Segment 2 Of 3     Previous Hearing Segment(1)   Next Hearing Segment(3)

 Page 135       PREV PAGE       TOP OF DOC    Segment 2 Of 3  


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 10:00 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.

    Present: Chairman Baker; Representatives Lucas, Manzullo, Ryan, Terry, Toomey, Roukema, Royce, Kanjorski, Bentsen, Waters, C. Maloney of New York, and Jones.

    Chairman BAKER. Good morning. I wish to reconvene the hearing of the Capital Markets Subcommittee. For those not attending last week's hearing, it went on at length and we determined to recess the hearing so that the participants of that second panel could be given full attention with the hearing today.

    Additionally, at the last hearing there was a request that former Member Congressman Walter Fauntroy be given an opportunity to be heard. We are glad that he was able to work out to participate in our second panel this morning.

    We have also, on that second panel, extended opportunities to Reverend Graylan S. Hagler and Mr. Bruce Marks, who is CEO of Neighborhood Assistance Corporation. These are additions to our originally-posted agenda for the morning.
 Page 136       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    At this time I would like to recognize our first witness, who is speaking here today in his capacity as a representative of the Citizens Against Government Waste, Mr. Tom Schatz. Welcome, Mr. Schatz.


    Mr. SCHATZ. Thank you very much, Mr. Chairman. Thank you also very much for convening this important series of public hearings on the Government-sponsored enterprises, and for taking such an even hand in allowing each side to be heard.

    I am Tom Schatz, President of Citizens Against Government Waste, a nonpartisan, nonprofit organization, with more than one million members and supporters nationwide who are dedicated to eliminating waste, fraud and abuse in Government.

    CAGW is part of the Homeowners Education Coalition, or HomeEC, which is comprised of taxpayer groups, including those represented here today. This newly formed group is raising questions with our members and the media, Congress and the public about the Nation's GSEs and how their activities impact taxpayers.

    Based on the reports just this past Monday about Freddie Mac's agreement with the risk capital standards being proposed by the Office of Federal Housing Enterprise Oversight and the possible plans to split the company into two parts, it is clear that the Chairman's bill and these hearings are already having an impact on the GSEs.
 Page 137       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    CAGW was created sixteen years ago, following the report of the Grace Commission. The Commission examined the operations of the Federal Government, including Government-sponsored enterprises. I request that the Commission's recommendations on those GSEs be entered into the record.

    Mr. SCHATZ. The Grace Commission recognized that the GSEs' agency status assures them access to credit at a preferential rate. The Commission concluded that the implication of Federal support ensured that, quote: ''even without full faith and credit, the Government would rescue an agency in trouble.''

    The Grace Commission concluded that the special advantages enjoyed by Fannie Mae and Freddie Mac acted as, quote: ''a powerful disincentive for well-capitalized private sector entities to compete in the mortgage market.''

    The Commission summed up why it is important for Congress to convene hearings such as these and continue oversight of the GSEs. ''The Government does not control agency growth because it is private, but the agencies depend upon Federal sponsorship for their growth. This contradiction has extremely important consequences now and for the future.''

    Fannie Mae and Freddie Mac were endowed at their inception with a raft of special privileges, which have been discussed at these hearings previously. They don't have to register their securities with the Securities and Exchange Commission, which saved them $280 million last year. They are exempt from State and local taxes, worth $690 million last year.

 Page 138       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    The total subsidy, according to the Congressional Budget Office, was worth $6.5 billion in 1995. That study also determined that one-third of the subsidy was absorbed by Fannie and Freddie rather than going directly to benefit homeowners.

    Fannie and Freddie don't have to meet the same capital requirements that are imposed on banks and thrifts. They can borrow money at lower rates and their high bond rating is due to their financial fundamentals, the implied Government support of the enterprises and the competitive advantages they enjoy as a result of their special status.

    Another great advantage is that financial markets believe that Fannie and Freddie are simply too big to fail.

    CBO also found in 1996 that 40 percent of the earnings of Fannie Mae and Freddie Mac could be traced to their Government-sponsored status, and the implied guarantee is reinforced by the $2.25 billion line of credit that each has at the Treasury Department.

    Since the creation of the GSEs, times have certainly changed. Home ownership rates hover near 67 percent. Fannie's and Freddie's success in helping millions of Americans achieve the quintessential American dream of owning their own home is laudable. The economy is strong and both companies enjoy double digit growth rates.

    If that were the end of the story, we wouldn't be here today. But the GSEs' duty to shareholders requires that they maximize profits. There is also that duty to the taxpayers, and again these missions do come into conflict.

 Page 139       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    While these links to the Government obligate Congress and regulators to pay special attention to what the GSEs do and how they do it, Fannie and Freddie have characterized those who have made an issue of their activities as being anti-home ownership, and some of the Members of this subcommittee have characterized the recommendations to reform the GSEs as being based simply on a fight for market share within the banking industry.

    Mr. Chairman, let me set this record straight. CAGW has spent the past sixteen years exposing waste, mismanagement and inefficiency in the Federal Government. It is not our intent to drive up costs for homeowners. We are not members of FM Watch. I couldn't tell you who belongs to FM Watch or when they were created.

    Our interest in this issue precedes the creation of that organization by more than a decade and the presence in Congress of the vast majority of the Members of this subcommittee. Our intent is to simply improve and increase oversight of Fannie Mae and Freddie Mac. The Treasury Department, the General Accounting Office and the Congressional Budget Office all share our concerns, and Chairman Greenspan of the Federal Reserve system also expressed concern recently over the systemic risks associated with the GSEs.

    The housing GSEs have become so ascendant in the financial markets that their activities have far-reaching effects throughout the entire national financial system and therefore into the pocketbooks of ordinary citizens. In January of this year, Fannie Mae announced it was positioned to issue its debt securities in unlimited quantities. By 2003, the GSEs combined will have more debt outstanding than Treasury debt held by the public.

    At current growth rates, they will carry $3 trillion in debt by 2005.
 Page 140       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    It isn't just the amount of their debt that should raise questions at these hearings. The GSEs purpose is to provide liquidity in the mortgage market, purchase mortgages and bundle them into securities and resell them to private sector investors who then bear the risk. The focus should be on the nature of the debt they hold, the maturity of the mortgage market and the direction that Fannie and Freddie are taking in the future.

    In particular, the proposed replacement of Treasury debt with Fannie and Freddie debt as a marketplace or benchmark deserves the utmost scrutiny.

    Since 1993, Fannie and Freddie have begun to repurchase their own mortgage-backed securities and hold them in their portfolios. This has directly affected their double digit growth rates over the last few years.

    Instead of dispersing risk into the private market, the GSEs are reconcentrating it in their own portfolios, which are implicitly backed up by the taxpayers. The question should be asked how repurchasing mortgage-backed securities furthers the congressionally-chartered missions of Fannie Mae and Freddie Mac.

    At the same time that Freddie Mac is considering a long-term proposal to break up the company into two entities, according to reports on Monday, Fannie Mae announced it has begun to purchase from banks zero down mortgages. This means lenders who are financing 100 percent of the purchase of a home are selling these mortgages to Fannie Mae. These mortgages are usually available to the most qualified buyers, raising more questions about the commitment to low- and moderate-income homeowners raised by the witnesses last week. Also these zero down mortgages are expanding when lenders are increasing the amount of debt a borrower may carry and still qualify for a home mortgage.
 Page 141       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Clearly, the cost and risk of default of a zero down mortgage is greater than that of a mortgage that requires 20 percent down.

    Mr. Chairman, you asked us about H.R. 3703, and we strongly favor the elimination of the GSEs' line of credit with the U.S. Treasury. We also concur with Treasury Under Secretary Gensler's concerns as to whether commercial banks ought to be permitted to hold in portfolio unlimited percentages of GSE debt.

    During his recent testimony before this subcommittee, Fannie Mae's chairman repeated several times that the activities of Fannie Mae pose zero risk to Government and the taxpayers. But in the world of high finance, growth and a high rate of return are inextricably linked to risk.

    In addition, Fannie Mae has been running ads about the financial stress tests they are required to undergo. The stress test was established as part of the 1992 legislation, but it will be at least another year before it is activated. While Freddie Mac recently agreed that this would be a good idea, Fannie Mae has consistently resisted submitting to the stress test.

    Mr. Chairman, we would like to submit this ad along with a series of letters from Fannie Mae criticizing the stress test into the record.

    Mr. SCHATZ. With Fannie Mae and Freddie Mac, we have two quasi-governmental entities that claim agency status when it suits them and simultaneously claim to be private financial institutions when it suits them. As one long-time observer of financial markets has noted, with the creation of Fannie Mae and Freddie Mac we have succeeded in privatizing the profits and socializing the risks.
 Page 142       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Now while the economy is strong is the best time to examine crucial questions regarding the nature of the Nation's Government-sponsored enterprises. On behalf of our one million members and supporters, we thank the subcommittee for the opportunity to speak today and I look forward to answering any questions. Thank you.

    Chairman BAKER. Thank you, Mr. Schatz. Your testimony and all of the addenda which you cited will be made a part of the record.

    Our next witness this morning is speaking in his capacity as a representative of the National Taxpayers Union, Mr. Peter Sepp.

    Welcome, Mr. Sepp.


    Mr. SEPP. Thank you. Mr. Chairman, on behalf of the 300,000 members of the National Taxpayers Union, I am deeply grateful for the opportunity to testify today, not as a financial market guru or a political insider, but as something of an amateur historian. In some small way, I hope I can convey that the issue of GSEs should transcend any political environment.

    To take just a quick jog down memory lane here, my organization has been involved in GSE issues since the 1970's, when we compiled a taxpayers' liability index. We testified at one of the first major GSE hearings in 1989. We most recently sponsored a conference, Freddie Mac and Fannie Mae: Issues for Taxpayers.
 Page 143       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    So obviously this is an issue of long-standing importance to taxpayers and taxpayer organizations.

    Over the years, there have been many, many proposed reforms for GSEs, but they all have one thing in common. They are well beyond the scope of H.R. 3703, to the regret of some and the approval of others.

    The bill essentially aims to improve oversight activity so we don't have the kind of gaps that allowed the S&L crisis to slip through the cracks unnoticed and develop into something that made a taxpayer bailout one of the only options.

    The GSEs themselves dismiss any analogy to a potential second S&L crisis as paranoid. Well, a useful document to help test this analogy is this, ''Origins and Causes of the S&L Debacle: A Blueprint for Reform.'' It was prepared by the National Commission on Financial Institution Reform, Recovery and Enforcement. I will refer to it from now on as ''the Commission'' in order to save time and a whole lot of words.

    I will begin by quoting one of the Commission's most important findings. Quote: ''Fundamental condition necessary for collapse, Federal deposit insurance on accounts at institutions.''

    Now, in a totally unsubsidized environment, S&L consumers would have helped to act as self-regulators against institutions that invested in deposits and risky portfolios, but the Commission concluded that the Government created an oversubsidized environment in which, I quote: ''depositors could benefit with no meaningful risk of financial loss.''
 Page 144       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Although not mandated to do so by law, Washington does effectively extend a kind of deposit insurance to housing GSEs.

    Now the GSE officials tended to downplay this connection, but the Congressional Budget Office disagrees, and again I quote: ''Short of placing an explicit guarantee on the securities of the housing GSEs, the law could hardly be more clear: the Government's financial interests in the safety of Fannie Mae and Freddie Mac ensure that their obligations are safe from the risk of default.''

    Socializing the risk behind their investments freed the S&Ls from many prudent business constraints and allowed the industry to grow by a spectacular 56 percent over a three-year period in the 1980's; but, we all paid the price later.

    These growth rates are being matched today by Fannie Mae through other riskier ventures, such as consumer credit, jumbo mortgages and derivatives.

    Now to return to the Commission report, I quote: ''Factors precipitating the macro-economic shock of unprecedented high interest rates adopted to combat soaring inflation.''

    Due to their regulatory charters and their habits of business, S&Ls tended to operate in a niche market of long-term mortgages. This situation changed when interest rates began to soar, in turn leading S&Ls to disastrous attempts to grow their way out of their problems by seeking more profitable and more volatile investments. But if a new interest rate crisis were to affect Fannie Mae adversely, history would be repeating itself, not just inflicting itself on a new victim.
 Page 145       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Earlier this summer, Treasury Under Secretary Gensler reiterated the observation that in the 1980's Fannie Mae was, quote: ''insolvent on a market-to-market basis.''

    Now today, housing GSEs resort, within limits, to diversifying their holdings or services. However, there are few worlds left to conquer within a literal reading of their charters. This has created a dilemma that Congress and GSEs will have to confront. Diversifying portfolios within their mission risks concentration of entire lending sectors. Diversifying them outside of their mission risks a sort of industrial policy that could reward entities who enjoy a substantial public subsidy over their private rivals.

    To cite yet another Commission finding, I quote: ''Factors intensifying and prolonging the collapse—a systematic breakdown in the political system.''

    According to the Commission, regulators were often blinded to the poor business practices of certain S&Ls due to the absence of an information structure that obscured the extent of the mounting losses and the degree to which the Federal deposit insurance program and the Treasury were exposed to loss.

    Despite recent efforts to establish reporting and capital standards for the GSEs, transparency is still an elusive goal. GSEs can trade on the New York Stock Exchange, but are exempt from SEC Commission fees and reporting requirements that burden other companies. Nor are they required to disclose trading positions held by top level managers. Private banks and thrifts must maintain a level of total risk-based capital for on balance and off balance assets at 8 percent. Fannie Mae and Freddie Mac fall under just two core requirements, 2.5 percent for on sheet assets, .45 percent against off sheet assets. An impartial risk-based standard is only now being implemented.
 Page 146       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    GSE officials say they are in a far better position than most financial institutions in the private sector, but outside analysts seem unable to reconcile those claims.

    Now to conclude, the Commission observed that, quote: ''Congress transformed S&Ls into agents of national housing policy and that Government regulation sheltered S&Ls from competition, allowing the industry to be profitable and failures to be rare.''

    But beginning with the interest rate problems of the 1980's, policymakers were, quote: ''Ill-prepared to deal with the crisis, the result being a large and unnecessary expense to taxpayers that has shaken the public confidence in financial institutions, Government, and the political process.''

    National Taxpayers Union contends that this need not occur with other congressionally-chartered instruments of national housing policy, the GSEs. Any diehard GSE privatizer in this room can probably support the increased transparency intended in H.R. 3703. Just the same, any true believer in the refederalization of GSEs in this room can applaud the regulatory accountability intended by H.R. 3703. In short, all anyone needs to be in order to admire at least part of this bill is concerned, concerned that taxpayers, lawmakers and GSE officials all participate in this process on an equal basis. And a little healthy respect for history helps, too.

    Again, I thank you for your time and I will try to answer any questions you may have.

 Page 147       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Chairman BAKER. Thank you very much, Mr. Sepp. We appreciate your comments.

    Our final witness on this panel represents the Competitive Enterprise Institute, Mr. Fred Smith. Welcome.


    Mr. SMITH. Thank you, Mr. Chairman. My name is Fred Smith. I head the Competitive Enterprise Institute, a pro-market public interest group that has long been active in financial regulatory issues, the banking and S&L deposit insurance crisis of the 1980's, most notably.

    I am pleased to testify here today on the moral hazard problems created by Freddie Mac and Fannie Mae. I think you all by now know that that term ''moral hazard'' means a tendency of bad incentives to create bad risk management policies; the Freddie Mac, Fannie Mae problem.

    These firms may once have merited some special attention as infant industries, but they have clearly grown up now. It is time to put them out in the adult private market.

    The continuance of these special privileges creates a serious hazard to the market, to taxpayers, to the economy and perhaps most of all to the poor, whose real needs, economic opportunity, is given lower priority by pushing middle and upper class housing mortgages to the front of the capital queue.
 Page 148       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I would like to add some more remarks to my prepared testimony that you had last week, and I also would like to add three documents that I think would help the subcommittee make a consideration. The first is a recent publication by the American Enterprise Institute, which details the level of the risk that Fannie and Freddie are imposing on the American taxpayers, ''Nationalizing Mortgage Risk,'' and ''A Microeconomic Analysis of Fannie Mae and Freddie Mac,'' by Robert VanOrder, who is the senior economist of Freddie Mac. He makes a lukewarm endorsement of his agency.

    Then to illustrate that actually one can talk about things without putting everyone to sleep, a recent Wall Street Journal editorial, ''Fannie Mae's Problems,'' the Dear Abby one that some of you saw this week, which was a wonderful illustration that economics doesn't need to be quite so boring.

    That also illustrates that the task before you of educating the American public to the need for reform is not an impossible task. It is something you can achieve.

    Let me summarize my testimony. First, note that Fannie and Freddie are strange organizations, neither private sector fish nor political sector fowl. As a result, no one is quite clear how these entities should be evaluated or how they should be held accountable. They are largely immune from competitive market regulation. They are outside the market discipline, and yet they lack effective political scrutiny.

    Mr. Nader last week made that point very well, basically arguing that what we see here is profit-side capitalism and a loss-side socialism. That asymmetry is dangerous and evades the whole system of checks and balances that is the basis of the American political and economic system.
 Page 149       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    You know, we fought a war once to oppose taxation without representation. Yet today, in this situation, we have seemingly endorsed subsidization without representation. Did we really mean to define GSEs as Government-subsidized enterprises?

    The roots of this problem stem from Fannie's and Freddie's ability to obtain funds at rates far lower than any real market firm. Cheap money guarantees them high profits.

    Now making a profit is normally a tough game, but if you are allowed to play with monopoly money and everyone else has to use the real thing you can buy up all the houses, all the hotels, from Baltic Avenue to Park Place, without passing go and, of course, without running the risk of going to jail. Monopoly money makes it easy to become a monopolist, and as these hearings have illustrated, Fannie and Freddie are well on their way to becoming the largest monopolist in history. They, of course, argue that this misses the point. They simply want everyone to realize the American dream. Good rhetoric, not good policy.

    First, note that some of the housing subsidy is dissipated in higher housing costs, just as some of the subsidized student loans contributed to the rapid increase in college tuition. You are going to be doing some studies on this issue. I hope you ask that an estimate be made of the extent to which the Fannie-Freddie system is actually making affordable housing less affordable to the poorest of America.

    Still, as the ads we have been seeing over and over again in the papers illustrate, they basically are out there to try to persuade us that they really are vital to housing in America. They do, after all, lower interest rates. Doesn't this make the American dream more affordable, at least for those not priced out of the housing market? Perhaps.
 Page 150       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    But there are other American dreams: Getting a job, starting your own business, having a better school for your kids, and those dreams also require capital.

    Fannie and Freddie create no new capital. They simply move it around the political game board. For those pursuing other dreams, Fannie and Freddie isn't a dream; it's a nightmare. At least in the game of Monopoly you can buy something else besides real estate.

    Fannie and Freddie claim their successes reflect skill. Perhaps. Certainly there are some smart people at these agencies. At the salaries they offer, there should be, but the successes of Fannie and Freddie have less to do with their smarts and a lot more to do with their subsidies.

    Had they been purchasing livestock, race tracks, movie theaters, car dealerships, railroads or even aluminum siding, they would still have made money. Indeed, give anyone in this room the right to issue their own personalized Treasury bills and I predict that they too will become very wealthy in very short order.

    Subsidies weaken the stability of the American financial system. That is what moral hazard is all about, and it is those unintended consequences of helping one American dream at the expense of all the other American dreams that should concern this subcommittee, this Congress.

    These risks threaten to get worse. Last week's hearing illustrated that point. Groups taking more funds for lower income housing were critical of Freddie and Fannie. They sought more resources for lower income housing. In my view, that will do very little to help the poor. Luring families into nonaffordable debt does them no favor, as I suspect we are going to be hearing later on today. Nor would it do much to address the affordable housing issue directly.
 Page 151       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    That problem is far more linked to any growth initiatives and other Government policies.

    Yet it will certainly increase the likelihood of a Fannie-Freddie default. Fannie and Freddie are being urged to increase their riskier lending without incurring any additional risk. There is not much chance of that happening in the real world, but as long as the taxpayer is forced to cover those risks I suspect that Fannie and Freddie will be rushing out to do exactly that.

    What can we do about all of this? Not much if we are not willing to rein this agency in, and political regulation has a very poor track record. The real problem remains that in any political calculus, Fannie and Freddie are already too big to fail. Their stock is held in too large blocks by too many important groups. Today if a crisis were to occur, it is unlikely that anyone responsible would actually get a haircut. The sad reality is that a crisis would more likely end in Freddie and Fannie getting a perm.

    Tinkering at the edges isn't likely to resolve this instability. Rather, we should take advantage of the current good times and the good management of these agencies to diffuse this time-bomb while we can. I recommend that you do endorse most of the provisions of H.R. 3703. Phase out the ability of other groups to hold Fannie and Freddie stock as Treasury bill equivalents in their visible line of credit. End their exemption from State and local taxes.

    Incidentally, as a citizen of the District of Columbia, I suspect that former Representative Walter Fauntroy will be recommending that later on this morning also.
 Page 152       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Eliminate the ability of these agencies to use taxpayer backed money to enter other sectors of the credit economy, increase their capital reserves, and create a liquidation plan that would plausibly avoid a bailout if and when the next economic crisis occurs.

    Some subcommittee Members have suggested we proceed carefully, and I fully agree. But that does not mean delaying further action. The unintended consequences of past inaction are already very serious, and the growth projection of Fannie and Freddie suggest that there is much worse in store. Delay is always the easiest course in the short term. Recall the prayer of the youthful Saint Augustine, ''0 God, make me chaste—but not yet.''

    Still even if you move expeditiously, I suspect it will not be enough. Fannie and Freddie have no real world existence. They exist as artifacts of the special privileges they possess. Masquerading as market entities, they are better viewed as costly and complex means of transferring capital around the political game board. This is not wise. If we want to nationalize our credit industry, let's do it honestly rather than under the guise of GSEs.

    Thus, I have suggested in my written testimony that DOJ be urged to develop a divestiture or breakup plan for Fannie and Freddie. They should be converted from TBTF institutions—too big to fail institutions—into normal market entities. You know that Fannie Mae's Ms. Gorelick comes from Justice and they have got a good experience at breaking up firms now. Why don't they take that expertise and use it to good purpose by breaking Fannie and Freddie into firms that are reasonable size and actually might be able to bear the risk of failing if they keep operating as they already do.

 Page 153       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Congressman, Mr. Baker, this can't be a pleasant hearing for you guys. You are finding out in these hearings that Fannie and Freddie have outlived their usefulness, have engaged in mission creep to a level never before seen in history, have weakened the private housing finance markets and now they reject reform, and they are not paper tigers. They have massive resources and seem willing to use them, without limits, for lobbying, propaganda, political contributions and attacking anyone, including yourselves, who dare to challenge their supremacy.

    Moreover, most of the people are only going to see the ads in the paper. They are not going to be at these hearings.

    Yet, America has survived to date because we are a representative Government. You were elected to represent the good of the American people, not the privileges of the powerful. You have some powerful allies in this, Alan Greenspan, some members in the Treasury, when they are allowed to speak. Moreover, you have a bully pulpit to educate the American people on this issue, and the Wall Street Journal editorial earlier this weak makes it clear that you can do it.

    This isn't that complicated. Indeed, any high school civics class in America would laugh the Fannie-Freddie get-rich-quick scheme off the stage. These hearings begin the educational process for reform. I would like to commend you, Chairman Baker, and everyone on this subcommittee for the willingness to diffuse this time-bomb. We at CEI look forward to working with you and proceed with the rest of this process. Thank you.

    Chairman BAKER. Thank you very much, Mr. Smith.
 Page 154       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. Schatz, you raised an important issue I had not previously considered in other hearings that I think from here on in I should certainly follow, and let me explain myself. There are allegations by some that people have economic interest in this issue and that there are lobbying organizations that are being formed and created to affect public policy, primarily for the purpose of economic outcomes.

    Given those concerns, let me ask each of the witnesses this morning, are you here in your capacity solely as a representative of your respective organization or have you received compensation from the organization known as FM Watch or any business enterprise, let's say within the last two years, well before Fannie Watch started; in a two-year clock? I am only asking not for disclosure of your donors, but in relation to this issue have any of your respective organizations received economic compensation to participate or represent anti-GSE sentiment?

    Mr. Schatz.

    Mr. SCHATZ. Mr. Chairman, our history in this goes back sixteen years. Certainly the members of the Grace Commission included interests from the banking industry, so we continually receive support. It is very possible that someone who made a contribution off of our membership list has some interest in this issue, but we actually created this coalition with groups that we work with on a consistent basis to fight waste, mismanagement and abuse in the Government, bringing a lot of other coalitions together. It was our concept to come up with this group here, and certainly if anybody wants to support what we are doing we are happy to accept that support from any side of the aisle.
 Page 155       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. So that is a qualified no? You may have someone who is a donor, but——

    Mr. SCHATZ. Yes, it is possible. We do receive a lot of contributions. I am not trying to avoid the question, but I would have to look at every single person that gave us a contribution over the last several years, because we do receive a lot of individual contributions.

    Chairman BAKER. But you can clearly say that no one has given a contribution to the organization with the intent of imposing a particular philosophic view on this subject?

    Mr. SCHATZ. No. This is our view. We are representing ourselves. We have worked, as I said, with these organizations on budget reform and tax reform, and having looked at the Grace Commission recommendations, it often surprises me that the things that were proposed sixteen years ago are still relevant, but this is Washington.

    Chairman BAKER. I will eagerly admit that each of you in your respective capacities have been long-standing troublemakers. I am just trying to establish on this subject there is some degree of purity.

    Mr. Sepp.

    Mr. SEPP. Well, presuming that FM Watch hasn't mastered the art of time travel, no, I am not being paid to say this. My boss wasn't paid to say it, my goodness, twenty-one years ago.
 Page 156       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. Mr. Smith.

    Mr. SMITH. No. But I think, as Tom pointed out, we also don't take any Government subsidies. So we are not funded by Fannie and Freddie. We certainly haven't been approached by any private groups, but, I guess, if you guys want to do more to help rational discourse on this, funding would be useful.

    Chairman BAKER. Maybe something to be considered later.

    Mr. Sepp, I understand it was the Taxpayers Union that took the 1996 CBO methodology and took current data, as best possible available, and made a determination that the current day value of the subsidy to be at least a $10 billion figure, is that correct?

    Mr. SEPP. Yes, that was an NTU Foundation issue brief that we projected forward; yes, that was published about a year or so ago.

    Chairman BAKER. And was it the conclusion reached in updating the value of the subsidy that about one-third of that amount was perceived to flow through the shareholders?

    Mr. SEPP. Approximately one-third, yes.

    Chairman BAKER. Well, that is consistent with the CBO's work previously. I have had some complaints expressed about the efficacy of that methodology and, for the record, I have requested that the Federal Reserve assist the CBO in establishing a methodology that hopefully will be above question, and we now have pending a request for an update of the valuation of that subsidy for that purpose.
 Page 157       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Would each of you choose to make brief comment, because I am—maybe I will just save it for the second round. I am just about out of time. My next question was going with concern of concentration of bank holdings of securities by the GSEs and the potential for significant concerns about the Federal deposit insurance system in relation to those holdings. But I am out of time and I want to try to stick to the clock as best I can.

    Mr. Kanjorski.

    Mr. KANJORSKI. Thank you, Mr. Baker.

    I guess we have to respect the fact that you all are rabble-rousers. That is good, because sometimes you are rabble-rousers on issues we agree on, and sometimes you are rabble-rousers on issues we don't agree on. I think all three of you are supporting my effort, and Mr. Boehner's effort, to oppose H.R. 21 in order not to create a Federal reinsurance program and subject the American taxpayer to undue risk. In that regard, I compliment you.

    The problem is, there is not any winner or loser on this issue. On both sides of the aisle of this committee and on both sides of the aisle of the Congress there is a recognition that these unusual organizations require periodic study, mission definition, and control.

    It is interesting, however, that last night we had on the floor Mr. Hinchey's amendment to the VA-HUD appropriations bill asking for full funding for OFHEO. That amendment made the request of approximately an additional $5 million, and all funding for that regulator comes from Fannie Mae and Freddie Mac. OFHEO has concluded that these additional funds are necessary if they are to properly enforce the new risk-based capital standards, and they have requested the Appropriations Committee to make those additional funds available.
 Page 158       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    From my standpoint, there is nothing more important than strong regulation. It helps us to see what is happening in advance, and to try to prevent improper activities from occurring so that the horse does not get out of the barn before we close the door.

    We are going to have a vote on that additional funding for OFHEO this afternoon.

    Now, I have one simple question for you. If you were sitting in the Chamber, how would you vote on the issue of providing the funding requested by OFHEO? This increase does not cost the American taxpayers anything, but comes out of the regulated organizations themselves. Apparently, the Appropriations Committee and a good part of the other side of the aisle have argued against giving those additional funds to provide for better regulation. How would you vote on that issue?

    Mr. SCHATZ. Mr. Kanjorski, we have long supported the concept of increasing oversight by the Government. We would certainly hope that the Congress would approve that amendment. We would also like to see more funds for Inspectors General and GAO and other people that do these studies.

    So I have no problem with that amendment.

    Mr. SMITH. I guess I would have some. I am from Louisiana so good government was one of the early casualties in my belief system, but I think that the idea that more money will help the regulators to do a better job, maybe. I guess if I were in your situation I might well vote for it also, but I think the real inclination is to realize that nothing works better than market-based regulation, which essentially means that if you trust the institution you are investing in you are far more likely to be an effective disciplining force than a regulator who only has his intellectual acumen to go on.
 Page 159       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Fannie and Freddie can outbid the pallet pool and will get much smarter people to run circles around any Government regulator.

    Mr. SEPP. I would be forced to cast a vote in favor as well. I think that if Congress is to impose regulatory opportunity costs on private banks and institutions, well, then those institutions, the GSEs, can absorb those costs as well.

    Mr. KANJORSKI. The bill we are considering here is something that prospectively will come to order to either reform the mission or the structure of GSEs. Today, however, this full committee and the Congress on both sides of the aisle are going to have an opportunity to put the money where their mouth is. That way, if they really do fear S&L disasters in the future, then they can support maintaining a strong regulator out there with the capacity to properly regulate.

    It would be somewhat of an interesting position that here before the subcommittee we will be arguing to clean up the act of Freddie Mac and Fannie Mae. This afternoon, however, some of the very Members that are proposing this long-term cleanup or what could prospectively occur in the future are declining the immediate vote today. Today's vote will provide the money to the regulators to do the job that may give us the opportunity to save financial risk in these organizations. Is that correct?

    Mr. SMITH. Mr. Kanjorski, I agree in part. Obviously the sentiment you are expressing, I think, though certainly odd, I believe members of this panel would agree, the risk is that in effect you anesthetize the force that is now being developed to reform these institutions in a real, more substantive way. There is always the risk that by putting a sterile fruit fly in a niche, you never really do anything useful there.
 Page 160       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I agree with you, I might well vote for it today.

    Mr. KANJORSKI. I am not suggesting this afternoon's vote for stronger regulators is going to cure the problems that you have argued today. But, how could anybody on this subcommittee or in the Congress on either side of the aisle say that we should not at least give the regulators what they are asking for to do a proper job of regulation?

    Mr. SMITH. I am not in Congress. I would probably go along with you, Congressman.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    For the record, I also support that effort very strongly.

    Mr. Smith, just to respond to one brief observation you made, I was in the Louisiana legislature fifteen years, and upon arrival in Washington I can honestly say I have not seen anything from the White House to the Congress that has impressed me as much, so I just want to make a record of that.

    Mr. SMITH. I did not want to tell you I believed in Santa Claus when I moved to Washington. I still have the same skepticism.

    Chairman BAKER. I think we are looking at the world the same way.
 Page 161       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. Manzullo.

    Mr. MANZULLO. I was in Baton Rouge about four weeks ago at the old State capitol, whereupon I saw a very prominent sign that said ''Democracy is not in the voting, but in the counting.''

    Chairman BAKER. I would only add there was a bumper sticker not long ago that said, ''Vote for the crook. It is important.'' So I have to put all of this in perspective.

    Mr. MANZULLO. Mr. Baker, my father was born in Louisiana and migrated to Illinois. So we understand what is going on.

    I appreciate having us reconvene. Mr. Schatz, I would like to address my remarks to you. I have been very much concerned over this so-called grass-roots effort of our office receiving 2,000 letters, telegrams, ostensibly on behalf of the constituents that I represent.

    I looked at these. I thought there was something odiferous about them and instructed my staff to call people from all over the district on a sampling. Of the 29 phone calls that we made, 8 people had agreed to put their name on that telegram or petition, whatever it is called—I think they called it a telegram—16 people knew nothing about the petition or the letter; 13 people said no, they did not want anything sent in their behalf, but they were still sent; 2 people did not exist at that address, and in fact, Mr. Sweeney has two constituents who sent him a telegram. The problem is that they were dead.
 Page 162       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    This was Fannie Mae's grass-roots effort, and it bothers me, because these are the good names of the people I represent that were being misused commercially to try to influence my vote here as a Member of Congress.

    I wanted to know what this cost Fannie Mae. I think it is important, because any time they spend money on efforts like this it is written off and they don't pay taxes on that portion of the money that would be attributable to these expenses.

    They refused, said ''This is proprietary; we can't give this to you.'' But I did get enough information, Mr. Schatz, based upon the total names available, 352,000; total completed calls, 160,000. I believe I have asked you, because Fannie Mae refuses to tell the American people how much it cost for this grass-roots effort, I have asked to see if you could come up with a figure on that.

    Mr. SCHATZ. Mr. Manzullo, thank you for allowing me to come up with this estimate. I would estimate, based on the kinds of activities we have engaged in in the past in telemarketing and also talking to people in the industry, obviously anonymously, about what the issue was, that it was anywhere from $250,000 to $350,000, conservatively, for this effort. That would include getting the names, making the calls, sending out the 45,000 telegrams, sending out about 33,000 follow-ups to the individuals who sent the telegrams.

    The question I really had was really the process by which this was done. These people never saw a piece of paper explaining this issue to them. They received a phone call saying ''There is a bill out there that will affect the cost of home ownership. Would you like to sign a petition? We are calling on behalf of the Fannie Mae.'' That is the essence of the script that I have looked at, which you have provided to me.
 Page 163       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    It seems to me that the normal process is that someone gets a letter first explaining an issue that is this complex. Clearly it is complex. There is a lot of disagreement about what should be done. It is also extremely important. And the follow-up phone call is if you don't respond or if you want to follow up and encourage people to sign the petition, but the normal process is to provide a piece of paper first.

    Mr. MANZULLO. At least it is in front of them.

    When the people received the phone call, they were told it was on behalf of a Coalition for Home Ownership. I inquired of Fannie Mae as to if they are the only ones behind this, how one organization could be part of a coalition, and there was no response to that.

    I am also concerned over the fact that this could be a violation of false advertisement under the FTC or could indeed be an actionable tort for invasion of privacy whenever a person's name is used without their authority for commercial purposes.

    It just really bothers me that even before getting to the merits of Mr. Baker's bill that we have to go through this fight with Fannie Mae to have them square up and be totally honest with us.

    To this date, they have not. I received a four-page letter from Mr. Raines that tries to explain all of these things, and all he can say in that letter is the fact that ''I should have contacted you in advance to let you know these were coming. For that, you have my sincere apology; that I understand why you would be concerned if some people you represent were not sent confirming letters. I apologize if this was the case.''
 Page 164       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    It goes on to talk about the computers that were used, the people that were involved, and so forth, but most interesting is the fact that he said that ''we cannot reveal proprietary information.''

    The proprietary information is the 2,000 letters that he sent to us. There certainly was no reticence to send to us, falsified and misleading, the proprietary information. So I had to use you to be able to make this estimation, because Fannie Mae simply has not been square with me.

    Thank you.

    Chairman BAKER. Thank you, Mr. Manzullo.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman. I am not going to say anything about Louisiana or all of that.

    Chairman BAKER. Thank you.

    Mr. BENTSEN. I think it all goes without saying.

    Let me thank you again for having these hearings. I do want to quickly go back to the Hinchey amendment before I go into another line of questioning, because it is fascinating that at the time when this subcommittee, under the Chairman's leadership, is taking a very hard look at the GSEs and in particular we are all waiting with great anticipation the final rules from OFHEO, and we know that OFHEO is receiving numerous comments on their proposed regs and trying to go through that, and whether you support the Chairman's bill or some variation thereof or not at all, I think all of us want to at least get some handle on the law that Congress passed in 1992, that we would certainly want to provide them with ample resources.
 Page 165       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    So I am glad to hear what the members of the panel had to say.

    I do want to ask Mr. Sepp, with at least some grain of seriousness you said that you would support that amendment. Is that right?

    Mr. SEPP. Yes.

    Mr. BENTSEN. Would it be fair to say then that the National Taxpayers Union would not score that as increased spending on the annual survey that you all like to do? Or are you authorized to make that commitment at this point in time?

    Mr. SEPP. Well, that decision is actually made by three people in our office. My view would be that it is imposing a regulatory parity with private agencies and in that respect it could or it could not be scored. I can't imagine that it would be significantly scored among the 200 or so votes that we would include in our rating of Congress given the fact that a lot of votes in Congress occur over billions rather than millions of dollars.

    Mr. BENTSEN. I see. In this debate, would the panel tell me, do you believe that Fannie Mae and Freddie Mac, which are both Government-created entities, congressional-created entities, some might argue monsters that we created, do you believe that they have achieved their initial mission as Congress set out to do?

    Mr. SMITH. Congressman, I think that the—actually the article I appended to my testimony, the one by the Freddie Mac chief economist, more or less argues that the original purposes of these organizations have been achieved. They were, after all, created when there was no ability to have a nationwide banking system or an S&L system. We had State regulations which balkanized the industry, and therefore they basically were there to achieve some of the deficiencies that other Government policies had made impossible.
 Page 166       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Those are gone. The ability of S&Ls and other institutions to raise money by being able to raise interest rates is present today. So the original purposes are gone. The real question is, are we inventing new purposes? And I think the answer is we are, and I think those are dangerous, because they lead us into unchartered waters.

    So, yes, I think they have done what they were supposed to do. Whether that was right or wrong, or there were other ways of achieving that, we ought to go ahead now and get these off the taxpayers' backs.

    Mr. BENTSEN. Anyone else?

    Mr. SCHATZ. Mr. Bentsen, I would also agree that if you look at the strict chartered mission, that that is the case. And when you are talking about going out to Home Depot and you are going out and doing home equity loans, that those kind of things require the kind of oversight and careful thought that you all are giving this now. Whether that is something they should or shouldn't do, somebody should be taking a look at what's going on. Again, you have this conflict that was identified sixteen years ago, and I guess even longer by some other groups, that you have a profit motive and you have a taxpayer-based or congressionally-based mission that seemed to be in conflict. So at some point they do separate.

    In reading the article—if you give me one more second, in reading the article about what Freddie Mac is talking about in the papers Monday, they were going to keep the GSE strictly limited to mortgages, period, and the other types of investments that they would make would be totally separate and private. So there is a recognition that there is a separation of those two purposes.
 Page 167       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SMITH. Also there was an example, an earlier example, the Interstate Commerce Commission was created, of course, much earlier in history to regulate transportation rates and at a certain point the leadership of that institution, along with a lot of other American interests, decided that it was time to abolish that agency and allow rates and transportation to be set by buyers and sellers.

    I think that was a wise move, and it was done in part, because of the leadership of the ICC.

    One could hope that Franklin Raines will begin to show that leadership in Fannie Mae.

    Mr. BENTSEN. My time unfortunately has run out. I hope we will have a second round of questioning, because you didn't completely answer my question. I think, Mr. Smith, you started to.

    But I think what—if I can infer from what you said, is that in terms of the Congress being able to leverage private capital markets for the creation of a secondary market system and a stable supply of mortgage credit at a somewhat stable rate, that leverage has worked.

    I don't think anybody said that it hasn't worked. In fact, I think what I am hearing from those who are concerned is that maybe it has worked too well, to the detriment of some others. That leads me to another line of questioning.
 Page 168       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. Chairman, I will wait until the next round of questioning. Thank you.

    Chairman BAKER. Thank you, Mr. Bentsen.

    Mr. Terry. Excuse me, I had one other piece of business. Mr. Manzullo had asked that his letter to Mr. Raines and Mr. Raines' response to his initial request be made a part of the record.

    Without objection, it would be made a part of the record.

    Thank you, Mr. Manzullo.

    Chairman BAKER. Mr. Terry.

    Mr. TERRY. No questions.

    Chairman BAKER. Mr. Toomey.

    Mr. TOOMEY. Thank you, Mr. Chairman. I would like to thank our witnesses for testifying today.

    A couple of lines of questioning that I would like to pursue. One is, if any one of you could help me with this issue of quantifying in sort of a pragmatic or meaningful way the risk of loss to the taxpayers. The reason I mention this is we can easily quantify the extent of Government-sponsored enterprise debt, guarantees of debt, outstanding obligations, but as we all know, those obligations are collateralized with quite a lot of collateral in the form of home mortgages.
 Page 169       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Now, there is still a significant risk, but I am wondering if there has been any systematic effort to say under various scenarios what kind of actual loss could be expected to be incurred. And, therefore, rather than just looking at the total face value of outstanding debt, what is the actual risk that the taxpayers are potentially on the line for?

    Any thoughts on that?

    Mr. SMITH. It is hard. The article by the Freddie Mac one basically is a very honest article, I think, and I commend it to you. It basically says we understand there is a systemic risk here. We understand there is a moral hazard, and putting a precise number to it is very difficult.

    The other piece I recommended, the EAI one, again looks at the total outstanding debt, discusses some of the moral hazard aspects and essentially suggests that it is large and growing and will grow particularly if we move outside of the traditional mortgage market. But, again, I don't think anyone is very comfortable with a precise number. It would be nice if we had that. I don't think we do.

    That is what markets are really for, to try to have someone who has their money at stake, not taxpayer money at stake, to make that assessment for us.

    Mr. SEPP. I would also recommend this report, ''Origins and Causes of the S&L Debacle,'' as it discusses in detail the proportion of savings and loan institutions that experienced financial difficulties and the portion of the industry that eventually was subject to the taxpayer bailout.
 Page 170       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I can't locate the fraction very quickly, but I believe it was something on the order of 30 percent. So if you infer from a $200 billion taxpayer bailout or so, you are talking about a potential of some $600 billion in assets and $200 billion of which eventually became subject to repayment.

    Mr. SMITH. It should be noted in that case, the S&Ls are a good example, I think it is good to bring that up, because the real disasters did not occur before the crisis. They occurred when the crisis was perpetuated, allowed to continue, because of the so-called forbearance period when it was politically difficult to close the doors of some of these poorly managed institutions.

    We only have two of these big entities out there now and the political pressures to forebear in these cases would be massive, and since they are so dominant in these fields, moving from relatively stable to total instability could happen very, very quickly in today's electronic financial market.

    Mr. SCHATZ. Let me say one thing as well, Congressman, and that is that the increase in risk goes along with the changes in the types of investments. For example, going from mortgages to derivatives to home equity lines and home improvement loans, other things that both Fannie Mae and Freddie Mac are looking at or are trying to get into, that adds to their risk. Again, it is hard to put a number on it. I think it would be useful if the subcommittee would take a look at that, because we are all interested in that answer.

    Mr. TOOMEY. I think it is important to have some methodology for assessing that, because what we are doing with—I mean, in the big picture what we are saying is that we are making a conscious decision for taxpayers to take a risk, and a risk involves a cost. I mean, there is a value to that risk, as we see in the marketplace every day. When you take risks, you get rewarded for it.
 Page 171       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    The taxpayer is not being directly rewarded. The idea is that the reward comes in the form of lower mortgage rates, and we can measure that. We can measure the extent to which we have lower mortgage rates, but if we don't know the risks we are taking we don't know whether the taxpayer, our society in general, is getting an adequate return for this, which leads me to my next question. Mr. Raines testified before this subcommittee, and in separate conversations he has indicated to the subcommittee and to me personally that 100 percent of the benefit of the savings that is derived from the implicit backing of the taxpayer, 100 percent of that is passed on in the form of lower mortgage rates.

    Now, that strikes me as extremely counterintuitive, especially given the prima facie evidence of the spectacular returns that Fannie Mae has earned in terms of returns on equity.

    I believe from earlier comments, that you folks are estimating that it is actually anywhere from a third to a half goes to shareholders and not directly passed on in the form of lower mortgages. I am wondering what kind of methodology do you believe we ought to use to analyze that question and be able to quantify how much of this benefit is going to the people who own stock in Fannie Mae versus those who want to buy a home?

    Chairman BAKER. And you can do that briefly.

    Mr. SCHATZ. The Congressional Budget Office has done that and, of course, there is disagreement with how they have done it, but I haven't seen anything different that indicates that they are wrong other than Fannie and Freddie saying that they are wrong.
 Page 172       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Of course, you could look at a lot of these other investments as other ways that if their profit increases they could pass it on to the shareholders as well. Just to get quickly to the State and local tax exemption, for example, if they paid State and local taxes they would simply be less profitable versus saying that they are going to increase mortgage rates. It is kind of the Washington Monument syndrome. When you threaten to close down the Government, the first thing they close is the Washington Monument, because that is the thing people see, and everybody gets all upset, but there are a lot of ways to do this that would increase the opportunities for homeowners and maybe not make them quite as profitable.

    Mr. SMITH. The OMB has an office that tries to estimate the level of these risks on on-budget entities, and I would suggest you ask the OMB's office that tries to estimate for like GNMA to figure out how to do it for this one.

    But remember, there is also another big cost. We lower the rates for sort of politically preferred housing, middle and upper class housing, but we increase the capital cost for small businesses and an array of other ones that are pushed down the queue.

    There is no creation of capital by Fannie Mae and Freddie Mac. It is just moved around. Where you help, you also hurt. I think we ought to estimate those harms, as well as the benefits.

    Mr. TOOMEY. Thank you, Mr. Chairman.

    Chairman BAKER. We will come back around to a second round since we have a limited number of Members.
 Page 173       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. Jones.

    Mrs. JONES. Yes. Good morning.

    Mr. Schatz, are you saying that Fannie Mae and Freddie Mac have outlived their usefulness? And I need short answers. We have five minutes and I am going to cross-examine. No long answers, please.

    Mr. SCHATZ. I noticed that last week, Mrs. Jones.

    Mrs. JONES. Good.

    Mr. SCHATZ. Their purpose is still valid. The question is whether they are the appropriate vehicles to perform that purpose.

    Mrs. JONES. If they are not, who should perform that purpose?

    Mr. SCHATZ. We haven't had the opportunity to have the private sector get into those areas, because they have pretty much foreclosed anyone from entering that market.

    Mrs. JONES. So you are saying—you suggest that the private sector should perform the mission of Fannie Mae and Freddie Mac?

 Page 174       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SCHATZ. They could. They could try.

    Mrs. JONES. They could?

    Mr. SCHATZ. They could.

    Mrs. JONES. And they would do—would they lower housing costs if the private sector did so?

    Mr. SCHATZ. This is a little bit of an answer to Mr. Toomey. If you had an institution that was truly nonprofit and you passed on all of your subsidies to——

    Mrs. JONES. No, don't give me that.

    Mr. SCHATZ. Well, nonprofit——

    Mrs. JONES. The question I asked is, could they lower housing costs?

    Mr. SCHATZ. They could.

    Mrs. JONES. How?

    Mr. SCHATZ. If there was a goal of an organization to provide the lowest possible mortgage rates at the least possible profit, they could do it.
 Page 175       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. JONES. Now, are you suggesting that Fannie Mae or Freddie Mac are poorly managed?

    Mr. SCHATZ. No. We are saying that they are managed in conflict with two missions, one of which is to produce profit; the other of which is to provide better mortgage liquidity.

    Mrs. JONES. Do you find that that happens in other organizations as well?

    Mr. SCHATZ. Sure, it does.

    Mrs. JONES. OK. Now let me go to who would—currently, Fannie Mae does not make any mortgages itself, correct? The mortgage is made by the banking institutions, correct?

    Mr. SCHATZ. Correct.

    Mrs. JONES. OK. The banking institutions are saying that Fannie Mae doesn't buy all of the mortgages that we make and we think that is unfair; that is part of this whole discussion about reorganizing the GSEs, correct?

    Mr. SCHATZ. Correct.

 Page 176       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mrs. JONES. What do you believe Fannie Mae should do differently in order to respond to the banking institutions' claim that they are not buying the mortgages that sit on their shelves and are causing dollars to be stuck in these large companies? Do you understand my question?

    Mr. SCHATZ. Yes. It works both ways, because if Fannie Mae doesn't buy the mortgage it usually doesn't get made. They essentially determine what mortgages are created by the banks.

    Mrs. JONES. It doesn't get made by the banking institutions?

    Mr. SCHATZ. Right.

    Mrs. JONES. It doesn't get made by the prime?

    Mr. SCHATZ. Right.

    Mrs. JONES. Because the subprimes are out there making the mortgages that the prime banks won't make, correct?

    Mr. SCHATZ. That is correct.

    Mrs. JONES. Maybe I want to move on. How much time do I have left, two minutes?

 Page 177       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Chairman BAKER. Two minutes.

    Mrs. JONES. OK. Let me talk with Mr. Sepp for a minute. What is the position of the National Taxpayers Union on the issue I just raised with Mr. Schatz? Should a private entity perform the services that Fannie Mae is currently providing?

    Mr. SEPP. Yes.

    Mrs. JONES. And how would that private entity—how would you improve home ownership rates if a private entity were in that position?

    Mr. SEPP. Through the competitive advantages of the marketplace.

    Mrs. JONES. Be a little more specific with me. Don't be so cute, OK?

    Mr. SEPP. When firms compete with each other for business in an unfettered environment, they tend to deliver the best possible product at the lowest possible price.

    Mrs. JONES. You are suggesting that Fannie Mae operates in an unfettered environment? Or a fettered environment?

    Mr. SEPP. Yes.
 Page 178       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. JONES. What is the fettered environment?

    Mr. SEPP. The fettered environment is an unsecured profit margin that socializes the risks of their investments to taxpayers.

    Mrs. JONES. Isn't it a fact that many of the banking institutions have socialized—what is the term you used?

    Mr. SEPP. Yes, and that was a great contributor to the banking crises earlier. Fortunately, Congress helped to address that by establishing capital standards.

    Mrs. JONES. Are you suggesting that the current banking institutions also find themselves in that position?

    Mr. SEPP. Not to the degree that Fannie Mae and Freddie Mac do.

    Mrs. JONES. Not to the degree. The question is, do they find themselves in that position?

    Mr. SEPP. In a similar position.

    Mrs. JONES. Thank you.

    Lastly, Mr. Smith, in your commentary—there is not enough time here. I have a lot of questions.
 Page 179       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. If you wish to get organized, there is a few number of Members and we are going to come back for a second round.

    Mrs. JONES. I am going to use my last minute up, because I may have to leave in a moment.

    This is Mr. Smith's testimony here. Mr. Smith, you suggest that H.R. 3703 is the means by which we ought to deal with the GSE dilemma, for lack of a better term; is that correct?

    Mr. SMITH. I actually went beyond that and suggested we move to full privatization and provided a way of doing that.

    Mrs. JONES. What would be the advantage to the homeowner for full privatization?

    Mr. SMITH. Well, the homeowner is also a small businessman, and other factors. It would have a more rational capital market in the——

    Mrs. JONES. Slow down, again. The homeowner is what?

    Mr. SMITH. The homeowner also is either an employer or an employee. They also have schools to go to. They have other capital needs, and they would have a more rational allocation of capital for all of their dreams, not just the dream we pick.
 Page 180       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. JONES. Wait a minute. Slow down. Most homeowners are not small businesspeople.

    Mr. SMITH. Most homeowners are employed by someone who is either a small businessman or large businessman, both of whom have capital needs. Many of them have children that need to go to schools, and those schools need capital. City and State governments need capital. Everything that we have a dream about has a capital component, and we are distorting capital markets by this unfortunate entity.

    Mrs. JONES. What is the distortion?

    Mr. SMITH. The distortion is we are giving them special privileges that allow them to put middle and upper class housing above the needs of the poor, above the needs of the employees in America, above the needs of the other American dreams.

    Mrs. JONES. You are suggesting that Fannie Mae and Freddie Mac don't have the interests of low-income at heart?

    Mr. SMITH. Of course, they don't. They are not even trying to provide housing in that area, because they can make more money by going after the low-risk loans.

    Mrs. JONES. You say this is happening across the country?

    Mr. SMITH. Well, they are the ones who have the markets for these loans, yes.
 Page 181       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. JONES. And upon what statistics do you base this?

    Mr. SMITH. The fact that they are not in the market for the so-called low-income marketing house. You have to be much more——

    Mrs. JONES. Wait a minute. I am asking the questions. I want short answers.

    Mr. SMITH. OK.

    Mrs. JONES. Upon what statistics do you base the statement that you make?

    Mr. SMITH. The data that shows where they are making loans and are not making loans. They are not in the so-called subprime market very heavily today.

    Mrs. JONES. Whose data is this?

    Mr. SMITH. Well, this is from all the stuff—well, it is in there. It is in the——

    Mrs. JONES. I don't know what this is. For the record, what are you pointing at? For the record, tell me what that is.

 Page 182       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SMITH. I am sorry. It is the Nationalizing Mortgage Risks: The Growth of Fannie Mae and Freddie Mac. It is a publication by the American Enterprise Studies of Financial Market Deregulation by Peter J. Wallace. It has a tremendous number of tables of where Fannie and Freddie are.

    Mrs. JONES. Did you bring those for us?

    Mr. SMITH. I have asked that they be made a part of the record.

    Chairman BAKER. They have been made a part of the record.

    Mrs. JONES. Thank you.

    Chairman BAKER. If I may, Mrs. Jones.

    Mrs. JONES. I said thank you. I am done.

    Chairman BAKER. OK. Great.

    Mr. Ryan.

    Mr. RYAN. Thanks for coming today, guys. I wanted to focus on one narrow aspect of the whole GSE issue, and that is the repurchasing of mortgage-backed securities.
 Page 183       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. Schatz, I was able to hear your opening statement and you talked about the repurchasing of mortgage-backed securities. I don't think the people at Fannie Mae and Freddie Mac are bad people. I just think there is a conflicting mission, two missions, a shareholder mission and a Government mission. So it is the structure of the entities that is giving the conflict that is cause for these hearings. It is not bad motives, bad people. It is just a strange structure that tears them in two different directions.

    On the mortgage-backed securities, I am still trying to find out how repurchasing 30 percent of your mortgage-backed securities is critical to fulfilling the mission of home ownership and securitizing the secondary market, number one. Number two, it poses a new kind of risk on the books. It poses an interest rate risk, a prepayment risk on the book of business.

    What I would like each of you three to identify and discuss is, as you analyze this, as you analyze the safety and soundness and the risk that is posed, does moving from 4 percent of repurchasing or retaining your mortgage-backed securities in 1993 to 30 percent repurchasing and retaining of your mortgage-backed securities, respectively for Freddie and Fannie today, pose a new kind of risk regardless of the kinds of hedging devices that may be available in the marketplace and is that mission critical? Does that do something to put people into more homes, or is that more of a profit motivated action by the GSEs?

    I will start with you, Tom, and go through.

    Mr. SCHATZ. Thank you, Mr. Ryan. Clearly, if you look at the structure of the GSEs and their original mission, it was to buy the mortgages, not mortgage-backed securities. So we talked briefly with Mr. Bentsen and others about the purpose and whether they have exceeded or outlived their purpose. That is related to providing an increase in profit, not all of which, of course, has gone back to homeowners; it has gone to shareholders. So this is a question the subcommittee should be discussing and I am certainly pleased you have brought it up, but I don't know how it is directly related to the mission.
 Page 184       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SEPP. I am certainly at a loss as to its direct relationship to the mission. I would also say that that sort of risky practice, along with derivatives and the like, may be perfectly acceptable in a private lending firm or any other financial management firm, but when there is an implicit, full taxpayer guarantee, we need to look more carefully at that.

    Mr. SMITH. Essentially, Fannie and Freddie were created to create a securitization market, a secondary market. They did that because other Government policies made it hard for a private entity to do that.

    There is plenty of ability in the private sector to create secondary markets now. We don't need the Fannie and Freddie anymore. Why are they in this market? They are in this market because it allows them to make money. It is a product they can buy with cheap money and sell at real money rates.

    It is not the mortgages that count. They could be buying anything. They could be buying McDonald's franchises and would be able to make money. If you can use cheap money and sell at real market rates, anything you buy you are going to make money on. It doesn't take brains; it only takes subsidies.

    Mr. RYAN. Some people have compared this to the S&L crisis. I don't know if that is accurate or not, but I would like to go down this road a little bit further. By keeping these mortgage-backed securities in their portfolio, are the GSEs becoming more like the biggest S&Ls, doing asset liability management, than a mortgage conduit between originators and investors? Do you see a similar comparison, an interest rate risk? Do you see that, but on a much, much larger scale, because we are talking about trillions of dollars, not billions of dollars here? Do you think that that is an accurate comparison to make?
 Page 185       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SEPP. I am afraid it is. I would pick up on Fred's point earlier that interest rates are such a volatile kind of economic indicator that you don't know that the liabilities are on the books, that the bailout is staring you in the face until it is too late. Having stopgaps in place, having transparency in place to catch this situation before it blows up in our face, that is the important thing.

    Mr. SMITH. The reason that they are taking back these MBSs is, because when you are willing to assume risk you can make profits out of it. You get paid to take risks.

    What they have done is they are getting the profits, but they are not taking the risk. That is the perversity in this situation. That is the obscenity of Fannie and Freddie.

    Mr. RYAN. What the GSEs, and I don't want to put words in their mouth, I think what they will tell you and I think this is what Mr. Burns or Mr. Raines said last time we asked them this question, is that it ends up reducing interest rates, that the retaining or repurchasing of mortgage-backed securities reduces interest rates by a small number of basis points.

    I find that when you look at the econometric miles that support that statement, it is not an analysis of just the retaining of mortgage-backed securities, but it is an analysis of the entire secondary market and the retention of mortgage-backed securities. So I wonder what the reduction in interest rates is attributed solely to reducing or retaining mortgage-backed securities? I think that is something that we ought to take a look at.
 Page 186       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I see the time has run out. I yield.

    Chairman BAKER. Thank you, Mr. Ryan. I intend on this next round to pursue further the mortgage-backed issue as well.

    I think all Members on this side have been recognized once. Mr. Royce would be recognized, regular order.

    Mr. ROYCE. I appreciate that, Mr. Chairman.

    Another aspect of GSE expansion is what is happening with the Federal Home Loan Banks with the Chicago program. One of the things I wanted to look at, or ask the panel about, is with the new expanded powers from the Gramm-Leach-Bliley bill, are we concerned about what is happening with that Chicago program? I have a copy of a Barron's article entitled, ''House Odds, Critics Say Home Loan Banks' Mortgage Program Puts System at Risk.''

    I thought I would just quote a couple of lines out of the article and then ask the panel for their observations.

    One piece from the article says: ''Chairman Bruce Morrison of the Federal Housing Finance Board, which oversees the Federal Home Loan banks, predicts that the volume of these loans will hit $100 billion in two years, because he is going to lift the cap.'' It says that ''lifting the cap on MPF will be his last official act before Morrison quits June 30th.''

 Page 187       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    The article goes on to say that ''mortgage market worry-warts with whom we spoke''—that might be you gentlemen—it says that they ''believe some of the banks are skimping on interest rate hedges on mortgage partnership finance loans to fatten their own bottom lines. Each bank decides how much risk it wants to take. Critics say the banks are leaving two-thirds of loans naked or unhedged on the assumption that they will all be paid off in five to ten years. Such prepayments are common, owing to the propensity of homeowners to move or refinance.

    ''Another problem, say these worriers, lies in the bank's reporting. They don't mark their portfolios to market, because if a bank's loan portfolio pulls the institution under water, lenders might hear about it and pull out with their stock and thus leave Uncle Sam to clean up the mess.

    ''The system's own regulator,'' it goes on, ''has proposed tougher risk-based capital standards for the Home Loan banks. Memories of the collapse of the federally-insured thrift system are apparently still fresh in Washington.''

    So let me ask about this particular type of GSE, as well and your observations on this Chicago program, if I could.

    Mr. SCHATZ. I think, Mr. Royce, based on what you just said, clearly there are concerns about having these loans out there depending on people refinancing over a period of time. Obviously, if interest rates go up there won't be as much refinancing and we don't know what the Fed will do the next two times that they meet, but that will clearly reduce the number of people that will refinance, because the rates will be higher than they were just a year or two ago.
 Page 188       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    So I think clearly there is an increased risk. Again, greater regulation—I should say greater oversight is certainly helpful, and we appreciate you bringing that up.

    Mr. ROYCE. Thank you, Mr. Schatz.

    Mr. SEPP. I would have to agree. It is very easy to concentrate just on Fannie Mae and Freddie Mac and the matter of trillions of dollars of assets when there are other entities that have a smaller amount of assets but face very similar problems. I would think that what we should be aiming to do is to complete the job that Congress began and establishing meaningful capital standards for other institutions out there and apply them toward these institutions.

    Mr. SMITH. The technical role played by these institutions can be played in a relatively risk-free way. You could totally hedge all of your risks, and so forth, but then you would also limit your profits dramatically.

    What we are really seeing is a game playing where they get involved in activities that can have or cannot have risk, depending on how much you are willing to push that risk back to the private sector. They want it both ways. They want the profits, but they don't want the risk, and that is the problem with the Federal Home Loan Bank and all the other groups in this area.

    Mr. ROYCE. I thank you, Mr. Smith.
 Page 189       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    In my view, the best policy would be to completely privatize all three of the housing GSEs, Fannie, Freddie and the Federal Home Loan Bank system, but by completely privatizing, I mean any tie to the Federal Government such as line of credit and any form of housing goals or mandates. I think we need to recognize that that is what this means if we go down this road.

    Frankly, I think that should be the goal.

    Mr. SMITH. Congressman, the Wall Street Journal editorial I mentioned earlier mentions that HUD itself is not very pleased with the performance of these institutions for the low-income housing goals and I think that is quite appropriate. These entities—when you get to the frontier of a financial—or any frontier, financial frontier or otherwise, you are dealing in a risky environment, an environment where a lot of creative energies are required. That is where you want all the safeguards to be in place, and nothing ensures better investment strategies than realizing that if I guess wrong it is my money, not your money that is at stake.

    Mr. ROYCE. Thank you. I am going to, Mr. Chairman, for the record, if I could, insert this Barron's article.

    Chairman BAKER. Without objection.

    Mr. SMITH. I read it too, Congressman.

 Page 190       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mrs. Maloney, did you have questions?

    Mrs. MALONEY. Yes, Mr. Chairman. Thank you.

    Welcome, everyone. It has been well established that there are many peripheral benefits of home ownership in addition to the financial investment that they represent to individual families. Homeowners are more active in their communities, they keep up their neighborhoods and work to prevent crime. They take a greater interest in their school districts and they really contribute more to the society, to their neighborhoods, their villages, their cities. When they own, they are really more responsible to their larger environment.

    While I know these benefits may be hard to measure, surely all of you must agree that they have a very important value in our country.

    I think that it is important to take these values or the values that home ownership brings into account when you consider the costs of home ownership incentives that the Government has enacted. These include the mortgage interest tax deduction, the Federal assistance programs and the benefits that go to Fannie Mae and Freddie Mac.

    I would like to ask the panel to comment. Are you opposed simply to the benefits that Fannie and Freddie have or to all programs, Federal, local, State, even private sector, that operate to enhance or to advance home ownership? Do you acknowledge that there are important benefits to home ownership that Government should encourage?

    Mr. SCHATZ. Well, first of all, Congresswoman, I appreciate your point and I don't want to be flippant, but I am curious to know if there is actually a list or an actual total of what the cost of those benefits would be. I don't know if the subcommittee has it or the full committee has it, but how they compare, for example, with other benefits the Government provides and what value we are getting.
 Page 191       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Our point is to provide, if the Government decides affordable housing as a goal, the most effective way of doing that. It is not clear that Fannie Mae and Freddie Mac at least are the most effective way of providing that support right now.

    We have FHA loans. You have other programs throughout the Government. You have a lot of other ways that provide people with assistance, but certainly the fact that the economy is going well and interest rates are relatively low is another way that provides people with the ability to purchase homes.

    There are certainly a lot of benefits. Any neighborhood that has a lot of homeowners tends to be kind of a better maintained place, but I wouldn't want to insult renters by saying that either, because a lot of them are responsible as well. And not everybody should own a home. It is possible that people are somehow overreaching by these, for example, 100 percent mortgages that are being put out there as a product right now.

    Mrs. MALONEY. But the FHA loans also that you mentioned, then we have many, many programs that encourage home ownership, but that also is Government, somewhat, supported.

    So my question is, do you support FHA loans and say the tax deductions that we give to certain businesses that put up affordable housing, or are you just opposed to Fannie Mae? That is my question, is it just opposed to Fannie Mae or are you opposed to all Government-sponsored support?

 Page 192       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SCHATZ. I didn't say we were opposed to Fannie Mae. I said that we were questioning whether they were the most effective way of providing support and how they fit in with all of these other programs. There were clearly concerns last week at the hearing about whether or not they are reaching to the subprime market, which I would assume would be of concern to a lot of people on the subcommittee.

    We are looking for really an evaluation of how well those programs work. We don't think there is enough oversight, period, in Congress, and that is why we appreciate this effort right here.

    Mrs. MALONEY. I appreciate Mr. Baker's leadership, too.

    As I understand it, each of our witnesses on this panel supports the repeal of the statutory access of the GSEs to U.S. Treasury credit lines. Is that correct?

    Mr. SCHATZ. Yes.

    Mr. SMITH. Well, I certainly do.

    Mr. SEPP. Yes.

    Mrs. MALONEY. All of you do. OK. This credit line has never been used and would have a negligible impact in saving a GSE from large scale financial losses. As a result, would you explain why it would be important to repeal something that seems to be of little use and little more—it is really symbolic, it is obsolete, it has never been used? So I just would like to know why you feel so strongly about repealing that.
 Page 193       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I apologize that I didn't get here earlier. We are having a debate on the floor right now that I had to participate in.

    Mr. SEPP. Well, to use the S&L crises is just one analogy. After the Great Depression and throughout, say, the 1950's, 1960's and 1970's, bank bailouts and S&L bailouts were quite rare. The deposit insurance limit was raised from, I believe, $30,000 for $100,000 per insured account on the basis that——

    Mr. SMITH. $5,000.

    Mr. SEPP. Yes, from $5,000, on the basis that it would never be used; it would never certainly burden taxpayers to the tune of tens or hundreds of billions of dollars; but it did.

    Mr. SMITH. The pipeline—as long as that pipeline is there, it is like it is very expandable. It is only $2 billion today. It could be $200 billion tomorrow, and that is exactly what we saw in the S&L crisis. By cutting the link and saying, look, you are out of the house now, you are on your own, you finally make these institutions grow up. It is the only way to do it.

    As long as they know that they have a line of credit to the parents, they are never going to be anything other than infant industries.

    Chairman BAKER. Is that all, Mrs. Maloney?
 Page 194       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. MALONEY. I just didn't hear from the first two panelists on my first question, and I apologize that I was not here to hear all of your testimonies, and I will read it tonight. But what is your goal? Is your goal just over—what are you trying to accomplish? He made clear that he would like more of an understanding of what the benefits are and a way to measure the benefits. I would like to know, is it your goal in this?

    Mr. SMITH. Your question was a very good one. Obviously, I was the head of the Washington Cooperative Housing Association, co-ops in Washington, for a number of years. So I have a tremendous belief that ownership really does convey all of the things that you are talking about.

    But, of course, there are many ways of achieving ownership. One is by having a healthier economy. One is to have more employment in the area, some of the things that were discussed at last week's hearing. To reach into that process and pull one variable out, mortgage rates, and not for all Americans, only for middle- and upper-income Americans, and therefore arguably raising the price for other people cut out of those mortgage rates, may not be a very effective way of conveying the benefits, which we all agree of home ownership.

    I think one of the things that the subcommittee is looking at is possibly convening a study group or maybe convening a study which will look into these things a little bit better.

    The argument is, is it better to have a healthier economy over all and then letting people use that for home ownership or whatever other dreams they have, or is it better to reach into that and to pull one privilege from one committee and another committee pulls another one and we pull the capital markets in too many ways and we make us all poorer than we would otherwise be and probably hold down home ownership?
 Page 195       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SEPP. I would point out, of course, that the Tax Foundation, for example, shows that a median-income American family's single biggest expense is taxes. More so than housing, transportation or food. I would argue that that is an area we need to concentrate on if we are going to encourage home ownership.

    Chairman BAKER. Thank you, gentlemen.

    I would like to move on, if I may, Mrs. Maloney. We will come back for another round.

    Mrs. Roukema, did you have questions?

    Mrs. ROUKEMA. No.

    Chairman BAKER. I just want to go briefly, because I would like to get to our next panel, I know Mr. Bentsen had some follow-ups, perhaps others, two very important issues raised so far, one with regard to the risk associated with holding one's own mortgage-backed securities. It is a phenomena that has grown rather dramatically over the most recent years. I may be just rhetorically asking each of you to address this in writing at some subsequent point for the subcommittee's benefit.

    As one prepares a new security instrument, if secured by the mortgages of thousands of homes, when you hold the whole loan in portfolio you have not only credit risk, interest rate risk, prepayment risk, all of the risks associated, that is probably the highest risk one could have, so you then form these new securities, pass them off to third party investors and the third party investor then assumes interest rate risk, decreasing the risk to the GSE itself.
 Page 196       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    So I am not a critic of mortgage-backed securities in themselves. I see the advantages they create in minimizing risk to the enterprises. However, when a third of one's portfolio is the repurchasing of your own mortgage-backed security, I would presume it is for income reasons, because there is a higher degree of risk; therefore, a higher rate of return is paid, and therefore enhances the profitability of the enterprises.

    The sale of a mortgage-backed security does not create one new home loan for a consumer.

    I would very much appreciate your professional staff taking a look at that issue and giving us a critique of those observations.

    Second, with regard to concentration of bank holdings of GSE securities, there are in excess of 4,000 banks which hold 100 to 500 percent of capital in GSE securities. That does not mean all Fannie Mae or Freddie Mac, but it does mean GSE securities.

    I would suggest that if it is any other GSE other than Fannie and Freddie, we ought to really be concerned. But to that end, loan limits to one borrower amount to 10 percent of capital not being made available to an individual, regardless if it is a AAA-rated corporation or not.

    The advisability as to some transition rule perhaps charging the new regulator with responsibility to assess the risk, because if a GSE would stumble for any reason and market capitalization would deteriorate, the value of those holdings of those financial institutions—saying it another way, according to Gary Gensler, 41 percent of all institutions in the country have 100 percent of their capital invested in GSE securities, it is of enormous proportions in risk to the taxpayer if there were to be a downturn in the economy, a softening of home demand and interest rates tick up. Again, I know you didn't address it in detail in your testimony, but if you would make note and please give the subcommittee the benefit of your insight on that subject unless you just want to make a brief comment.
 Page 197       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SMITH. I did mention in my remarks today, though, that we should move that capital out of other institutions. It is very dangerous for them to be holding so much of it, given the riskiness of these kinds of adventures. They are not Treasury bills. They shouldn't be treated as Treasury bills.

    Chairman BAKER. Well, particularly since the only thing permissible for that purpose is Treasury's cash or GSE securities. I would suggest that a AAA-rated corporate bond may perhaps be an equally safe investment in relation to a GSE security.

    Mr. SMITH. Well, people are looking at it who have their own money to risk rather than the regulators, I agree.

    Chairman BAKER. Thank you very much.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman. Well, I would assume, just to follow up on that, that the CFO or the investment analyst at the bank that is making that investment, I would certainly hope they are looking at it, although I have dealt with a number of investment analysts over the years. Whenever anything goes wrong, they are always shocked to find out that they had not quite looked at something as closely as they should have.

    Mr. SMITH. In preparation for this testimony, some people from the community called up and said, ''Why are you against Freddie and Fannie?''
 Page 198       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I said, ''Well, I am not really. I just think they shouldn't be shifting risk.'' I said, ''Well, let me ask you, would you be rating these groups differently and recommending you not be buying them so quickly if you didn't think there was a taxpayer line of credit and subsidy?''

    He said, ''Of course not.''

    I said, ''Aha.''

    Mr. BENTSEN. Well, I think that—this is not my line of questioning, but I think we do need to keep in mind the fact—I think the Chairman raises a very interesting point. The reason why GSE debt is held is in part because it is considered eligible securities under the Bank Holding Company Act. So it has the same standard as community bonds and Governments and others.

    I think it is a little bit of a stretch to infer that most banks look at this in the same way that they would Government debt. If they do, I think you might think twice about buying the stock of that bank.

    Now, I want to talk a little bit about the secondary market actions. Are any of you all aware of any other type of financial institution engaged in the secondary market which buys back securities that it has packaged or offered for their own account?

    Mr. SMITH. We could come back to that question, and I would submit the testimony. Of course, there are a lot of other secondary mortgages. There are accounts receivable. There are auto loans and other areas. So there are markets in those that exist. We can check and see whether or not those entities buy back or not.
 Page 199       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. BENTSEN. Anyone else?

    Mr. SCHATZ. I don't know offhand of any, Mr. Bentsen.

    Mr. SMITH. Of course it is different. They are bearing their risks directly, not through the taxpayers.

    Mr. SEPP. I can't imagine that they would have such a high proportion.

    Mr. BENTSEN. I will answer the question for you. I would think this is right, and I may stand to be corrected, but I think every market maker on Wall Street in every security buys back various securities that they offer, and the reason they buy them back is to enhance the secondary market for their securities and to enhance the primary market for their securities.

    Now the question is, and I don't think anybody in the room knows the answer to this on either side of the table, and it is an intellectual question worth trying to get an answer to, is at what level are you buying your debt or offering on the secondary market for your own account to support the price to inure to the benefit of pricing at the primary level, or are you doing it as some form of an arbitrage play?

    But I don't think you can say outright that this is some type of arbitrage play until you have had a chance to look at it, and I think that has been missed, with all due respect, by the panel as well as by Members of the subcommittee.
 Page 200       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    That takes us to a broader question. And so I think, Mr. Chairman, it might behoove us to perhaps bring in some market experts and economists who follow that type of activity to take a harder look at that.

    The next question is this broader question, where I think people are going. That is, are the GSEs, by the benefit of their congressional creation and ability to borrow money at a somewhat subsidized rate, implicit or whatever, are they borrowing money cheaply and investing it with greater risk than they might otherwise, because they have the basically cheap money at their disposal so they just keep churning it to make more money?

    Now, the panel has made reference to the S&L crisis and saying this is a potential S&L crisis occurring. It is correct, I believe, that the S&L crisis was initiated because of an interest in maturity mismatch given the type of products that S&Ls were created by. However, that problem, I think the panel would agree, and in fact you reference this in your testimony, was really exacerbated by actions by Congress that expanded the investment ability of the S&Ls into nonmortgage products, nonsingle family products, or nonmortgage products is probably better than single/multi, and basically led them away from their original mission where they were using somewhat subsidized money through the deposit insurance system and the question is, does that really compare to Fannie and Freddie where you also argue in your testimony that you are concerned that they are too heavily invested in mortgages and control too much of the market. Yes, if there is a significant downturn in the mortgage market across the country, which would mean there was something else going on in the general economy, then there would be a problem, but I don't think you can draw the—I think you have to be careful in drawing the same comparison.

 Page 201       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    It reminds me of my old English teacher saying you need to use the same tense in the same paragraph, and I am not sure you are doing that in your testimony. So I would recommend you do it.

    I know the Chairman is about to cut me off.

    Mr. SMITH. Could I respond briefly that? Because I don't think I agree with you there. I think that, first of all, it has been a while since I have looked at the S&L research literature, but I understand George Princeton looked at the extent to which S&Ls got into trouble who did and who did not use those expanded investment opportunities, and he found no correlation.

    You can lose an awful lot of money in traditional mortgages, just like you can in all the other things they got into, and there was bad performance in both categories, but it didn't look like the use of those additional powers per se created it.

    Having said that, let me argue that I think there is risk when you only have two guys as opposed to the thousands of S&Ls. One of those guys could have gone down, but it is impossible for me to imagine Freddie and Fannie going down without a massive intervention effort. So the risk is very concentrated, it seems to me.

    To allow them to go into the more risky markets, given the inherent risks they already take, I think does create a problem.

    Diversification is good when it is your money. It is not good when it is our money.
 Page 202       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. BENTSEN. With the Chairman's indulgence, I want to say one thing. I do want to make a point. I think everybody, and I didn't get a chance to read all of Mr. Smith's testimony, but what everybody said was—and the question I have raised with every other panel—is, rather than follow the Chairman's approach of cutting Fannie and Freddie off at one end and shackling them on the other, wouldn't the appropriate approach be to say ''you have finally grown up,'' using the analogy of children, ''you have finally grown up and it is time for you to leave home and we are going to spin you off into the private market.'' Would that be the better way to go, and ''we will not shackle you at all, you will become private.''

    Mr. SMITH. I would think that that would be an excellent recommendation. I think Fannie—you know, Franklin Raines seems to be a very competent individual. He certainly had a background of being able to handle high risk investment areas, and other leaders of other Government-sponsored enterprises, ICC, CAD, took the leadership and took their institutions private. I would love to see this leadership grow up and get out of the Government trough.

    Mr. BENTSEN. I wonder if that is what FM Watch wants?

    Mr. SMITH. I don't know what FM Watch wants.

    Mr. SCHATZ. I have no idea what they want.

    Mr. BENTSEN. I am not asking you really what they want.

 Page 203       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SMITH. They may not, you know, because this could be a pretty vigorous competitor and they may like in between, not quite a fowl, not quite a fish. But that is—you are not representing FM Watch. We are not representing FM Watch. We are, I think, all trying to figure out what the best way is of representing the public interest in this category.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Bentsen.

    Mrs. Roukema.

    Mrs. ROUKEMA. I do have a brief question. Well, it is a question, although I will qualify it by saying I was necessarily called away from some of the testimony or some of the questioning, so forgive me if this question has been asked in this way, but I do want to hear your answer to it and it somewhat relates to the first part of Mr. Bentsen's question. That is concerning the parallel with the S&L crisis. OK?

    In the 1992 conference, new capital standards were established for Freddie and Fannie. Certainly I was here during the S&L crisis and one of those that led the reforms, but hearing what you had to say regarding the parallels there, it is my understanding that based on those capital requirement reforms of 1992, that OFHEO, the Office of Federal Housing Enterprises Oversight, claims that the capital requirements, $18 billion for both Freddie and Fannie, along with the ten-year stress test testing requirements, which my understanding is they enforce vigorously or rigorously, and that very few banks or S&Ls could, even in this day and age, even now, meet the stress testing requirements which Freddie and Fannie are required to meet by OFHEO in that legislation.
 Page 204       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    So I agree that mission creep is a problem, and I think that is what Mr. Bentsen was referencing. So I agree with that.

    But how do you respond in terms of those capital standards and the stress test requirement, and is that contradictory to what your observations were? Particularly Mr. Sepp, your reference to that study.

    Mr. SEPP. Well, for my part the overt risk-based capital standards for on-balance and off-balance sheet assets for private banks and thrifts is 8 percent. Fannie Mae and Freddie Mac fall under just two core overt requirements, 2.5 percent on sheet, 0.45 percent off sheet. Now, this capital——

    Mrs. ROUKEMA. Excuse me. So you are contradicting the numbers that I was using, that those capital requirements are not in place?

    Mr. SEPP. To explain further.

    Mrs. ROUKEMA. I see.

    Mr. SEPP. The risk-based capital that Fannie Mae and Freddie Mac claim to be complying with and the stress test is based on, to my understanding, an internal model that they have developed that independent financial analysts have not really been able to analyze very deeply, and that is part of the problem. We have claims that risk-based capital standards are implemented and are being followed, but it has not been very easy for any of us here to verify that.
 Page 205       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mrs. ROUKEMA. So you are not disputing it. You are just saying it has not yet been verified that those standards are being maintained.


    Mr. SMITH. Let me take a different cut at that. One of my former employees is now one of the gurus in the derivatives market. He was a student of the late Merton Miller, who just recently passed away, who created the mathematics behind this, and from time to time I sit down and have a drink and he explains to me what all this market is about and how much risk is there and I walk away with a headache and not a lot more understanding.

    There is an incredible array of very complicated, very sophisticated, risk management mechanisms out there. How they perform under various crisis situations is a very, very complicated process, and I think we have reached the point now in the financial markets, the mature financial markets in the United States and the world, where that disciplining task had better be done by people who have as much reason to get it right as the original investor does, and that is why generally CEI believes that the regulatory role will have to be performed by markets. They can't be performed by bureaucrats.

    GS–14s are not going to be as smart as market analysts are going to be.

    Mrs. ROUKEMA. All right. Thank you. We will have to go over these numbers again on this, but you did respond and we will check into it. Thank you.
 Page 206       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. Thank you, Mrs. Roukema.

    Mr. Kanjorski.

    Mr. KANJORSKI. Yes. Would it be unreasonable for me to sum up your testimony? If you were testifying at the point in time when we were originally anticipating the creation of Fannie Mae and Freddie Mac, you would be opposed to the establishment of those organizations. Is that reasonable?

    Mr. SCHATZ. I don't know, Mr. Kanjorski, if we would be opposed. I think we would probably look at how, number one, they were done at a time when we didn't have the benefit of the S&Ls and number two they were done at a time when there was a need to create this national mortgage market. The question would have been, and I would assume is debated, as to whether the private sector could have done that better than creating the something out of the Government, and if at some point—let me just say one more thing. If you had created them under these circumstances, at some point you would say they have achieved what they originally intended to achieve and at that point you want to move them into something else.

    Mr. KANJORSKI. Mr. Sepp, would you have supported the concept of establishing these organizations?

    Mr. SEPP. Well, hindsight being 20/20, it would be easy to say we would have opposed it from the outset. We probably would have recommended other alternatives to creating something that straddled both the public and private worlds.
 Page 207       PREV PAGE       TOP OF DOC    Segment 2 Of 3  


    Mr. Smith, what would you have done?

    Mr. SMITH. I would have opposed it. I would have basically argued that you don't create a fix on a problem the Government has created in the first place.

    Mr. KANJORSKI. Do you all believe that the secondary market for real estate would have occurred in the United States if we had not created those organizations?

    Mr. SMITH. I certainly believe had we removed the barriers that prevented private actors from being in these areas, we would had a secondary market earlier, more vigorous and far more disciplined than the one we have today, yes.

    Mr. KANJORSKI. Again, why do you think we did not have a small business secondary market until we created that?

    Mr. SMITH. First of all, I don't know whether there are impediments there or not, but markets evolve. There are plenty of areas that we can envision markets going into that they are not there yet, and the best way to do it is to have people explore, create mechanisms, take risk, and that process has produced America. It is a great idea.

    Mr. KANJORSKI. So, you probably would have been opposed to the creation of these organizations, but clearly you are telling us at this point they are fully matured and should be cut loose. If we cut them loose, having no input as to their operations or their mission, and with still only two organizations, do you think they are not going to be so large as to fail?
 Page 208       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SMITH. That is why I have suggested very strongly that you do have—having created a Government-sponsored monopoly, you do have an instability problem. I would suggest you break them up into subparts and then you have got a more stable privatization scheme. I think you have to think about that.

    Mr. KANJORSKI. Well, we have other problems in the financial services industry. We have huge organizations that are, quote: ''too large to fail.'' Would you agree?

    Mr. SMITH. Because of deposit insurance, yes, we do.

    Mr. KANJORSKI. OK. Do you think the Congress should move to break these organizations up?

    Mr. SMITH. I think you ought to——

    Mr. KANJORSKI. They are organizations, but if they fail, it is the general consensus that we are going to have to do something governmentally to bail them out. Is that correct?

    Mr. SMITH. That is a question I would like to expand on later, but I think there are certainly situations where we bailed out institutions where I think subsequent analysis, like Continental and so on, suggested we didn't have to bail them out. I think very few of the S&Ls and private sector activities are too big to fail. I think none of them are.
 Page 209       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I do think Freddie and Fannie, as artificial creations, have gotten way out of size and they are troublesome in the political environment we live in here.

    Mr. KANJORSKI. Let us make the assumption that they are too large to fail and that we would have to bail them out. Would you still make the argument that it is better to allow them to do anything they wish, having no Government regulation or input as to their mission or their operations?

    Mr. SMITH. No, that is not what I recommended. I recommended that you allow Miss Gorelick to use her talents to break them out and create viable institutions that can succeed or fail on their own, not on our wallets.

    Mr. KANJORSKI. So, you are not breaking them in half, you are talking about breaking them in tenths?

    Mr. SMITH. Well, that is obviously a question to be decided. But this isn't a complicated task. You take their loan portfolio, you randomize it and you give one fraction to each of the fractions you decide, and then those entities can fail and they should be allowed to. Let them decide how much risk and what lines of business they want to go into, but of course cut off all the other subsidies that we talked about earlier.

    Mr. KANJORSKI. Mr. Smith, that is almost a fallacious argument. If we break them up into ten entities, and we have an economic crisis in the country, whether they are one entity or ten entities, they are all going to suffer loss. All ten would probably collapse.
 Page 210       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SMITH. No, I don't think that is true. There is no reason why all ten entities have to have the same uniform policies. Absent Government subsidies, they would explore other strategies. Some would be high riskers, some of them would be low. Some of them would be better managed; some wouldn't be.

    Companies don't succeed or fail as a whole. Why should a privatized Fannie-Freddie?

    Mr. KANJORSKI. Did not our experience of the S&L industry really indicate that this issue is not a question of one failure to another?

    Mr. SMITH. No, I don't think so at all, Congressman. We had in the S&L crisis a very large number of S&Ls. Many of them were well managed. The growth in the taxpayer burden, as I mentioned in my testimony, we went from a $600 billion asset industry to a $1.2 trillion. All of that growth, most of that growth, occurred in the below the waterline, the bankrupt entities, and it occurred because of the moral hazard that was created by deposit insurance. It did not occur as a market phenomenon.

    Mr. KANJORSKI. Mr. Smith, that argument is always the argument that I hear from all my friends. This year's budget is larger than last year's budget. With inflation and the growth of population, that is inevitable. Our economy today, when this Administration took office, was a $6 trillion economy. Today it is almost a $10 trillion economy. Everything, proportionately, is that much larger.

 Page 211       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SMITH. But that happened from 1981 to 1984 and the growth in the industry was not uniform. It occurred in the worst managed institutions, and some of the smartest investors in the world rushed to invest money in stupidly managed institutions, criminally managed institutions, because it wasn't their money at risk. It was our money at risk, and that is where the $200 billion bailout occurred because we left in place a moral hazard problem.

    Let's diffuse the moral hazard of this entity before we face that crisis.

    Mr. KANJORSKI. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Ms. Kanjorski.

    Mrs. Maloney, did you have another question?

    Mrs. MALONEY. I know the Chairman wants to move on so I will be very, very brief.

    Last night we had a debate over the funding for OFHEO, an increase. I would like to ask Mr. Smith, I understand that on March 9, at a press conference, the Competitive Enterprise Institute indicated that it found the idea of a single regulator, which is created under H.R. 3703, troubling. Is that still your view? And how do the rest of the panelists feel?

    Mr. SMITH. Unfortunately, the person who was representing us has now left my organization, but, yes, we still have that position. But the position is a very subtle one. It is based on the view that the Federal Home Loan Bank element of this whole GSE complex is probably totally fulfilled, that it is a different entity and it could go in a different direction, and also a broad view that competing—if you are going to have regulatory agencies, competing bureaucracies, competing regulators, can sometimes create a more viable way of disciplining an organization than can a monolithic regulator.
 Page 212       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Monolithic regulators with monopolies can sometimes too easily reach accommodation and nobody is watching the chicken coop. So it is a complicated position, but we do still have that position. We have reservations. We didn't take a position one way or the other in our testimony on that particular part of the bill.

    Mrs. MALONEY. Would the other panelists like to comment?

    Mr. SEPP. Having regulatory oversight in competing bureaucracies can be a good principle. I agree with Fred. But, of course, we are not really operating in an ideal world here and sometimes when you fail to have sort of a coordination among overseers, the various economic problems of institutions slip through the cracks.

    So what we need to do is explore the way to meld those two advantages together.

    Mrs. MALONEY. Mr. Schatz.

    Mr. SCHATZ. I think that the approach taken by Mr. Baker's bill is certainly a good starting point, and that the idea of one regulator would make some sense in this case, especially the way this one is constructed; that it is not subject, for example, to the appropriations process. You wouldn't be having the votes such as the one that is coming, I guess, sometime today about whether to add another $4.7 million to OFHEO. You would have it funded a lot differently outside of that process. It would be less political as well.

 Page 213       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mrs. MALONEY. OK. Thank you very much.

    Chairman BAKER. Mrs. Jones.

    Mrs. JONES. I want to try and be brief, Mr. Chairman, because I know everybody is ready to go, but I need to ask a couple more questions.

    Mr. Sepp and Mr. Schatz, your organization endorses a flat tax. Is that correct?

    Mr. SCHATZ. That is correct.

    Mr. SEPP. Yes.

    Mrs. JONES. How do you perceive them? Well, does a flat tax support home ownership? When you contemplate that, you would oppose, I am assuming, a home mortgage interest tax deduction and low-income tax credits?

    Mr. SCHATZ. Ms. Jones, first of all, some of the studies of flat tax indicate that the average family would get about $3,000 more in income with which they could certainly make payments on a home.

    Mrs. JONES. $3,000 doesn't do too much for owning a home, though, does it?

 Page 214       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SCHATZ. If you look at an average mortgage payment or you look at other ways that people make decisions about what they purchase, then it would be certainly helpful.

    I also, by the way, don't believe that if there were an actual flat tax, as we tried the last time in 1986, that you still wouldn't have a number of interests pushing for the home mortgage and charitable deductions. So we can talk about it as an ideal, but it is unlikely to actually occur.

    Mrs. JONES. Mr. Sepp.

    Mr. SEPP. I think the implicit deal of a flat tax was much like the 1986 tax reform. You get lower rates and fewer deductions. Now, obviously it would be up to Congress to ensure that the rates don't creep up again like they have since 1986, and erase the benefits that potential homeowners would have of more money in their pocket to buy houses on their own.

    Mrs. JONES. So you are saying that because people would have more money in their pockets they wouldn't need a home mortgage tax deduction or a low-income housing credit to increase opportunities for affordable housing?

    Mr. SEPP. Not necessarily, considering that one-fourth of all people who file an income tax return itemize, and yet 67 percent of people own homes. Obviously, not everyone who owns a home or wants to own a home has to take the deduction.

 Page 215       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mrs. JONES. But these are opportunities to encourage home ownership. That was the purpose they were put in place. Fair?

    Mr. SEPP. Yes.

    Mrs. JONES. Let me ask these questions, these T-shirts, ''Stop Loan Sharking,'' what organization—are they with you guys?

    Mr. SCHATZ. No, not us.

    Mr. SMITH. I think they are the next panel, Congresswoman.

    Mrs. JONES. OK. I didn't know. I saw them sitting there.

    Let me ask this of you, Mr. Smith. What would the transition from Fannie Mae-Freddie Mac to total privatization look like? And over what period of time would that occur?

    Mr. SMITH. How long does it take to grow up I guess is the question you are asking? How long does it take for anyone to grow up? I think those are good questions. I don't have the answers to those. I think that is part of what the study Commission should do, and you are looking at, as I understand it, as part of this bill as to how does one create a crisis management plan? I see it as breaking up or at least reviewing the potential breaking up of the entity into stable groups, cutting away the subsidies over a time period and then gradually releasing these into the real world to survive or fail. It could take as long as a decade. It is not so important how long it takes. It is very important that it start.
 Page 216       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    There is another approach, the one where Sallie Mae was privatized, which I know less about, but the idea of creating a sort of a secured current market and then allowing the high risk stuff to take place in a purely private enterprise.

    Mrs. JONES. In the interim, how do you deal with market fluctuation? How do you keep that from occurring such that people are not penalized out there in the world, those who have no stock in Fannie Mae or Freddie Mac or any other institution, to maintain their ability to maintain their home mortgage?

    Mr. SMITH. Well, market rates won't change that are out there now. They aren't going to change very much if we eliminate these subsidies. It is not a big market subsidy.

    Mrs. JONES. The market rate changed just when we started having a discussion of a GSE. Surely it would change if you are talking about cutting them totally out. It did change, right?

    Mr. SMITH. It did change, but remember, it changed for the middle- and upper-income. It didn't change for the people—it may have changed adversely for the poorer people in America who are not part of the subsidized housing market in that sense, they are under other programs, and very well may find themselves partially finding it harder to have affordable housing. When one group of capital users are privileged, other groups of capital users are deprivileged.

 Page 217       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mrs. JONES. I am done. Thank you. I would have liked to have had you answer it, but we don't have enough time. See you next time.

    Chairman BAKER. Just for the record, from the date of introduction of H.R. 3703 through the date of the last hearing, using Freddie Mac's posting on the Internet of current mortgage rates available, mortgage rates during that period dropped 20 basis points. That is a matter of record.

    Second, from June of last year through the current moment, Alan Greenspan has raised interest rates 1 3/4 points. I modestly suggest the Greenspan effect is of far more significance than the Baker effect.

    Ms. Waters.

    Ms. WATERS. Thank you very much.

    Let me apologize for not being in the subcommittee earlier. We have competing committees and of course the floor that is going on with an important debate on the WTO. But I was anxious to try and get here, because I think that the amount of time that we are spending on this issue is unusual and almost extraordinary, as I look at how little time we spend on many issues in this subcommittee. But I must commend Mr. Baker. He is singularly focused on the GSEs.

    May I ask you, Mr. Smith, and you may answer, too—I believe it is Mr. Schatz.
 Page 218       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SCHATZ. Sepp and Schatz. You are close.

    Ms. WATERS. I can't see without my glasses—whether or not you have taken any action—let me ask Mr. Smith whether or not you have taken any action to voice your concerns about Fannie Mae or Freddie Mac prior to Mr. Baker's getting involved in this issue?

    Mr. SMITH. We have been involved in GSEs, it has been a general area—corporate welfare has been a theme of CEIs since——

    Ms. WATERS. No, no, no. My question is very specific. Have you written or raised your voice or took leadership in any way to point out the ills of the GSEs?

    Mr. SMITH. Generally, yes. I don't think——

    Ms. WATERS. Specifically.

    Mr. SMITH. I don't know specifically about Fannie Mae or Freddie Mac.

    Ms. WATERS. OK. So this is the first time you have organized your thoughts about the——

    Mr. SMITH. That is certainly true.
 Page 219       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Ms. WATERS. ——about how bad GSEs are?

    Mr. SMITH. Not GSEs. We have taken on that, but Fannie and Freddie——

    Ms. WATERS. Fannie and Freddie, OK.

    Mr. SMITH. The first in terms of Fannie and Freddie.

    Ms. WATERS. Can I ask the other two gentlemen, because I don't know what your testimony was, and I am trying to go through it here, whether or not you have taken leadership, specific leadership, prior to now to write or to urge Members of Congress to take a closer look at Fannie and Freddie, because you felt that somehow they were involved in some actions that you did not think were good?

    Mr. SEPP. Yes, we first testified on this topic before the Subcommittee on Oversight, Committee on Ways and Means, September 28, 1989. Our July August 1993 issue of our member——

    Ms. WATERS. 1989, what did you testify?

    Mr. SEPP. I am sorry?

    Ms. WATERS. What was your testimony in 1989?
 Page 220       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SEPP. Our testimony was in regards to the Fannie Mae and Freddie Mac.

    Ms. WATERS. Specifically.

    Mr. SEPP. Before the Subcommittee on Oversight, Committee on Ways and Means.

    Ms. WATERS. Yes, but what I am asking is whether or not you were at that time pointing out the dangers of these GSEs.

    Mr. SEPP. Oh, yes.

    Ms. WATERS. And the fact that they had too much power, too much influence, and that somehow they should be reined in by Congress. Was that your testimony?

    Mr. SEPP. Yes, indeed.

    Ms. WATERS. Would you submit that for the record?

    Mr. SEPP. Be happy to.

    Ms. WATERS. Anybody else take any leadership prior to now?

 Page 221       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SCHATZ. Yes, Ms. Waters. This is the Grace Commission report from 1984. That includes several recommendations on the GSEs that I have submitted for the record, that the Chairman has included in the record, and I did mention that they pointed out the issues of the conflicting mission of the taxpayer subsidy and their private profit.

    So this has been a sixteen-year discussion, not every year, but certainly on and off over the years.

    Ms. WATERS. You have submitted that for the record?

    Mr. SCHATZ. Yes, I have.

    Mr. SEPP. So that we can take a look at that?

    Mr. SEPP. I would also like to submit these other articles as well.

    Ms. WATERS. That would be fine.

    Which of you are—how many of you are familiar with FM Watch?

    Mr. SMITH. After these committees it would be hard not to.

    Chairman BAKER. Ms. Waters, if I may help you on that point, before the witnesses began their testimony today, Mr. Schatz, in his testimony mentioned the fact that there are others out there trying to influence. And so I asked every panelist, every witness, had they accepted monetary compensation in the last two years from FM Watch or a related entity, had they been asked by any of those participants to construct this testimony, and I put all this on the record. So I just want the gentlewoman to know I asked those questions.
 Page 222       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Ms. WATERS. I appreciate that, Mr. Chairman. Now let me just ask, you are familiar with FM Watch, and you are familiar with their strategy? Have you seen their documents, internal documents, about the strategy that they were going to employ in this subcommittee as it relates to Fannie and Freddie?

    Mr. SCHATZ. No.

    Mr. SMITH. No.

    Mr. SCHATZ. As I said, we have all, as Mr. Sepp and Mr. Smith said, we have worked together on a lot of issues over the years on mismanagement, inefficiency and the failure to——

    Ms. WATERS. No, no, no. I am just interested in now.

    Mr. SCHATZ. But the answer is no.

    Ms. WATERS. No. Are you aware of any of the strategy that has been put together by FM Watch?

    Mr. SCHATZ. I have never met with FM Watch.

    Ms. WATERS. I didn't ask if you have met with them.

 Page 223       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Mr. SCHATZ. I may have read about it, but I can say that it was not the basis of my testimony.

    Ms. WATERS. Are you familiar with the terminology of mission creep?

    Mr. SCHATZ. I think that terminology has been used by others as well.

    Ms. WATERS. But are you familiar with that as being a part of the strategy and the wording that has been used in the internal documents that describe how FM Watch was going to move forward in its efforts to rein in the GSEs?

    Mr. SCHATZ. Only having read about it; not directly.

    Ms. WATERS. All right. Let me just tell you why I raise these questions. You and I have some of the same goals for wanting to expand housing opportunities for poor people and for working Americans in this country. I think that we all must act in ways that will help to do that.

    What I have been trying not to do is to get caught up in the market share war, the war of—that has been initiated by FM Watch, because they believe that Fannie Mae is expanding its mission, that the mission is creeping over into their area of subprime lending or predatory lending, however you want to define those terms, and what is interesting about it is the internal documents pretty much describe the manner in which they are going to move forward, and it appears that some are caught up in that strategy and some may be inadvertently caught up in that strategy using some of the same words, using some of the same terms, that have been described in the documents.
 Page 224       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I would like to basically ask you, number one, if any of you believe that this is a battle between those who are organized under FM Watch, many of them bankers and mortgage companies, in order to stop Fannie Mae from encroaching on what they believe is their territory, or to slow them down, because they think they have gotten too big? Do any of you believe that?

    Mr. SMITH. One of the—before you came in, Congresswoman, I introduced an article from an AEI report by the Freddie Mac senior economist. He actually argued that you can look at this market more as a market share battle, as you put it, between the traditional S&L institutions and Fannie and Freddie and actually saw it as kind of two Government entities fighting it out over their—using their relative subsidies, the fact that one has the power——

    Ms. WATERS. Do you believe that there is a war, a competition war, that is going on now between FM and the GSEs?

    Mr. SMITH. I think that Freddie and Fannie are certainly engaged in a war. You may have seen editorials in the paper that——

    Ms. WATERS. So you think that the banks and the mortgage companies that are organized under FM Watch are not at all concerned about market share and have a strategy to put the brakes on them by way of creating public policy to do that?

    Mr. SMITH. I think the argument that we have been trying to make, at least I have been trying to make as a panelist, is that the real challenge is whether or not we are harming affordable housing by the type of distortion to capital markets we are creating in GSEs. I think that is the more important question than whether one entity or another—but if I had to pick I would much rather a private sector entity be in any market than a taxpayer-subsidized entity, because I don't think they manage our money very well.
 Page 225       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Ms. WATERS. Mr. Smith, I appreciate that. I just wanted to know if you thought there was a market share war going on, yes or no?

    Mr. SMITH. I think that Freddie and Fannie are engaged in the most predatory war I have ever seen in my life.

    Ms. WATERS. No, I am asking do you think there is competition and a war going on between FM Watch and the GSEs?

    Mr. SMITH. I have worked in now CEI, this is our seventeenth year. I have rarely seen any business entity fight for its self-interest as well as I have seen Freddie and Fannie fight for theirs. I would certainly hope FM Watch would be more effective in fighting for what it believed in.

    Ms. WATERS. Thank you very much, Mr. Smith. Reclaiming my time, you refuse to answer that, so I take it that you would rather talk about what you perceive is a war between the GSEs rather than answer the question. Let me just ask——

    Mr. SMITH. That was the——

    Ms. WATERS. Let me ask any of the other panelists whether or not you believe that any of the entities that are organized under FM Watch are predatory lenders who are causing defaults of homes because of their lending practices where they have excessive fees, high interest rates and practices that are not in the best interest of the homeowners?
 Page 226       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SCHATZ. Ms. Waters, if I knew who the members of FM Watch were—I am not trying to be flippant, but I don't know who.

    Ms. WATERS. I cannot hear you.

    Mr. SCHATZ. I don't know who belongs to FM Watch, so I couldn't answer the question. I honestly don't know who they are.

    Ms. WATERS. I am sorry. You don't know who are members or who are organized under FM Watch?

    Mr. SCHATZ. No.

    Ms. WATERS. Do you think they are mortgage companies or banks?

    Mr. SCHATZ. I don't know. You would have to look at them—I don't know who they might be——

    Ms. WATERS. So you don't know the FM Watch—you don't know their relationship to these hearings and their strategy and how they play into all that we are doing?

    Mr. SCHATZ. We represent a million members and supporters, as we have been looking at this since 1984, so I would in essence say, if there are arguments about the GSEs, maybe they took some of them from us, versus the other way around.
 Page 227       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. SMITH. You should invite FM Watch to talk about these issues.

    Ms. WATERS. Excuse me. My time, Mr. Smith.

    I think that is very interesting, and let me just say that you may want to look at some of the underlying influence on what you are here today to talk about, because I think it is very important for you to know and understand, particularly if you are interested in expanding the opportunities for people to be homeowners.

    Thank you very much, Mr. Chairman.

    Chairman BAKER. Yes, ma'am. Just for the record, to accommodate the lady's inquiry, I am making note that most Members had two rounds of questions and five minutes apiece, so I did let you go on for ten or twelve minutes. That is to equate your time with everyone else.

    Ms. WATERS. Well, that means I have a little more time coming.

    Chairman BAKER. No, you actually went over, two minutes beyond what anybody else got.

    Ms. WATERS. All right. Then I will relinquish.

 Page 228       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Chairman BAKER. Thank you very much.

    Before we dismiss this panel, I want to express my appreciation to your courtesy in postponing and coming back a week later to give us your testimony. I would note for the balance in the record that each of you, in some form or fashion, felt H.R. 3703 had elements that were advisable, but none of you claimed, I don't think, that it went as far as necessary; that each of you had varying degrees of how one would get to privatization, which H.R. 3703 does not advance.

    Am I correct in characterizing your testimony as H.R. 3703 is a modest beginning from your perspectives, is that correct?

    Mr. SCHATZ. Yes.

    Mr. SMITH. That is my perspective, Congressman.

    Mr. SEPP. Yes.

    Chairman BAKER. Well, I just wanted to point out for the record that as usual I am right in the middle of all of it.

    Thank you very much for your testimony.

    I would like to ask our second panel to come forward. We have Mr. Bruce Marks, the Chief Executive Officer of the Neighborhood Assistance Corporation of America; Reverend Graylan S. Hagler, Senior Minister of the Plymouth Congregational United Church of Christ; and former Member also of this committee as well, and DC. Delegate, former Congressman Walter Fauntroy, but who appears today in his capacity as representative of the National Black Leadership Roundtable.
 Page 229       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    If the witnesses would come forward, please, I welcome each of you to our hearing today.

    I would first recognize Reverend Hagler for any comments you choose to make. Your official testimony will all be made a part of the record, and if you would choose to summarize your written testimony that certainly would be helpful. Thank you, Reverend


    Rev. HAGLER. Good afternoon. Thank you for the opportunity to be here. I am Senior Pastor of Plymouth Congressional United Church of Christ, located in the District of Columbia. I am also Development Director for the Neighborhood Assistance Corporation of America, which is a nonprofit organization that is represented by Bruce Marks here today, based out of Boston, Massachusetts.

    I want to direct some of my comments clearly toward Fannie Mae and Freddie Mac, but my primary experiences have been with Fannie Mae. There is a frightening dimension of Fannie Mae, and I say this after witnessing its heavy-handed techniques in helping to shape public opinion and even causing advocacy groups to acquiesce to the power and influences of this publicly traded Government-sponsored enterprise.

    For the last two or so years, I have watched and participated as Fannie Mae and Freddie Mac have hosted numerous conferences and gatherings, which means that they have in part at least financially underwritten those gatherings and many of the conferees under the auspices of groups like the Civil Rights Leadership Conference, the National Community Reinvestment Coalition and the Neighborhood Reinvestment Corporation. I watched as Freddie and Fannie peddled their desire to engage in subprime lending, taking the position that some people would never qualify for prime lending, but still needed to be serviced and they were the ones who were able to attend to this underserved market.
 Page 230       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    At face value, one would not necessarily see the problem with an arrangement of this kind. After all, conferences should be an environment where ideas are allowed to flow, disagreements surface and strategies for addressing problems gel.

    Unfortunately, I found that these conferences are usually not the place for this type of interaction or development. Instead, the purpose seems to be clear, particularly when they are underwritten by Freddie or Fannie, and that is to buy submissive loyalty with silent approval to the actions and the new ventures that these GSEs want to participate in.

    An example of this occurred nearly three years ago. While participating in a conference on community lending by a nonprofit organization here in Washington, DC., which was partially underwritten by Fannie Mae, I with some colleagues challenged then CEO of Fannie Mae, Mr. Johnson, in reference to zero down lending. Approximately a week after challenging Mr. Johnson, I received a note from the executive director of the nonprofit organization saying Fannie Mae has canceled an $80,000 grant with us. Are you happy?

    The note was in direct reference to the questioning that we subjected the CEO of Fannie Mae to around their position on zero down lending.

    Another glaring example of Fannie Mae's ability to shape public opinion took place during the recent serious financial crisis in the District. I, along with many other clergy, engaged Fannie Mae and engaged the public, particularly around the issue of the tax exemption of Fannie Mae, and pressed Fannie Mae in hopes of recuperating some share of revenue that is protected from taxation for the District of Columbia. It only seemed fair, because roads and water and fire services and police services help to facilitate this profitmaking, shareholder-owned, Government-sponsored enterprise.
 Page 231       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    However, as we participated in the work, gradually one minister after another dropped out of the work of the coalition with each quietly meeting with me and citing that they had received money from Fannie Mae for one project or another, and therefore their speaking now or acting or organizing would no longer be prudent.

    Though this advocacy didn't bring any new monies into the District, evidently for the price of silence and inactivity some groups received funds that may not have otherwise been made available to them.

    These two examples, I believe, are important ones, because corporations like Freddie and Fannie, which enjoy special benefits and subsidies by being GSEs, should not be engaged with the public in ways that quiet protests, mute questions or discourage spirited debate. However, the very size and money of these GSEs has leaned toward this tendency and when so much is spent on public relations like ''Showing America the Way Home,'' there is a natural resolve to silence anything that threatens to tarnish the hype.

    It is clear to me that these GSEs need more scrutiny and accountability. Being a type of hybrid, both a shareholder-owned corporation and yet enjoying generous Government subsidy, these GSEs sometimes get caught up in their own spin. On the one hand, they seek and claim to do good, making money available for home ownership and attempting to come up with strategies to help larger segments of the American population achieve that dream. Yet at the same time, these GSEs are responsible to shareholders in maximizing return on investment.

    I believe this is one of the motives that have led Fannie Mae and Freddie to enter the subprime market. Of course, Fannie and Freddie publicly claim that they are entering those markets, by doing so they have the ability to regulate the dollars and the product in the arena and therefore, in a sense, clean it up.
 Page 232       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    However, the real reason can probably be more accurately found in higher interest rates, greater fees, prepayment prohibitions and greater profits to the corporation and the shareholders. A friend of mine once told me that ''De-nial is more than a river in Egypt.''

    Of course, the real fear is that when the economy goes south or just through one of those cycles that we normally go through, if Fannie and Freddie are engaged in these subprime markets then they will be left holding the bag and the American taxpayer with them.

    If Fannie and Freddie are protected by their great ability to buy silence, then who is going to protect Joe and Jane Taxpayer from the imprudent moves that come when one is above questions and fair criticism, like it seems that Freddie, and particularly Fannie, is?

    It has been suggested by previous witnesses that these GSEs should be setting the standard for what is offered in the marketplace; they should not be spiraling the market downward and into exploitation and predatory lending, but should be leading the market upward to new places of social responsibility.

    I concur with the previous witnesses that these GSEs should be monitored and evaluated according to a well-founded criteria of social responsibility, meaning: what communities have been helped by these enterprises; what families, precisely where; what income levels and how have these enterprises made a difference in the particularly under- and unserved communities?

    Also as a final note, it is dangerous and frightening and undemocratic that GSEs like Fannie Mae, while receiving billions of dollars in Government subsidy, also uses millions of dollars to lobby Congress, fund political campaigns and silence critics. This is an unfair and unintended advantage of these GSEs and should be corrected.
 Page 233       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    It further protects the GSEs from scrutiny and even regulatory inquiry, because they have the right and financial might to politically lobby and silence any critic they choose.

    Thank you.

    Chairman BAKER. Thank you very much, Reverend.

    Our next witness is the Chief Executive Officer of the Neighborhood Assistance Corporation of America, Mr. Bruce Marks. Welcome, Mr. Marks.


    Mr. MARKS. Thank you very much. It is good to be here.

    Let me try to summarize my remarks and make them as brief as possible so we can answer any of the questions. I am the CEO, as you have stated, of the Neighborhood Assistance Corporation of America. We are the largest housing services organization in the country. We now have 21 offices around the country. We have $3.8 billion in the best mortgage product in the country for working people. Through NACA you can buy a home with no down payment, with no closing costs, no application fee, 7.5 percent interest rate. Sounds too good to be true, but it is the reality.

 Page 234       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Some of the members are behind us in the yellow shirts. We have been in the forefront of taking on predatory lending. We had attended Senate Banking Committee hearings five years ago, focusing on Fleet Finance. Obviously the predatory lending hasn't stopped. The HOEPA legislation that was passed was only the first step.

    When you deal with predatory lending, Mr. Chairman, you are absolutely correct, you have to focus on the GSEs. We can talk about this predatory lender or that predatory lender, and you look at them as roaches out there. You step on one; two or three of them are just going to be right out there doing the same thing, sometimes worse.

    But how is it that the predatory lenders are able to survive? It is because you have got the GSEs, who are subsidized by the taxpayers out there, who have a mission to lend to low- and moderate-income people, but what they do is they are creating the market. They are preventing working people who are credit qualified, hard working people working two or three jobs, who should be able to get a conventional loan, but these working people cannot get conventional loans. This is because the GSEs define a conventional loan, which is often referred to as a Fannie Mae loan.

    Fannie Mae sets the standard for a conventional loan. When Fannie Mae says to people that if you don't have considerable savings, or you don't have perfect credit, then you can't get a conventional loan, they create the market for subprime lending. So the only way to systematically reduce in a considerable way subprime lending is to expand the criteria for how working people can get a conventional loan. That means to hold Fannie and Freddie and the other GSEs accountable.

 Page 235       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Let me give an example. Lawrence, Massachusetts, in 1994, was a city that was going through hard times. NACA decided, with some private sector non-government entity lenders, to do lending in Lawrence, Massachusetts. Over the last five years, 600 people have purchased homes in Lawrence, Massachusetts through NACA and major lenders. They purchased a home with no down payment, no closing costs, and no application fee, at a below market rate. Now Lawrence, Massachusetts, is open for business. It is a stabilized, growing community.

    Fannie Mae said they would not buy any mortgages in Lawrence, Massachusetts, or required a premium because it was, quote/unquote: ''a declining value community.'' Fannie Mae and Freddy Mac redline communities. That is why the predatory lenders are able to survive and grow. If NACA did not do lending in Lawrence, you would have seen the predatory lenders out there just like they are throughout the country.

    So it is extremely important that your focus is on the GSEs. It is a predatory lending issue. If the GSEs want to do whatever they want to do to maximize profits, let them, but don't let them do it on the backs of the taxpayers.

    Let me talk about some of our experiences with Fannie Mae. Fannie Mae plays hardball. So some of the questions we have heard here were how does Fannie Mae try to get the support of the Congress and how do they organize to keep their tax exempt status?

    One of my staff people got a call. The caller said that they are a nonprofit and they are calling for Fannie Mae, and they asked a question, ''Are you for affordable housing?''

 Page 236       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    And the staff person said, ''Yes, I am for affordable housing.''

    They said, ''Well, do you know that Congressman Capuano is trying to destroy affordable housing because he is trying to take on Fannie Mae, he does not support Fannie Mae?''

    ''No, we didn't know that.''

    ''Well, will you sign a letter that says that we support Fannie Mae?''

    This is what they are doing. This is what they are doing with our tax dollars. And so we are here with NACA, with thousands of members around the country, in support of H.R. 3703.

    Mr. Chairman, you are exactly right. They have to be held accountable. These are important hearings. It is important that there is an oversight committee that oversees the GSEs. It is important that they get the tax benefits taken away from them. We don't come here very often to testify, but we do organize around the country.

    Working people out there are fed up with Fannie Mae saying that because you don't have substantial savings, you don't have perfect credit, or you don't meet our other standards, then you cannot be homeowners.

    What we have here is we have thousands of postcards from thousands of people, real people, not people who have been scammed by Fannie Mae, who say, ''I am a hardworking taxpayer who has always dreamed of owning a home. It is outrageous that a taxpayer-supported organization such as Fannie Mae believes that I am unworthy of home ownership because of the requirement that I save thousands of dollars to meet their qualifications.'' And it goes on.
 Page 237       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    These are the people with their names and their addresses, thousands of people from around the country, Los Angeles, Atlanta, Charlotte, Massachusetts, you name it, that say we want the ability to be homeowners. You can check them out. Their names, their addresses and their phone numbers are here.

    So let me end the testimony by asking that these cards be put into the record, by asking that the NACA Avenger, which explains the NACA program, be put into the record; that all the homeowners on this map who purchased in Lawrence be put into the record.

    The fact of the matter is, out of 583 NALA homeowners in Lawrence, only two people have lost their homes, only two people. These are people that Fannie Mae says should not get a loan, and the current delinquency is thirteen people, eight of which are only thirty days late.

    I would say to Fannie Mae, beat that. No one can. It is a respect for working people that they don't show. So it is interesting to have a discussion here, but when you go out into the neighborhoods and out to the communities, Fannie Mae, supported by the taxpayers, is not doing it. Thank you very much.

    Chairman BAKER. Thank you very much, Mr. Marks.

    Welcome back, no stranger to this hearing room, former Member of Congress and Member of this committee, representing the District of Columbia for some number of years, Walter Fauntroy. Welcome, sir. I understand you are here today representing the National Black Leadership Roundtable.
 Page 238       PREV PAGE       TOP OF DOC    Segment 2 Of 3  


    Mr. FAUNTROY. Yes, and thank you so much, Mr. Baker and Members of the Committee. I want to thank you for giving me this opportunity to discuss in some detail what I summarized last week.

    I do have to warn you that my remarks are those which are the result of the arrogance of old age and experience that has come not only from twenty years on this committee, but forty years seeking to declare good news to the least among us. So I am very clear on three things: one. that politics is the process of determining who gets how much of what, when and where in five areas: Who gets how much income generated; who gets how much education; who gets how much health care; who gets how much housing; and who gets how much justice.

    I am also clear on something that Maxine Waters, our distinguished colleague, former colleague there, pointed out in terms of the extent to which over my years of experience at the court many changes in public policy that affect people of African descent whose experience in the area of housing reflects most acutely the mission that Fannie Mae and the GSEs were given, and that is that the 20th century has been a century of democracy, of corporate power and corporate use of propaganda to defend the corporations from democracy.

    Now I understand that very well. So I understand what FM Watch is doing, and I understand what the two colleagues here at the table have experienced with respect to Fannie Mae. I am also very aware of the use to which those who want to deny income, education, health care and housing and justice to the least of these employ countervailing strategies by which they work out such things as I have seen in that plan, by which we say to people you are different from them; let's you and them fight, while we laugh all the way to the bank.
 Page 239       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I have seen it in Africa. I have seen it in the Third World generally, and I have seen it here.

    So having said that, I appear before you today in three capacities. The first is as President of the National Black Leadership Roundtable, the national network vehicle of the Congressional Black Caucus. It is composed of the heads of more than 200 national black organizations in 18 categories of American life. That Roundtable convenes twice a year to determine how best to support Congressional Black Caucus policy agenda initiatives designed to improve the quality of life in those five areas that I have talked about.

    For guidance on matters of housing and community development, we rely heavily on two member organizations who are out there where the rubber hits the road in terms of affordable housing. They are the National Black Caucus of State Legislators and the National Conference of Black Mayors and its parent body, the World Conference of Mayors.

    With your permission, I would like to enter into the record at this point letters sent to me on this subject of H.R. 3703 by State Representative James L. Thomas, who is President of the National Black Caucus of State Legislators, and the Honorable Johnny Ford, Founder and Director of the World Conference of Mayors and one who benefited from our struggle in the South to involve millions of people of African descent in the process of determining who gets how much of what, when and where, and who served for twenty years as the Mayor of Tuskegee.

    He has led the State there to support Fannie Mae's efforts to remove remaining barriers to home ownership and to bring even more families close to the realization of the American dream.
 Page 240       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    They also oppose H.R. 3703, because it would, and I quote them, ''impede future progress of increasing home ownership in this country.''

    Second, Mr. Chairman, I testify here today against the background of nearly twenty years that I spent on this committee, six of them as Chair of the Subcommittee on Domestic Monetary Policy and four of them as Chair of the Committee on International Development, Finance and Trade.

    And third, Mr. Chairman, I testify against the background of these more than forty years as an inner city pastor here in the District of Columbia, a civil rights activist across the country, including the District of Columbia, and these mission-driven companies that have a role in accomplishing a very important objective for those of us who are concerned about housing for the least among us.

    Having said that, Mr. Chairman, I would like then to move on to the question—if you will bear with me just a moment, I have lost one of my pages. Let me move on then just to point out that it is clear that in the effort to establish a program for making affordable housing available to people for whom the private commercial market was not providing that kind of access to mortgages and ultimately to second mortgages, we put in place in this subcommittee the Fannie Mae program, the GSE program and we are the first to admit that it has not worked as we were inclined.

    There are two reasons that I am here. One is that I am so proud and appreciative of the role that this committee took in passing the Act of 1992, which redefined not only the mission and charter of the GSEs, but also placed them under regulatory authority of the one agency that is formed and designed to assure that America's people are affordably housed. I think they have done a reasonably good job since 1992, not enough, but the facts point out that our national ownership rate stands now at 67 percent; and a little closer to home here in the District of Columbia it has risen to 42 percent. And while a lot more needs to be done, I am pleased at the progress that has been made.
 Page 241       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Minority home ownership during the 1990's grew tremendously, and that is not to say that much does not still have to be done, but the African American home ownership rate today is over 47 percent, up some 42 percent from 1993; and the Hispanic rate is up to 46 percent, up from 39 percent at a time when you passed a very important piece of legislation to harness the potential and the focus of the GSEs.

    So it is clear that our GSEs are part of the answer to narrowing the home ownership gap and the rising rate of minority ownership of homes. These are significant results and these are results that should not be taken lightly, Mr. Chairman.

    For that reason, I want to see that the reforms proposed do not limit what has begun to happen, and that is the tremendous encouragement that has come about, because HUD did set goals of 50 percent of Fannie Maes and the other business as serving low- and moderate-income families.

    I will be watching to see if that continues to improve, and indeed have some plans right here in the District of Columbia to force the kind of cooperation between not only the GSEs, but all available Federal and private programs designed to provide affordable housing for the people of the District of Columbia.

    A second reason I have been very much concerned is that there is a greater need today for this kind of mission than perhaps at any time since the charters were given. I refer you to the report of the HUD to the Congress this last March. In its report on the worst case housing needs of the country, it informed you that worst case housing has already reached an all time high of 4.5 million households that are unable to qualify for home ownership, and that is 600,000 worse than it was before you acted in 1992.
 Page 242       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    You ought to know that here in the District of Columbia that problem reflects itself most acutely than any other place in the Nation. In the last two years, Section 8 waiting lists in the District have increased by 29 percent. Our public housing waiting list is 24 percent. There is underway a process of the removal of low- and moderate-income people from this city and many urban centers across the country that really cannot be allowed to continue.

    The situation here and across the country would have been worse, I tell you, if we had not passed that 1992 Act, and I want to see the fruits of that Act borne before we move to dismantle. There is much more that needs to be done. We need to challenge these GSEs to clean up the predatory loan market for second mortgages. They need to come up with even more creative ways of making home ownership available to senior citizens on limited income, and moving more creditworthy and low- and moderate-income loan applicants from the C to D to A ratings, where those moves are warranted.

    Once they become homeowners, our GSEs need to facilitate access to affordable, nonpredatory home improvement loans, such as they have begun to focus on since the Congress acted in 1992.

    I would like to take a moment, Mr. Chairman, to challenge some of the points made by the critics of the GSEs. There are those who assert that GSEs should no longer exist, that whatever market field they were originally created to address has been remedied and that the private market without the GSEs can fully meet the financial needs of the country and the low- and moderate-income people who are still frozen out of home ownership.

 Page 243       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    I have listened to the arguments. Some of them are rather cute, but not correct, and some of the authors may be serious, but they are seriously wrong and sincerely wrong.

    The fact is that it is precisely because the private market has not provided this mortgage lending that the Congress has seen the need to enact laws like the Community Reinvestment Act. It is precisely because this so-called private market, left to its own devices, will not serve certain segments of our communities, segments where it is perceived the risks are too high and the returns too low.

    This is not to say that everyone can and should be a homeowner. It is just that the Congress determined that it was the appropriate thing to do to focus the resources of what we call GSEs on meeting this market.

    I am disappointed, I have been disappointed for many years, that they were not doing it to the extent that I feel necessary, and I am pleased that the arrangement in 1992 has resulted in a greater focus and one that needs to be built upon rather than have these organizations dismantled.

    The effort to dramatically change or privatize would mean, in my view, that the underserved would be even more underserved, and I await anyone's explanation of how that can be avoided.

    I have heard complaints about Fannie Mae and mission creep, but Fannie and Freddie are just trying to do the job that the Congress gave them. For example, critics say that home equity loans are mission creep. Well, that is not mission creep. Home equity loans are an important part of the mission that we gave Fannie Mae, and I want them to get into it.
 Page 244       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Today's fancy term ''home equity loan'' was and is a second mortgage. At least that is what we called it back in 1984 when I was here, and this committee explicitly added second loans or home equity loans to the list of products we wanted Fannie Mae to buy. We did this because it meant that second mortgages would come down in price and having Fannie and Freddie in these markets, I think, lower consumer prices for those products, and that is good.

    Others critics say that Fannie Mae and Freddie Mac are risky. This too is ridiculous. Fannie Mae and Freddie Mac are the best risk managers on the planet, as we know. Their credit losses are low.

    Chairman BAKER. Mr. Fauntroy, if I can, you have been going for about fifteen minutes. If you can begin to wind it up, that clock with the numbers on it is just for five minutes over. It is not five minutes left.

    Mr. FAUNTROY. All right. Let me then just briefly mention the criticism that Fannie Mae ought to be subjected to State taxes. As you know, we chartered these organizations to lower the cost of home ownership in all 50 States, and we did it to smooth out the regional imbalances in the mortgage supply and to integrate regional mortgage markets into the national capital markets, by creating a liquid secondary market for mortgages in all 50 States. Fannie Mae also lowers the exposure to banks and thrifts to regional downturns, and so I would not want to see that happen. I am pleased that we require them to pay Federal income taxes and to pay the local property taxes, as they do here in the District of Columbia. Although we in the District of Columbia are denied many of the same rights that citizens of the 50 States have, we do have that right and for that reason I would not want to see the institutions denied this ability to avoid the ability to smooth out the availability of mortgage credit and to smooth out the effects of downturns in various communities.
 Page 245       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    With that, I will just conclude my remarks and ask that you include in the record the correspondence to me from both the World Conference of Mayors and the National Black Caucus of State Legislators.

    Chairman BAKER. Yes, sir. Thank you very much. Every witness' complete testimony, as well as all addenda suggested by the respective witnesses, will be made a part of the official record.

    Reverend Hagler and Mr. Marks, let me follow on to the precedence set in the earlier panel of witnesses to establish your motivation for being here today. Have either of you been requested by Fannie Watch or Fannie Watch-related interests to appear here today or to direct your testimony in any manner; or have you financially benefited from activities of Fannie Watch in your organizational interests?

    Rev. HAGLER. No, I have not.

    Mr. MARKS. Absolutely not, and we testified, both of us, four years ago in front of the DC Committee, and at that time spoke out against the Fannie Mae subsidy and stated that they should pay taxes.

    Chairman BAKER. For the record, on the other side of the coin, Reverend Hagler, I assume that your organization has some time in the past had a financial relationship with Fannie and/or Freddie, is that correct? You no longer have a relationship?

 Page 246       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Rev. HAGLER. No, that is not correct. We have had no relationship with Freddie or Fannie.

    Chairman BAKER. Financial or otherwise?

    Rev. HAGLER. Financial or otherwise; a relationship of advocacy trying to make them do the right thing, but that is not a monetary one.

    Chairman BAKER. Given the suspicions that surround all these considerations, I think it is important to establish your perspectives. I took the liberty to assume your testimony was adverse to Fannie's and Freddie's interest. That is why I asked that question.

    Mr. FAUNTROY. With the Chairman's permission, I would like to answer the question as well.

    Chairman BAKER. Certainly.

    Mr. FAUNTROY. Let me say that I have received no funding from Fannie Mae ever. I have never attended a conference of Fannie Mae. I have spent years in the trenches providing housing for low- and moderate-income people here and around the country through programs that have been supported on a bipartisan basis by both President Johnson and President Nixon, as my testimony shows.

    So I am sincerely focused on the need to spare those who are being left behind in larger numbers now from the American dream, by market forces at work, market forces I see at work in this room given what I know about corporate power and corporate propaganda.
 Page 247       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. Mr. Fauntroy, specifically I really wasn't asking about you personally. I was asking about them in their capacity in which they appear here today and their organizations.

    You appear here today for the National Black Leadership Roundtable. That statement is true for them as well?

    Mr. FAUNTROY. And for New Bethel Baptist Church, the church of my childhood, the church where I have been pastor for forty years and from which base I have engaged in civil rights activity and political action designed to properly distribute income, education, health care, jobs and justice among the least among us, too many of which are represented in the black community.

    Chairman BAKER. And that statement with regard to the church and to the Roundtable is that, to your knowledge, neither Fannie or Freddie or FM Watch, to your knowledge, contributed to any of those?

    Mr. FAUNTROY. I assure you FM Watch has not come to me.

    Chairman BAKER. I kind of figured that.

    Mr. FAUNTROY. You can rest assured that during my twenty years on this committee, I came to understand what I testified to in the record here about what Paul Volcker and Alan Greenspan taught me.
 Page 248       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. To your earlier testimony of last week in which you were interested in some pilot project within the District, innovative housing opportunities to achieve that end, do you think it is ill-advised to ask the GSEs to contribute, since their corporate headquarters are located here, through some assessment toward District improvements?

    Mr. FAUNTROY. We have a very serious problem in this country and I am experiencing it in my neighborhood, where people are being run out of this town, what we call Ward 9, and I want to do in the immediate future what we did thirty years ago, and that is to coordinate and concentrate all available Federal programs and private sector programs on that problem, and for that reason I am going to be after everybody.

    Chairman BAKER. Let me make sure I understand. Are you opposed to or do you support imposition of a fee or a tax on Fannie or Freddie on just their District holdings? I am not talking about a national tax.

    Mr. FAUNTROY. No.

    Chairman BAKER. Only to help the DC. housing market?

    Mr. FAUNTROY. No. I am not for—I want it to carry out its mission, and its mission, while it exempts it from local or State taxes on income, does not exempt it from property taxes.

 Page 249       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Chairman BAKER. Correct.

    Mr. FAUNTROY. Therefore, I want them to pay their property taxes, and I want for the District of Columbia residents what every other citizen has, and that is access to Fannie Mae GSE programs designed to provide access to decent, safe and sanitary housing for people who have been left out of that access by the private sector.

    Rev. HAGLER. Mr. Chair, I am sort of also listening to the testimony as you are, and I was curious, because I wanted to know an answer to a question, and that is whether the Roundtable received any grants, funds from Fannie Mae, Freddie Mac? And I wasn't sure if I heard that.

    Chairman BAKER. The question I asked, because he is appearing today as the National Black Leadership Roundtable representative, I assumed that was the gentleman's answer, that they have not.

    Mr. FAUNTROY. I want to make it very clear, absolutely not.

    Chairman BAKER. That is what I understood.

    Mr. FAUNTROY. I put in the testimony of two organizations that are a part of the National Black Leadership Roundtable, which is the Caucus Roundtable upon whom we lean for guidance; Conference of Black Mayors who have to deal with these problems in these cities every day; and second, the National Black Caucus of State Legislators, who recognize what would happen if States could tax income of the GSEs in terms of making sure that the money got spread around to the people who most need it at a time when their market conditions may not be favorable to access to credit for low- and moderate-income people.
 Page 250       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. Thank you, sir.

    I am going to go on just for a minute longer. I have one other question, since we have a limited number of Members who are here. Relative to a joint press conference by Secretary Summers and Secretary Cuomo, relative to recommendations to curb predatory home mortgage lending, I would like each of you just to respond.

    There is a recommendation which I would intend to include in the construction of H.R. 3703, which is not today in H.R. 3703, which states that Congress should enact legislation to clarify as necessary the authority of HUD and Federal Housing Finance Board to prohibit through regulation Government-sponsored enterprises purchasing loans with predatory features.

    Now I don't know exactly what that means, but would any of you have any objection to that inclusion in H.R. 3703?

    Mr. MARKS. Absolutely. It needs to be put in. We would absolutely support it. There is absolutely no reason not to include it. Fannie Mae is out there to maximize its profits. Their economic interest says if we can push someone who can get an 8 percent mortgage into a subprime loan and we can get 10 percent, we all know what Fannie Mae is going to do, because their job is to maximize their profits.

    So absolutely, that is an important addition to the legislation, because the economics say they are going to constrain the conventional criteria to get 200 more basis points to get even more profits.
 Page 251       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. Thank you.

    Mr. Fauntroy, I would ask your response on that, but while I understand your testimony being concerned about obstructing the progress of these enterprises engaging in their mission, what in H.R. 3703, in your opinion, does that?

    Mr. FAUNTROY. I think the Act of 1992 does all that needs to be done at this time. I think it—and I segue right into your last question, namely that I would support what HUD is recommending as freestanding legislation, for the reason that HUD is carrying out the mission that we gave it to regulate these GSEs and also to give them goals and targets that they must meet, and they have begun to do that.

    Chairman BAKER. You would support whatever the regulators at HUD think is advisable policy?

    Mr. FAUNTROY. That is right. I think that is their responsibility.

    Chairman BAKER. I would point out for the record that HUD recently was significantly chastised by Members of this subcommittee for having reported that they felt that the underwriting criteria used by the GSEs resulted in, not that it was discriminatory, but it resulted in discriminatory lending practices by the GSEs and significant criticism was leveled at the GSEs by HUD for their failure to comply successfully with their mission goals. So I point that out.
 Page 252       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. FAUNTROY. HUD is doing their job. Leave them alone.

    Chairman BAKER. We are almost close there. Good.

    Rev. HAGLER. If I could also say one more thing in reference to the predatory lending piece, I think that it is very important that it somehow be embedded in there, because one of the things that has been in my experience, and, just like Reverend Fauntroy, I have been involved in the civil rights movement and other human rights-type movements in the world as well as in the country, but one of the things, alarming things I saw was Fannie Mae with its huge war chest basically going around into the lending-type advocacy communities and in the civil rights communities attempting to put forth a program of moving into subprime and predatory-featured lending, with the quiet fear there that if you disagreed with it you would be cut off from the grant mechanisms, and so forth, and so forth, that Fannie Mae and Freddie Mac came forth with. So that is a danger and that is a place where, in a sense, GSEs should not be in terms of trying to really quell public opinion and expression in that way to move into a market that brings more profit and unfortunately exploits millions of people.

    Chairman BAKER. Thank you, sir.

    Mr. Kanjorski.

    I am sorry.

    Ms. Waters.
 Page 253       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Ms. WATERS. Thank you, Mr. Kanjorski, for allowing me to take this time.

    I think it is probably only fair, and I am going to do this, to ask, Mr. Chairman, that I am able to insert into the record some information on behalf of Fannie, because of the statement that was made about them redlining in Lawrence. What they have sent here, and I will pass it on down to you, is documentation that they have financed a total of 1,056 single-family loans between 1995 and April 2000 in the City of Lawrence, supporting 1,600, and it looks like 50, houses of the 72.5 percent served households of low- or moderate-income, and 80 percent were located in lower and minority tracts.

    So I would ask that in all fairness, I think probably should be included.

    Chairman BAKER. That is without objection.

    Ms. WATERS. Thank you. Thank you very much.

    Mr. MARKS. If I could respond to that as well?

    Ms. WATERS. I beg your pardon?

    Mr. MARKS. If I could respond to that as well?

    Ms. WATERS. No, I haven't asked you to. Thank you.
 Page 254       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Let me just say that I really do appreciate your being here, because all of this is quite interesting to me and I am learning an awful lot. I don't know if you were aware of the fact that we had a financial services modernization bill that passed through here with Mr. Gramm literally ending up negotiating with this Administration in the wee hours of the morning and that they basically beat me out in trying to stop an attack on CRA and those of you who try and service CRA, because this whole business about transparency, I thought, was just an attempt to try and weaken the CRA organizations and it was a very painful experience for me. I really left that experience feeling quite put upon by Mr. Gramm and most of my Republican friends, including the Chair of this subcommittee where you are here today who opposed CRA, and CRA organizations, and the whole law that I try and desperately hang on to, because I believe that the work is important.

    And so when I find the CRA groups in front of this subcommittee with Mr. Baker, I really have to try and understand what we are doing. I think we all have the same goals, that we want to have opportunities for people to be homeowners and we want the lenders, no matter who they are, whether it is Fannie Mae or the banks or the mortgage companies, to make these loans available. We want them to be available to minorities and to poor communities and we want a fair interest rate and we don't want exorbitant fees. We don't want predatory lending. I think we all share those goals and I think you do, too. But what I am finding out is as I fight through all of this and learn every aspect of this, and I intend to do that for the next however many years that I am here, I guess what I am finding is that we are all caught up in this spiral of lending by institutions, I guess good, bad and indifferent.

    I take it that you—Mr. Marks, you are a CRA agency, is that right, nonprofit?
 Page 255       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. MARKS. We are a nonprofit organization.

    Ms. WATERS. And you help to enforce CRA and create agreements with banks and lending institutions on behalf of the people you try and serve, is that right?

    Mr. MARKS. We certainly take on predatory lending and fair housing issues.

    Ms. WATERS. So what you have is you have some agreements with some banks?

    Mr. MARKS. Yes, absolutely.

    Ms. WATERS. Is that right? Which banks do you have agreements with?

    Mr. MARKS. Bank of America, First Union, Fleet, others.

    Ms. WATERS. And Fleet?

    Mr. MARKS. Yes.

    Ms. WATERS. Now, Mr. Marks, I didn't see you during the time I was getting my head caved in on the conference committee on the banking services financial modernization bill. Where were you?
 Page 256       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. MARKS. Well, with all due respect, Ms. Waters, when the issue of predatory lending came up and this organization was the one that put it on the national agenda.

    Ms. WATERS. No, no, no, no.

    Mr. MARKS. Excuse me. I am trying to answer your question.

    Ms. WATERS. Mr. Marks, let me frame my question again. This was not about predatory lending. I am asking a specific question about, where were you?

    Mr. MARKS. We had been——

    Ms. WATERS. When they tried—Mr. Baker and his colleagues—tried to kill CRA, where were you?

    Mr. MARKS. We were out there. We were contacting—we were doing the grass-roots organizing. Every once in a while, as you know, Ms. Waters, you have to get out of the Washington mentality and you have to organize on the neighborhood level. That is what we are doing with tens of thousands of people. You go in your district, in your district and you go to a NACA workshop where there are 300 to 400 working people, predominately minority, and you ask them and you stand up and we will give you any opportunity you want, and you can say you stand up for Fannie Mae because Fannie Mae says these people, our members do not deserve home ownership.

 Page 257       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    Ms. WATERS. Mr. Marks, reclaiming my time, reclaiming my time, Mr. Marks.

    Mr. MARKS. Yes.

    Ms. WATERS. I think I said one thing. I think that I gave you the benefit of the doubt in saying that you want to do good things. I think I said that. I asked you a specific question about where were you when I was getting my head kicked in trying to save CRA.

    And I am going to move from that, because obviously you weren't here.

    Rev. HAGLER. The reality is we would have been with you if there was an invitation. We have also been working on developing and making sure our offices functioned to the best of our ability to service the community. The same thing with NACA.

    Ms. WATERS. Reclaiming my time. I did not ask you. I will get to you. Reclaiming my time.

    Chairman BAKER. Gentlemen, if we can, just to have regular order here, the lady does control the time.

    Ms. WATERS. You were not here either, and if you came unsolicited today I would expect you to come unsolicited when I am trying to save the ability for you to represent the people that you care about. That is all I am saying. If you ask me if I was hurt by that experience, that you were not here, yes, I am.
 Page 258       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Rev. HAGLER. OK.

    Ms. WATERS. Because I want to tell you, it is not easy to sit in this room at 12:00 or 1:00 in the morning fighting Phil Gramm, all of the Republicans, Democrats who turn on you and the Administration who even comes in and negotiates with Mr. Phil Gramm behind my back. So, now, having said that, Mr. Marks, it is all right for you to come here and criticize these GSEs. I don't care. As a matter of fact, a pox on everybody's house that is not doing what they should do for poor people and for people who deserve it.

    But you sit here with agreements from Bank of America, First Union and Fleet, some of the worst. I remember when Fleet was in this room with horrible stories about second and third mortgages and how I had to take somebody from Fleet in the back and force them to let a gentleman out of a loan that they had refinanced many, many times and he was paying four times for a house what he started out to pay.

    So what I ask you, if you are a part of or you know who is involved in FM Watch or whether or not you are participating with them in any way, I want you to know that all of the organizations that you have agreements with are a part of FM Watch, the Financial Services Roundtable.

    So when you come here, I would expect that you would not only talk about what your problems are with the GSEs, I would expect you to talk about the predatory lending practices that Fleet was famous for and the fact that the Bank of America has redlined in South Central Los Angeles for many years and if First Union is the same First Union that I know about, they are now teaming up with Nick's Check Cashing in Los Angeles so that they can get involved in payday loans and predatory loans in the worst possible way.
 Page 259       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Now, having said that, because I am learning all of this stuff, we have got some problems with everybody that you are in bed with. They are predatory lenders.

    We have got problems with the GSEs, because we want them to do more. But one thing for sure, I can get Franklin Raines on the telephone, into my office, into my district, creating projects while I am banging him across the head to expand lending and increase their goals as they have just done.

    Now, if you come in here and you take on the GSEs and you don't take on some of the worst in the industry, yes, it does make me wonder about what you are doing. These are the same people who want me to undo CRA. You are in bed with the enemy. You are in bed with the same people who say that we don't know what you are doing and you know what Mr. Phil Gramm said about you, he said that you guys were guilty of blackmail practically. He has used terrible words in these meetings.

    Chairman BAKER. Ms. Waters, if you can begin to wrap up, the gentlelady has gone on now for some time.

    Ms. WATERS. Yes, and I am going to—unfortunately these things happen this way. I am going to leave, because I have got to get to a meeting of the Congressional Black Caucus, and you won't have an opportunity to say much more than you have said. The facts are irrefutable.

    Rev. HAGLER. Well, Congresswoman Waters, with all due respect——
 Page 260       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. MARKS. You should ask about the integrity——

    Ms. WATERS. No, no. I am on my time, on my time. Reclaiming my time. I am reclaiming my time. This is on my time. Mr. Marks, this is on my time. Mr. Marks, this is on my time.

    What I want to leave you with is this, I am your friend. I have taken some big blows for CRA. I have worked hard, and I continue to fight the very people that you end up having to do these agreements with. And all I want you to leave with is this: Just as you come unsolicited, as you supposedly have done today, and you are not a part of FM Watch and the strategy that they have developed around these GSEs, I want you to come to me unsolicited.

    I have to tell you, I don't know who everybody is out there, but I expect when you read the newspapers and when you see the biggest bill of our lifetimes that is changing banking forever and ever in this country and CRA is at stake, I expect to hear from you. I expect you to be here with me. That is all I am telling you today. Just as you are here today.

    Chairman BAKER. Thank you.

    Rev. HAGLER. Can I have a comment before you leave, Congresswoman Waters?

    Chairman BAKER. I think she is probably on her way to a meeting, but I would be happy to recognize you for a few minutes, if you choose to speak now.
 Page 261       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Rev. HAGLER. Let me say this, the fact is that the so-called agreements only shows that you don't know who NACA is. NACA has fought tooth and nail each of these institutions around redlining and caused them to see the light, caused them to see what the problem is. And the fact that we created a structure to better deliver the services to those who are most in need and underserviced than even those banking entities is the reason that we are there.

    We have always been in the trenches. We continue to be in the trenches. We have developed our offices in a meticulous way in terms that there is a glove treatment to every single client who walks through the doors absolutely free, and we work with them not only to repair their credit, but to deal with them so they can get the best deal and be able to stabilize their communities.

    You know, so one of the problems here is the problem of pointing fingers and looking for demons under every rock. The issue, I would hope, is that everyone on both sides would inquire into the truth, to inquire into what are the realities out there and what are not the realities, to define what can make the systems work better and to ask the question of how do we begin to deliver the services that were probably—hopefully intended from the first to the people who directly need it.

    We are not raising that. We are protecting one entity or we are trying to crucify the entity rather than coming down the middle and inquiring on what is the truth and what really needs to be discerned here, and the truth that needs to be discerned here—thank you, Congresswoman. The truth that needs to be discerned here is that, yes, there is a lot of manipulation that has been going on, and really by the GSEs, because that is where we have experienced them.
 Page 262       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Chairman BAKER. If I may, let me ask Mr. Marks to respond for a couple of minutes to get his comment on the record. Mr. Marks.

    Mr. MARKS. It is true that Senator Gramm has called us ''bank terrorists'' and he has called us worse things than that. He has called us ''extortionists,'' and we wear that as a badge of honor in the tradition of Robin Hood, if that is necessary to provide working people the opportunity to be homeowners, we are absolutely going to do that. If we have the banks who are working in partnership with NACA to provide $3.8 billion in the best mortgage product of the country, we wear that as a badge of honor. If you do not know our history, go back and see what we did in the four-and-a-half-year war against Fleet, in the campaigns against First Union, in the campaigns against a number of other institutions where we have gotten them to the table, where they have made agreements that meet the needs of working people. You have to focus on getting the job done, which is what NACA does versus what Fannie Mae and the other GSEs don't do.

    It shouldn't be the fact that the major lending institutions in this country do more for affordable housing than taxpayer subsidized GSEs. That is the question. If a taxpayer is going to foot the bill, then the GSEs have to step up to the plate. We don't subsidize the banks. They don't have a charter with the Government that says they have to meet the needs of low- and moderate-income people. Therefore, Fannie Mae should do at least and more of what the other lenders out there do. They should disassociate, divest from the Government, both with its charter and with its subsidy, and compete with the rest of the lenders in this country.

    Chairman BAKER. Thank you, Mr. Marks. Let me move on.

 Page 263       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    I am going to recognize Mr. Kanjorski in just a minute. I have a couple of comments I would like to make. I do think the proceedings, unfortunately, over the past couple of weeks have taken on an unusual tone; and last week some were questioning whether Ralph Nader was truly a consumer advocate. I found that somewhat noteworthy.

    Second, today, although I may not agree with every activity the groups have engaged in, I don't consider myself a person who is out to destroy CRA, and I have respect for people who are in the real world trying to help poor people get into decent housing. I think that is a very laudible goal, and I commend both of you.

    Let me also say I commend you for your courage for coming into this hearing room and saying on the record what you said. Whether we all agree with it or not, it is not a simple thing to do.

    There is one other thing I want to bring up and I am saying this without anger, Mr. Kanjorski, so I don't want to start another fight, but it is serious. There has been distributed around the subcommittee hearing room today, to the media, a Dow Jones wire service story which indicates Members of this subcommittee have received significant financial contributions from Fannie Watch related interests, meaning a bank belongs to Fannie Watch. Therefore, if a bank gave a Member a contribution in 1992, there is an implicit relationship that this legislation is moving forward to advance the interest of Fannie Watch or those individual Members.

    I am specifically mentioned in it. Mr. Kanjorski is mentioned in it, but at a far lower level. Let me come to your quick defense. You made the cut, but just barely. And there are a lot of other Democrats and Republicans. It is preponderantly Republican.
 Page 264       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I note that one particular GSE representative has been distributing this during the course of the hearing.

    Certainly anyone can question my motives, but I will say on the record, you can examine me from stem to stern and you will not find within me motivation to disrupt GSEs, the delivery of housing product or to be steered by financial contributions from anyone for any reason; and I think the fact that that information is being utilized has opened another door.

    Mr. Fauntroy, can you tell me what relationship——

    Mr. KANJORSKI. Mr. Chairman, I think I should ask for my five minutes.

    Chairman BAKER. I recognize you for five minutes.

    Mr. KANJORSKI. I listened to the testimony of the Reverend and Mr. Marks. I think I made a mistake when I bought a ticket for my return flight back from my district. I obviously said ''Ozland,'' because I am listening to your testimony and you sound like virgins in Washington. I did not know there were any, but I am glad there are a few left.

    You indicated in your testimony, Reverend, that something that really set you off was some funding that you were going to get from one of these GSEs. After you spoke your mind, however, the executive director said, ''Thanks an awful lot for losing the $85,000 grant.''

 Page 265       PREV PAGE       TOP OF DOC    Segment 2 Of 3  
    I do not want to get into all that, but that is what I understood. There was a motivation there.

    Rev. HAGLER. Let me set the record straight, because you have got that fact wrong, so it is important to set that record straight.

    It was a conference on the Community Reinvestment Act that Fannie Mae may have had partially underwritten. In that conference, the CEO, Mr. Johnson, spoke. We confronted Mr. Johnson as a participant in the conference, not applying for any grant from anybody.

    Mr. KANJORSKI. I thought you said that after you got back——

    Rev. HAGLER. No, I got it from the executive director of that coalition who said, ''You see what you cost us by speaking out?'' I don't have anything to do with that. I was a participant in the conference. I spoke the truth.

    Mr. KANJORSKI. You made the assumption that that refusal of $85,000 was directly as a result of your statements?

    Rev. HAGLER. I didn't make the assumption. That is what the executive director told me when I did call him.

    Mr. KANJORSKI. He, of course, knows that because he lost the grant or he was in communication with the people who decided the grant. I am not going to argue that position with you. It just sounds rather naive to me that you think that it occurred. If it did occur, maybe we should examine all of those things in the future.
 Page 266       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. Marks, you are here as a CRA advocate. I have to tell you, when I came to the Congress of the United States, my record on CRA was rather clear. I opposed it. You probably convinced me today that I was right when I first came here. This last time when I decided to support CRA, I may have made a mistake. What you are telling me is there has been a tremendous reaction from the banking communities of America to do all these wonderful things without any compulsion of law. If you think that, you are the most naive individual I have ever heard testify here.

    The only reason you are getting the support of some of these banking communities is because CRA is in place. I did not think the idea of transparency was that bad, quite frankly, when we debated it during last year's conference on financial modernization. I had heard a lot of comments that CRA organizations were out there drumming up contracts and grants to keep them alive and to pay for their expenditures at the threat of stopping mergers, consolidations and other activities. That is probably as practical to make that judgment as the $85,000 grant that was a result of the ministers' statements, misstatements, or whatever.

    Mr. MARKS. Mr. Kanjorski, may I respond?

    Mr. KANJORSKI. I am going to let you respond. I do not normally defend Ms. Waters. She is much further to the left than I am, quite frankly, but to see organizations such as yours come in here and talk of—I think $3.5 billion of mortgaging, warrants such defense.

    I commend you for doing that, but $3.5 billion, Mr. Marks, is not even a spit in the ocean for disadvantaged mortgaging in this country.
 Page 267       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I could jump to the next logical conclusion of your argument, that of why we should not have CRAs. You have convinced me. The other testimony of the first panel here warrants that we ought to do away with GSEs. We never needed them to begin with. We really have done a disservice to the Congress of the United States. I think the private market out there would be doing everything that is being done today better and certainly more responsive to the poor and minorities of this country if we stepped out of the picture and repealed all the laws that we have in place. That is what I am hearing from your testimony.

    Mr. MARKS. If I can respond, I appreciate the lecture on whether I know CRA or not.

    I used to work for the Federal Reserve Bank of New York. I was in the domestic applications area. I dealt directly with the mergers and acquisitions of the major institutions in District 2. So while you were doing your piece, I was doing this at the Federal Reserve. I understand CRA, both how it was implemented when I was at the Federal Reserve Bank; I understand how the regulators look at CRA. I understand CRA is a good premise, very important, but it has no teeth.

    We also understand that——

    Mr. KANJORSKI. So we——

    Mr. MARKS. I am sorry. If you could give me the respect that I gave you when I listened. The point I would like to say——
 Page 268       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. KANJORSKI. There are separate roles here, Mr. Marks. We call you to respond to our questions. We do not call you to give you a platform, OK? If you want a platform, go outside in the square. That is where the television cameras are and you can speak there.

    But, respond to our questions when you come in here, OK?

    Mr. MARKS. It would be nice if they were factual.

    Mr. KANJORSKI. I do not know that I have made any factual comments. I am drawing conclusions. I am listening to the testimony of witnesses, and what I gather from these witnesses is that we have done a terrible thing in this country for the last sixty years in creating GSEs. We have not solved the problem. The private market would have done a lot better, and one of the major mistakes we made in this country was passing the Community Reinvestment Act. I think maybe we ought to go back and rethink all these things. I think you persuaded me that you have the right answers and that your contacts and relationships with these major banks would have occurred in spite of what the Federal Government has undertaken. That the legislation, I think, has been visionary legislation over the last thirty or forty years to accomplish what we have arrived at. You probably have opened my mind.

    I may think back to this day when we get into those rooms in the future and start negotiating and remember that we probably are holding you back. We ought to cut you loose into the private market. You would go crazy in that private market and take care of all these needs and all these standards you talk about.
 Page 269       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Thank you, Mr. Chairman.

    Mr. MARKS. If I could respond, with all due respect——

    Chairman BAKER. You can on my time, but be brief, because I have got a few things to get off my chest.

    Mr. MARKS. I will.

    The fact of the matter is, absolutely CRA, sir, is important, but so are fair lending laws. So are the other laws out there. When NACA took on Fleet Finance, it was around the legal issue, around RESPA, fair housing. CRA, as you understand, is not enforceable except during a merger or an acquisition. It has to have more teeth. We understand that. We are out there taking on that fight. So obviously, CRA——

    Mr. KANJORSKI. Mr. Marks, you do not take on that fight. The Congress of the United States passes that. That is the problem. What you have done is take a major step back, because you are starting to lose the support of people that you have in the Congress for the very thing you want to give teeth.

    I will tell you what teeth was. If Mr. Gramm had his way, he would have pulled out every tooth in the mouth of CRA because it would have gone. I am not saying that you are right or you are wrong, or that other people are right or wrong. I am just saying, we should hear the testimony and jump on forty or fifty years of history in this country in progressive policy toward housing for poor people and average people. Nobody will claim that we had it right or that you had it wrong. You seem to be saying to me that you are the only person who knows how this thing works. It is not working because of the laws this Congress has passed, but it is working because you have been able to make these arrangements with all these banks. I would like to give you an opportunity to go back. Without the benefit of all these laws, go back and make that free market negotiation.
 Page 270       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Mr. Marks, I tell you, if we did not have CRA and if you knocked on the door of any one of the three banks you mentioned, they would not even let you talk to the assistant, to the under-assistant, to the deputy assistant, to the treasurer of that institution. The only reason you are in there and have those agreements is a thirty- or forty- or fifty-year fight in the Congress of the United States to try and open this up.

    Have we done it right? Not in its entirety. You come in here, however, attacking the policy and supporting the last table that was here. They want a flat tax. I guess we could say that you guys want it too.

    Do you really want it? I guess I should ask that question.

    Mr. MARKS. The focus is on GSEs. It is not on CRA. When you are in the affordable housing area, you develop coalitions based on the issue. This coalition is when some people on the Republican side and the Democratic side say that GSEs have to be held accountable.

    Well, we develop these coalitions to keep affordable housing and mortgages for working people. So let's not confuse this with CRA. Let's keep the focus on what the GSEs subsidized by taxpayers have to do as per their charter. Let's not confuse the issue. Let's not blur the issue, with all due respect.

    Mr. KANJORSKI. You come over to the floor this afternoon, and you watch whether the Majority party supports more money for the regulators of Fannie Mae and Freddie Mac. I assure you, they will not. We have to ask is there something that can be done today to make sure the mission is being carried out, and that the responsibility, safety, and soundness of the system is being protected? Are they going to support it? Is that amendment going to pass?
 Page 271       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    I will wager with you right now it does not pass.

    Mr. MARKS. But the question is, are Fannie and Freddie doing what they are required to do, not whether CRA is there.

    We will stand with you for CRA. We will stand against the people who are against that. But you should have the focus and the strength of your integrity to say, is Fannie Mae the solution or the problem? Focus on that.

    Chairman BAKER. If I may try to get back in the game here, I have got a couple of minutes of stuff before we wrap this up. Again, I appreciate your courtesies in being here. I return to the subject of contributions to Members of the subcommittee in regard to their support or opposition to legislation. I just want to make clear, Mr. Fauntroy, does the National Black Leadership Roundtable have any leadership to the Congressional Black Caucus foundation or are they two separate enterprises?

    Mr. FAUNTROY. Absolutely no relationship.

    Chairman BAKER. What I wanted to bring to Ms. Waters' attention—and unfortunately, she has now left—for example, if we start following money and influence, the aggregate contributions to all Members, not one—on the Republican side, in the cited article, it was $250,000. Some are assuming that is going to influence Members' judgment on H.R. 3703. I can tell you it hasn't, but in 1998, the Fannie Mae Foundation—I may be incorrect about ''Foundation,'' whether it is Fannie Mae—gave the Black Caucus Foundation $82,000, but in 1999 gave them $500,000.
 Page 272       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    Now, I don't think any of that has relevance to the considerations of this subcommittee, but I am saying to all parties, let's conduct a professional debate of the issue. Stop questioning each other's motives and why one appears for or against the legislation, and eventually we will vote on this proposal.

    I started it with the premise that my work was based on recommendations of the CBO, the GAO, the Treasury, Alan Greenspan and a number of other people who happen to know more about this than I do. And if there are defects with the bill, I am perfectly willing to accept modifications.

    In the case of predatory lending prohibitions, last week in taking the Community Reinvestment recommendation with regard to mission compliance and line-of-credit suspension, I think there are a lot of good ideas that have been promoted through these hearings to this point. My door is not closed to anyone. This is a work in progress.

    And let's put down the accusatory attitude about the reasons for this subcommittee's work and see if we can't enhance consumer delivery of low-income product while at the same time protecting taxpayers from unwarranted risk. Those are absolutely the two points of this legislation. To the extent it doesn't achieve it, I am still waiting on the GSEs to deliver a document to my door that says how we get there. I haven't gotten it; I have asked repeatedly. They viewed the bill and its content before its introduction.

    I am going to extend to Mr. Kanjorski in the next day or two an offer to have a study group plan, but I hope—on some rules of conduct that I hope he will find acceptable, because I want to open it up more. If there are more people who want to come in and tell us what is wrong with what we are doing, let's hear from them. We will have more hearings. I just hope the tone of the last hearing and this one can be slightly modified to where we can hear from people with differing opinions come to professional conclusions and make appropriate decisions for all parties.
 Page 273       PREV PAGE       TOP OF DOC    Segment 2 Of 3  

    To that, did you care to respond, Mr. Kanjorski?

    Mr. KANJORSKI. No.

    Chairman BAKER. I am saying this with the highest degree of sincerity. We have worked together on Home Loan Bank and a lot of other tough issues over the last decade, and I think it is time we focus on an appropriate manner of conduct for this subcommittee.

    With that having been said, we will have a meeting in July for market participants.

    This hearing is adjourned. Thank you.

    [Whereupon, at 1:47 p.m., the hearing was adjourned.]

Next Hearing Segment(3)