannie Mae derives from explicit policy.
If you look at things—you know, the fact that banks are permitted to invest unlimited amounts in GSEs, the authority to use the Federal Reserve Bank in ways that other institutions are not able to, exemption from State and local taxes, I mean there is a whole series of measures that treat the GSEs uniquely, and I think they go to this issue, and I think that the pricing of Fannie Mae debt clearly reflects that. I mean, Fannie Mae has a lower cost of funds than it could have without the implicit backing of the Federal Government.
Mr. RAINES. Actually, let me quibble with you a little bit on that, because if you look at the pricing of our debt and compare that to Treasury's, which is riskless, on our ten-year debt we pay 125 basis points more. On our thirty-day debt we pay 110 basis points more.
Mr. TOOMEY. I am not saying that they are exactly equal.
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Mr. RAINES. But that is a lot. I mean, that is the market saying we see a big difference here in the matter of guaranteed debt.
Mr. TOOMEY. Here is the thing. The folks at S&P have publicly stated that if Congress moved in the direction of changing the relationship and changing that implicit backing, there would have to be a reassessment of the credit rating, and given the capitalization of Fannie Mae and the size of its balance sheet, that would make sense, and that would suggest higher cost of funds in that event. So the market is attributing of value and it is quantifiable.
My point is that I think, like any guarantee, there is a cost to that. The cost is not necessarily explicitly paid in cash, but there is a cost in the form of a risk transfer to taxpayers, and that is embedded in this guarantee.
So when we look at the activities of Fannie Mae, we have to ask ourselves, how is that cost being divided? It seems to me it is divided, in part, to the shareholders of Fannie Mae who have earned superior rates of return by just about any measure you could apply, and it also extends to lower mortgages. So there is a combination of the subsidy that comes from this implied guarantee. It goes in a combination of ways to the shareholder and to lower cost mortgages. Do you accept that?
Mr. RAINES. Well, we believe we have demonstrated consistently over a number of years, that the entire benefit that we receive from our charter is passed on in lower costs to consumers, and it is not shared by our shareholders.
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Indeed, Fannie Mae's financial performance is outstanding, but it is no more outstanding than other outstanding financial companies. There are other companies that have higher returns than we have and they certainly have higher stock prices and higher P/E ratios than we have. So a superior company can achieve the returns that we have achieved without partaking of the subsidy, as you described it, as part of that return.
We believe that it is clear, based on a request actually from the Chairman to OFHEO when he asked S&P to rate us, most recently S&P rated us AA-minus. There are only seven financial institutions in the United States who have a AA-minus rating, so we are one of the top-rated companies, putting aside any kind of Government backing that we may have, and we believe our financial returns have more to do with our risk management capability than with the subsidy.
Mr. TOOMEY. I fully acknowledge the quality of the risk management of Fannie Mae; it is well-known. But CBO certainly thinks that part of the taxpayer subsidy goes to the benefit of shareholders, and if you look at the consistent well-above-market-returns that Fannie Mae has generated over time, when compared to anything resembling a peer group, I think it is hard to attribute all of that superior return to just being more sophisticated and better at managing risk.
Anyway, my point is that—and we may disagree on this, but it strikes me that the evidence is pretty strong anyway—that this subsidy that comes from the taxpayer goes both to lowering mortgage rates and to generating better rates of return. For instance, in the absence of the implicit guarantee, it seems to me quite likely that Fannie Mae would be compelled to raise equity capital in the marketplace to—you know, if you played out a scenario in which there was no Government involvement.
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Chairman BAKER. You have exhausted all of your time, Mr. Toomey, if you could wrap it up.
Mr. TOOMEY. I will wrap it up.
My point being, that I think this issue of how this cost is shared between the mortgage, lower mortgage cost and shareholders, is one that obliges Congress to look very closely into expansion in the new areas of activity which could actually increase the cost to the taxpayer, while not necessarily, or at least not proportionately, benefiting the cost of home ownership.
Mr. RAINES. Mr. Chairman, if I could just respond quickly. I agree with you that that is a legitimate question that this subcommittee has to look at consistently. In 1992, this subcommittee and Congress did look at that and came to the conclusion that they needed to make adjustments, and they made those adjustments, by increasing our obligations in terms of our affordable housing goals, and also increasing the capital requirements placed upon us.
In terms of whether Fannie Mae could operate successfully as a business in the absence of its charter, I think the answer is simply a resounding yes. We are rated AA-minus without the charter. The only difference you would have is that the benefits we now pass on to consumers, they wouldn't get, because we wouldn't have them to pass on to them, but Fannie Mae would be a successful company with or without the charter.
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The last point I would simply make is on the CBO subsidy estimates. If you take the CBO subsidy estimates and correct them simply for errors that they made in the calculation of the estimates, you move from us receiving any of the benefits, according to their terms, to us having a net payout of benefits of $3 billion. Remember, even CBO said two-thirds of the benefits passed on. So we are only talking about the $2.1 billion that is in doubt. If you correct that for errors, in fact, using CBO's methodology, you would see that all of the benefit is, in fact, passed on to the marketplace.
Chairman BAKER. Mr. Brendsel, did you want to respond?
Mr. BRENDSEL. I am not certain whether to enter into this discussion or not. It is the age-old question about the implied guarantee, and so let me just summarize my view this way with regard to part of this question.
One is benefit to homeowners versus the benefit we enjoy in the capital markets. I don't think there is any doubt but that we are able to finance ourselves in a way, access to the capital markets, size, liquidity, rate, albeit a much higher rate than paid by the Treasury or whatever, than what we would otherwise be able to do were we not a very special company chartered by the United States Government.
The question then is whether or not the homeowners benefit exceeds or is smaller than this capital-raising capability. I think the CBO numbers, which goes back to the 1996 hearing around this, my view is more discredited. I think Chairman Raines shed some light on that. And second, beyond that, there are benefits to home buyers that don't get simply measured by that.
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Indeed, a different way of looking at this, asking the question, is what would happen if Freddie Mac and Fannie Mae weren't there as Government-chartered corporations? All you have to do is look to other parts of the market, look to the subprime market, look to predatorial lending and so forth, where Freddie Mac and Fannie Mae aren't today directly involved, and you can start to see a vision and a picture for what the mortgage markets, what the housing finance system at least might be like or trend to.
So we bring competition, we bring small lenders, we bring a whole host of things into the marketplace, into the local communities, that aren't directly captured by simply measuring a difference in currently jumbo rates, or whatever it is, and conventional mortgage rates, which is in the way of how some of these calculations are done.
The final point I would make is that, the fundamental question, are we a risk to the taxpayers? Our securities aren't guaranteed, but are we still a risk to the taxpayers, because of whatever obligations might occur in the future that frankly the Nation, Congress, feels that they might have? The 1992 legislation clearly put in place an approach to regulation, an approach to capitalization that says these companies, chartered for a special public purpose, we expect to remain safe and sound, and they put in place an approach to capital regulation and regulation in general that would do everything possible to make certain that they would remain safe and sound, as judged by the Government, without at the same time imposing unnecessary costs on home buyers and renters.
Chairman BAKER. If I may suggest as to process, we still have four Members who have yet to be recognized the first time, and there are some Members who are indicating a desire to ask a second set of questions. So to the extent—I want to facilitate your appearance—that your remarks can be targeted for the remaining discussion, it would be helpful to everyone.
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Mr. Mascara.
Mr. MASCARA. Thank you, Mr. Chairman. I would ask permission to enter an opening statement into the record.
Chairman BAKER. Without objection.
Mr. MASCARA. While I don't profess to be an expert on Fannie Mae or Freddie Mac, I do want to compliment you for doing a great job, and that might be part of your problem. I will get to that later.
While I do not want to diminish the importance of these hearings, I congratulate the Chairman and Ranking Member Kanjorski for holding them, I do question the genesis of H.R. 3703, GSA reform. I understand you are not perfect and you don't claim to be perfect about what you do, but in earlier testimony and questions, I think we got past the issue of solvency, and I am satisfied with your response, Mr. Raines, to the earlier questions regarding that matter.
But I took some notes, and my notes said you create no debt, you have equity in the loans you purchase, you carry some form of insurance, the full faith and credit of the United States is not issued in this case; there is no risk of insolvency. In fact, you would probably be the last to go if everything went. You are rated double-A, is it? Minus 2, whatever that means, it must be good. And the obligations you have are solely the responsibility of Fannie Mae and Freddie Mac. You invest in high liquid assets. If a bank or thrift finances a mortgage, the paper which it is financed through, Fannie Mae, Freddie Mac, replaces short-term debt for the banks with long-term debt by Fannie Mae. I mean, it goes on and on.
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What I am asking is, and I don't want to put you on the spot, but could it be possible that you are performing too well and that the banks and thrifts that you serve feel that you are encroaching upon their domain somehow?
I ask this question, because in earlier testimony, you talked about the Internet and the use of the Internet, and to either Chairman Brendsel or Mr. Raines, one of you or both of you recently partnered with Microsoft to provide on-line services which could even further speed the process, and it would appear that these technological developments blurred the distinction between loan origination and secondary mortgage market. What assurances can you provide this subcommittee that these activities remain within your mission and do not pose a threat to the market for loan origination?
I would like to cut to the chase. There is something wrong here that I must be missing. What you do, you do well; you are sound, you are serving a lot of people in this country who want to own a home and couldn't own a home if you weren't available to them. Is that part of the problem? Is technology a part of the problem?
Mr. BRENDSEL. Congressman, you brought up Home Advisors and Microsoft, and that is a venture, a partnership by Freddie Mac. Freddie Mac has always been at the forefront of innovation, exploring new frontiers; how to use technology to link up with our customers, with mortgage lenders, and in this case, Home Advisor, which is a newly created company involving several manager mortgage lenders as investors, and Microsoft. But a separate company uses Freddie Mac's technology for automated underwriting, underwriting mortgage loans, combined with the Internet, to allow lenders that are on that site to be able to originate a mortgage loan and sell it into the secondary market using the latest technology and using the efficiencies of the Internet.
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Indeed, we are not permitted by charter to originate, to close a mortgage loan and, indeed, we are not in this venture, and I will be happy to provide, in fact, a letter that I recently wrote to Congressman Royce regarding this particular venture, since I am very excited about it. Indeed, I think it is one of many ways that we can use technology and the Internet to make the mortgage lending process and the financing process more efficient.
Mr. MASCARA. Thank you.
Chairman BAKER. Mr. Raines.
Mr. RAINES. We are not involved in the Microsoft venture. But going to your core question, I believe there are—putting aside this particular bill, because I believe that the Chairman's interest in this bill stems from his interest in systemic risk. So putting that aside, there are people who criticize us because they believe that we will, in fact, bring the benefits of the secondary market to the underperforming parts of the mortgage market in which they have been operating. When they look at that they say, what are we going to do? We have been charging higher points, higher interest rates and giving worse service. And Fannie Mae is now going to bring a system that has worked well for middle class America, worked well for moderate income America, they are now going to bring that to lower income America, and they see that as a challenge and they would prefer not to have that challenge.
So they have banded together, as in the old Washington tradition, to come to Congress and to go to the Administration, go to our regulators and say, please slow them down, stop them, do something to keep them from bringing this market to customers that they have traditionally served.
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Now, we only can go anywhere with lenders, so it is an ironic debate. It is really a debate amongst lenders in which one set of lenders is saying, don't let these other lenders in, because they think these other lenders are going to bring Freddie Mac and Fannie Mae with them. But neither of us can originate a loan, we can only go where lenders want to go; we can only innovate loans that lenders want to offer.
So there is an aspect of competition. But I am sure that you as a Member of Congress and the other Members, this is not new, this is not the first industry in which people wanted to bring competition to Capitol Hill rather than do it out in the marketplace.
We prefer to do it in the marketplace. If others have a better product, they will win. If they don't have a better product, why should they win?
Mr. MASCARA. That is a good response, Mr. Raines.
Chairman BAKER. Your time has expired, Mr. Mascara.
Mr. MASCARA. I thank you, Mr. Chairman. You are doing a good job.
Chairman BAKER. Did you mean me or Mr. Raines?
Mr. MASCARA. Certainly, the Chairman also.
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Chairman BAKER. I was just getting a clarification here.
I would point out that the Members on the Democrat side all have been recognized at least once to speak. There are a couple of Members on the Republican side who have not yet been recognized, so we will do those back to back.
Mrs. Biggert.
Mrs. BIGGERT. Thank you, Mr. Chairman.
Before I begin my question, I would just like to say that many of the local banks and thrifts which originate mortgages in my district belong to the Federal Home Loan Bank of Chicago. Alex Pollock, the President of the Chicago Home Loan Bank, has provided a written statement for today's hearing, so I would ask unanimous consent to submit Mr. Pollock's testimony into the record on his behalf.
Chairman BAKER. I am sorry, I was diverted in my attention. Could I ask you to restate? I will give you your time back.
Mrs. BIGGERT. Since there are many local banks and thrifts in my district which belong to the Federal Home Loan Bank of Chicago, and the CEO and President, Mr. Alex Pollock, has provided a written statement or testimony for today's hearing, and I would ask unanimous consent to submit his testimony.
Chairman BAKER. Absolutely. Without objection.
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Mrs. BIGGERT. Thank you. Based on that, in his testimony, when you get to the end, most every question has been asked, so I would ask your indulgence.
In his testimony, Mr. Pollock suggested that the focus of this legislation should be to encourage competition among the three GSEs that are here by leveling their regulatory playing field for the GSEs to the greatest extent possible. He suggested that the more competitive and efficient secondary mortgage market will benefit both community mortgage lenders and the American home buyers.
So I would like to ask the witnesses if they agree with this suggestion that by encouraging GSEs to compete against one another, the consumer would benefit greatly?
Mr. BRENDSEL. Absolutely. We already compete against each other. With regard to—an additional comment about the Federal Home Loan Banks. I would only say that I think, as Mr. Hage has said to start out with, the Federal Home Loan Banks have a somewhat different mission, have a somewhat different purpose, have a different capital structure and capital standards. So we are kind of comparing apples to oranges in regard to the nature of the institutions.
But certainly in the secondary market, I can guarantee you today and in the future, Freddie Mac and Fannie Mae will be very intense competitors, which is to the benefit of America's home buyers.
Mr. RAINES. Indeed, it was a brilliant stroke to have created both Fannie Mae and Freddie Mac, because we have been very competitive over the years. But let me say a word about the Home Loan Banks. The Home Loan Banks and their traditional role of making advances have a unique role. It is the GSE for banks and it helps them obtain the funding they need to manage their businesses.
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The Chicago Bank, and Mr. Pollock in particular, has been leading an effort to try to expand the range of the Home Loan Banks into actually owning assets, owning mortgages in particular, and to become an active participant in the secondary market. We take no position on whether or not that is good policy or bad policy, but we think it does raise a number of issues that are not addressed in the bill before you.
There are issues of capital, whether or not the risk-based capital standards that Fannie Mae and Freddie Mac have to live with in the secondary market will apply to them. Issues of taxation—as Chairman Leach said, we pay Federal income taxes, they do not. There are issues of housing goals; if you are going to be in the secondary market, do the housing goals, percentage of business housing goals, apply to you as they apply to Fannie Mae and to Freddie Mac? And in terms of the nature of your capital, do you have to have permanent equity that is not refundable, not callable, not in any way temporary, but permanent equity owned by entities that are not using insured deposits to pay for?
I mean, those are big differences. So that if the Home Loan Banks would like to become a bigger competitor in the secondary market, we think there are a whole range of issues that the bill doesn't deal with as to will they have the same structure that has worked so well for Fannie Mae and Freddie Mac in doing that.
Mrs. BIGGERT. No comment?
Mr. HAGE. A lot has been said and a lot has been well intended. The change that is underway at the Federal Home Loan Bank system challenges us all to find the appropriate way for us to respond to our mission. Our mission hasn't changed; it is to be a provider of funding for home mortgages. The notions of purchasing assets has some merit, but it does have many of the considerations that have been already mentioned in terms of capital implication, and risk management implication.
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Mrs. BIGGERT. Thank you.
Chairman BAKER. Thank you, Mrs. Biggert.
Dr. Paul.
Dr. PAUL. Thank you, Mr. Chairman.
Before I ask my question, I did want to relate to Mr. Raines that our office, too, has some experience in calling some of our constituents, and some of them did volunteer the term ''Fannie Mae Foundation'' that they were approached by, and whatever that means, I don't know, but they definitely did volunteer that term.
In my opening statement I mentioned that I was interested in what the Government Sponsored Enterprises do in relationship to monetary policy. Last year, when the Y2K crisis was approaching, the Fed took it upon themselves to be prepared, nevertheless, by increasing credit significantly. Since there were not enough Treasury bills available, the Fed started purchasing the Government agency securities, and they had a large number of these. They started in October and they said they would do this for a period of six months.
After the first of the year occurred and there was no crisis, they sold a lot of these, but they maintain a significant amount, $25 to $30 billion worth, and they then canceled the program in April like they had initially indicated.
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To me, this may or may not have some significance, but you are concerned about losing an $8.5 billion line of credit which you have never had to use, and at the same time, it looks like the Fed is accommodating support; I mean the Fed is a lot stronger lender of last resort than anybody, since they can create the money out of thin air, endlessly. So it seems to me that the stage is set for maybe losing the line of credit and you relying on the Federal Reserve to take care of any potential problems. That certainly came about with a foreign company. Long-Term Capital Management happened to be a foreign company. They came to the rescue there in a hurry to make sure that there were no problems. So I see no reason why the Fed wouldn't come to the rescue.
My question is, are you ever involved in discussions with the Fed? Did you know this was coming about? Does this have any significance? Do you expect the Fed to provide the credit necessary if there were problems in the marketplace? It seems like this is every bit as significant as the line of credit to the Treasury, and maybe even more so. Could you comment?
Mr. RAINES. Well, let me make a couple of comments. First, my understanding is the Fed activity at the end of last year was to make eligible for repurchase agreements, mortgage-backed securities as collateral for a bank to take to the Fed as collateral for the advances from the Fed. Not that they were buying mortgage-backed securities, but that this was an eligible collateral.
Dr. PAUL. That becomes an asset of the Fed; that is listed as an asset.
Mr. RAINES. Yes, if they were to buy it. I don't know if anyone actually did repos with the Fed, using that collateral, but that is what they did. It wasn't that they were expanding their own purchases. They had a program of expanding the use of that collateral as one of the things that people can use.
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Second, I think Chairman Greenspan in a recent speech made very clear what he viewed the role of the Fed with regard to financial institutions that may get into financial difficulties is, and that was to worry about systemic risk and not about the fortunes of an individual entity. I think that is right. I think that the focus should be on maintaining liquidity in the marketplace. Indeed, our risk management techniques depend on the Fed doing its job in maintaining liquidity. And one of the reasons that we invest in such highly liquid assets is to benefit from the market's perception of liquidity. So we are quite comfortable with the Fed's position that if they maintain liquidity in the marketplace, that well-financed companies like Fannie Mae will indeed benefit from that type of a Fed role.
Dr. PAUL. But let me suggest again that the Fed actually holds these securities as assets. Don't you think this would provide a service for you, other than in the broad sense of just increasing credit? I mean the actual purchase of these assets? They are capable of doing it; it is legal for them to do it. There is no law that says they can't. So it seems to me that you have the protection that you need, and the line of credit of the $8.5 billion doesn't have as much meaning.
Mr. RAINES. The Fed has the discretion to buy a variety of assets to carry out their activities. They look for high quality, highly liquid dollar denominated assets. Ours are our debt, and our MBS would fit that category. But they, in their discretion, would decide how to operate in that realm, and I would not want to give the Chairman any advice as to how to do that.
Chairman BAKER. Thank you, Dr. Paul.
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Mr. Royce.
Mr. ROYCE. Thank you, Mr. Chairman. I think there is a little bit of an irony here when we look at the underlying bill that we are speaking to, H.R. 3703. It seems to do very little to manage or restrict the expanding risks of the Federal Home Loan Bank system. And I just wanted to ask Mr. Hage a few questions about that, because the Federal Home Loan Finance Board is pushing regulatory changes that would drive your system to participate more heavily in the Chicago mortgage partnership finance program. This program started as a $750 million pilot. It is now touted by the Chairman of the Federal Housing Finance Board as ''the future of the system,'' in his words. You might know that I have expressed concern over the past few years over the Chicago mortgage partnership finance program.
I believe the so-called Chicago pilot goes beyond the mission of your Federal Home Loan Bank system. I think it significantly increases the risk, both credit and interest rate risk. I am concerned that it takes the system too far away from the traditional advances business and too close to basically managing a portfolio. I am further concerned that the program is now actively purchasing FHA loans expressly guaranteed by the Federal Government. Finally, I am extremely concerned that the capital requirements of the system are significantly lacking.
I don't know how much retained earnings or core capital the system has beyond what members must hold for membership in borrowing. I am sure you could tell me that. I would like to know the new risk-based capital standard in Graham-Leach-Bliley. Does that mirror the risk-based capital standard maintained by Fannie Mae and Freddie Mac? That would be my second question. Third, does the Federal Home Loan bank system have a ten-year stress test that measures extreme swings in interest rate and extreme credit losses? That would be my third question of you.
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Mr. HAGE. Congressman Royce, those questions are not answered today because the capital regulations are still being formed and presented for final rulemaking. There certainly is concern that the addition of member-purchased assets does change the risk profile of the traditional balance sheet of the Federal Home Loan Bank system, and it is my understanding that that risk is being assessed and weighed as the capital regulations are being formulated today. Many of our members have concern about that risk profile and whether that is an appropriate risk and how we are going to manage it, because our underlying concern is that the system remain strong and safe and sound in any environment that it is in.
Clearly, the membership of the Home Loan Bank system still views the advances as the traditional product that it looks to get from the Home Loan Bank system, and that product does allow us to provide credit to housing finance and economic finance in our communities.
Mr. ROYCE. Well, that is reassuring, but apparently there is a conflict division here, because as the Chairman of the Federal Housing Finance Board, he says no, the Chicago program is the future of the system. So I am reassured that your board members view that differently, but it does highlight, I think, a little conflict in debate here.
Mr. HAGE. As I said, the debate is still emerging.
Mr. ROYCE. OK. Well, my other question would be to Mr. Raines. I think that Chairman Baker is appropriately focused on the risk to the American taxpayer and I would like to explore this area with you a little further.
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At least for banks and thrifts, we have all learned a very tough lesson, that the American taxpayer can be called upon to provide a backstop to the Federal Government. And I can assure you that I would be the strongest opponent to any taxpayer bailout of Fannie Mae or Freddie Mac, and I am rather convinced that the debt obligations and securities of these companies expressly state that there is no backing. We in Congress have made that law. But as Mr. Baker stated, I want to make sure that there is no such risk.
So perhaps if you could walk us through how a home mortgage becomes risky, what credit and interest rate protections are there in statute, in regulation, or in your business practice, that stands between the GSEs and the American taxpayer. Perhaps the way you could do this so that we could follow it would be if you took us through the process that occurs when a mortgage goes into foreclosure. What does it mean to the bank; what does it mean to the GSE; what does it mean to the investor? I think that would be helpful.
Mr. RAINES. Sure. I would be delighted to walk you through that.
The key elements in managing the risk in our business are two things; one is the credit risk and the other is interest rate risk. Let me say something about the credit risk, which was the example that you were giving.
When we measure the credit risk of an asset, we first start with underwriting. What are the terms under which we will buy a loan, and what must be the terms that the lender uses in making the loan? What are the criteria for down payment, for credit, for the collateral that we have backing up the loan, what kind of appraisal requirements? So underwriting is a key way that we begin in implementing the process.
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Then we look at the issue of who is going to bear which risk, and we are big believers in risk-sharing. We believe that in order to manage the large level of credit risk we have, we can't simply take all of that risk on to ourselves and believe we can put a price on that; we have to share that risk.
What this chart shows you, for example, on our book of business, $1.2 trillion, how much credit loss protection there is, even before our capital is involved. What you can see here is that we have over $740 billion of borrower equity protecting us in the event that a loan were to go bad. On the average loan that we have outstanding, it is about 40 percent of the value of the home is in equity. So if a loan were to go bad and we were unable to help the consumer stay in the home—which, by the way, we are able to do that in 50 percent of the cases, because people don't just stop paying their loan because they want to stop paying, they stop paying because they got sick, divorced or lost their job. So 50 percent of the cases we work out. And the other 50 percent, you look to the equity, you acquire the loan and you sell it. If there is sufficient equity in the home, then you pay off the loan. If there is not sufficient equity in the home, the second place you would look for a loan that had a lower-than-normal down payment, lower than 20 percent, would be mortgage insurance. So the mortgage insurance industry essentially exists solely for the purpose of insuring investors like Fannie Mae and Freddie Mac against defaults. These entities are rated AA or AAA, and we would second look to them and look to mortgage insurance to help people, whatever the loss would be.
The third place we would look would be to recourse from the lender. This might have been a transaction in which the lender kept some of the credit risk in a negotiation with us, so we would look to them. That is another $30 billion.
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So we have $838 billion standing, before any losses would occur at Fannie Mae. And that is the reason that you can see, on a very large book of business, in excess of $1 trillion, our average credit losses over the last ten years was $285 million. Last year it was $124 million against capital of $19 billion.
So our credit losses are a fraction of those of other financial institutions, and they are a fraction of it because we start with a great asset and we do an enormous amount of risk-sharing. We, unlike most depository institutions, don't say we will take the entire risk and we will manage it all. We say we want to find risk-sharing partners with us.
I don't have the equivalent chart on interest rate risk, but I could give you exactly the same scenario on interest rate risk. We buy loans and we match their funding, but, because there is this option for the homeowner to give the loan back to you when it is in their interests, when it is probably not in your interests, when rates have dropped, we try to match that potential cash flow. We don't just guess what they will do, we sell debt that has the same option.
So if the homeowner has an option to give us back the loan, we have an option to give back the debt. If the homeowner decides to keep the loan, we have the option to keep the debt. So we engage in risk-sharing there. That is why I said in my testimony, we spend $6.4 billion a year to buy risk-sharing with other players. We spend over $4 billion to buy that for interest rate risk, and we spend over $1 billion to buy that for credit risk.
So this whole risk-sharing structure that has been put in place is the major protection for our capital. So you would have to go through all of this, through all of our protection on interest rates before you touch our capital.
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That is why Fannie Mae and Freddie Mac can withstand the ten-year stress test as rigorously as we have and why other entities can't. Because if you ask them, what is the stress test you use, they will say well, we assume interest rates might move 100 basis points or we assume that our losses might double. Whereas we are facing what at least one analyst referred to as the nuclear winter stress test. I mean if all of those things really happened, it would be an unusual world, but it would be the case that Fannie Mae and Freddie Mac would still be there, and all of the people who have been criticizing us as being undercapitalized would be out of business.
Chairman BAKER. Mr. Royce, you have well exceeded your time, and he may have expired you as well. I don't know.
For Members wanting to ask a second round of questions, we will start those now, and I would start.
To clarify for the record, Mr. Raines, I am sorry Mr. Mascara has departed, the genesis of H.R. 3703 is modestly, after some years of concern, an expression on the subject going back to the day of prior CBO reports to this subcommittee in 1996 that I requested relative to systemic risk issues. Again to say that this is not a criticism of anyone at Fannie Mae or Freddie Mac or Home Loan Bank today, but we have an obligation to perform regular and routine maintenance. If this were an airplane, you would not want to wait until the engine went out to ask the question, what is our maintenance schedule? I think while you are high-flying and doing well, that is the time when you spend a little resources on worrying about adverse circumstance.
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To that end, when an institution is as large as any of the institutions represented at this table, in your case, the third largest asset-sized corporation in America, the potential for that organization to have financial difficulty and, thereby, harm innocent third parties is quite obvious, and the Fed, in many cases, has interceded to preclude those adverse economic circumstances from having that ripple effect in the economy.
I believe it is our mission to provide market discipline through enhanced transparency, so people do understand the business plan and understand the true risk they are assuming when they either buy a security or take an equity position. The trouble is that in marketing securities, and I am not saying that you market it this way, I am just saying this is information provided to me about how securities may be marketed, prospective investors are told that members of the board are appointed by the President, the Fed exempts agency securities, including mortgage backs—accepts, rather, securities, including mortgage backs as collateral; that there is no limit on the amount of holdings that a bank may have of GSE debt, which, in fact, there are 4,003 banks today which have between 100 and 500 percent of total capital invested in GSE securities; that you are regulated by HUD and that you are subject to OFHEO's stress test, which of course is almost there. The marketing approach would skew market discipline, because it tells the prospective investor, don't look at the underlying business fundamentals necessarily.
Now, of course, any analyst is going to do that, but I didn't turn to Moody's rating, to which you made reference. Moody's said its ratings reflect good financial fundamentals; granted, the strong implied Government support of the Government Sponsored Enterprises and the competitive advantages they enjoy as a result of their special status.
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Now, I take that to mean that a respected rating service is saying, you are priced where you are because you are good, number one; and two, because of the implicit guarantee.
That is exactly the point which I have been trying to make for some time. I think we are performing an excellent opportunity in the secondary market by standardizing mortgages. I think the underwriting criteria are excellent. I think it facilitates home ownership. It is my role, however, I think appropriately, to ensure that the market is not having its vision of the underlying business fundamentals totally skewed by the belief that there is an implied guarantee; therefore, no risk.
It is clear Chairman Greenspan, in recent remarks, has said many are operating on the basic assumption that there are large financial institutions in this country—and I think he chose those words very carefully—not to say banks, that are being viewed as above all risk in the market because of the implied guarantee, and that is a false assumption.
So can you work with us here?
What I am getting back from Fannie Mae is that there is not one thing that we could suggest that we alter with this legislation that is worthwhile to pursue. In fact, it has been described as sand in the gears of a well-oiled machine. I just want to make sure I know where the machine is going and whose collateral it is going to take to make sure it runs at double digit return for the next generation. There has to be some way to get our arms around the enormous growth, the simple rate of return and, frankly, the lack of a safety and soundness regulator being functional.
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You and I have had conversations where I think you have indicated to me that you would like to see a strong functional regulator, because it would help you marketing your product in the secondary market. Can we at least start there? Can you respond?
Mr. RAINES. Well, Mr. Chairman, I think those are very helpful comments, and I hope I said properly, in answer to Mr. Mascara's question, that I believe that your interest in this legislation stems from the issue of systemic risk. I hope I have made that clear.
Chairman BAKER. Absolutely, yes, sir.
Mr. RAINES. I have no doubt in my mind that that is what your interest is.
Chairman BAKER. At best, arm's length, but further than that, as far as I am concerned, with any other economic group trying to press any other advantage within the Congress, and I would tell all Members that. The provisions of this bill have been out and about for a long time and I shared them with all of the principals before the bill was introduced, so there has been no effort to take anybody by surprise.
Mr. RAINES. Right. But just a couple of points. On your last point, we do not say that the system that we have now is absolutely perfect and no one could conceivably think of any change that would make it better. Indeed, when you invited me to review your bill, I did so with the thought that we would be involved in a discussion. But for, I am sure, good and sufficient reasons, you introduced your bill and went forward on the bill, so we have not had further discussions of what might be changes that could be made, not driven by one particular bill. Our comments so far have gone to the bill as introduced as opposed to the issue of is there anything that could make the system better.
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So I don't rule out that there are things that could make the system better, and I would be delighted to talk to you about things that deal with issues of systemic risk that might make the system better and could relieve concerns that you may have.
In terms of the marketing, I just came back last week from Europe, in which I had the opportunity to meet with a number of our debt investors, and a couple of things became very clear. They clearly understand that our debt is not guaranteed. Indeed, some of them resent the idea that smart institutional investors are operating under a total misapprehension about billions of dollars that they have invested of their investors' funds, so they are very clear on that question.
They also, though, are very clear that there is something called this agency market that is somewhere between the Government and ordinary corporations, and they know that there are certain indicia that go with that and they look for those indicia, because they believe that what that says is that these are entities carrying out an important public purpose and that they will be closely regulated from a financial standpoint, and therefore, they are not easily dispensable. The Government will not simply look and go, well, it is gone and we don't care, which it might very well do with an individual bank or an individual S&L.
So they are looking for the Government to protect its own interests in the public policies that we advance by ensuring that we are safe and sound. That matters to them. It doesn't make us guaranteed by the Federal Government, because they charge us dramatically more than they charge the Treasury, but it does make us a better investment than if we were an ordinary corporation not pursuing a matter of public importance.
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Chairman BAKER. Well, if you took out the name Fannie or Freddie and the ''security,'' and you put almost any other name in America in that slot, and then said there are 53 banks in the country today, this morning, that have 500 percent of their total capital invested in GSE securities. Now, I have always operated on the premise that concentration in a single line, in a geographic area—the great lesson I learned from the S&L problems of the 1980's, coming from Louisiana and the oil and gas turmoil, was that diversification, geographic and business line, was extraordinarily important to management of risk.
When we have institutions at this level of concentration, which no other corporation enjoys that exemption from that level of concentration, isn't that some small measure—I guess you dispute Under Secretary Gensler's remarks in that area as well?
Mr. RAINES. Well, let's just go to the facts. I think the factual description is just inaccurate in this case.
There are two limitations that banks have, a 10 percent limitation on investments in securities and a 15 percent limitation on loans. It only applies issuer by issuer or borrower by borrower. It doesn't apply to a class. So there is no class of GSEs that is limited for banks, just as there is no class of oil companies or no class of department stores. So it is an individual-by-individual issue.
If you look at Fannie Mae holdings, the average holding of Fannie Mae securities by banks is only 15 percent. If you look at the banks who hold 100 percent or more of their capital in Fannie Mae, they represent 1.28 percent of total bank assets. They are little banks. If you look at the 20 percent of the banks that hold two-thirds of the assets in the system, they hold less than 10 percent. They all would qualify under the rule as currently established.
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So from a systemic risk situation or circumstance, it is the big banks you worry about. They don't hold excessive amounts of Fannie Mae debt.
Chairman BAKER. But 41 percent of all banks have 100 percent of capital in GSE securities. I mean it can't be dismissed so simply, because——
Mr. RAINES. But the rule doesn't apply to GSE securities. It applies to Fannie Mae securities, to Freddie Mac securities, to General Motors securities.
Chairman BAKER. I understand, I understand.
Mr. RAINES. If you look at it issuer by issuer, what you find is relatively few banks—there are 725 banks that hold more than 100 percent of their capital in Fannie Mae, and that is only 8 percent of all banks and they represent 2.1 percent of bank assets.
Chairman BAKER. Well, your point is well made and I understand your point, but once you get past Fannie and Freddie and you go to the list of the GSE securities that are available beyond your two organizations, my level of concern only goes up incrementally. You are well-run and well capitalized, and I have no concern about business risks with you, but the further you go out on that GSE limb, the weaker it gets. Somewhere I am looking for something we can agree on where we might be able to communicate that there are points that are worth pursuit.
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I have far exceeded my time.
Mr. RAINES. Mr. Chairman, I think you have just put your finger on one that we can sit down and talk about. We believe that in the legislation passed in 1992 you set up a state-of-the-art capital requirement on Fannie Mae and Freddie Mac, and it is very tough. We believe that similar requirements being applied to all of the GSEs would be a step forward. We believe that if others can survive the same stress test that we can survive, it would give you a lot of assurance on just the issue you pointed to, and we would be delighted to work with you on how can you get that same level of insurance that all of the GSEs can survive that same kind of very difficult stress test that Fannie Mae and Freddie Mac are going to be required to survive.
Chairman BAKER. I just wish we had it in effect now.
Mrs. Jones, you are next.
Mrs. JONES. You wore me out, Mr. Chairman. I don't have any more questions.
Chairman BAKER. I don't believe it. Ms. Waters does, though.
Ms. WATERS. Mr. Chairman, I apologize if this has been discussed already.
I was concerned about the requirement in the legislation for HUD to have to approve new products. I don't understand the reason for that, and I don't understand what obstacles would be placed in the way of implementing new products that may be very meaningful and cost-effective and good for the consumer.
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So let me just ask both Mr. Raines and Mr. Brendsel about this requirement in the bill.
Do you think it is a good idea for HUD to be further involved with the GSEs, particularly as it relates to the oversight and the concurrence and new products? And if they are, how could that help you or hurt you?
Mr. BRENDSEL. Frankly, I think it is a bad idea. It would stifle innovation and, frankly, just add to costs. We respond to our customers, our lenders, and occasionally we come up with a new idea ourselves along the way. Regardless, it would require, particularly in terms of introducing this to the market, it would require endless delay, add to the cost; and ultimately, who would want to work with a company like Freddie Mac to bring a new mortgage program to the marketplace if they had to go through a lengthy delay of three months, six months or whatever as a result of this entire mortgage or new product approval process?
All of the products, all of the programs that we do must meet the test of being consistent with our charter, and today, under the current legislation, if there is a significant new activity, a new program, frankly it already must meet that regulatory requirement of being approved by the Department of Housing and Urban Development, as our mission regulators. So this particular provision would just go way beyond that and add a bureaucracy that frankly would not achieve, I think, the intended purpose, which is really to make certain that we have very strong, safe and sound regulation, an independent regulator. It would not enhance that regulatory structure at all.
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Ms. WATERS. Mr. Raines.
Mr. RAINES. I agree with that. In the 1992 legislation there was put in place a program approval process where if we were to begin a brand-new program of activities, we had to go to HUD to get approval. And the authors of that provision were very clear that it was not to get into the level of products and processes which would burden the companies and keep them from innovating. As we read the draft of the legislation at this point, it says that any new process that we enter into with a lender would require approval by HUD.
So that means—for example, we have been working with Mrs. Maloney for a while now on co-op loans, which has always been hard to get into the secondary market, and we have tried a variety of different loans to see what will work. That would have meant every time we did that, we would have to go to HUD and say approve this, approve that. If we had a lender who said I have a new way of servicing loans that I think will make a difference in terms of the value of this loan to you, we would have to ask HUD to approve that.
So as written now, it is the most extensive activity approval process that I have ever seen in Government. I don't know of any other regulated entities whose everyday normal business practices would require approval by a Government agency filing in the Federal record, and then an independent determination by that agency whether it thinks it is a good idea.
Chairman BAKER. If I may suggest, you are just about out of time. In any event, we have two Members that want to wrap up and then we could perhaps close this hearing. Can we just proceed at this moment.
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Ms. WATERS. Am I out of time yet?
Chairman BAKER. Well, you are about 10 seconds away.
Ms. WATERS. Were you stopping, Mr. Raines? You are finished?
Mr. RAINES. Yes, I am finished.
Ms. WATERS. Thank you very much.
Chairman BAKER. I thank you for your courtesy.
Mr. Ryan, and then we will go to you, Mr. Riley.
Mr. RYAN. Thank you, Mr. Chairman. I will try and be brief.
I would like to revisit the mortgage-backed security issue. My purpose for asking these questions, I am not trying to drive an agenda, I am just simply trying to get to some facts. It looks like there has been a change in policy by both Freddie and Fannie in that beginning in 1993, your share of outstanding mortgage-backed securities, the retention or the repurchasing or purchasing, whatever terminology you want to use, was for Freddie, 3.5 percent and for Fannie, 4.9 percent in 1993. That grew dramatically in 1999 to Fannie repurchasing or retaining 29.3 percent of the MBSs, and Freddie, 28.2 percent. So there is a dramatic increase in the retention or repurchasing of your mortgage-backed securities.
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Let me start with you, Mr. Brendsel, because the last vote cut us off and I feel bad about that. Let me just ask two quick questions which I think you can answer very quickly. Does the repurchase or purchase, whatever terminology you choose to use, does that advance home ownership? Does the repurchase of a mortgage-backed security put a person into a home that they otherwise would not have been able to afford?
Mr. BRENDSEL. Yes.
Mr. RYAN. How so?
Mr. BRENDSEL. Because it provides additional liquidity, it reduces mortgage rates. It reduces costs.
Mr. RYAN. OK. So I think the point that is worth clarifying is that this is an interest rate risk, not a credit risk, and I think Mr. Bentsen brought that up, which is that bringing the mortgage-backed security back on your books represents an interest risk.
So are you saying that you are calculating the perceived reduction in interest rates by buying those mortgage-backed securities back on your books, does that exceed the interest risk that you are putting on your books by concentrating that risk or by repurchasing that mortgage-backed security?
Mr. BRENDSEL. I would put it this way. We are redistributing that risk to different investors through different techniques. If you go back to 1993, that period of time and prior to that, what you had developed during the 1990's is the market for additional types of financial instruments, callable debt, as an example, that didn't really exist in the 1980's to be able to fund mortgage loans, mortgage-backed securities.
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Mr. RYAN. The market has diversified and that is why the greater concentration of the repurchasing of these securities?
Mr. RAINES. Well, actually it is not a concentration. I think what Leland is saying is it actually disburses it. If you own the mortgage-backed security, you have all the risk. If we own it, we then share that risk with a lot of investors, some of whom buy callable debt, some of whom buy bullet debt, and the residual risk remains with us. So we can take that risk and spread it around to more people.
Mr. RYAN. OK. So by repurchasing the mortgage-backed securities, you are saying you are not concentrating that interest risk, that you are actually spreading that risk out?
Mr. RAINES. That is because we are in the risk management business, not in the risk aggregation business. We are in the business of taking risk and spreading it to the best possible investors. Sometimes we are the best investor, but usually we are not. Usually there are other people who are the better holders, so we give them what they want.
Mr. RYAN. I think it is clear and I think it would be irrefutable that a good profit is derived from repurchasing those mortgage-backed securities, correct, by Freddie and Fannie?
Mr. RAINES. But no different really than purchasing whole loans.
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Mr. RYAN. But a profit is derived.
Mr. RAINES. Well, absolutely. We hope so. We hope so.
Chairman BAKER. Can you turn him loose? Because I want to get to Mr. Riley.
Mr. RYAN. I think we are going in circles here, but I appreciate having you spend the whole day here answering these questions. I would probably like to follow up another time and maybe we can meet in person to get to that issue.
Chairman BAKER. Thank you.
Mr. Riley.
Mr. RILEY. Thank you, Mr. Chairman.
Gentlemen, I want to thank you for staying here today. Your patience exceeds that of Job. But there are a couple of issues that I would like a clarification on.
Mr. Raines, if I understood your testimony today, you said that the actual proposal of this legislation had no impact on mortgage rates, if I understood you right?
Mr. RAINES. No. The only impact on mortgage rates was the people assuming that this legislation would be enacted. Because in a lot of countries, you know, it is not the long path from the introduction of legislation to it actually being enacted. They don't have a system like we do.
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Mr. RILEY. OK. I guess that is my point. In your letter that all of us received, it says: ''However, today, there is a bill, H.R. 3703, that has already had a negative impact on mortgage costs.'' Can you quantify that? Can you tell me how much of a negative impact there was?
Mr. RAINES. We can walk you through. It has varied over time.
Mr. RILEY. Give me a ballpark figure of what it costs. Was it 1 basis point, 100 basis points?
Mr. RAINES. Well, I think the impact that various outside observers have measured is anywhere between 20 basis points and 40 basis points, depending on the day.
Mr. RILEY. OK. Well, based on that, assume it was 20 basis points, and according to a statement made by someone in your organization that said that just the consideration of this bill would cost 208,000 families a chance at home ownership.
If that is based on 20 basis points, give me a calculation of how many houses that Chairman Greenspan has caused not to be financed in the last year-and-a-half. The best I can calculate if this is 20 basis points, then there would be 1,500,000 people that did not have the opportunity to buy a house because of the action of the Fed and Chairman Greenspan. Would that be an accurate assumption?
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Mr. RAINES. Well, actually, it is much more complicated than that, because Chairman Greenspan only can affect the short-term rates directly. And when he raises short-term rates to fight inflation, which you will often find is long-term rates actually declining, so if Chairman Greenspan were sitting here he would explain to you, I think, and I hate to—I may say it more clearly than he might.
Mr. RILEY. I know he would appreciate that comment.
Mr. RAINES. I think he would say that his actions have actually helped home ownership, because he has held down long-term rates from where they were. But I think that would be his answer.
Mr. RILEY. So you are telling me that if he raises interest rates another one-half point today, it will lower long-term rates for most homeowners?
Mr. RAINES. Well, I think if the Fed is viewed as a credible inflation fighter, long-term rates would be lower than they otherwise would be, and I think we have seen some action of that just in the last few days. Just yesterday, long-term rates actually came down a little bit as people believed the Fed would step in and be a tough inflation fighter.
I am as big an advocate of growth as anyone, so I don't want to come across as being in favor of the Fed overreacting, but I do want to give them fair credit. Because of the Fed's, I believe—their very good management of the monetary policy, in conjunction with good fiscal policy, I think we have had lower home ownership costs in this decade than we otherwise would have, and I think that has been important.
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Mr. RILEY. We are running out of time. But if this bill were enacted, how much of a rate increase do you believe there would be? Would it still be around 20 basis points, or would it be higher if we enacted the legislation that we are considering today?
Mr. RAINES. It is impossible to know, but I believe it would be significantly higher. I believe the 20 basis points was discounted by the likelihood of people thinking it was going to pass, but if people thought that these companies would be saddled with these restrictions, I think the rates would be substantially higher.
Mr. RILEY. Substantially, to 50 basis points, 100, 150?
Mr. RAINES. I would be guessing at that level.
Mr. RILEY. That is exactly what I would like for you to do; guess.
Mr. RAINES. I don't want to guess. I think one basis point that was unnecessary is too many. I mean every basis point that is necessary is all right, but one that is unnecessary I think is too many.
Chairman BAKER. If we can, gentlemen, we need to wrap this up, because Members need to make this vote. Mrs. Maloney wants to know, Mr. Raines, if Fannie Mae will take another creative look at Kiddie Mac.
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Mrs. MALONEY. I really first want to thank you for this thoughtful hearing.
Maxine Waters mentioned earlier, new products. And there is one that I would hope that you would take a look at and expand to. I think it would be appropriate to bring the GSE structure to child care, an area that has been failed by the private markets. You literally revolutionized home ownership in this country, it is now at an astonishing 70 percent, yet child care, we can't get the financing. It is not supported. I would like to know, would Fannie and Freddie be opposed to having the authority to buy child care facility mortgages?
Chairman BAKER. If you would, let me suggest we are down now below five minutes on this vote. Please let me make the formal request that you respond to Mrs. Maloney and myself with regard to her question in writing at a later time, if that is acceptable.
Mrs. MALONEY. OK.
Chairman BAKER. Certainly any Member who has an interest in Kiddie Mac.
Chairman BAKER. Let me say thank you to all of you gentlemen for your time. I wish to announce that our next hearing on this subject will be June 7, and that next week we do expect to get a letter back from the Federal Reserve in response to our questions concerning systemic risk, which we will be sharing with the agencies.
Mrs. MALONEY. Mr. Chairman, who will the witnesses be at the next hearing?
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Chairman BAKER. We are waiting on confirmations. We will have that for you next week.
Mrs. MALONEY. But what kind of witnesses?
Chairman BAKER. Good.
Mrs. MALONEY. Good witnesses.
Chairman BAKER. Yes. They will be financial.
But I do thank you for your courtesies. We do have follow-up questions. I think my staff has prepared some, and I would like to leave those with you as well. Thank you.
[Whereupon, at 2:15 p.m., the hearing was adjourned.]