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much of what you have to say today applies to them as well. In fact, you say that because the Federal Home Loan Banks can design their advances to encompass almost any type of risk, they are even more complex to analyze than the GSE's.

As you know, we are looking at establishing a new regulator. If such a new regulator were established, do you believe that the Federal Home Loan Banks as well as the GSE's should all be under the same regulator?

Chairman GREENSPAN. I do, Senator.

Senator CRAPO. With regard to the capital standards, in your testimony you state that “Determining the suitable amount of capital for Fannie and Freddie is a difficult and technical process, and in the Federal Reserve's judgment, a regulator should have a free hand in determining the minimum and risk-based capital standards for these institutions."

Do you believe that in any legislation we establish, we should stay away from establishing a capital standard but instead set the risk-based factors or at least get some kind of policy analysis so that the regulator is involved in setting both the minimum and the other risk-based capital requirements?

Chairman GREENSPAN. Senator, I think that the way it is handled for depository institutions is the model that I think should be followed, which is there is a generic authority given to the regulator. For example, we have as you know under FIDICA a set of catgories which the Congress put in legislation not in numbers but in the nature of where we should be putting various different sorts of numbers. I believe the 2 percent is statutory. But there is very considerable discretion on the part of regulators as to where we then essentially translate the notions expressed by the Congress in legislation into numbers, and those numbers will change from time to time, as indeed they should.

So, I would say you could do worse than just take a look at the statutes which you enable us to function under.

Senator CRAPO. Thank you.

With regard to your testimony, you also indicated that the leverage which Fannie and Freddie now are able to utilize would not be possible without the expectation of a Federal guarantee. Do you believe that the current capital standards that Fannie and Freddie operate under are too low given the risk that is being incurred?

Chairman GREENSPAN. Senator, it is difficult to make a judgment, and let me express why. There is a tradeoff in interest rate risk or management. It is, as I indicated before, theoretically possible to so create a hedge structure that you fully eliminate all interest rate risk, and then, all you are dealing with is credit risk. And there is no question that mortgages per se are fairly safe instruments.

My own suspicion is that there is likely to be some increase in capital requirements if you have a regulator, largely because it is very difficult to get what we call “convexity hedging as the result of a tendency in a big refinance boom for problems to arise.

The general issue is that you can create a very significant hedge but not without very significant cost. So that there is a tradeoff here between the cost that the GSE's are willing to expend, effectively, to get zero duration gap, and appropriate convexity hedging, and the issue of capital. There are tradeoffs.

So it is conceivable to me that Fannie and Freddie could set up a set of hedges which would require very little capital to be supported. But remember, crucial here is the fundamental question which comes first-is the Federal Government going to stand behind those instruments?

If indeed the Federal Government is going to guarantee the debentures of Fannie and Freddie, the required capital is called "zero"—you do not need any capital under those conditions.

Senator CRAPO. Thank you. That leads to the last question I wanted to ask. I would like to into a lot more on the capital, but I just have one last question to ask, and that is, assuming that it would be the policy of the Congress to make it clear that the Federal Government was not providing a guarantee and that we were to do something in any legislation to try to clarify that, I am struggling with exactly how we would effectively do so.

For example, we could put language in the statute that said the Federal Government will not guarantee the insolvency of Fannie and Freddie, but there would still, it seems to me, be a perception

Chairman GREENSPAN. They will not believe you.

Senator CRAPO. Yes. That is the point. I mean, we can say it in the statute, and we could even put “and we really mean it,” but the question is how do we actually make it clear that this Congress will not back?

Chairman GREENSPAN. I think the only way to do it and I am not necessarily recommending this, because I think it is a very sensitive issue in the marketplace would be if you were to clarify how one would actually create a receivership and what would happen to the various holders of debt and equity and various other instruments, how they would be handled in advance, it might actually create a greater reality than I think merely a firm stipulation that you will not do anything would carry.

Senator CRAPO. Thank you. I look forward to working that out in a little more detail with your thoughts on that, and perhaps we might even find some procedural mechanisms to put into place that would require a super-majority vote in Congress. But I am not even sure we could pull that off. So, I thank you for those thoughts. Chairman SHELBY. Senator Stabenow.

STATEMENT OF SENATOR DEBBIE STABENOW Senator STABENOW. Thank you, Mr. Chairman, and welcome, Chairman Greenspan.

First, I would just indicate to you, Mr. Chairman, that given the comments about the importance of downpayments in terms of helping in homeownership, I would just point out that Senator Gordon Smith and I have for some time introduced a first-time homebuyers' tax credit that we believe is substantial and would help homebuyers, and we would welcome the opportunity to bring it up before the Committee and have the opportunity to debate and pass that legislation.

Before questions, I do have an observation, though, Mr. Chairman. I have watched as a member of the Budget Committee and had the honor of hearing you on a number of occasions on the Budget Committee as well as before this Committee debating the importance of paying down debt and the relationship to interest rates and the fact that we know, even during difficult economic times that it has been the housing market that has in large part sustained us because of low interest rates.

So, I find it interesting and surprising that now we would be saying today that interest rates do not matter that much for people, when I truly believe that in the situation that we have been in, and the challenging times economically, in fact the actions of your agency and the low interest rates and the housing market, the refinancing, the purchasing of new homes, has been a substantial part of driving the economy and helping people into homeownership.

I am surprised to hear you say somehow that interest rates do not matter, or that somehow the ability for Freddie Mac and Fannie Mae to make a difference on interest rates would not make a difference. Certainly it makes a difference in the monthly payment I know that I make, and I look very closely, as my constituents do, at the interest rate and how it relates to the payments that they have to make in order to buy a home.

Chairman GREENSPAN. I think you are raising an important issue which probably should have been discussed earlier.

All the evidence that we have suggests that the types of interest rate changes that really matter are not basis points but percentage points. In other words, you really need 1 or 2 percentage points' change to really change the overall outlook.

There is no question, though, that any small change in interest rates does affect the monthly payment that people make on their mortgages. But I want to point out that to the extent that that decline is the result of a contingent liability that might be arising because of a subsidy, the homeowner as taxpayer is actually taking on a commitment which is probably as large in some cases and under certain assumptions larger than the benefits that they would get from the lowered monthly payments.

There is no question that lowering interest rates-for example, all the refinancing that we went through—had a very important impact on consumer purchasing and on the basic economic wellbeing of the average American household. But all of our analysis, and we have done this for years, and so has everybody else-suggests that you really need far greater decreases in interest rates than 25 basis points, for example, to have a significant impact on either homeownership or on home construction.

Senator STABENOW. I appreciate you clarifying that, because I do believe that in fact what you are saying is true in terms of interest rates and the importance of interest rates.

I do have a question regarding the Passmore analysis in looking at this more closely and the really startling assertion that the GSE's do not contribute a significant rate difference between conforming and jumbo mortgages.

I notice that in the study—which admittedly is very complicated, as you have said; it is a complex economic exercise_Mr. Passmore's study concedes, though, that “These data are not up to the tax of measuring the GSEs' effect on mortgage rates precisely." My question is given the fact that he is admitting the complexity and that they have not been up to the task of measuring the effect precisely, this would suggest that the information is possibly incomplete or possibly inaccurate.

The question I would have is why would we assume, then, that his conclusions are absolutely accurate and complete.

Chairman GREENSPAN. The answer, Senator, is we do not. And we do something different. You are dealing in this particular area with very complex sets of relationships, and we have a number of very sophisticated statistical techniques which enabled us to get a model of how these markets function and, if we have data that is appropriate and accurate, interrelationships amongst various variables.

By the very nature of the way we do it, we cannot precisely estimate anything, but we get ranges. I mean, for example, one of the criticisms on this came from Dr. Greene at NYU the other day, and I read his piece, and it is a very interesting piece. It demonstrates that certain of the relationships create errors in the way the calculations are made. And I could add four or five myself as to what assumptions are made.

But what we do know is that in the very broadest sense, that even with all the errors, of which there are many, we can get a judgment of what is accurate.

For example, when everybody says about the Passmore study that, oh, it is incorrect here or incorrect there, or it does not do this or it does not do that, I am waiting for somebody to come up with an alternate model. It is one thing to say, well, this is not necessarily the case—and I would say, absolutely. But I would argue, for example, there is this very serious question as to what proportion of the subsidy flows through to the homeowner. And the argument is—is it, say, 7 basis points, 10 basis points, 12—the point at issue is what is the probability that all of the subsidy goes through to the homeowner. And I will tell you that approaches

In other words, we do not know exactly what the pass-through is—or, as Dr. Greene focuses on in his paper, the so-called “omega parameter” in Passmore's study—but we know with a high degree of probability that it is within a reasonable range, and that range essentially says that the proportion of the subsidy that flows through to the homeowner is far less than I suspect is conventional wisdom as to what happens in the world.

So while it is certainly the case that all of these models are weak, in one form or another, they are very robust with respect to answering the question, in what range do these numbers tend to fall, as distinct from what the specific number is.

I would suggest—and indeed, we are very thankful that people are trying to address this issue; I find that I am quite pleased that everybody is trying to help us-I ask, in addition to them helping us, instead of just saying this could be wrong, this could be wrong, this is likely to be in error, to come up with a system which is an alternative way of looking at the same problem and demonstrating that the conclusion, the generic conclusion that is made in the Passmore piece, is wrong.

zero.

And I will tell you if they do that, we will be the first to say, “Congratulations. That is a remarkable piece of analytical work. I am waiting.

Senator STABENOW. Mr. Chairman, if I might just quickly ask one other issue, because I think there is another important piece of all that. That is, as we are talking about the benefits of the GSE's, we also give them responsibility, we also give them affordable housing goals, we also set up certain criteria for them-and, as you are suggesting privatizing on the one side, of course, then the question is will in fact those goals be able to be met on the other side, and wouldn't eliminating the Government sponsorship and eliminating the affordable housing goals redirect capital in the second market toward loans that are easier to make. Often, these are difficult goals to achieve, and there are public purposes for it, which is why we have the GSE's in the first place, and I would have a real concern about whether or not capital would be redirected in the secondary market without this relationship.

Chairman GREENSPAN. I understand your concern, but we have the Federal Housing Administration, they come directly at the issue of homeownership by effectively getting downpayments down. I am not sure that there are not a whole series of alternate means to enhance homeownership.

I think that the GSE's, whether private or not private, are exceptionally well-structured to maintain a viable secondary mortgage market, which is an extraordinarily valuable asset in this country.

The issue of the impact on homeownership is far more directly done by other means. If, for example, these institutions were privatized, I think that you are quite right, they would not and should have as a private organization any requirement of homeownership responsibility. But I do believe there are innumerable other vehicles to do that. They are not the only ones to do it, and actually, I am not sure that that is an efficient way of doing it.

What they do is a very efficient way of maintaining a viable, deep, and liquid mortgage market which has great importance beyond housing. But I would never consider that that particular economic structure is well-suited or best-suited for the purpose of enhancing homeownership.

Senator STABENOW. Thank you.
Chairman SHELBY. Senator Sununu.

STATEMENT OF SENATOR JOHN E. SUNUNU
Senator SUNUNU. Thank you, Mr. Chairman.

Mr. Greenspan, oftentimes going last means we get a choice to either ask you strange questions that have not yet been asked or just to make you repeat the good stuff, so bear with me here as I try to add something to this discussion. And I know that you want to talk more about "convexity" and "omega," but I do not understand any of that.

I do understand a little bit about risk, though, and you spent some time talking about an ideal world where these GSE's could hedge all of their interest rate risk. It would be expensive, but they could do it.

Now, even if that were accomplished, is it still the case, however, that they would maintain credit risk, and they would maintain pre

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