Posted on Monday, February 14, 2011
In a speech at the American Securitization Forum’s (ASF) conference in Orlando, FL, Congressman Scott Garrett (R-NJ), Chairman of the House Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, delivered the following remarks on ways to prevent taxpayer exposure to Fannie Mae and Freddie Mac:
“Thank you, Tom and Ralph, for inviting me to speak this morning.
“It really is an honor to address such an esteemed and diverse group. I was flipping through the agenda for the rest of the conference and it is quite amazing the wide variety of issues that will be discussed and the very knowledgeable panelists that will be presenting.
“For my discussion with you this morning, I thought I would start off by addressing some of the broader work being done by the House of Representatives and then discuss the issue I know most of you are interested in – housing finance reform. I will then be happy to take any questions you might have.
“As you all know, it’s a very interesting and challenging time to be in Washington, DC. We are dealing with a number of very important and complex issues at the moment, and because of the ongoing economic problems the country faces – there is a great deal of pressure to ensure that Congress and the Administration are fostering a business environment that will best facilitate private sector job creation.
“Job creation is literally priority one, two and three for House Republicans. It is imperative that every action we take is considered in the context of job creation.
“Majority Leader Eric Cantor routinely offers this advice to members that I have taken to heart. He is always reminding us to stop and ask ourselves: ‘Are my efforts addressing job creation and the economy; are they reducing spending; and are they shrinking the size of the federal government while increasing and protecting liberty? If not, why am I doing it? Why are we doing it?’
“Following the ‘Cantor Rule,’ I believe, will help all Members of Congress stay focused on our responsibility to the American people and remind us of the bounds laid out by the Constitution in which we have to operate.
“And while I believe that House Republicans will follow Leader Cantor and Speaker Boehner in this vein, it is important to remember that Republicans are not in charge of Washington – Democrats are. Democrats still control the Senate, and Democrats still wield the veto pen in the White House – at least until 2012.
“Until then, yes, House Republicans can stop many other bad policies from being enacted, but we cannot, on our own, roll back some of the job-killing laws like ObamaCare that were passed last Congress.
“Things would be much easier if the president applied the same standard to compromise as he did when he met with Congressional Republicans in 2009. Fresh off his 2008 election victory, the president said: ‘Elections have consequences, and we won.’ Meaning that, yes, he would work in a bipartisan manner if Republicans agreed to what he wanted. Hopefully he will use this same logic this year, but somehow – I am not that optimistic.
“I am, however, optimistic about finding compromise on one of the most pressing issues this Congress will have to tackle – the massive debt and deficits crippling our country and economy.
“The reason I am more optimistic about reaching some agreement on this front is because of the simple fact that we must find agreement. For the sake of our children and grandchildren we cannot let our nation’s fiscal crisis spiral any further out of control.
“As we saw recently with S&P’s downgrade of Japan’s credit – huge debts and deficits have real world consequences that can severely stunt economic growth. The debt and deficit are directly tied to our efforts to help promote job creation.
“In addition to my work on the Financial Services Committee, I also serve on the Budget Committee, and when the Congressional Budget Office released its new $1.5 trillion deficit projections a couple weeks ago, I realized just how tough my job is going to be on the Budget Committee.
“In the House, we are planning to roll back spending levels to Fiscal Year 2008. While that is a good start, I felt the ’08 levels were too high in ’08!
“Because of that, and to show people how serious we are about cutting spending, Rep. Jim Jordan, Senator Jim DeMint and I recently offered legislation that would cut $2.5 trillion over the next 10 years, which included rolling back spending levels to ’06 levels.
“Of course, I haven’t even gotten around to discussing the problems with entitlements – Medicare, Medicaid and Social Security!
“I wanted to lay out the current budget dynamics because I believe it is important to view the topic I know the majority of you are most interested in – housing finance reform – through the broader budgetary context.
“The Fannie and Freddie bailout stands at $150 billion and counting, and 95% of the U.S. mortgage market is currently being financed by the federal government.
“Needless to say, we cannot continue with the status quo – this issue needed to be addressed yesterday.
“Before I get to the question I know you are all dying to hear about – the future of what U.S. housing finance will look like – I want to focus on a different question that I feel is just as important – if not more.
“Applying the Cantor Rule to the GSEs, the question I believe needs to be answered first is – What are the things we can be doing right now, this very instant to: 1.) Protect taxpayers; 2.) End the bailouts; 3.) Get private capital back in our mortgage markets; and 4.) Decrease government exposure to housing?
“I believe these four objectives should be the driving forces in our initial decisions regarding GSE reform legislation.
“There are literally countless ways to begin addressing these four goals legislatively. I won’t go into all of them here today but I will discuss 4 specific areas that would be good places to start.
“The first area I’d like to address is their portfolios. The combined retained portfolios of Fannie and Freddie are roughly $1.5 trillion.
“Through the conservatorship agreement, the portfolios are set to decrease by a small percentage each year until they reach a certain set level. I believe this could happen faster.
“One of the risks associated with a $1.5 trillion mortgage book is it contains a significant amount of interest rate risk. As we begin to eventually head into a more volatile interest rate environment, it will become increasingly difficult to hedge a book that size against those movements.
“I also believe there are significant unrealized gains in the portfolios that could be realized.
“If you look more specifically at the GSEs’ book, half of it is actual agency MBS, another quarter of it is non-agency MBS, and the rest of the balance includes mortgage loans of all different types.
“Some of the assets can be sold off more quickly; others cannot because they are less liquid. The GSEs own different assets and there are specific markets for each of these assets. We need to more closely look at each of the portfolio components and figure out how to wind them down sooner to protect taxpayers.
“I understand that selling some of these assets more rapidly could have an effect on their price and I also realize that the Treasury and the Fed own a number of these assets. But almost every market participant I talk to says it can happen faster and if it does, that it will reduce taxpayer risk. I even bet a number of you in this room would be interested or in the market for some of their assets??
“If you compared what the government has done with Fannie and Freddie to what the FDIC would traditionally do when it takes over a bank, there is a wide discrepancy. The FDIC would normally come in and gain control of the assets and then get rid of them. If the FDIC had taken over Fan and Fred, they’d be liquidated.
“The second thing that should be done to help end the bailout of Fannie and Freddie and to be completely honest and transparent with taxpayers, is put both entities on the federal government’s budget. Currently, the federal government explicitly stands behind all of their securities and debt issuances – let’s properly account for it.
“I know it will be painful, especially given the current budget environment, to put the cost of their credit subsidies back on-budget and subject their debt issuance to the debt limit. There is a lot of work currently being done to force financial institutions to bring their off-balance sheet liabilities directly on to their books and the government should not be held to a different standard.
“Also, if the two entities are truly on-budget – those increased budgetary pressures will force Congress and the Administration to deal with them and not let them continue on existing in perpetuity.
“Another area that should be addressed is the Conforming Loan Limit. Currently, they are almost $730,000.
“To afford a house of that value, a family would need to earn roughly a quarter of a million dollars. These are the same people that the president wants to raise taxes on.
“It doesn’t make much sense to raise taxes on those families because they are too “rich” and then turn around and have the government subsidize them when they want to buy a house!
“And finally, The Affordable Housing Goals – which numerous studies point to as one of the main causes of the GSE’s collapse – should be abolished.
“I’m sure most of you have heard the quote by the former Chairman of the committee when discussing the safety and soundness of the GSEs: “I want to roll the dice a little bit more in this situation towards subsidized housing…”
“Well, we did roll the dice with the affordable housing goals and it came up snake eyes. It is absurd that these two entities, under federal government conservatorship and hemorrhaging billions of taxpayer dollars, have their conservator publishing new affordable housing goals for them to hit.
“The only goal these two entities should currently have is to reduce their burden on the American taxpayer.
“These are just a few things with Fannie and Freddie that we can be doing right now to protect taxpayers, end the bailouts, get private capital off the sidelines, and reduce government exposure to the housing market.
“Now let me delve deeper into the question: ‘What will the future of U.S. housing finance look like?’
“First, let me say that, whatever shape the future of U.S. housing finance takes – I believe securitization will play an integral part in, and be vital to, the resurrection of the U.S. mortgage market.
“We have a national housing market over $11 trillion and almost 75% of that market is financed through securitization. You can’t have a mortgage market of that size without securitization.
“There is not enough capital in the banking system to support a mortgage market of this size. Three-fourths of the mortgage market is funded by you – the secondary mortgage market and MBS investors.
“But, while there are a wide variety of positions on the future of housing finance, two things everyone can agree on is that having the federal government continue to underwrite 95% of our nation’s mortgage market and having the FHA specifically insure 50% of new originations is completely unsustainable.
“A number of areas of the Securitization process have produced very significant problems during this crisis but I also believe securitization, if done correctly and with the proper incentives, can be a very significant part of the cure.
“The securitization process, at its core, allows capital to flow more efficiently and effectively from investors to borrowers across the country and even across the world.
“It enables a retiree in Oregon to lend money to a young family in Florida in order to buy their first house. Securitization makes it possible for a dentist in Minnesota investing in a mutual fund to help finance a new shopping mall in New Jersey.
“Because the securitization process is so vital to the movement of capital, we need to ensure we have a viable and sustainable housing finance system for the future.
“And, let me stress and be very clear that, going forward, I am firmly committed to a purely private U.S. mortgage market over time – free of government guarantees and subsidies.
“I realize that this will not be an easy or immediate goal but it is one I feel strongly about – especially given the role that government involvement in the mortgage market played as a central cause of the financial crisis.
“Considering the turmoil and havoc that have been wrought on our economy largely because of our nation’s housing policy; it would be foolish for us to go back to anything close to the system we are transitioning away from.
“If we don’t learn from our mistakes, we will be doomed to repeat them.
“I also realize there are many issues that need to be thought through in great detail to make the transition work.
“Many people that support a government role in the housing market raise a wide variety of concerns about a purely private mortgage market, but there are just as many concerns with any model that includes government support.
“Therefore, I thought I would walk through eight of the central claims and assertions made by what some refer to as the ‘Housing Industrial Complex.’ Then, I’d like to offer some additional comments or pose questions that need to be further considered. I do not plan on us resolving our nation’s housing finance questions today but feel it is important to clearly identify many of the main areas that need to be given additional thought.
“The first assertion offered is: ‘The 30-year fixed rate mortgage product cannot survive without a government guarantee.’
“Given the fact that there was a fairly robust 30-year jumbo market before the crash and that you can get a 30-year fixed jumbo today, I don’t believe that assertion is correct.
“Prices would presumably increase, but by how much precisely? Down payments would be higher but is that a bad thing? Would newer, more consumer friendly products emerge? How do other countries that have higher homeownership rates survive and even thrive without the 30-year fixed? Are there ways borrowers could access options in the private sector to hedge against interest rate risk?
“It appears to me that this statement is used more to gain political leverage in the debate rather than to truly look at it objectively.
“The next assertion is: ‘The government can easily price the tail or catastrophic credit risk associated with the mortgage market.’
“The government’s history in pricing risk is extremely poor. The Deposit Insurance Fund, the National Flood Insurance Program, and the Pension Benefit Guaranty Corporation are three government insurance programs that historically have terrible records of properly pricing for risk.
“If you have politicians setting the price – would politics inevitability get involved? What happens when the economy starts to grow and the housing market recovers? Will members of Congress easily revert back to the pre-crisis mantra that the risk premiums are too high and must be lowered so that more people can achieve the American dream and own their own home?
“Politics, much like our housing market, is very pro-cyclical – and, if politicians are in charge, it will be hard for them to take away the punch bowl during the middle of the next party.
“The third assertion is: ‘The To-Be-Announced (TBA) market must be kept viable and the only way to ensure its existence is to have a government guarantee.’
“While I agree the TBA market has provided benefits to consumers by allowing them to lock-in interest rates earlier – it must be remembered that the TBA market is a product of the government guarantee – not the other way around.
“Could the benefits of the TBA market be derived by a more robust interest rate futures market? Are there other ways to achieve the homogeneity of the TBA market by using common underwriting standards or other means?
“Fourth, one of the most common assertions I hear is: ‘There should be a government guarantee because the government always, eventually, steps in if there is a problem.’
“I don’t disagree that the government, especially the current administration, can’t help itself from intervening in a number of areas of the free market.
“I would ask, if you set up a specific system and structure to allow the government to step in, won’t the chances of the government actually stepping in be much greater?
“Also, how does a government guarantee affect a creditor’s incentive to monitor risk? Does this lead to more moral hazard?
“The fifth assertion raised is: ‘Rates investors are only willing to accept interest rate risk and do not want to take credit risk.’
“Having rates investors interested in our national mortgage market is central to achieving a significant amount of liquidity. Are there ways to minimize credit risk for rates buyers through sound and strict underwriting standards that have performed historically at quantifiable levels regardless of market conditions?
“Or perhaps we can achieve the same objective through structure: for example, through strict over-collateralization or senior-subordinated structures. With the proper structure, can’t credit risk be substantially minimized for rates investors?
“Would rates buyers be interested in investing in a U.S. covered bond market? As many of you know, I have been working on covered bond legislation for several years and am hopeful we will be able to finally get it signed into law this Congress.
“Last year, there was over $22 billion of dollar denominated covered bonds issued by foreign banks to U.S. investors – 80% of those investors were rates buyers. I am aware that $22 billion is a small number but every market has its start. And I believe they can be an important component of the broader market going forward.
“Another assertion, the sixth, being advocated by some in the regulatory community is: National Mortgage Servicing Standards should be included in the final version of the Qualified Residential Mortgage (QRM) definition.”
“Some argue that to get securitization functioning properly again, investors must feel comfortable that the problems in the mortgage servicing area be addressed.
“While I agree that there have been many troubles with servicing standards and that the issues must be dealt with, I don’t recall at any time during the Dodd-Frank debate – mortgage servicing standards being mentioned.
“Also, because the QRM definition applies to the characteristics that must be met at origination for a security to be exempt from risk-retention – how would a failure in servicing, which is done over the duration of a loan, impact the security that has already been exempt?
“I believe this is a very important topic but one that regulators should not unilaterally address without proper authority from, and discussion by, Congress.
“The seventh assertion is: ‘Any policy decisions should weigh the impact on affordable housing.’
“I believe that, if there is to be any government assistance to homeownership, it should be limited to first-time homebuyers or rental housing and that the assistance should be on-budget and appropriated annually by Congress.
“Many supporters of affordable housing liked having it funded “off-balance sheet” and many providers of affordable housing funds use it to give them additional political leverage in other areas.
“And the final, and a very common, assertion is: ‘The government has to play such a large role in our mortgage market because the private sector refuses to.’
“This is a classic chicken and egg scenario. Is the private sector not getting back in because it doesn’t want the risk? Or is the private sector being priced out by the government’s involvement?
“Other asset-backed markets are functioning without government support. Also, after laying out the very bleak budget picture in the U.S., how much risk ultimately can the federal government assume? We already have close to $100 trillion of unfunded liabilities, now we are supposed to take on the credit risk of the entire housing market?
“In conclusion, it will be a top priority of mine this Congress to answer each one of these questions more fully and develop a consensus on the future of the U.S. housing finance market.
“As President Obama so eloquently said in his State of the Union Speech: ‘The first step in winning the future is encouraging American innovation… Our free enterprise system is what drives innovation.”
“I wholeheartedly agree. Considering all of the amazing things our country has been able to achieve – landing on the moon, inventing the internet, or building the Transcontinental Railroad – I have full faith in our country’s entrepreneurial spirit and our ability to establish a vibrant and efficient free-market housing finance system.
“Thank you and I’d be happy to take any questions.”