when we released the draft of the Passmore study, we hope that people will criticize it. Senator SARBANES. Am I right in thinking that the rates offered by mortgage lenders are such that the rates on conforming mortgages are 25 to 30 basis points less than the jumbo loan rate? Chairman GREENSPAN. Let me say this issue that has been raised about-you can look in the newspaper, and you can find all these rates, and differ the jumbos look significantly different from the conforming-what Passmore and his colleagues did was basically to look at the actual transactions that occurred. Remember that these things that you read in the newspaper are list prices, and list prices have never, in any market, been a good reflection of what transactions were. And while there are questions about the quality of the transactions data-there is an issue there of whether or not there are sub-prime loans in those data Senator SARBANES. That is right. Chairman GREENSPAN. -but there is no question that you do not use posted prices or offers or listed prices when you have transaction prices, which is essentially the market, and it is the market which determines what the spread is between jumbos and conforming mortgages. Senator SARBANES. What do you think that spread is? Chairman GREENSPAN. I think the numbers that came out of the Passmore studies look-since I did not do the actual numbersthey look to me like they did a fairly sophisticated job. Senator SARBANES. What are those numbers? Chairman GREENSPAN. What is the actual number used in that? [Conferring.] Dr. Passmore says it is 16 to 19 basis points. Senator SARBANES. That is Dr. Passmore there? Chairman GREENSPAN. That is Dr. Passmore. [Laughter.] And if you have questions for him, by all means go ahead. [Laughter.] He is not just a pseudonym in the Federal Reserve System. Chairman SHELBY. He is real. Senator Sarbanes, he is real and breathing. We just saw him in action. Senator SARBANES. I see that, I see that. Okay. Chairman GREENSPAN. Sorry I outed you, my friend. [Laughter.] Senator SARBANES. Chairman Greenspan, Comptroller General Walker testified to this Committee that the Federal Housing Finance Board, FHFB, had just 10 examiners in July 2002 to examine the 12 Home Loan Banks-10 examiners-and the Board is planning to expand that to only 30 examiners by the end of this year. Now, most observers feel that the Federal Home Loan Banks are engaging in riskier activities than they used to be. This point of concern was raised by former Assistant Secretary of the Treasury Sheila Baer at a hearing held here last year. I understand, actually, that the OCC has as many as 20 or more examiners resident in each of the large national banks. What is your view of the capacity of the Federal Housing Finance Board to meet its supervisory responsibilities? Chairman GREENSPAN. The number seems quite low in the context of what the banking regulators' general relationship is between examiners and examined institutions. I do not know what the actual numbers are, but our number is very substantially greater, and I assume the Comptroller's is as well, than the numbers you cite. Senator SARBANES. You said earlier that you thought the Federal Home Loan Banks should be brought under the umbrella of this supervisor of the GSE's, but I think it might be helpful to us if you gave us some of your rationale and reasons for thinking that. Chairman GREENSPAN. The reason basically is first that they too have a subsidy very similar to that of Fannie and Freddie. Indeed, the GSE subsidies are generally fairly consistent with one another. Then, of course, the major asset that is involved in the Federal Home Loan Bank System is mortgages. So both the assets and the liabilities are quite similar and have the same economic effects. And as a consequence, it would strike me that many of the principles that would be involved in supervising and regulating Fannie and Freddie would also be applicable, with some changes, to the Federal Home Loan Bank System. Senator SARBANES. Well, the Chairman had to leave, and I am going to wrap it up. It is a great temptation, obviously, at this point, but I am going to forego that temptation and thank you, Chairman Greenspan, for coming before the Committee. We appreciate, as always, your testimony. The hearing stands adjourned. [Whereupon, at 12:13 p.m., the hearing was adjourned.] [Prepared statements and response to written questions supplied for the record follow:] PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI As we are coming to the close of hearings on the regulatory oversight of the housing Government Sponsored Enterprises, we should take a step back to where we began. At that time, the focus of the hearings were on the accounting errors of Freddie Mac and whether the Office of Federal Housing Enterprise Oversight was sufficient in catching those errors in a timely and effective manner. Today, it is clear that the issues as well as our national housing agenda have become much broader than that. Not only are we discussing a new regulator for Freddie Mac and Fannie Mae but there has also been much discussion of whether to include the Federal Home Loan Banks into the system. Back in August, I sent a letter with a few of my colleagues to Treasury Secretary Snow that a new regulator for Fannie Mae and Freddie Mac should be established and that the new regulatory entity have sufficient resources and tools to oversee the complex financial instruments used by those two entities. In addition, I stated that the regulator must be independently financed. Today, I still believe that those issues are valid and necessary. Our housing market is still one of the most important driving sectors of our economy. That is due in large part to the Federal Reserve Board's ability to maintain low interest rates and from homebuyers being able to tap into the equity of their homes built upon the tremendous growth of the housing market. The housing industry bears little resemblance to what it looked like 15 years ago. However, from a rural State perspective, there are still improvements that can be made. As we debate the new regulatory structure of the Government Sponsored Enterprises, I believe that it is essential that we maintain the individual characteristics of Fannie Mae and Freddie Mac and the Federal Home Loan Banks. Wyoming, as a rural State, has benefitted from the unique nature of both systems. We must be cautious not to make any legislative changes that may limit the distinctions or cause those distinctions to disappear in the future. In addition, if the new regulator is to be entrusted with complete oversight of the Enterprises, the regulator must be structured as not to impede rural or Native American housing needs or the Enterprises ability to solve those difficult housing problems. I look forward to working with you, Mr. Chairman, and my colleagues as we will be considering legislation in the near future. Another vital component of the housing market is the need for reform of the real estate settlement process. The settlement process has helped us achieve the growth in the housing market. The Department of Housing and Urban Development has pending a regulatory proposal to amend the regulations implementing the Real Estate Settlement Procedures Act. This proposal has been very controversial both from a small and a large business perspective. Recently, I had the opportunity to meet with Acting Secretary Jackson. I told him that reform of the settlement process is essential, however, I strongly believe that it would be in the best interest of everyone involved that the rule be reproposed. This will allow everyone a fair opportunity to comment on whatever changes the Department intends to make. In addition, it will give the Department a chance to fix its flawed small business economic analysis. It is important this rule proposal be done properly otherwise it could significantly affect our strong housing market. Turning for a moment to topic unrelated to the housing industry, Chairman Greenspan, you recently stated before this Committee on the skills of our workforce, "what will ultimately determine the standard of living of this country is the skill of the people." You went on to state, "[w]e need a level of skills of our working population which is continuously becoming more conceptual to match the types of goods and services that consumers want." The Workforce Investment Act Amendments is designed to accomplish the goal that you describe-preparing the 21st century workforce for 21st century jobs. The well-being of our workers, their families, and our country depends on meeting this goal. This legislation has passed both the House and the Senate. In light of your comments, I am urging the leadership of both parties to appoint conferees on this vital legislation for the growth of our economy and for the jobs of our people. Thank you Mr. Chairman for holding this important hearing. And thank you Chairman Greenspan for being with us today. PREPARED STATEMENT OF ALAN GREENSPAN FEBRUARY 24, 2004 Mr. Chairman, Senator Sarbanes, and Members of the Committee, thank you for inviting me to discuss the role of housing-related Government Sponsored Enterprises (GSE's) in our economy. These GSE's-the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Banks (FHLB's) collectively dominate the financing of residential housing in the United States. Indeed, these entities have grown to be among the largest financial institutions in the United States, and they now stand behind more than $4 trillion of mortgages or more than three-quarters of the single-family mortgages in the United States either by holding the mortgage-related assets directly or assuming their credit risk.1 Given their ties to the Government and the consequent private market subsidized debt that they issue, it is little wonder that these GSE's have come under increased scrutiny as their competitive presence in the marketplace has increased. In my remarks, I will not focus on the Federal Home Loan Banks, although much of this analysis applies to them as well. In fact, because the Federal Home Loan Banks can design their advances to encompass almost any type of risk, they are more complex to analyze than other GSE's and, hence, raise additional issues. During the 1980's and early 1990's, Fannie Mae and Freddie Mac (hereafter Fannie and Freddie) contributed importantly to the development of the secondary mortgage markets for home loans and to the diversification of funding sources for depository institutions and other mortgage originators. Although the risk that a home mortgage borrower may default is small for any individual mortgage, risks can be substantial for a financial institution holding a large volume of mortgages for homes concentrated in one area or a few areas of the country. The possible consequences of such concentration of risk were vividly illustrated by the events of the 1980's, when oil prices fell and the subsequent economic distress led to numerous mortgage defaults in Texas and surrounding states. The secondary markets pioneered by Fannie and Freddie permit mortgage lenders to diversify these risks geographically and thus to extend more safely a greater amount of residential mortgage credit than might otherwise be prudent. The key to developing secondary markets was securitization, and Fannie and Freddie played a critical role in developing and promoting mortgage securitization, the process whereby mortgages are bundled together into pools and then turned into securities that can be bought and sold alongside other debt securities. Securitization by Fannie and Freddie allows mortgage originators to separate themselves from almost all aspects of risk associated with mortgage lending: Once the originator sells the loan into the secondary market, he or she may play no further role in the contract. This development was particularly important before the emergence of truly nationwide banking institutions because it provided a dramatically improved method for diversifying mortgage credit risk. Fannie and Freddie demonstrated that, by facilitating the diversification of mortgage portfolios and insisting on the application of sound loan underwriting standards, the credit risk associated with holding con 1 Fannie Mae and Freddie Mac stand behind mortgages in two ways: The first method is to purchase mortgages, bundle them together, and then sell claims on the cashflows to be generated by these bundles. These claims are known as mortgage-backed securities (MBS). The second method involves Fannie's and Freddie's purchasing mortgages or their own mortgage-backed securities outright and financing those purchases by selling debt directly in the name of the GSE. Both methods create publicly traded securities and thus permit a wide variety and large number of purely private investors to fund mortgages. Using the first method, Fannie and Freddie are relieved of interest-rate risk but are still exposed to credit risk because they guarantee MBS investors against the risk that some homeowners will default on the underlying mortgages. The second method of funding mortgages increases Fannie's and Freddie's debt outstanding and expands their balance sheets. In this case, Fannie Mae and Freddie Mac must manage the interest rate, prepayment, and credit risks associated with the mortgages they purchase. In the conforming mortgage market, Fannie Mae and Freddie Mac, using these two methods, play dominant roles in funding and managing the credit risk of the mortgages, but they do not participate directly in the origination of mortgage credit. Depository institutions, mortgage bankers, and their affiliates originate most mortgages. However, the underwriting standards of Fannie Mae and Freddie Mac substantially influence which borrowers receive mortgage credit. As discussed below, because of Fannie Mae's and Freddie Mac's Government sponsored advantages, there currently is no secondary market for conforming mortgages other than that provided by Fannie Mae and Freddie Mac. If a bank chooses not to sell the mortgage that it originates, it must fund that mortgage and manage the associated credit and interest rate risks itself. forming mortgages could be reduced to very low levels and could be distributed across a wide variety and large number of investors. This innovation in the mortgage market led to the securitization of many other assets and to the creation of many other types of securities. During the 1980's, the GSE's led the private sector in this innovation, and their contribution enhanced the stability of our financial markets. Mortgage securitization continues to perform this crucial function, and its techniques have now been applied by the private sector in many markets, including markets for automobile loans, credit card loans, nonconforming mortgages, and commercial mortgages. Asset-backed securities and the secondary markets in which they trade generally provide both households and businesses with excellent access to credit at an appropriate risk-adjusted interest rate. Moreover, credit supply is far more stable today than it was because it is now founded on a much broader base of potential sources of funds. The aspiring homeowner no longer depends on the willingness of the local commercial bank or savings and loan association to hold his or her mortgage. Similarly, the sources of credit available to purchasers of cars and users of credit cards have expanded widely beyond local credit institutions. Unbeknownst to such borrowers, their loans may ultimately be held by a pension fund, an insurance company, a university endowment, or another investor far removed from the local area. This development has facilitated the substantial growth of nonmortgage consumer credit. Indeed, in the United States, more than $2 trillion of securitized assets currently exists with no Government guarantee, either explicit or implicit. Given their history of innovation in mortgage-backed securities, why do Fannie and Freddie now generate such substantial concern? The unease relates mainly to the scale and growth of the mortgage-related asset portfolios held on their balance sheets. That growth has been facilitated, as least in part, by a perceived special advantage of these institutions that keeps normal market restraints from being fully effective. The GSE's' special advantage arises because, despite the explicit statement on the prospectus to ĜSE debentures that they are not backed by the full faith and credit of the U.S. Government, most investors have apparently concluded that during a crisis the Federal Government will prevent the GSE's from defaulting on their debt. An implicit guarantee is thus created not by the Congress but by the willingness of investors to accept a lower rate of interest on GSE debt than they would otherwise require in the absence of Federal sponsorship. Because Fannie and Freddie can borrow at a subsidized rate, they have been able to pay higher prices to originators for their mortgages than potential competitors and to gradually but inexorably take over the market for conforming mortgages.2 This process has provided Fannie and Freddie with a powerful vehicle and incentive for achieving extremely rapid growth of their balance sheets. The resultant scale gives Fannie and Freddie additional advantages that potential private-sector competitors cannot overcome. Importantly, the scale itself has reinforced investors' perceptions that, in the event of a crisis involving Fannie and Freddie, policymakers would have little alternative than to have the taxpayers explicitly stand behind the GSE debt. This view is widespread in the marketplace despite the privatization of Fannie and Freddie and their control by private shareholders, because these institutions continue to have Government missions, a line of credit with the Treasury, and other Government benefits, which confer upon them a special status in the eyes of many investors. The part of Fannie's and Freddie's purchases from mortgage originators that they do not fund themselves, but instead securitize, guarantee, and sell into the market, is a somewhat different business. The value of the guarantee is a function of the expectation that Fannie and Freddie will not be allowed to fail. While the rate of return reflects the implicit subsidy, a smaller amount of Fannie's and Freddie's overall profit comes from securitizing and selling mortgage-backed securities (MBS). Fannie's and Freddie's persistently higher rates of return for bearing the relatively low credit risks associated with conforming mortgages is evidence of a significant implicit subsidy. A recent study by a Federal Reserve economist, Wayne Passmore, attempts to quantify the value of that implicit subsidy to the private 2 Conforming mortgages are mortgages that are eligible for purchase by Fannie and Freddie. Fannie and Freddie can purchase mortgages only below the conforming loan limit (currently $333,700) and will purchase only those mortgages that meet their underwriting standards, including, for many mortgages, the standard that the mortgage is equivalent in risk to a mortgage with an 80 percent loan-to-value ratio. This latter requirement makes it difficult to know the extent of the market, but market participants generally believe that Fannie and Freddie purchase a large share of the truly conforming mortgages. |