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1 1 2 3 THE FINANCIAL CRISIS INQUIRY COMMISSION 4 5 Official Transcript 6 7 Commission Hearing 8 Friday, April 9, 2010 9 Rayburn House Office Building, Room 2123 10 Washington, D.C. 11 9:00 A.M. 12 13 COMMISSIONERS 14 PHIL ANGELIDES, CHAIRMAN 15 BILL THOMAS, VICE CHAIRMAN 16 BROOKSLEY BORN 17 BYRON GEORGIOU 18 KEITH HENNESSEY 19 DOUGLAS HOLTZ-EAKIN 20 HEATHER MURREN 21 JOHN W. THOMPSON 22 PETER WALLISON 23 24 25 Pages 1 - 262 2 1 C O N T E N T S 2 SESSION 1: 3 FANNIE MAE 4 EXAMINATION OF ROBERT J. LEVIN and 5 DANIEL H. MUDD PAGE 6 By Chairman Angelides 24 7 By Commissioner Murren 40 8 By Commissioner Wallison 51 9 By Commissioner Georgiou 68 10 By Commissioner Holtz-Eakin 82 11 By Commissioner Thompson 97 12 By Vice Chairman Thomas 105 13 By Commissioner Hennessey 106 14 By Commissioner Born 114 15 By Commissioner Hennessey 123 16 By Commissioner Georgiou 125 17 By Commissioner Wallison 126 18 By Vice Chairman Thomas 129 19 20 21 22 23 24 25 3 1 SESSION 2: 2 OFFICE OF THE FEDERAL HOUSING ENTERPRISE OVERSIGHT 3 EXAMINATION OF 4 ARMANDO FALCON, JR., and 5 JAMES LOCKHART PAGE 6 By Vice Chairman Thomas 166 7 By Commissioner Murren 174 8 By Chairman Angelides 183 9 By Commissioner Georgiou 194 10 By Commissioner Holtz-Eakin 211 11 By Commissioner Born 224 12 By Commissioner Hennessey 232 13 By Vice Chairman Thomas 241 14 By Commissioner Thompson 246 15 16 17 18 19 20 21 22 23 24 25 4 1 2 P R O C E D I N G S CHAIRMAN ANGELIDES: Good morning. The 3 meeting of the financial crisis inquiry division will 4 come to order. 5 the past two days we have been examining the issues of 6 subprime lending and securitization and how they might 7 have affected the financial crisis and contributed to 8 the financial crisis that has gripped our country. 9 For those of you who have watched over Today we will be examining what occurred at 10 Fannie Mae and its regulator, OFHEO, the Office of 11 Federal Housing -- Federal Housing Enterprise 12 Oversight, and its successor agency, the FHFA, the 13 Federal Housing Finance Agency. 14 This morning we will be hearing from 15 Mr. Daniel Mudd and Mr. Robert Levin, who were with 16 Fannie Mae, and so thank you very much, gentlemen, for 17 joining us this morning. 18 I'm going to start off by asking you to do 19 what we have customarily done with all witnesses to 20 date, and we will do with all witnesses from here on 21 forward, and that is to ask you both to stand so I can 22 administer the oath to you. 23 Do you solemnly swear or affirm, under 24 penalty of perjury, that the testimony you're about to 25 provide the Commission will be the truth, the whole 5 1 truth, and nothing but the truth to the best of your 2 knowledge? 3 MR. MUDD: 4 MR. LEVIN: 5 CHAIRMAN ANGELIDES: 6 Yes, I do. I do. Thank you very, very much. 7 Now, we are going to start this morning by 8 asking each of you to give an oral opening statement. 9 We have your testimony in hand, and we thank you for 10 that. We'd like you each to take no more than ten 11 minutes for your oral statement. 12 13 And, Mr. Levin, we're going to start with you today. 14 And so we're ready for your testimony. Before I start, though, Mr. Vice Chairman, 15 would you like to make any opening remarks this 16 morning? 17 VICE CHAIRMAN THOMAS: No, thank you, 18 Mr. Chairman. But I would take the opportunity, as is 19 usual with me, to ask you that if over the rest of the 20 Commission's existence we have reason to continue 21 discussion over the material that you presented, would 22 you be willing to respond to written questions in a 23 timely fashion and in an ongoing way? 24 MR. MUDD: 25 MR. LEVIN: Yes, sir. Yes. 6 1 2 VICE CHAIRMAN THOMAS: Thank you, Mr. Chairman. 3 4 Thank you. CHAIRMAN ANGELIDES: All right. Mr. Levin, proceed. 5 MR. LEVIN: Thank you. 6 CHAIRMAN ANGELIDES: Oh, and by the way, 7 one last item. 8 and when it gets to one minute, if you see these 9 little lights on the table, it will move to yellow 10 You'll see a light in front of you, with one minute to go and red when time is up. 11 MR. LEVIN: 12 VICE CHAIRMAN THOMAS: 13 14 Thank you. And that just flip them to off. MR. LEVIN: Thank you. Mr. Chairman, 15 Mr. Vice Chairman and distinguished commissioners, 16 thank you for providing me the opportunity to appear 17 before you today to assist the Commission in examining 18 the causes of the financial crisis. 19 As you know, I submitted to the Commission 20 a written statement in advance of this hearing, and I 21 will not repeat the more detailed explanation, but I 22 thought I would highlight a few of my thoughts now. 23 I'm happy to provide whatever assistance I can. 24 25 VICE CHAIRMAN THOMAS: Mr. Levin, if you would move the mic a little closer, they're very 7 1 sensitive and directional, is the light on -- 2 CHAIRMAN ANGELIDES: 3 VICE CHAIRMAN THOMAS: 4 Is the light on? the mic? 5 MR. LEVIN: 6 VICE CHAIRMAN THOMAS: 7 There's a green light. CHAIRMAN ANGELIDES: 9 MR. LEVIN: 10 Good. Okay, thank you. CHAIRMAN ANGELIDES: over. We'll start your time Good, sir. 12 MR. LEVIN: 13 CHAIRMAN ANGELIDES: 14 VICE CHAIRMAN THOMAS: 15 CHAIRMAN ANGELIDES: 16 weak mic. Okay. MR. LEVIN: 18 CHAIRMAN ANGELIDES: 21 CHAIRMAN ANGELIDES: 24 25 It sounds better. It sounded like a very We'll start over. Good morning, Mr. Levin. MR. LEVIN: 23 Good, now, yes. It's now -- it's now -- 20 22 Oh, I'm sorry. All right. 17 19 Yeah, it just needs to be a little closer. 8 11 Is the light on, on Yes, thank you. Let's go ahead and -- and start over and let's go. MR. LEVIN: Okay. Start over, from scratch, sir? VICE CHAIRMAN THOMAS: Sure. 8 1 MR. LEVIN: Okay. Mr. Chairman, Mr. Vice 2 Chairman and distinguished commissioners, thank you 3 for providing me the opportunity to appear before you 4 today to assist the Commission in examining the causes 5 of the financial crisis. 6 As you know, I submitted to the Commission 7 a written statement in advance of the hearing, and I 8 will not repeat the more detailed explanation, but I 9 thought I would highlight a few of my thoughts now. 10 I'm happy to provide whatever assistance I 11 can and will do my best to answer all of your 12 questions to the best of my ability. 13 I was at Fannie Mae for 27 years until my 14 retirement in August 2008. 15 Mae prior to the takeover and the imposition of 16 conservatorship, I continued to work as an advisor to 17 senior management for about six months at the request 18 of the new CEO. 19 And while I left Fannie At Fannie Mae I was privileged to work with 20 many fine individuals and organizations, including 21 mortgage lenders, community groups, housing 22 organizations, and other stakeholders to help 23 Americans achieve the dream of homeownership and 24 affordable rental housing. 25 My pride at the contributions of Fannie Mae 9 1 has understandably been overshadowed by the events 2 that give rise to this hearing. 3 From my perspective, Fannie Mae was 4 engulfed by an unprecedented decline in home prices 5 and resulting dislocations in the housing markets. 6 And these were truly catastrophic. 7 While some people foresaw a correction, 8 few, if any, predicted the unusually rapid and 9 devastating destruction of real estate values that 10 11 occurred. In hindsight, if we, in the industry, as a 12 whole, had been able to anticipate the nature and 13 extent of the crisis that engulfed the market, it is 14 clear that we all would have conducted our business 15 differently during this period. 16 else, were surprised by the unprecedented extent of 17 the economic crisis. 18 But we, like everyone However, Fannie Mae, unlike other financial 19 institutions, was res- -- was restricted to one class 20 of assets because of the charter, and thus we took the 21 brunt of the crisis head on. 22 At the same time, the global economy was in 23 the middle of a liquidity and credit crisis that 24 damaged the capital markets. 25 unemployment rose. Shortly thereafter, 10 1 This extraordinary upheaval in the economy 2 and in the mortgage market in particular, challenged 3 Fannie Mae in ways that would have been difficult to 4 overcome regardless of any business decisions that 5 preceded the crisis. 6 As the Commission is aware, Congress 7 created Fannie Mae as a government-sponsored 8 enterprise and, as such, we had a variety of important 9 stakeholders, which included the Congress, our mission 10 and safety and soundness regulators, private 11 shareholders, debt and MBS investors, mortgage 12 lenders, housing organizations and others. 13 As a private company, Fannie Mae raised 14 capital from investors and sought to provide them with 15 a competitive rate of return. 16 As a company with a public purpose, Fannie 17 Mae sought to ensure the liquidity of the mortgage 18 market, its only permissible line of business, and to 19 promote affordable housing, which also included 20 meeting government-mandated housing goals. 21 The housing goals were set forth in Fannie 22 Mae's charter act. Some of the goals related to our 23 single-family business, some related to multi-family. 24 In general, certain goals required that a 25 specified percentage of our business be for families 11 1 at lower income levels, and other goals required that 2 a specified percentage of our business be in -- be 3 located in certain places in the country that were 4 considered underserved. 5 HUD increased these goals from time to 6 time, frequently requiring levels of affordable 7 housing in underserved market business that were 8 higher than what our market naturally produced. 9 In response, the company engaged in efforts 10 to create business to help us meet the goals. 11 efforts included outreach programs and the application 12 of different underwriting and pricing standards. 13 These Part of Fannie Mae's business in the 14 secondary mortgage market was to purchase and 15 securitize mortgage loans created by lenders. 16 Mae's influence on the type of loans that lenders 17 originated often changed depending upon market 18 conditions and the availability of alternative sources 19 of capital for lenders. 20 Fannie When Fannie Mae was one of the principal 21 sources of capital in the mortgage market Fannie Mae's 22 influence was greater. 23 were more plentiful, as in the period prior to the 24 crisis, Fannie Mae's influence was diminished. 25 When other sources of capital Fannie Mae and the other GSEs were unique. 12 1 We took our duties to our shareholders and our public 2 missions very seriously. 3 Throughout most of my 27 years at Fannie 4 Mae, the company was able to balance successfully its 5 potentially conflicting objectives. 6 more difficult when the markets experienced 7 significant change and during periods of great stress 8 in the system. 9 However, this was The growth in the last decade of the 10 private label mortgage-backed securities market is one 11 such change that had a significant impact on the 12 mortgage markets and Fannie Mae. 13 Private label securities, or PLS for short, 14 are mortgage-backed securities issued by entities 15 other than Fannie Mae, Freddie Mac, and Ginnie Mae. 16 PLS financed three main types of mortgage products, 17 subprime mortgages, Alt-A mortgages, and jumbo loans. 18 In 2003, which was also a year of heavy 19 refinance activity, the size of the PLS market was 20 about half of the size of Fannie Mae's security 21 issuances. 22 PLS market increased and Fannie Mae decreased. 23 volumes of PLS exceeded that of Fannie Mae MBS and 24 almost reached the levels of Fannie Mae and Freddie 25 Mac combined. In 2004, that changed dramatically. The Dollar In 2005 and early in 2006, that trend 13 1 continued with the dollar volume of PLS issued 2 exceeding the MBS issue by Fannie Mae, Freddie Mac, 3 and Ginnie Mae combined. 4 The effects of PLS on Fannie Mae's business 5 were significant. 6 the overall market declined dramatically during this 7 period of time. 8 9 Our business activity relative to Secondly, many of the new products funded by PLS have features that attracted low income 10 borrowers, which threatened our ability to meet our 11 mandated housing goals. 12 previously experienced market changes of the magnitude 13 that we were seeing during this period. 14 Fannie Mae had never There was an article in 2006, in a 15 publication called Mortgage Banking, which I quote in 16 my written statement, which summarized the 17 significance of these trends. 18 here, quote, a change in the mortgage-backed 19 securities market that began more than two years ago 20 appears to have completely reshuffled the industry's 21 deck of cards. 22 And to briefly quote it Now issuer -- issuers of PLS are holding 23 the aces that were once held by the 24 government-sponsored enterprises, Fannie Mae and 25 Freddie Mac. Once a junior, the powerful player in 14 1 the market, PLS are now the leading force driving 2 product innovation and net overall volume of mortgage 3 origination. 4 dominant role for private securities may be here to 5 stay, unquote. 6 Further, it appears that the new, The PLS phenomenon and the resulting 7 consequences for our business confronted Fannie Mae 8 with critical strategic questions. 9 changes temporary or were they permanent, and second, First, were the 10 would we best be able to deliver competitive returns 11 to shareholders, stay relevant to customers, and meet 12 our mission requirements by doing nothing new or by 13 increasing our participation in these markets to some 14 degree. 15 These and related questions were the 16 subject of continuous and serious discussion and 17 in-depth analysis by the Fannie Mae management team 18 and the board of directors over the last decade. 19 We address these issues in a series of 20 dedicated strategic planning sessions as well as -- as 21 well as day-to-day discussions. 22 credit risks and the new markets, our capabilities to 23 manage business, and the impact on our achievement of 24 housing goals, our financial results, and our 25 strategic positioning in the marketplace. We consider the 15 1 These considerations led management to 2 expand Fannie Mae's already existing Alt-A business 3 incrementally over time. 4 decisions, management continued to mitigate risk by 5 applying underwriting standards that were more 6 conservative than the standards prevalent in the 7 market at the time. 8 9 In implementing these Although Fannie Mae's Alt-A books sustained disproportionate losses, it did perform better than 10 the market and sustained smaller losses than otherwise 11 might have occurred. 12 Our involvement in the subprime market was 13 minimal. 14 the Triple-A-rated private label securities secured by 15 subprime loans, and these purchases contributed 16 greatly to housing goal objectives. 17 It primarily consisted of the purchase of With the benefit of hindsight, had we 18 anticipated the extraordinary market meltdown, we 19 would have been far less likely to expand our 20 involvement in these nontraditional products. 21 We began to reduce our participation in the 22 Alt-A market in 2007 as the market and our business 23 took a turn for the worse. 24 pace of our withdrawal with our public mission to 25 provide liquidity, a critical function, as the PLS We tried to balance the 16 1 market had dried up. 2 3 CHAIRMAN ANGELIDES: Can you wrap up, Mr. Levin, please? 4 MR. LEVIN: Yes, sir. 5 In closing, an unprecedented decline in 6 home prices, a high unemployment rate, a global 7 liquidity and credit crisis engulfed Fannie Mae and 8 its only line of business, the secondary market from 9 mortgages. 10 These crises were centered on our market 11 and our asset class, and we took the full brunt of the 12 market crisis head on, which would have been difficult 13 for the company -- company to deal with under any 14 circumstances. 15 16 Thank you. I'm pleased to answer any questions that you have. 17 18 19 CHAIRMAN ANGELIDES: Thank you very much. Mr. Mudd? 20 MR. MUDD: Thank you, Mr. Chair, Mr. Vice 21 Chairman. I've had the opportunity to watch some of 22 the Commission's proceedings this week, and having 23 submitted remarks which cover a broad array of topics, 24 I'm going to try a little bit to tailor my remarks to 25 some of the issues that you've been pursuing. And 17 1 thank you for the opportunity to appear today. 2 I joined Fannie Mae as the chief operating 3 officer in 2000, following a decade at GE in December 4 of `04, I served as interim chief executive officer. 5 In June of `05 the board of directors, with the 6 approval of our regulator, named me the CEO. 7 During my time at Fannie Mae, the company 8 and the U.S. housing market faced many challenges. 9 During the early part of my tenure, I worked to 10 reinvent the company and move forward with a sense of 11 purpose and value and humility. 12 I worked to improve the relationship 13 between Fannie Mae and its regulator, the former 14 OFHEO, and to return Fannie Mae to timely filing 15 status with the SEC. 16 After the completion of that, one of the 17 most complicated restatements in recent history, the 18 company emerged to face the housing depression and the 19 financial crisis, and it did not survive. 20 I want to be clear, I was the CEO of the 21 company and I accept responsibility for everything 22 that happened on my watch. 23 Over the past couple of days I've heard 24 Mr. Greenspan assign himself a 70/30 rating, and I 25 believe the Chairman gave himself a 51/49 rating. I 18 1 am envious. 2 of 2007 and 2008, at the GSEs it was virtually 3 impossible to get on the positive side of that ratio 4 because so many decisions were a choice between 5 unsavory alternatives. 6 My experience was that during the crisis Certainly Fannie Mae endeavored to be best 7 in class and to continuously improve our business. 8 hired talented executives to build world-class risk 9 management, modeling capabilities, maintain strong 10 We controls, and comply with regulations. 11 I did the best that I knew how to consider 12 alternatives, to develop processes, to listen to 13 critical voices, and ultimately to try to predict the 14 perilous path of the housing market. 15 I could not do what a private firm could 16 do, leave the market, close the window, or short 17 mortgages. 18 provide liquidity, and obviously were structured to be 19 long-only mortgages. 20 The GSEs have to stay in the market, The GSE structure required the companies to 21 maintain a fine balance between financial goals and 22 what we call the mission goals. 23 revenue and profits and growth, the company could not 24 attract global capital to the U.S. housing market, and 25 on the other hand, without meeting the mission goals On one hand, without 19 1 for affordable housing and liquidity, the GSEs could 2 not meet the requirements of their congressional 3 charter. 4 Thus I agree with former Treasury Secretary 5 Paulson's ultimate assessment that the root cause of 6 the GSE's troubles lies with their business model. 7 mono-line -- GE -- GSE, asked to perform multiple 8 tasks, cannot withstand a multi-year 30 percent home 9 price decline, on a national scale, even had it been 10 A without the accompanying global financial turmoil. 11 The government-sponsored enterprises were 12 able to balance business and mission when home prices 13 were rising. 14 flat. 15 2008. They could perform when home prices were They could survive a 30-year flood, but not 16 As you know, the GSEs acquire mortgages in 17 the secondary market to promote liquidity, stability, 18 and affordable housing for the American people. 19 The congressionally created GSE businesses 20 were specifically prohibited by law from participating 21 in any business outside the secondary market for 22 mortgages in the United States. 23 Unlike other financial institutions, this 24 left the GSEs unable to diversify and, therefore, to 25 avoid losses stemming from any U.S. housing finance 20 1 crisis, and 2007 to 2010 was not merely a housing 2 crisis, we witnessed a market collapse, a collapse of 3 the only market that the GSEs were in. 4 Starting in 2007, the financial sector 5 grappled with what most observers view as the worst 6 conditions ever seen in the modern capital markets. 7 In the midst of turmoil, virtually every other housing 8 sector investor fled the market and the GSEs were 9 specifically required to take up the slack. 10 Through the spring and summer of 2008, my 11 colleagues and I worked with government officials, 12 regulators, our customers in the banking system, 13 housing advocates and others to maintain the 14 excruciating balance between providing the liquidity 15 to keep the market functioning and protecting Fannie 16 Mae's regulatory capital. 17 Until the time the government imposed a 18 conservatorship, OFHEO stated that Fannie Mae had 19 maintained capital in accord with the relevant 20 regulatory standards, and we were still, along with 21 Freddie Mac, the principal source of lending to the 22 mortgage market. 23 Based on ongoing examinations and frequent, 24 if not daily, meetings into late August 2008, our 25 regulator continued to declare us in full compliance 21 1 with our capital requirements. 2 We were also balancing against our HUD 3 housing goals, our role in the global capital markets, 4 our fiduciary responsibility to our shareholders and, 5 critically, the need to help individual homeowners 6 afford their mortgages, stay in their homes, and avoid 7 unnecessary foreclosures. 8 consistent with a very strict interpretation of our 9 congressional charter. 10 And we sought this balance As the crisis became havoc, Fannie Mae was 11 called upon by the administration to refinance 12 subprime borrowers who could qualify for a fixed rate 13 loan. 14 The GSEs were asked to provide the lead in 15 providing modifications. 16 warehouse loans by lenders who had previously resisted 17 the idea of Fannie or Freddie entering that market. 18 From other corners, Fannie and Freddie were variously 19 pushed to raise capital, earn returns, rescue more 20 borrowers and cut costs. 21 They were asked to provide I sought to balance the fine points of 22 mission and business, insofar as I could understand 23 them, with the support of regulators and policy 24 makers. 25 2008, and I am sorry for that. That was no longer possible by September 6th, 22 1 Since that time, as all agree, the 2 companies have been operated to implement public 3 policy. 4 portion of my energies went into balancing the 5 increasingly conflicting demands of operating an 6 enterprise sponsored by the government. 7 of balance is now a thing of the past. As I've tried to explain, a considerable 8 9 10 That notion Shortly after conservatorship the regulator declared both the housing goals and the capital standards invalid. 11 I believe, in retrospect, that there was 12 overinvestment in housing. 13 origination standards slipped. 14 intermediation. 15 Homeownership rates probably rose too high. 16 I believe, in retrospect, There was too much There were too many middlemen. The GSEs were chartered to expand and 17 increase homeownership while operating as private 18 companies. 19 crisis but they did not precipitate it. 20 In doing so, they contributed to the Let me end by suggesting that homeownership 21 remains essential dream for many Americans. I believe 22 that once this crisis is behind us, the fundamental 23 and solid economics of homeownership will reassert 24 themselves. 25 opportunity to engage in the future structure of the And I hope, in that, there's an 23 1 housing finance system. 2 There was a lasting consensus in this 3 country, really going all the way back to the Great 4 Depression, that homeownership was a net good for 5 individuals, for communities, and for the country at 6 large. 7 Absent some new consensus, I fear it will 8 be difficult to choose between competing models for a 9 new housing finance system. Government entities 10 created to support homeownership as a social good will 11 tend to socialize the risk to all taxpayers. 12 Purely private companies will exercise 13 their fiduciary responsibility to pass the costs and 14 the risks to homeowners. 15 Hybrid organizations, such as a GSE, will 16 be left to balance conflicts between taxpayers and 17 homeowners and shareholders. 18 answers. 19 There are no simple I appreciate the Commissions' work to 20 understand the causes of the crisis and I thank you 21 very much. 22 CHAIRMAN ANGELIDES: Thank you very much, 23 Mr. Mudd and Mr. Levin. We will now proceed to 24 questioning by Commissioners. 25 questions today before we move on, and so let me just I will start with some 24 1 move into this. 2 EXAMINATION BY CHAIRMAN ANGELIDES 3 CHAIRMAN ANGELIDES: So, really, to either 4 one of you or both of you, in each of these questions 5 I'm going to put some facts on the table for the 6 public and for you. 7 the 2009 Form 10-Ks, Fannie Mae reported about 134 8 billion dollars of net losses in `08 and `09, most of 9 which were driven by credit-related expenses, loan According to your SEC reports, 10 losses, which totaled more than 104 billion dollars 11 in credit losses, which totaled more than 40 billion 12 dollars. 13 If you look at the losses, very 14 significantly, they come from loans with higher risk 15 product features, Alt-A, subprime, interest-only, 16 loan-to-value of 90 percent-plus, loans with FICO scores 17 of less than 620, that were originated in 2006 and 18 2007. 19 At the heart of it, looking back on that 20 business decision, would you kind of go to the 21 thinking behind the -- your thinking behind, as 22 leaders of this organization, that really the dramatic 23 expansion in these higher risk products in that 2006, 24 `7 period, what was at the core of the decision to 25 move more dramatically into that arena? 25 1 And just for the edification of you and 2 others I guess, as you look at losses, for example, in 3 losses in `07, all loans, the selected higher risk 4 product features constitute, I believe, 29 percent of 5 the loans with 58 percent of the losses; in `08, 28 6 percent of the loans, 75 percent of the losses; 19 -- 7 2009, 24 percent of the loans and 69 percent of the 8 losses. 9 MR. MUDD: Mr. Chairman, certainly the -- 10 the -- the higher risk loans put on the books closer 11 to the time that the -- the underlying home market 12 collapsed were the worst performing and were the -- 13 were the first to go. 14 So if you could go back retrospectively and 15 look across the book of loans, I think anybody 16 could -- anybody could say that in particular, the 17 Alt-A book is, as you pointed out in your data, a 18 source of the difficulty. 19 The thinking -- the thinking goes back over 20 a period of time. And just as a bit of context, the 21 company had come out of a period where, through the 22 `90s, Fannie Mae was really the dominant force in the 23 marketplace. 24 And during the period of the restatement, 25 that had slipped on one hand, and on the other hand, 26 1 the market had developed a number of ways to go 2 around, and any mortgage was a Fannie Mae mortgage, 3 and an Alt-A mortgage stood for nothing more than an 4 alternative to a -- an alternative to a Fannie Mae 5 mortgage. 6 So there were a number of -- a number of 7 studies, questions, process to look at the market and 8 to determine whether the features that went with Alt-A 9 mortgages were things that we had been asking for, for 10 ten or fifteen or twenty years that were no longer 11 relevant to the market. 12 CHAIRMAN ANGELIDES: 13 MR. MUDD: 14 CHAIRMAN ANGELIDES: 15 MR. MUDD: Pull the mic into you. Oh, yes, sir, I'm sorry. Yeah. Or whether they -- whether they 16 were -- whether they were key data that were still 17 needed, what were the variances between the A market 18 and Alt-A market and so forth. 19 And overriding that, a broad -- a broad 20 concern that under the continuation of these trends, 21 Fannie Mae and, by derivation, Freddie Mac's role in 22 the market would be less relevant. 23 So there was a sort of a strategic question 24 of relevance that went to that, led us to use the data 25 that we had to study the market, and develop a plan to 27 1 understand it, go in prudently, buy some securities, 2 get the data, look at the data, develop some experts 3 that understood how the market operated, look at the 4 originators, do business with those we knew, and we 5 built it out from there. 6 It was a reflection of the growth that 7 Mr. Levin described in his statement of that whole 8 segment of the market, but that portion of the book 9 grew; it grew along with the market. 10 CHAIRMAN ANGELIDES: Let me ask, very 11 specifically, your market share in 2002 was of the 12 mortgage market about 29.4 percent; 2003, 36 percent; 13 2004, 24.8 percent; 2005, 19.6 percent. 14 and I don't want to tilt it, I want to ask, of the 15 things you laid out, in terms of your considerations, 16 was it market share, competitive position that drove 17 you or mission-related items that drove you? 18 MR. MUDD: 19 CHAIRMAN ANGELIDES: 20 21 Was this -- Well, it was -And I -- I would actually like to ask you and you, also, Mr. Levin. MR. MUDD: Sorry. I would say it was a 22 combination of those things, but I would say that we 23 did not consider market share itself to be a primary 24 output, right. 25 So market share, to me, is kind of a 28 1 secondary indicator of our -- do you have a role in 2 the market or are you -- are you remaining relevant to 3 the market. 4 5 I mean, it's really a very fine point. CHAIRMAN ANGELIDES: So if that's secondary, what's primary? 6 MR. MUDD: Primary is the mission component 7 in the business. So, are we -- are we -- are we 8 performing our mission, are we in the markets that 9 we're supposed to be in, is homeownership growing, on 10 one hand, and on the other hand are we maintaining 11 capital, are we earning a fair return for our 12 investments, are we managing the financial side of 13 this. 14 CHAIRMAN ANGELIDES: And I'm asking –you to weigh these, 15 so you’re saying market share is not the 16 driver unto itself, but then let me take the two 17 mission-related, and to be clear, you're not 18 necessarily talking about public-policy-related, but 19 it could include that; you're talking about your 20 corporate mission at large. 21 And you are saying, obviously, return on 22 equity to shareholders, profitability growth, and then 23 homeownership mission. 24 25 MR. MUDD: How would you weigh those? I always try to weigh them about equally over the course of time. Obviously, on any 29 1 given decision, you could move one thing up or one 2 thing down. 3 CHAIRMAN ANGELIDES: 4 MR. LEVIN: 5 CHAIRMAN ANGELIDES: 6 Mr. Levin? I'm sorry, I would repeat. Can you pull that microphone in close? 7 8 All right. MR. LEVIN: Sorry, I'll get better as we go along. 9 The -- I would repeat, I think, the items 10 that Mr. Mudd said. I think the major macro driver 11 was this growth in the private label securities 12 market, which ultimately became larger in issuances 13 than Fannie Mae and Freddie Mac and Ginnie Mae 14 combined. 15 And that was the main cause behind the 16 numbers that you went over about our share of the 17 market. 18 19 20 21 CHAIRMAN ANGELIDES: So competition from Wall Street, bluntly stated? MR. LEVIN: That impacted -- that impacted our market position -- 22 CHAIRMAN ANGELIDES: Right. 23 MR. LEVIN: 24 Also dramatically impacted our ability to 25 influence what was going on in the market because of -- dramatically. 30 1 the competition. 2 And it posed a number of threats to the 3 company. 4 there was just simply less -- less business that was 5 coming into our market. 6 another market. 7 And it posed a financial threat because The business was going into It posed a mission threat, because many of 8 the products that were financed by PLS had 9 affordability features and so it threatened our 10 ability to meet our government -- government-mandated 11 housing -- housing goals. 12 It also threatened our relevance with our 13 customers. 14 saying, you know, to the degree I'm doing less 15 business with you, why should I invest in my own 16 company resources to continue to do more business. 17 18 19 20 And I -- you know, I recall a customer CHAIRMAN ANGELIDES: be? MR. LEVIN: That was a -- that was a conversation I had with the multi-family side. 21 CHAIRMAN ANGELIDES: 22 MR. LEVIN: 23 And that person would Oh, okay. You know, which also affected by this same -- 24 CHAIRMAN ANGELIDES: 25 MR. LEVIN: All right. -- same influence -- same 31 1 influence. 2 conversation. 3 I just happened to recall that And -- and, you know, and then overall, 4 there was such a strategic positioning in the 5 marketplace. 6 And so those were the strategic issues that 7 we were confronting and that we were trying to deal 8 with, you know, along with associated issues of, you 9 know, to what degree was this phenomenon permanent, 10 you know, to what degree was it temporary. 11 could we really sit out, would we be permitted to sit 12 out; that's what we were grappling with. 13 CHAIRMAN ANGELIDES: 14 MR. LEVIN: 15 CHAIRMAN ANGELIDES: You know, Right. We -Let me see if I can 16 quickly move to some other questions here. Not unlike 17 some others, you pursued a highly, I would say, a 18 highly leveraged growth strategy. 19 from about 1. -- your total assets plus 20 off-balance-sheet guaranteed mortgage-backed 21 securities went from about 1.4 trillion in 2000 to 3.2 22 trillion. 23 So that's about a leverage ratio, if my math training 24 does me well, probably on the order of, well, I got it 25 here, actually, your leverage ratio was generally Your assets went Your capital ratio was about 1.5 percent. 32 1 anywhere from 62 to 1 to up to 73 to 1. 2 Now, you weren't alone. I mean, during 3 this same period when, you know, you're doubling -- 4 more than doubling your assets, Goldman Sachs is 5 almost tripling them, J.P. Morgan is almost doubling 6 them. 7 But, you know, on reflection, your capital 8 held was extraordinarily low, 2 and a half percent of 9 capital against on balance assets, just .45 percent or 10 45 basis points on your off sheet, on your 11 off-balance-sheet. 12 And if you look at some of the numbers 13 that -- when we look at our investigation of all, you 14 know, your data, it shows that the level of loans with 15 higher risk product features were many times the level 16 of Fannie's reported capital; for example, Alt-A loans 17 alone were 583 percent of capital in 2006; 644 percent 18 of capital in 2007. 19 I just have to ask you, and this is not a 20 question, I'll just say, but what were you guys 21 thinking just in terms of that extraordinary level of 22 leverage? 23 that any kind of market bump is going to shake your 24 company to its very foundations, if not collapse it? 25 Where you're 62 to 1, you're 72 to 1, so MR. MUDD: It's a -- it's a terrific and 33 1 fundamental question, Mr. Chairman. 2 The -- my interpretation is that by virtue 3 of the -- the GSEs being put into business as private 4 companies with a public mission, the private company 5 component of it, in order for Fannie Mae and Freddie 6 Mac to attract global capital and put it to work in 7 the U.S. housing market, we had to be able to provide 8 a competitive return on that capital, e.g., 9 competitive with other financial institutions. 10 Other financial institutions during the -- 11 the -- the period of my memory, probably in the 15, 12 18, 20 percent range of return on equity, our return 13 probably one notch below, below that, in the 15 to 17 14 percent range of return on equity. 15 So -- so, in some sense, the capital, which 16 was statutory on the government's side, became the 17 capital to do business on the business side of the -- 18 of the equation. 19 20 CHAIRMAN ANGELIDES: minimum capital, statutorily? 21 MR. MUDD: 22 CHAIRMAN ANGELIDES: 23 Yes. You could have been above that? 24 25 But that was the MR. MUDD: were. And we were. And we were. We were above the minimum capital. We There was a 34 1 regulatory override. 2 override and, in fact, had raised capital all the way 3 through 2007 and 2008 so that actually at the end of 4 my time at the company, we had more capital than we'd 5 had at any point in the company's recent history. 6 We were above the regulatory CHAIRMAN ANGELIDES: All right. Let me ask 7 you a couple of other questions here in the way of 8 framework. 9 There are a number of documents we looked 10 at, July 19, 2005, board meeting where Citi and McKinsey, who 11 I guess were financial advisors, you basically stated that staying the 12 course was not an option; in other words, that you did have to move into 13 the nontraditional market more dramatically. 14 There was a February 21st board meeting 15 where I believe you presented a plan that said we 16 need to reserve -- reverse market share by increasing 17 market share of mortgage-backed securities from 23 18 percent to at least 25 percent. 19 There's a July 18th board meeting in which 20 you talk about why you need to ramp up again because 21 this issue of market share relevance. 22 There was one other report, though, June 23 2005, at a company retreat, a Mr. Lund made a 24 presentation called Single-Family Guarantee Facing 35 1 Strategic Crossroads, in which, at least he indicated 2 to us, that he recommended staying the course. 3 And I guess, had you taken that more 4 conservative route, looking back on it, would it have 5 been wiser to maintain your underwriting standards, 6 stay on the existing market course, or would you still 7 have been swept under by the size of the wave? 8 9 MR. MUDD: It's -- it's -- if I can give you a three-part answer. The -- on the last part, the 10 analysis that -- that -- that I've done suggests, if 11 you presume that Fannie Mae would need to remain a 12 Triple-A company to do the business that it was in, 13 and you presume that in order to maintain a Triple-A 14 rating that agencies usually require no more than 30 15 percent preferred capital, and if you used every 16 dollar of the maximum net income that the company 17 ever -- ever earned, about 6 billion dollars and put 18 it to servicing additional capital, the maximum 19 theoretical capital that the company could have raised 20 would have been about 90 billion dollars. 21 wouldn't have been enough under any circumstances. 22 23 24 25 CHAIRMAN ANGELIDES: And that Would not have been enough? MR. MUDD: To -- to my -- to my knowledge. That -- that's the first part. 36 1 The second part, Mr. Lund's presentation, 2 we -- we actually did follow his advice. 3 advice was to -- we didn't think of it as a 4 black-and-white choice. 5 the 30 or 40 amortizing fixed rate loans only, or do 6 you do only the other stuff. 7 And his Do you -- do you -- do you do The question was how -- how far do you want 8 to move to make sure that the market's not going to 9 shift away from you permanently. 10 So his suggestion, as I recall it, was, 11 let's -- let's stick to our knitting. 12 let's -- let's emphasize the product that, after all, 13 is our bread and butter, that 30-year loan, but we 14 also need to understand these other markets and have 15 controlled, managed, high process intensive 16 participation in the -- in the -- in the markets. 17 Let's -- And then the third point is actually 18 separated from that, not really part of that analysis, 19 was the McKenzie Citi work, which was really to assess 20 whether, in the context of thinking about the business 21 model that I've -- we've talked about probably enough 22 today, was another business model appropriate; in 23 other words, should we -- should we turn in the 24 charter and privatize the -- privatize the company and 25 thereby restructure through some of these challenges 37 1 that -- that -- that we faced. 2 CHAIRMAN ANGELIDES: And let me just -- the 3 Citigroup was as a financial advisor to you in this 4 capacity; correct? 5 6 MR. MUDD: Yes. But I don't want to miss answers there. 7 CHAIRMAN ANGELIDES: 8 MR. MUDD: 9 CHAIRMAN ANGELIDES: 10 11 No, as I say -- As opposed to what? It was -- yeah, they were advising; correct? MR. MUDD: They were advising and they 12 are -- they and McKenzie were more or less engaged 13 under the same terms to do the same work but to do it 14 independently so that we could -- there wouldn't be 15 group think, if you will. 16 CHAIRMAN ANGELIDES: All right. Here's my 17 last question for both of you and then I want to move 18 onto other members. 19 The conservatorship, the memo 20 recommending conservatorship, which was, I think, 21 September 6th, correct, from FHFA, it's a pretty 22 damning document in terms of its assessment of Fannie, 23 and it, you know, refers to members of the executive 24 management team made imprudent decisions. 25 decisions were unsafe and unsound. Many of the 38 1 They go on to talk about, despite clear 2 signs in the latter half of 2006 and `7 of growing 3 problems in the economy, management continued activity 4 in riskier programs and maintained its higher 5 eligibility program for Alt-A loans. 6 I'm just going to ask you to comment on 7 whether you agreed or not with the assessment of the 8 conservator's report? 9 And both of you, just as briefly as you 10 can, and I may ask you for more, on the record, in 11 this, in terms of writing, so I don't consume all the 12 time, here. 13 14 MR. LEVIN: I had announced my retirement. I never saw that document at that time. 15 CHAIRMAN ANGELIDES: 16 MR. MUDD: Okay. Thank you. I did not agree. And if I can 17 just back up for a short period of time. 18 the spring, summer, and fall of 2008, we were engaged 19 in a -- a really broad array of wide-ranging good 20 faith discussions with both OFHEO and -- my first 21 visit, when I became the CEO, was to get in a car and 22 go downtown and see the then-director. 23 Throughout The first thing I did when the new director 24 came in was gave him the security badge that had all 25 of the same door openers that mine had; there were 39 1 examiners on-site; we were having conversations every 2 single day. 3 And like with any examination routine, 4 there are issues that are identified, could be 5 self-identified, could be identified by the regulator. 6 You put a project and a process and a budget and some 7 people around them, and you work your way through 8 them. 9 and age no examiner's going to sit there and say, you 10 And that's happening all the time, in this day know, we're not paying attention to anything. 11 So those conversations continued all the 12 way through the date of that letter. 13 when I -- I received it I was -- I -- I had to believe 14 that it had been stuck up in the mail somewhere and it 15 was something from so far in the past, because the 16 issues were known in the process, were remediating, 17 many of them had already been remediated; they had all 18 been identified to the regulator. 19 And when I -- So I think it simply goes to the context 20 that the purpose of the letter was really to force 21 conservatorship. 22 CHAIRMAN ANGELIDES: All right. 23 for more in terms of written. 24 questioning now and go to the vice chairman. 25 Chairman? I may ask I'll stop my Thank you, by the way. Mr. Vice 40 1 VICE CHAIRMAN THOMAS: Thank you, 2 Mr. Chairman. 3 end, because there are commissioners who have not only 4 have a very great interest in this area, I do as well, 5 but they have spent not just the time of this 6 Commission, but years, examining these institutions 7 and the circumstances surrounding them as you have 8 been asking questions, Mr. Chairman. 9 questions until the end and let those folks carry the 10 11 12 13 14 15 16 I'm going to hold my questions to the So I'll defer my questioning for now. CHAIRMAN ANGELIDES: Mr. Vice Chairman. All right. Thank you, Ms. Murren? EXAMINATION BY COMMISSIONER MURREN COMMISSIONER MURREN: Good morning and thank you for being here. I'd like to follow the -- the discussion 17 from earlier about corporate goals and individual 18 professional goals and specifically looking at the way 19 that you determined those -- those particular goals. 20 And I also refer back to some of the 21 documents that we've had an opportunity to review. 22 One of them is a strategic presentation from 2007 23 where goals are articulated in a list. 24 11, for -- for the record. 25 It's on page Also other documents, including annual 41 1 reports, proxy statements, internal types of 2 presentations, PowerPoints, and what was remarkable to 3 me or what was noteworthy, and perhaps you can help me 4 understand a little bit better, is when -- when goals 5 were articulated in their most elemental form, 6 typically the growth goals were the first ones, 7 earnings growth, revenue growth, market share growth. 8 9 10 And later on, you would also mention what you described as your public purpose or your mission-driven type of orientation. 11 And again, I would like to get back to 12 whether you could give us a sense of which ones were 13 the most important. 14 Was there a rating that you could assign? 15 referenced that you looked at them all equally. 16 you look at it the same way? 17 for us in a more quantitative manner perhaps? 18 Were -- was that in priority? MR. MUDD: You Would Could you characterize I can try. The goals changed 19 over a period of time. So one of the -- one of the 20 lingering issues post the restatement was that 21 there -- there had been an overemphasis on earnings 22 per share. 23 So for some period of time, the goals, if 24 you look back at the period of `05 and parts of `06, 25 were -- were not related to financial outputs, 42 1 although there were -- there were capital goals, per 2 se. 3 They were mostly related to the things that 4 were most important to the company at that time, get 5 the restatement, get in good -- get in a good -- a 6 good faith, goodwill relationship with the regulator, 7 manage risk, build out. 8 9 We were under a consent order at the time that I took the job. And there was an item -- a list 10 of something like 80 items that needed to be completed 11 for that, so that was an objective in that time. 12 What we tried to do in `07 and `08 was to 13 kind of rebalance those goals out so that we didn't 14 lose sight of the mission responsibility, regulatory 15 side of it, but, you know, if you're not making money, 16 you're not driving profits, you're not increasing 17 revenues, you're also unable to grow your capital and, 18 therefore, you're unable to participate in the -- in 19 the -- in the marketplace. 20 So I would say that, for me, as the CEO of 21 the organization, it was about an equal balance. For 22 folks that worked for me, depending on the nature of 23 their job, if it were really, you know, in its -- in 24 its extreme example, an origination job or a sales 25 job, that was much more financial-goal-oriented. 43 1 But we also had people who did work with Indian 2 reservations in the west, and they would have mostly 3 goals oriented around the mission. 4 from those folks to me, the proportions would change. And as you tiered 5 But at the top of the organization, I think 6 the concept was always that there was a -- there was a 7 fine balance to be found there. 8 COMMISSIONER MURREN: 9 So the notion that because of its order, that revenue and earnings growth 10 were not necessarily the driving forces behind your 11 motivations to achieve your corporate or individual 12 goals? 13 MR. MUDD: They were -- they were -- they 14 were a driving force and, you know, in my -- my -- my 15 mind's balance, half of it. 16 COMMISSIONER MURREN: And when you think 17 about compensation, which is -- for executives at any 18 corporation are really oriented to the performance of 19 the corporate goals, there is an emphasis on stock 20 ownership which aligns your interest with 21 shareholders. 22 Could you talk about what Wall Street's 23 goals were for your company? I would guess that they 24 were oriented towards earnings and revenue growth; is 25 that correct? 44 1 MR. MUDD: I'm sorry, just to understand, 2 so what was my impression of what Wall Street expected 3 as, kind of, output measures for Fannie Mae? 4 COMMISSIONER MURREN: Yes. I would think 5 that as a large stockholder, that you would be very 6 sensitive to the orientation of Wall Street. 7 So Wall Street's impression or their 8 expectations for your company and what drove the stock 9 price related to financial performance? 10 MR. MUDD: They're, as I think you know 11 from your background, their models are largely related 12 to having financial outputs from the company that go 13 into their models and their expectations for the 14 company's financial performance. 15 I think, in addition to that, there was an 16 understanding from the analysts that I talked to 17 that -- that, you know, there was -- there was -- the 18 company had to perform its mission as well and in -- 19 and in parallel, or else it would be hard to achieve 20 the financial goals, or the non-achievement of mission 21 goals would translate themselves into headline risks. 22 And headline risk in and of itself would have an 23 effect on the stock price. 24 25 So it -- it -- for those analysts, the analysts that were on that plane, they were -- I think 45 1 they saw it as a balance but they didn't necessarily 2 model the mission in the same way that a financial 3 analyst would model a financial goal. 4 COMMISSIONER MURREN: Okay. So there was 5 still a balance there between financial and mission 6 goals; correct? 7 8 9 MR. MUDD: I think they saw the company in that light, yes. COMMISSIONER MURREN: So let's talk a 10 little bit about the numbers. 11 course of your tenure at Fannie Mae extremely well 12 paid, both of you were; correct? 13 MR. MUDD: 14 COMMISSIONER MURREN: You were over the I think so. When you look at how 15 the board determined compensation, could you talk 16 about how they actually got to the numbers? 17 the methodology that they used to determine your cash 18 bonus and your stock compensation? 19 MR. MUDD: What was Directionally, although I -- 20 I -- I was not in the room, it was executive session 21 of independent directors, and I did not make any 22 recommendations whatsoever on my own compensation or 23 see it before it went into the room. 24 you what the general process was. 25 But I can tell The general process was that salaries were 46 1 set to be competitive at a marketplace level, bon- -- 2 annual bonuses were determined based upon the 3 achievement of those goals that we talked about, so 4 back to the example, for a sales person, largely sales 5 and revenue-oriented, for a mission person, largely 6 oriented around projects that they were working on or 7 housing goals that they might have brought in the 8 door, and for somebody at our level, kind of an 9 aggregation of -- of -- of all those into our 10 individual -- my individual goals were not very 11 distinguishable from the corporate goals, being the 12 top guy. 13 And then the long term was -- was set to a 14 level, to the best of my knowledge, about 70 percent 15 of the total compensation for comparable positions in 16 the marketplace. 17 COMMISSIONER MURREN: Okay. So the use of 18 comparables was an important part of determining what 19 the actual numbers were. 20 of performance, per se, but what is the marketplace 21 for someone with your skill set, with your 22 responsibilities, that would serve in the same types 23 of institutions as yours that would have similar types 24 of goals; correct? 25 MR. MUDD: It wasn't so much a measure Yes, I think that's fair. 47 1 COMMISSIONER MURREN: Okay. So, when I go 2 back to the proxy for 2006 on page 33, they also 3 mentioned that this is, in fact, correct that 4 comparability is a very important part of how you 5 measure compensation. 6 And in fact, they give a very specific list 7 of companies, there's 17 of them, against whom you are 8 measured to be comparable. 9 almost ten minutes, about how you served a number of And we've now heard, for 10 different constituencies: 11 company, Wall Street, and a mission driven in a public 12 purpose. 13 Corporate America, your own But what was really striking to me is in 14 this list of 17 companies, which I will not make you 15 listen to, but I do note that they include AIG, 16 Countrywide, Allstate, American Express, Wachovia, 17 U.S. Bankcorp, Citigroup, and Wells Fargo, among 18 others, there is not one single company there that is 19 a mission-driven company. 20 And I would wonder if you could explain to 21 me, please, why you did not compare your compensation 22 to, say, someone like the director of the Homeless 23 Coalition, because if you have a public purpose, then 24 would your comparables not be at least balanced as 25 much as your goals are when you think about your 48 1 2 comparables? MR. MUDD: That would be -- two points. 3 That would be the reason that instead of total 4 compensation being pegged to 100 percent of market, it 5 was pegged to be 70 percent of the market. 6 Secondly, my experience in the company was 7 that for the people that we hired or the people that 8 we lost out of the company, most of them tended to go 9 to companies like those that you mentioned. To the 10 extent that people went to Homeless Coalition or many 11 of the other organizations that we -- that we know 12 relatively well, it was because they had retired and 13 taken on a job there or they were -- they were going 14 on to do voluntary service. 15 16 17 And so while -- while relevant, it wasn't a competitive factor in compensation. COMMISSIONER MURREN: But what you're 18 talking about is comparability and motivation. And to 19 the extent that you have an opportunity to cloak 20 yourself in the public service mission, whether it be 21 in your goals or the carrying out of your activities, 22 I've sat on a public company board, among others, and 23 when you look at comparables, they are supposed to 24 span the waterfront of all of what it is that you 25 do and motivates you. 49 1 And you just told us that you were 2 motivated by a public purpose. 3 reflected anywhere in how you actually got paid, 4 which, to me, suggests that maybe your motivation for 5 doing what you did was not related necessarily in that 6 great of a part to the public mission, but really 7 rather to achieving financial goals. 8 9 MR. MUDD: different opinion. But I don't see that Well, I -- I -- I have a And my opinion is that we had 10 to -- as during my time, we had to recruit people or 11 try to retain people. 12 going tended to be on the business side of the 13 equation. 14 And the places that they were For example, to hire a senior systems 15 person, a senior risk manager, a senior financial 16 person, the pay for being in a -- a public 17 service-oriented organization, unfortunately wouldn't 18 be sufficient to attract them to come to the company. 19 So, yes, you had an alternative, there, and 20 the alternative was probably to get somebody that had 21 less experience in the things that we were looking 22 for: 23 technology. 24 25 Capital markets, risk management, systems And -- but we did -- we did bow to the point you raised, I think, by saying no, actually, we 50 1 don't pay at a hundred percent of what -- what those 2 comparators pay for; we pay at 70 percent of that. 3 And that was about the balance that enabled us to 4 attract and retain the talent that we thought we 5 needed to run the organization. 6 COMMISSIONER MURREN: Well, I would say 7 that 75 percent of a huge amount of money is still a 8 huge amount of money. 9 Furthermore, could you tell me how many 10 consultants you engaged to determine your 11 compensation, both in terms of its amount and also the 12 methodology behind how you determined it? 13 MR. MUDD: I think that there were two 14 different firms that were engaged independently, one 15 by the compensation committee of the board, the other 16 by the -- by the human resources management, because 17 in order to get that comparable data and so forth, and 18 then there was a third override, which is throughout 19 my period, senior executive compensation was submitted 20 to the regulator before it was announced, awarded, or 21 granted. 22 23 COMMISSIONER MURREN: Do you recall what you paid those firms? 24 MR. MUDD: I'm sorry, I don't. 25 COMMISSIONER MURREN: If it were, say, for 51 1 one of them, in the range of $700,000 for one -- for 2 one assignment, does that ring a bell? 3 MR. MUDD: Well, it doesn't. It just 4 wasn't -- I can attempt to find out for you but I just 5 don't know what the number was. 6 COMMISSIONER MURREN: 7 MR. MUDD: 8 CHAIRMAN ANGELIDES: 9 Thank you. COMMISSIONER MURREN: 11 CHAIRMAN ANGELIDES: 13 14 15 16 All right. There's some time left on your clock. 10 12 Thank you. I yield my time. All right. Mr. Wallison? EXAMINATION BY COMMISSIONER WALLISON COMMISSIONER WALLISON: Well, now, for some easy questions. Mr. Mudd, I would agree with you that -- 17 that right after you took over as the head of Fannie, 18 you did reach out to people in the community, in 19 Washington, to try to gather the critics' views as 20 well as the views of others in order to -- in order to 21 do a better job. 22 And you were hit by a terrible crisis that 23 we heard about from, I assure you, many other 24 witnesses who have been before us. 25 But the chairman, Chairman Angelides, did 52 1 focus on what I think is one of the most important 2 questions that I think we'll have to resolve, and that 3 is the reason that Fannie acquired so many subprime 4 and Alt-A loans. 5 Between Fannie and Freddie, there were 6 about 12 million such loans out of a total, probably 7 of about 27 million loans, subprime and Alt-A loans, 8 all together in our economy. 9 these two companies, about two-fifths of all the -- So it was about, between 10 all the loans that were likely to fail when the bubble 11 deflated. 12 try to find out why, exactly, this was done. 13 So I think it's quite important for us to Now, it seems to me that there are three 14 possible ways, possible reasons, for proceeding in 15 this direction, acquiring what were acknowledged to be 16 risky loans, subprime and Alt-A mortgages, in other 17 words, between two -- 2005 and 2007, which everyone 18 seems to agree were the ones that have caused most of 19 the financial difficulties for you. 20 First of all, you've mentioned market 21 share, expand market share. Maybe you bought them in 22 order to expand your market share. 23 a secondary consideration. 24 that has been repeated frequently in the media as the 25 reason for competing with Wall Street or acquiring You said that was But that's -- that's one 53 1 these loans. 2 wanting to increase your market share. 3 You were competing with Wall Street, I -- I think that the documentary evidence, 4 and we'll go through that in a little bit, does 5 confirm that this is a secondary matter, if even that. 6 The second idea is that you wanted to make 7 profits. And we did hear this from an academic expert 8 who the Commission had engaged a few weeks ago; that 9 is that you acquired these loans in order -- the 10 subprime and Alt-A loans -- in order to make money 11 from them. 12 And the third is, of course, to comply with 13 the HUD's -- HUD's affordable housing regulations. 14 And that is what we've been referring to or you've 15 been referring to as your mission. 16 And I'll try to unpack all of these things, 17 because they are, of course, in your mind, and they 18 should be in your mind, all mixed together, because 19 they were all very important to the kind of thing you 20 were trying to do with this company. 21 But let me just mention that these, the -- 22 the HUD housing goals did increase substantially 23 during the time that we're talking about here. 24 25 In -- in -- they started at 30 percent, when they first came into effect in the -- in the 54 1 early `90s. But in -- but in 2000 they became 50 2 percent. 3 that you had that you bought, of the loans that you 4 bought from originators, 50 percent of those, and you 5 know this, of course, but for the audience they might 6 not, 50 percent of those had to be to people who were 7 at or below the median income in the areas where they 8 were living. And what that meant is that all of the loans 9 So at 50 percent, starting in the year 10 2000; it then increased to 52 percent in 2005, 53 11 percent in 2006, and 55 percent in 2007, in other 12 words -- and -- and some of this was in your -- in 13 your prepared remarks, and I got some of the same 14 sense listening to Mr. Levin and -- and to you that 15 you were really under pressure from HUD here. 16 They -- despite the fact that you had had 17 difficulties, accounting difficulties, which required 18 you to spend a lot of time on writing your 19 accounting, getting things back on course in your 20 accounting, HUD was not giving up on you. 21 pressing you to continue to make more investments in 22 these affordable housing loans. 23 during the exactly the time that we're talking about, 24 between 2005 and 2007. 25 They were So it was going up Now, let's -- let's consider the things 55 1 that I was referring to before. 2 of the market share. 3 reference to the presentation by Tom Lund in -- in 4 June of 2005, and in there he -- he really said, we're 5 facing a choice here; we either meet the market, which 6 meant that we're going to have to change the way we do 7 business; we're going to have to go after more of 8 these subprime and Alt-A loans, because that's where 9 things seem to be going, or we should stay the course. 10 First, this question Now, the Chairman made a And he considered whether you had the 11 resources to do that, not the financial resources, but 12 whether you had the resources of personnel and skill 13 and so forth. 14 capabilities, we lack the capability to go into this 15 market, we lack the knowledge of credit risks, we 16 lack -- we lack the willingness to compete on market 17 price, we lack the value proposition for subprime, and 18 we lack a conduit capacity, and there are also 19 regulatory concerns. 20 And he said, no, actually, lack of So basically he says, realistically, we are 21 not in a position to meet the market today -- this is 22 in the middle of 2005 -- therefore, we recommend 23 something you've already mentioned, and that as 24 Mr. Levin has, is the "stay the course" idea. 25 appears that you did follow this advice, although it And it 56 1 wasn't quite as you suggested, just not going into 2 subprime. 3 memo, underground efforts: 4 infrastructure, develop modeling capabilities for 5 alternative markets, and develop a conduit capacity. 6 7 10 Develop a subprime So does all that sound right to you, about the middle of 2005, you are agreeing with that? 8 9 It was to kind of, as he put it in his MR. MUDD: Yes, I -- that -- that -- that's correct. COMMISSIONER WALLISON: Now, there is no 11 documentary support for a contrary decision on this 12 market share or relevancy issue after that mid-June 13 presentation and recommendation. 14 nothing until 2007, and there's a very important 15 document in 2007. 16 wrote that, there's an 84-page comprehensive thing 17 that says -- it's called the Fannie Mae Strategic 18 Plan, 2007 to 2012; was that -- was that your work? 19 There's -- there's I want to be sure I know that you MR. MUDD: I -- I -- that sounds like 20 something I would have done, yes. 21 COMMISSIONER WALLISON: I mean, it's a very 22 fine piece of work, I must say, and very 23 comprehensive. 24 was -- this was the product of management's work 25 coming together to decide what the strategy of the But I just wanted to be sure this 57 1 company ought to be. 2 MR. MUDD: There was a -- we did a document 3 every year, and one of those years it was more 4 extensive, and without seeing it, it's hard to be 5 affirmative but I -- that's -- that sounds like -- 6 7 COMMISSIONER WALLISON: document. 8 9 10 It's an 84-page MR. MUDD: That sounds like the annual strategic planning document that the board would read before going to its annual strategic planning session. 11 COMMISSIONER WALLISON: Okay. Now, it 12 was -- the date of -- oddly enough, it was not dated, 13 but it did refer to the mortgage meltdown as something 14 you had to deal with, and so I would place it, then, 15 probably in June, July, or August of 2007. 16 be about right for when you had these regular planning 17 meetings? 18 19 20 MR. MUDD: Would that They were normally in the summer, yes. COMMISSIONER WALLISON: Okay. And it 21 really focuses, of course, on it's title, 2007 to 22 2012, it focuses on what Fannie will do in the future. 23 Seems pretty clear from that report, 24 however, that there was no plan at this time to move 25 strongly into the subprime and Alt-A market. 58 1 What we -- what we see is that that is what 2 is being decided, what has been decided and put in the 3 plan for the future. 4 research, and this is from the plan, after months of 5 research, analysis, discussion, preparation, our 6 senior management team met for two days in June in a 7 college classroom near the Fannie Mae headquarters, 8 and we made several strategic decisions at that point. 9 You say, after months of Item one on that list was deepen and 10 broaden business to maximize value, of course, right? 11 Item two was to add more credit-sensitive assets. 12 you say, under our new strategy, we will take and 13 manage more mortgage credit risk, moving deeper into 14 the credit pool to serve a large and growing part of 15 the mortgage market. 16 And Helping reputable lenders serve emerging 17 borrowers provides an enormous opportunity for Fannie 18 Mae to grow, provide value to customers, the market 19 and shareholders and -- and the "and" is emphasized in 20 this -- expand our affordable housing mission. 21 So it seems to me, and I'd like you to 22 address this, it seems to me that actually only in 23 mid-2007, when this piece was written, was it really 24 decided to expand market share by, quote, moving 25 deeper into the credit pool to serve a large and 59 1 growing part of the mortgage market. 2 Is that -- would that seem right to you? 3 MR. MUDD: I'll -- I'll -- I'll -- I'll add 4 some perspective to it, Mr. Wallison. 5 back to the 2000 -- and was Mr. Lund's `05 or `06? 6 COMMISSIONER WALLISON: 7 MR. MUDD: 8 COMMISSIONER WALLISON: 9 The -- going That was `05. '05. Middle of `05, about June of `05. 10 MR. MUDD: A process that we would use, not 11 uncommonly, to discuss the strategy was to kind of 12 create a framework that sets up two alternatives that 13 are starker than the alternatives that exist in real 14 life. 15 And, as -- as a result of -- of kind of 16 setting those bookends and having the debate, the 17 outcome -- the outcome was what you described the 18 single-family had a business recommending, which was 19 that we stay the course, we continue our investment, 20 we continue the process, we continue to emphasize the 21 30-year fixed rate mortgage, but that at the same 22 time, we developed the capabilities to understand the 23 business. 24 COMMISSIONER WALLISON: 25 MR. MUDD: Right. By way of reference the -- the 60 1 book of Fannie Mae's investment or participation or 2 guarantee of Alt-A goes all the way back to 1999. 3 COMMISSIONER WALLISON: 4 MR. MUDD: Right. So -- so the reason I point that 5 out is that Mr. Lund's presentation was part of the 6 continuum and participation of business was part of a 7 continuum. 8 COMMISSIONER WALLISON: 9 MR. MUDD: Right. And if you go through it, you -- 10 you -- you go through the years, the numbers that I 11 have here, the Alt-A business goes from 2000, 10 12 billion, 30, 60, 90, down a little bit, down a little 13 bit, then a hundred, and then it stays at -- then it 14 stays at about a hundred, certainly a significant -- a 15 significant part of the book. 16 But the -- the process was to develop those 17 capabilities. The construct of your question was, you 18 know, market share, profit, HUD goals. 19 yes. 20 apologies for trying to earn a profit when I was 21 running Fannie Mae. 22 you're running the business -- I can't -- I can't -- I cannot make any If you can't make a profit when 23 COMMISSIONER WALLISON: 24 MR. MUDD: 25 My answer is Right. -- you can't do the mission, you can't earn a return, you can't raise capital and all 61 1 of that. 2 And I think that the ultimate measure of prudence is 3 that a big problem -- and not perfect to be sure, but 4 Fannie Mae's participation in those segments to this 5 day, to my knowledge, is better by a factor of about 6 two than the same loans and the same securities that 7 were done by the banks in the private -- the private 8 market. 9 So the question was, do you do it prudently. So I think that the -- the process was 10 solid; the approach built itself out; there were 11 myriad activities going on between Mr. Lund's 12 presentation and the strategic document you 13 referenced, including, you know, building out, we 14 hired people from the industry who had been in the 15 subprime business, that had specialization in 16 modeling around Alt-A and all of that. 17 that, that gave us the ability to continue to 18 participate in the market. So as we did 19 COMMISSIONER WALLISON: 20 You were following the Lund recommendations. 21 I'm just trying to pin down is kind of the date when 22 the decision was actually made to go more deeply into 23 this subprime and Alt-A market. 24 25 Yes, absolutely. But what Now, I want to -- I want to just mention something for the sake of everybody who's listening. 62 1 Indeed, Fannie and Freddie, but Fannie particularly, 2 was required from in the early 1990s, as I suggested, 3 to start making these kinds of investments. 4 not just something that occurred between 2005 and 5 2007. 6 HUD press conference where the then-secretary, 7 Secretary Cuomo, announced that you would be required, 8 you and Freddie, would be required, with these -- with 9 new affordable housing requirements, to make two This was In fact, in -- in -- in 1999, there was a major 10 and -- 2.4 trillion dollars in affordable housing 11 loans starting right then, and in fact, there was a 12 statement by President Clinton saying, this is 13 wonderful because housing homeownership in the United 14 States was increasing substantially. 15 And that shows, in fact, that you were 16 under, really substantial, I think, political pressure 17 to make sure that you did these things, because not 18 only was it important for all of us to see that 19 homeownership was increasing in the United States -- 20 this is something that Americans have always wanted -- 21 but it was of particular interest of the Clinton 22 Administration and then subsequently, the Bush 23 Administration. 24 improving homeownership. 25 would agree with that? Both of them were focused on And I -- I would assume you 63 1 2 MR. MUDD: I would agree with that, my short comment -- 3 VICE CHAIRMAN THOMAS: Mr. Chairman, 4 Mr. Chairman, I would yield the Commissioner an 5 additional five minutes. 6 COMMISSIONER WALLISON: 7 MR. MUDD: Thank you. My short comment would be that 8 because Fannie Mae and Freddie Mac don't originate, 9 the business that comes in their door depends upon 10 what originators or others are willing to originate 11 and then willing to sell to them. 12 But the businesses being so big, usually an 13 actuarial sample, if you will, in the market would 14 come in. 15 went north of 50 percent, just by virtue of being 16 there and receiving loans, the companies generally 17 were able to reach their housing goals with a 18 reasonable degree of effort but not -- the 19 mathematical conundrum that I have always had, 20 Mr. Wallison, is -- and you touched upon this -- is, 21 as far as I understand it, median is about 50 percent. 22 And until the point when the housing goals So when you're required to have 57 percent 23 of your business be below 50 percent, that gap of 24 7 percent began to -- you have to create not just a 25 normal home for those mortgages, you have to create 64 1 attraction for those loans to come in the -- in the -- 2 in the door. 3 COMMISSIONER WALLISON: 4 MR. MUDD: Right. And that took an enormous amount 5 of our time and attention to continue to try to chase 6 that wheel. 7 COMMISSIONER WALLISON: Right. And, 8 indeed, you make that clear, because we're going to 9 turn -- I want to turn now to this question of could 10 this possibly have been for the purpose of making 11 profits? 12 Responding to -- as you -- as you were 13 speaking with the Chairman and Ms. Murren, you were 14 talking about your responsibility to the capital 15 markets to keep the company together as a 16 profit-making operation, hopefully even a Triple-A 17 operation, so that you would continue to be able to 18 function in that part of your mission. 19 So the question is, could you have been 20 buying these subprime and Alt-A loans in order to be 21 profitable. 22 academic student of Fannie and Freddie that that was 23 one of the motives. 24 25 And as I suggested, we have heard from an However, in this 2007 report that we've been talking about, you say this: The HUD affordable 65 1 housing goals are a public manifestation of our 2 mission. 3 risk appetite is critical in meeting these goals. 4 2004 to 2008, the goals require -- and this is exactly 5 what you're saying -- the goals require Fannie Mae's 6 acquisitions to finance a greater percentage of low- 7 and moderate-income family mortgages than the 8 proportion the market will produce. 9 point. 10 Our strategy of expanding and our credit For That's a That is especially true as housing 11 affordability, the combination of home prices, 12 mortgage costs, and incomes, has fallen. 13 absorb significant costs to meet the HUD purchase 14 money goals in 2006, and we are struggling to meet the 15 goals and sub-goals in 2007. 16 pursue every reasonable opportunity to expand our 17 purchases of goals-eligible mortgages. 18 We had to We will continue to So to me, at least, and I would like your 19 sense of what that language meant, but to me it says, 20 these things are costly to do. 21 money on these things. 22 struggling to do it. 23 what do you think it meant? 24 25 MR. MUDD: We are not making They are expensive and we're Is that your assessment too, or Your impression is correct, and, well, Mister -- Mr. Levin was right in the middle of 66 1 that analysis and he may be -- he may be in a better 2 position to answer it. 3 COMMISSIONER WALLISON: I have a question 4 for Mr. Levin, but that's a question of time, and I 5 probably won't have any, so why don't you just go 6 ahead, Mr. Levin, and respond to that? 7 COMMISSIONER MURREN: If I could, for one 8 second, Commissioner, respectfully, I just wanted to 9 make sure that I clarified the relationship between 10 the compensation and profitability or Wall Street 11 expectations. 12 It's not so much I meant, and perhaps I 13 didn't express myself clearly, that Wall Street 14 expects firms to be profitable; it's that they expect 15 them to grow and they expect them to grow at a certain 16 rate. 17 COMMISSIONER WALLISON: 18 COMMISSIONER MURREN: 19 VICE CHAIRMAN THOMAS: 20 21 Okay. Thank you. Mr. Chairman, yield the gentleman an additional two minutes. CHAIRMAN ANGELIDES: Two minutes, and then 22 we'll add another 30 seconds to that for that to 23 accommodate Ms. Murren's comments. 24 put it to 2:30. 25 MR. LEVIN: So why don't you Mr. Wallison, just rephrase 67 1 what you would like me to address. 2 COMMISSIONER WALLISON: Well, the paragraph 3 that I just read said, to me, at least, and I can read 4 it, I'll just read portions of it again. 5 the very end of this paragraph, and Mr. Mudd, who I 6 think was the author here, has written: 7 absorb significant costs to meet the HUD purchase 8 money goals in 2006, and we are struggling to meet the 9 goals and sub-goals in 2007. 10 This is at We had to What that says to me is, this was not a 11 profitable activity; this was something you were doing 12 because you had to do it. 13 MR. LEVIN: Much of the business that met 14 our housing goals came through standard channels at 15 standard returns. 16 higher levels than what the market was producing, we 17 had to make special efforts that involved outreach, 18 pricing adjustments, underwriting adjustments, and 19 there was a whole set of business that we did at 20 returns that were less than our normal returns. 21 But because the goals were set at COMMISSIONER WALLISON: Okay. Thanks very 22 much. Now, I'm not saying that you lost money. What 23 I'm -- we don't know that actually. 24 even your accounting would be able to show us that, 25 but it was clear that you were not making the kinds of I don't know that 68 1 money on -- on your affordable housing activities that 2 you were making on your standard kinds of activities. 3 And so this was something that had to be 4 done for mission purposes but not because it was a 5 profitable activity in preference to -- as it was for 6 example, for the Wall Street firms, it was probably 7 very profitable for them. 8 But you have a completely different set of 9 standards and -- and your business model is different 10 from the Wall Street firms. And so for you, it 11 probably wasn't profitable. And I think this 12 paragraph suggests that that's true. 13 14 15 16 17 So if I could get some time, later, we'll -- I'd like to, but I don't know that I will. CHAIRMAN ANGELIDES: Mr. Wallison. COMMISSIONER WALLISON: 18 for answering those questions. 19 CHAIRMAN ANGELIDES: 20 21 22 23 24 25 Thank you, Mr. Wallison. Thank you very much Thank you, And Mr. Georgiou? COMMISSIONER GEORGIOU: Thank you, Mr. Chairman. EXAMINATION BY COMMISSIONER GEORGIOU COMMISSIONER GEORGIOU: Mr. Levin, I would like to follow up on one thing I just got confused 69 1 about. 2 not count towards the affordable housing goals of 3 the -- of the mission; is that correct? 4 I understood that Alt-A mortgages actually did MR. LEVIN: It depends. So the affordable 5 housing goals related to the income level of the 6 borrower and where the loan was located. 7 were Alt-A loans that did count and there were Alt-A 8 loans that did not count. 9 COMMISSIONER GEORGIOU: Right. And there But in 10 your -- I understood in your interview with our staff 11 that you suggested that for the most part, Alt-A loans 12 generally did not count. 13 MR. LEVIN: My recollection that in the 14 aggregate, that Alt-A was less rich than the goals, 15 but that there would be portions of Alt-A that would 16 have contributed to the goals. 17 COMMISSIONER GEORGIOU: Right. But to the 18 extent that you actually financed Alt-A loans that 19 didn't contribute to the mission, then they would 20 actually reduce your ability to meet the mission 21 because they would increase the denominator, the total 22 number of loans that you had to compare your -- your 23 loan -- your mission-related loans to; isn't that 24 correct? 25 MR. LEVIN: That's right. That's right. 70 1 COMMISSIONER GEORGIOU: Okay. And you did, 2 nonetheless, increase your financing of Alt-A loans, I 3 guess about a percent a year for every year, it looks 4 like, from `04, at 8 percent; `05, 9 percent; `06, 5 11 percent; and `07, 12 percent; is that right? 6 These are figures that I'm looking at from 7 your purchases of nontraditional single-family 8 mortgages, from our staff report, which you may not 9 have seen. 10 11 MR. LEVIN: rest of the numbers, I'm sorry. 12 13 I'm not familiar with those, COMMISSIONER GEORGIOU: Okay, very good. Let's see. 14 Also in a summary that we have of the 15 interview that was conducted with you by our staff, it 16 says that in response to a question about Fannie Mae's 17 increased acquisition of private label securities or 18 PLS, that you said something to the effect that PLS 19 was considered a money-making activity, it was all 20 positive economics, and it was very conscious that 21 subprime PLAs -- PLS was housing-goals rich. 22 And so subprime PLS was also one of the 23 initiatives, if you will, that filled the housing goal 24 gap. 25 hitting goals, it was a very broad brush effort that There was no tradeoff between making money and 71 1 could be characterized as win, win, win, money, goals, 2 and market share. 3 4 Do you recall saying words to that effect to our staff? 5 MR. LEVIN: I do not recall those exact 6 words but -- but, you know, I would say that the 7 subprime PLS, we expected those to be profitable. 8 those did contribute -- contribute -- contribute 9 significantly to the achievement of the housing goals. 10 COMMISSIONER GEORGIOU: Okay. And All right. 11 So really, there were double -- there were at least 12 two mandates that you were following here in a lot of 13 your acquisitions of subprime and Alt-A loans, which 14 was to -- was to increase your profitability, increase 15 your market share, and meet your housing goals, meet 16 your affordable housing goals; would that be fair to 17 say? 18 MR. LEVIN: 19 COMMISSIONER GEORGIOU: 20 Mr. Levin, Mr. Mudd, rather, you're nodding your head as well? 21 22 Yes, sir. MR. MUDD: I'm nodding my head because I agree, yes. 23 COMMISSIONER GEORGIOU: 24 MR. MUDD: 25 COMMISSIONER GEORGIOU: Okay. All of those were factors. Very well, thank 72 1 you. I want to turn to compensation for just a 2 second, because it's already been touched upon, but I 3 think it's worthy of a little bit further elaboration. 4 During the years of 2000 to 2003, the OFHEO 5 budget, that is, the entire budget of your regulator, 6 ranged between 19 million and 30 million. 7 in all those years, the total compensation of the top 8 four executives at Fannie Mae and Freddie Mac exceeded 9 the budget of the entire regulator. 10 And in -- I mean, it was 33.6 million in 2000; 26 11 almost 27 million in 2001; 26 million in 2002; up to 12 51 and a half million in 2003. 13 that's -- it sort of dwarfs the ability of the 14 regulator to really play a significant role. 15 It strikes me that Were you -- you -- would you concur that 16 the regulator really didn't have adequate resources to 17 do the kind of regulation that would be customary in a 18 financial institution? 19 longer experience, really, at the agency, could you 20 speak to that? 21 22 23 MR. LEVIN: Maybe Mr. Levin, since you had I -- I really couldn't. I mean, that would be a matter for them to answer. COMMISSIONER GEORGIOU: Well, I'm sure they 24 will, but I was wondering if you -- if your experience 25 as the regulated entity might give you some insight in 73 1 that regard. 2 Mr. Mudd? MR. MUDD: I -- I thought and said at the 3 time and through my tenure that I -- I thought a 4 strong, credible, well-funded regulator made sense. 5 And that wasn't just apple pie and motherhood, because 6 it was actually helpful to me going out and meeting 7 with international debt investors and the S and S and 8 others to say, you know, the short story of Fannie 9 Mae, government-sponsored enterprise, public-private 10 mission, SEC registered, oh, and by the way, we're 11 regulated by a credible, effective, well-funded 12 regulator. 13 Their level of funding was set by Congress 14 every year, which -- which history can decide whether 15 that made -- that made sense or not. 16 have anything to do with that, per se. 17 The -- 18 COMMISSIONER GEORGIOU: So we didn't Well, it might be a 19 little bit too much to say that you didn't have 20 anything to do with it, because, if I recall, you 21 lobbied against the increase in budgets that OFHEO 22 requested, fairly considerably. 23 MR. MUDD: 24 25 Is that not true? I did not lobby. I did not myself lobby against the OFHEO budgets. COMMISSIONER GEORGIOU: But didn't Fannie 74 1 hire lobbyists to lobby against it? 2 3 MR. MUDD: I -- I -- I don't know. Not in my tenure as CEO. 4 COMMISSIONER GEORGIOU: 5 MR. MUDD: Well -- The thing that I would say, 6 Commissioner, that might be helpful to the discussion 7 is that OFHEO's heritage as a financial regulator of a 8 complicated institution coming out of HUD and staffing 9 itself with teams that had -- were available and 10 therefore perhaps not at -- not at the top levels of 11 other regulators and examiners and the statutory 12 limitations that were -- that existed around the 13 bifurcation of -- of -- of OFHEO being a safety and 14 soundness regulator and HUD being a mission regulator, 15 made it, in my experience running or working in 16 regulated institutions over the years, not -- not very 17 effective. 18 COMMISSIONER GEORGIOU: Okay, thank you. 19 Just for the record, I think it's -- I think that 20 Fannie's lobbying expenditures, according to our staff 21 investigation from 1998 to 2008 were roughly 80 22 million dollars, 8-0, which I suppose one could argue, 23 in light of the enormous lobbying that goes on by 24 financial services companies generally is modest, but 25 it -- but in a -- in a -- in an overall simply -- 75 1 simply viewed, 80 million dollars is a considerable 2 amount of money to be lobbying. 3 I mean, it was, in many instances, in some 4 years, almost comparable to the entire budget of the 5 regulator. 6 MR. MUDD: Just to comment there, 7 Commissioner, that, you know, within the housing 8 finance industry, you know, it is -- it is an industry 9 which is -- I cut down lobbying during my time there 10 and brought external lobbying inside, had people who 11 actually knew about the company do any lobbying. 12 And we were requested to come up here quite 13 often and talk about our programs, our efforts, our 14 capital, or what have you. 15 have that interface. 16 So it was important to But with a company so intimately involved, 17 government, government in fact in the name of its 18 business, as a government-sponsored enterprise, it -- 19 it -- some of that came with the territory. 20 I agree that there are limits, and there 21 are appropriate ways to do it, and we tried to follow 22 those during my time. 23 COMMISSIONER GEORGIOU: At -- at one point 24 there was a suggestion by Mr. Falcon, who we'll hear 25 from after you, this afternoon, that Fannie Mae 76 1 executives acted on a plan to have Senator Kit Bond 2 initiate an investigation of OFHEO by the HUD 3 inspector general in an effort to -- to head off an 4 investigation that they were doing into Fannie's 5 accounting practices. 6 with that particular effort? 7 MR. MUDD: Do you have any familiarity No, other than I -- I recall 8 that Senator Bond, as a general matter, was -- was -- 9 had regulatory budgets and OFHEO's budgets and 10 operations as an -- as an issue that he was focused 11 on. 12 13 COMMISSIONER GEORGIOU: In what respect? He was focused on that they were excessive? 14 MR. MUDD: I think I just thought of -- 15 I -- I -- I -- I remember thinking of him as sort of 16 the watchdog person in Congress around the issues 17 of -- of -- of -- of OFHEO budgets and operations and 18 the regulatory -- lots of people had interest in the 19 regulatory structure of Fannie and Freddie. 20 COMMISSIONER GEORGIOU: Right. But he -- 21 but he wasn't in favor of additional regulation. 22 was -- I mean additional oversight, but lesser 23 oversight of Fannie and Freddie at the time. 24 25 MR. MUDD: that. He I don't -- I don't remember I think most of the -- of -- plurality of the 77 1 people that I talked to were generally interested 2 in -- in better oversight, including both Director 3 Falcon and Director Lockhart, and I -- and I shared 4 that, but that's -- 5 6 COMMISSIONER GEORGIOU: Mr. Levin, do you have any recollection of that intervention? 7 MR. LEVIN: 8 COMMISSIONER GEORGIOU: 9 Okay. I don't. Okay. Let me try and go back to capital, briefly. 10 Secretary Paulson described GSEs -- the 11 GSE's capital as flimsy capital. 12 that characterization, Mr. Levin? 13 MR. LEVIN: Would you agree with Well, we had -- we had 14 regulatory capital requirements, and then we also did 15 our own internal analysis on appropriate levels of 16 capital. 17 On the regulatory side, there were what we 18 call the minimum capital levels, which were leverage 19 ratios, and there was also a risk-based regulatory 20 standard that was set by stressing our business from a 21 credit perspective and an interest rate perspective 22 and, from that, developing an amount of capital to 23 absorb any -- any -- any losses. 24 25 And, you know, we, you know, my recollection is when I left the company, we were in 78 1 compliance with both numbers, the leverage ratio, but 2 also the risk-based capital ratio, which attempted to 3 establish the correct capital levels based on the 4 exact product that we had and then stressing the 5 markets. 6 COMMISSIONER GEORGIOU: Yeah, but it wasn't 7 stressed adequately, in retrospect; would that be fair 8 to say? 9 MR. LEVIN: I think one of the -- I think 10 one of the lessons from the experience is -- is that 11 scenarios that people thought were really adverse 12 scenarios, that one of the lesson is, you can have 13 even more adverse scenarios. 14 COMMISSIONER GEORGIOU: Indeed. And that's 15 really what we ended up facing, which put us into this 16 crisis. 17 But during `06 and `07, your modeled loan 18 guarantee fees were higher than the fees you actually 19 charged, were they not? 20 21 22 MR. LEVIN: I don't have specific recollection, but that would happen from time to time. COMMISSIONER GEORGIOU: So if you didn't 23 charge the fee that you modeled, then -- then your 24 charging the lower fees meant that effectively -- than 25 the model fee -- then effectively you weren't pricing 79 1 the MBS guarantees commensurate with the risks that 2 you had established yourselves; is that not correct? 3 MR. LEVIN: I think the perspective that I 4 would put on that is that the model, the models would 5 set a target fee for the business. 6 were able to -- to get that target fee; sometimes we 7 were able to get more than that target fee; sometimes 8 we were -- the market only permitted us to get less 9 than that target fee. And sometimes we 10 So for example, and I'm just making these 11 numbers up to give the conceptual example, you know, 12 the model might -- the model might say -- the model 13 might say that the fee ought to be at a level that 14 produces a 16 percent rate of return, but what was 15 available in the marketplace was a 15 percent rate of 16 return, not what the model was as a target, but 17 something less that we still might consider 18 acceptable. 19 And if we consider those numbers acceptable 20 that we would do business at less than the model fees. 21 Although, we always had plans and we always pushed the 22 businesses to develop plans on how to get back up to 23 the model fees. 24 25 CHAIRMAN ANGELIDES: All right. I will yield three minutes, we want to keep on schedule, 80 1 three minutes. 2 COMMISSIONER GEORGIOU: Thank you. I 3 guess, you know, I guess I'm trying to get to what you 4 could have done to enhance your capital structure, 5 your capital base, to have avoided some of the 6 problems. 7 I mean, obviously I understand the market 8 didn't want to pay them, but if your model suggested 9 that the risk of the associated asset that you were 10 buying required that kind of fee to provide you a 11 sufficient return, it seems to me it was a deficiency 12 to -- to not attempt to collect it, to not -- or to -- 13 or to choose not to purchase those assets unless you 14 could actually obtain the guarantee fee that your 15 model suggested. 16 17 18 Mr. Mudd, you were looking to try to respond to that? MR. MUDD: Just to say that that -- that 19 one -- one option here would be to -- to -- to trade 20 at market and then therefore be in the position of 21 unconsciously knowing, and we're talking about matters 22 of single-digit basis points here whether you're being 23 accreted or decreted in terms of individual 24 transactions. 25 What I always thought the models helped do 81 1 was to enable us to decide consciously, do we want 2 to -- do we want to give up a little potential return 3 here, because there's more volume or because there's 4 more goals-rich or because of some other exogenous 5 factor. 6 of the relationship. The models in the model fee is one component 7 At the other end, you can't run a business 8 that's active in the capital markets every minute, as 9 you know, just by saying I can't answer questions, the 10 model has to answer the questions for you, because the 11 model themselves, the models themselves have to be 12 dynamic and reflective of what's going on in the 13 marketplace. 14 COMMISSIONER GEORGIOU: Understood. Let me 15 turn really quickly, I've only got a minute left, to a 16 couple of possible accounting issues that I think were 17 of some significance. 18 Did you actually not record losses on 19 delinquent loans until they were 24 months delinquent; 20 was that the policy at Fannie, Mr. Levin? 21 MR. LEVIN: I don't recall. 22 COMMISSIONER GEORGIOU: And -- and were you 23 required to repurchase loans from MBS Trust once they 24 became delinquent and then report them at fair value 25 on the balance sheet? Mr. Mudd, do you recall? 82 1 MR. MUDD: To my recollection, the way that 2 the accounting handled a purchase of a loan out of a 3 security, that -- that -- that loan had to come out 4 and be -- be marked at fair value and then, should it 5 recover, the -- the -- the -- the income off of that 6 loan would amortize back into the -- 7 COMMISSIONER GEORGIOU: 8 happen until 24 months after the loan became 9 delinquent; isn't that right? 10 late in the accounting world. Which is a little bit 11 CHAIRMAN ANGELIDES: 12 COMMISSIONER GEORGIOU: 13 that. My time is done. 14 gentlemen. But that didn't Time. I'll leave it at Thank you very much, 15 CHAIRMAN ANGELIDES: Mr. Holtz-Eakin? 16 COMMISSIONER HOLTZ-EAKIN: Thank you, 17 Mr. Chairman, and thank you gentlemen for taking your 18 time to be with us today. 19 20 EXAMINATION BY COMMISSIONER HOLTZ-EAKIN COMMISSIONER HOLTZ-EAKIN: One of the very 21 clear messages that both of you shared with us is that 22 the business model that was Fannie Mae simply could 23 not survive the precipitous price declines we saw in 24 residential real estate in United States. 25 And so I guess my first question is, what 83 1 did your internal risk metrics tell you, you could 2 survive; what kind of price declines were survivable 3 given your business model? 4 MR. MUDD: We -- our model, the models ran 5 thousands of paths, as you can imagine, and at any 6 time through the summer and fall of 2008, we were 7 disclosing what our best estimation was of -- of what 8 the likely losses were going to be. 9 We found ourselves, through that period, 10 basically not being able to imagine how bad reality 11 would be. 12 what the losses were ultimately going to be were -- 13 were trailing what the markets were actually 14 delivering as home prices fell, delinquencies went up, 15 and the macro economy had its effect. 16 So looking backwards, those estimates of But we -- we and outside advisors, as well, 17 looking at our capital, thought that that was 18 sufficient to withstand what I called earlier the 19 30-year flood. 20 But, just by way of reference, what that 21 30-year flood was, since the estimates had to be based 22 on a sample of real data, you couldn't make up the 23 data, we went back to -- to California in the 1990s, 24 the Texas oil patch in the 1980s, some of the severe 25 interest rate dislocations over a period of time, and 84 1 we took those scenarios and multiplied them by 50 2 states, and then extended them over a period of time 3 to do a stress assessment of whether we -- of whether 4 we would have sufficient capital. 5 And as we all know now, the reality of it 6 was that 2008 and 2009 and until home prices 7 eventually bottomed were worse than 50 times Texas oil 8 patch or 50 times California. 9 COMMISSIONER HOLTZ-EAKIN: So that was the 10 out-of-bound; I was just curious to know how badly you 11 contemplated in your stress testing of your portfolio? 12 MR. MUDD: Well, I think that the answer is 13 that our best estimate of the most likely outcome was 14 what we were disclosing, you know. 15 COMMISSIONER HOLTZ-EAKIN: It's not in the 16 disclosure. I mean, the question is, what constituted 17 stress in your scenarios, what I just described, 50 18 times oil patch in California or something like that. 19 That was a standard internal risk assessment being 20 done on a quantitative basis ongoing? 21 MR. MUDD: 22 COMMISSIONER HOLTZ-EAKIN: 23 things developed and you realized that you were 24 missing, did you alter those stress tests in any way? 25 MR. MUDD: Yes. Okay. Did, as This -- the stress tests were -- 85 1 were updated on a regular basis, I don't remember what 2 the regularity was but less -- you know, within some 3 number of months, to reflect the reality. 4 describing the earlier part answer to your question, I 5 wrote it down here somewhere, as of -- as of mid-2007, 6 our internal estimate of conventional conforming home 7 prices was a 1 percent decline for `07, a 1 percent 8 increase for `08, and a 3 percent increase for `09, 9 and a 4 percent increase for `010. 10 As I was So that close to the collapse of housing 11 prices we were -- we were still estimating that the -- 12 the odds were things were going to remain within their 13 historical parameters. 14 COMMISSIONER HOLTZ-EAKIN: 15 clear, that constituted stress? 16 MR. MUDD: 17 COMMISSIONER HOLTZ-EAKIN: 18 No, no, no, that constituted -- Talking over each other 20 MR. MUDD: 22 23 24 25 I'm interested in that vision -- 19 21 And, just to be There's a stress case, on the downside there's a nice case, on the upside -COMMISSIONER HOLTZ-EAKIN: That's what I'm interested in, stress on the downside. MR. MUDD: would have -- The stress test on the downside 86 1 VICE CHAIRMAN THOMAS: Mr. Chairman, it's 2 very difficult to follow the questions and answers 3 when the witness overrides the question of the 4 Commissioner. 5 6 CHAIRMAN ANGELIDES: Let -- let Mr. Holtz-Eakin ask the question and then respond. 7 VICE CHAIRMAN THOMAS: And then respond, 8 it's beginning to look like some of the shows on 9 television. 10 11 12 13 14 CHAIRMAN ANGELIDES: Let's add a minute back onto Mr. Holtz-Eakin. COMMISSIONER HOLTZ-EAKIN: Thank you, Mr. Chairman. My interest is in the internal risk 15 management procedures at Fannie Mae, which ultimately 16 failed and left the taxpayers with the single largest 17 bill we will face in this episode, and I'm curious as 18 to the nature of those procedures, their quantitative 19 assessment of the risk, not likely the outcomes but 20 worst case, and downside risk, and the degree 21 to which they were updated in light of clear misses, 22 and how they interacted with other mitigates against 23 risk, holding additional capital, which you have 24 already expressed an assertion that you held adequate 25 capital from all internal risk metrics, despite the 87 1 evidence to the contrary, and stronger regulation, 2 which would have put you in a better prudential 3 position. 4 So, that's where I'm going, it's not a 5 mystery, and I would just like to know how it was 6 done? 7 8 MR. MUDD: I apologize, I didn't mean to be disrespectful. 9 The -- I'll try to be brief but we had a -- 10 an independent risk management committee of the board; 11 we had an independent view from OFHEO, who effectively 12 ran a parallel model with their own set of stress 13 scenarios. 14 with -- who reported dotted line to me and straight 15 line to the board. 16 individuals who focused on single-family credit, 17 multi-family credit, et cetera. 18 were independently verified. 19 increasing amount of independent verification to 20 basically develop richer data as it became clear that 21 we were going through the phenomenon that I described 22 to you of the models not being able to catch up with 23 the reality. 24 25 We had an independent chief risk officer Under his organization, we had We had models which And -- and we used an And those were -- those were updated. were a topic of conversation at weekly management They 88 1 meetings. 2 `08, the board met something like 100 times, and this 3 would have been an item of discussion at that level. 4 And I think, in the year of either `07 or So I was -- and the process, our chief risk 5 officer had come out of the money-centered bank that 6 we had judged had the best process, and we asked 7 basically to install something that looked like a 8 blueprint of that, of that process, and that's -- 9 that -- that -- that, in summary, is how the system 10 was set up and operated. 11 And then those scenarios that we described 12 in the earlier question were -- were inputted and run 13 through. 14 COMMISSIONER HOLTZ-EAKIN: Are you aware 15 that yesterday we received testimony from the 16 Comptroller of the Currency, Mr. Dugan, who said that 17 when invited by the Fed to review risk management 18 procedures and the capital held at Fannie Mae was 19 shocked that they did not meet the standards that, for 20 example, a national bank would have, and that the 21 capital was so inadequate. 22 MR. MUDD: How do you react to that? I react to it that Fannie Mae 23 wasn't a national bank and under -- under its 24 regulatory regime, it was operating within the capital 25 standards that it had, A, and that, B, we were -- we 89 1 were aggressively raising capital throughout `07 and 2 into -- into `08. 3 So I don't want to dispute the notion 4 that -- that more capital was a better thing and yet 5 more capital would have been even a better thing. 6 There are natural financial limits, if you 7 will, on the amount of capital that you can actually 8 raise in the real world. 9 maybe -- maybe even earlier than that, where it There was a point in `08, 10 became, you know, it became clear that -- that the bar 11 shouldn't be minimum statutory capital, that it should 12 be higher than that, and we tried to operate 13 accordingly. 14 COMMISSIONER HOLTZ-EAKIN: If I can just 15 get, before we leave this, and I appreciate your 16 forthcoming on this, what precisely was the number for 17 the downside scenario? 18 was it a 10 percent decline? 19 MR. MUDD: Was this a 5 percent decline, I will try, I will be 20 forthcoming, but I can't tell you anything that I 21 don't specifically remember, because based upon what 22 the inputs and the methodology were, you could come up 23 with a variety of different -- a variety of different 24 numbers. 25 But I -- the last output was the one that I 90 1 described to you in the end of `08. 2 the outputs turned out to be subsequently once you had 3 the real data in terms of what -- in terms of what 4 actually happened. 5 I don't know what But the downside was consistent with the 6 structure and the calculations that we went through to 7 develop regulatory, consistent. 8 9 10 11 COMMISSIONER HOLTZ-EAKIN: I want to make sure I understand the business model, because it's always been of interest to me. There were really two things that you did: 12 One was to purchase mortgages, provide a guarantee and 13 generate MBSs for sale, and the second business was to 14 borrow and hold those risky MBSs in a large portfolio; 15 fair characterization of the basic, overall operation? 16 17 18 VICE CHAIRMAN THOMAS: Mr. Chairman, yield the Commissioner five additional minutes. COMMISSIONER HOLTZ-EAKIN: Thank you. And 19 in this spectrum of purposes that you had to pursue, 20 the public purposes, the product purposes, what 21 purpose did the portfolio hold? 22 MR. MUDD: When a -- when an originator 23 originates mortgages and builds up a book of loans 24 that they then put into a -- into a Fannie Mae or 25 Freddie Mac security, they -- they are still -- 91 1 they're the originator of those loans obviously, but 2 they still hold those loans but they're now in the 3 form of a mortgaged-backed security on their books. 4 The reason that the mortgage-backed 5 security is more valuable, per se, on their books is 6 because it's -- it's a straightaway Fannie Mae MBS 7 Triple-A security. 8 9 And therefore, it has a liquidity value in that the CFO, the treasurer, or whatever of the bank 10 can get those sold into the marketplace very 11 expeditiously should they have any, which they 12 couldn't do with the individual loans. 13 One of the things and to my view one of the 14 most important things that the portfolio did was it 15 provided the liquidity to ensure that even at the 16 worst times in the marketplace, 9/11 or parts of 2008, 17 there was always going to be a bid out there for those 18 mortgages. 19 And so we sort of were able to achieve a 20 liquidity premium on the price of the MBS through the 21 existence of the portfolio because there was certainly 22 no guarantee that anybody else would be out there in 23 tight markets. 24 25 COMMISSIONER HOLTZ-EAKIN: So number one, it was a Triple-A security because it was guaranteed, 92 1 right? It was guaranteed. 2 security. 3 So they had Number two, you're saying that by already 4 holding 3.2 trillion dollars worth of assets, this 5 gave them assurance that you would buy more? 6 MR. MUDD: 7 COMMISSIONER HOLTZ-EAKIN: 8 No. How does that help? 9 10 No. MR. MUDD: That was what I said, it was the question of what was the purpose of being in 11 that business, and that was one of the purposes of 12 being in the business. 13 COMMISSIONER HOLTZ-EAKIN: Another purpose 14 to be in that business was be to simply borrow what was 15 an implicit government guarantee very cheaply, and invest in 16 a very risky set of assets that, by your own 17 admission, got riskier as time went on, and take 18 advantage of the implicit backing of the taxpayer to 19 make money. 20 How do you feel about that? MR. MUDD: Not in agreement. The -- the 21 overwhelming bulk of the assets that were in the 22 portfolio were actually typical, conventional, 23 conforming mortgages. 24 notion that the portfolio was a locus of riskier loans 25 than the broad book was not accurate, in my So the notion that -- the 93 1 2 experience. COMMISSIONER HOLTZ-EAKIN: So that you held 3 a different set of assets in your portfolio than you 4 actually were funneling into MBSs, because, as you 5 said, you made a conscious, continual shifting to 6 Alt-A's, greater magnitude 2003, 2004, 2005. 7 your portfolio also become riskier as a result? 8 9 MR. MUDD: Didn't Over time the portfolio grew and over time as the portfolio participated in investments 10 and private label securities and other investments 11 consistent with the market, but I guess the point I 12 was trying to make was that -- that directionally and 13 qualitatively, though, the businesses are different, 14 but the classes of assets in which the two businesses 15 are investing are largely the same. 16 COMMISSIONER HOLTZ-EAKIN: But over time, 17 by process of elimination, there was not a decision to 18 hold greater capital backing, stay at the regulatory 19 minimums; there wasn't a decision in any way to stress 20 test more aggressively until very late. 21 only thing that seems to have happened is you have 22 relied more and more on the ability of the taxpayer to 23 pick up the pieces when it falls apart. 24 25 Indeed, the What did you do in the presence of this very large, risky portfolio and what others have 94 1 testified to be sort of inadequate internal risk 2 management to ensure that you don't -- didn't end up 3 in the position that you ultimately ended up in? 4 5 MR. MUDD: I will start and Mr. Levin might have some additional comments, if that's okay. 6 COMMISSIONER HOLTZ-EAKIN: I'm happy to 7 hear it, and I want to point out, this is not 8 something that is a revelation in circa 2010; this is 9 a concern circa 2003, when I testified at the 10 congressional budget office; this is something that 11 many people predicted. 12 that it was allowed to happen. 13 MR. MUDD: And knowing that, I'm curious By and large -- by and large the 14 locus of the credit crisis has been around credit risk 15 and not interest rate risk, the rate risk 16 fundamentally taken in the portfolio is interest rate 17 risk. 18 And the procedures around managing interest 19 rate, we've talked mostly today about credit risk, had 20 the same degree of controls and limits and models and 21 the other things that you would expect. 22 We -- we raised capital; we reduced limits, 23 we charged higher fees; we focused -- we focused all 24 of the organization on the risk management within 25 the -- within the portfolio. 95 1 So I guess maybe -- 2 COMMISSIONER HOLTZ-EAKIN: 3 4 Mr. Levin, briefly, and then I'll yield back, Mr. Chairman. MR. LEVIN: Yes. I wanted to go back to 5 one of your initial questions, which was why the 6 portfolio; what purpose did it serve? 7 VICE CHAIRMAN THOMAS: Yield the gentleman 8 an additional two minutes for purposes of the witness 9 answering the question. 10 COMMISSIONER HOLTZ-EAKIN: 11 MR. LEVIN: Thank you. And our portfolio served a very 12 important liquidity function in the marketplace. And 13 -- and -- and I would ascribe three levels of 14 liquidity, you know. 15 contribution to liquidity, which helped reduced 16 mortgage rates, which helped people get into homes. One would just be general 17 A second dimension of it would be in 18 periods of stress in the marketplace when other 19 sources didn't exist, the portfolio was a critical -- 20 critical function. 21 22 And Mr. Mudd mentioned 9/11, and I think the 2007 and 2008 period would be additional examples. 23 And then a third function of liquidity for 24 the portfolio would be for the class of mortgages for 25 which an active securitization market did not exist. 96 1 And I think a prime example of this would 2 have been the multi-family market, which over this 3 time period, there really wasn't much of a 4 securitization market. 5 was done in whole loan form in the portfolio. 6 Virtually all of that business And then just the final comment I would 7 make on purposes of the portfolio that there were also 8 products that would contribute to our affordable 9 housing goals that were better done through the 10 portfolio as opposed to being better done through the 11 other line of business. 12 13 And so I would put the -- what we did in the subprime in that example. 14 COMMISSIONER HOLTZ-EAKIN: I thank you both 15 for this. 16 to and pursue some of this, and just close with the 17 observation that even a very weak regulator took the 18 very first opportunity it had to limit the size of 19 your portfolios would suggest they were not entirely 20 in the interest of your public-for-risk mission. 21 Thank you. 22 23 24 25 I do want to reserve the right to come back CHAIRMAN ANGELIDES: Mr. Holtz-Eakin. Thank you, Mr. Thompson. COMMISSIONER THOMPSON: Mr. Chairman. Thank you, 97 1 EXAMINATION BY COMMISSIONER THOMPSON 2 COMMISSIONER THOMPSON: Good morning, 3 gentlemen. 4 housing bubble may very well have been a significant 5 contributor to the financial collapse. 6 Fannie and Freddie probably had the best view of the 7 U.S. housing market, particularly the segment of the 8 market targeted at low- to mid-income buyers. 9 Many in our country have believed that the And arguably, And while the private label security guys 10 were the Johnny-come-latelies you guys have been in 11 the market for -- since 1938, no question about that, 12 I think if you look at the period where house 13 ownership or homeownership in our country grew 14 substantially, there was about a four- to five-year 15 period where there was a 10 percent increase in 16 homeownership, quite substantially from historical 17 norms. 18 And so I guess my question is, at what 19 point does someone who has such great market knowledge 20 and has a public mission have a responsibility to also 21 say, something is going wrong here, and therefore use 22 your knowledge of the market to tell HUD and to tell 23 Congress, slow down, something's not right. 24 25 MR. MUDD: Mr. Mudd? I think there is that, there is that responsibility, we had those conversations 98 1 throughout the rule-making process as HUD established 2 the housing goals. 3 The other side of the coin, a little bit to 4 me, was that when I first started to look at this, the 5 data of homeownership, there was a 10 or 15, maybe 6 more, percent gap in -- in homeownership rates between 7 minorities and the majority. 8 ground to be made up there on a -- on a fairness 9 basis. 10 And there was clearly And President Bush had a minority 11 homeownership initiative that we participated in. 12 There were similar programs in earlier 13 administrations. 14 increase in homeownership was -- was -- was driven by 15 folks able to access the homeownership market for the 16 first time. 17 And a lot of the -- a lot of the In -- in -- in -- in retrospect, I think 18 that -- I think that it got too high. 19 reflected that there had been no progress for a period 20 of time, and then -- and then suddenly, in my 21 interpretation, as a confluence of all the different 22 programs and focuses and initiatives and so forth that 23 were underway, there was progress. 24 that was good progress. 25 COMMISSIONER THOMPSON: At the time, it And I thought that So but it is true 99 1 that part of that increase in homeownership was 2 attributable to loans that were originated that had 3 very, very low standards of origination and, 4 therefore, could have contributed to an eventual 5 collapse. 6 country at risk. 7 So the blind pursuit of metrics put our MR. MUDD: Well, as I tried to indicate 8 before, the business that Fannie Mae did was -- was in 9 order of do better than market, leaving at large, to 10 this day, about 70 percent of the loans in the market 11 are Fannie or Freddie loans, in total, and about 30 12 percent of the total market delinquency is 13 Fannie/Freddie. 14 Thirty percent of the loans in the market 15 are held by private institutions wherein reside 70 16 percent of the delinquency. 17 So I think we did act with prudence, we did 18 act as a breaking force. 19 absolutely right. 20 the home price rise with lower -- with lower equity in 21 the house are going to be the first to get hurt. 22 23 24 25 In retrospect, you're Folks that get in near the end of And, unfortunately, those were a lot of the emerging homeowners I was just describing. COMMISSIONER THOMPSON: Mr. Levin, you were with Fannie for a very, very long time. Would you 100 1 comment on that. Was part of the responsibility you 2 have to act on market knowledge? 3 MR. LEVIN: You know, we had -- we had 4 continual conversations with our regulators about what 5 we were seeing in the marketplace and so, you know, on 6 the -- 7 COMMISSIONER THOMPSON: 8 Congress or with HUD? 9 MR. LEVIN: How about with With HUD. 10 COMMISSIONER THOMPSON: 11 MR. LEVIN: Okay. And there were conversations 12 with, you know, with -- with all parts of -- all parts 13 of the government, but with HUD, we had regular 14 quarterly meetings where we would discuss issues like 15 this, and they were usually centered around our housing 16 goals and what we were seeing in connection with our 17 housing goals. 18 we thought to them as part of these meetings. 19 And, you know, we would express what COMMISSIONER THOMPSON: So you could 20 certainly describe your mission as somewhat 21 schizophrenic, the cross between trying to serve the 22 public's interests and the interests of shareholders. 23 As you look with the benefit of hindsight now at what 24 has happened with the GSEs, is this a mission that 25 really should have been undertaken, particularly as it 101 1 2 was structured? MR. MUDD: It's -- in my mind, 3 Commissioner, it's the most important question in the 4 whole discussion. 5 determination of whether you want an American 6 government in some way to tweak the system to the 7 advantage of homeownership. 8 9 10 And it goes to a broad COMMISSIONER THOMPSON: But I'm asking for your opinion. MR. MUDD: My opinion, my opinion is that 11 with where we are at 90-something percent of the loans 12 in the market today being -- being run through the 13 government in one form or another, the notion that you 14 would go back to a fully private structure cannot be 15 logistically accomplished in our lifetimes. 16 I do think that a -- a consensus around 17 what the models should be is important. If it were 18 for me to do, I would have the GSEs focused on 19 principally first-time home buyers getting -- getting 20 -- getting -- getting folks onto the ladder in the 21 first place, under terms, generally predictable 22 payment, fixed rate, 30-year loans with 20 percent 23 down, the old-fashioned way. 24 a portfolio. 25 -- as it had been. There -- there would be The portfolio would not be as large as And there would have to be some, 102 1 in my view, explication of exactly what the 2 relationship is between these entities and the 3 government. 4 COMMISSIONER THOMPSON: So what would that 5 change do to your housing goals? 6 plausible approach to the market, what should the 7 housing goals therefore be? 8 MR. MUDD: If that's the more Well, it always seemed to me, 9 sir, that if you were going to have -- if you were 10 going to have requirements like the housing goals, 11 they should also -- they should also be balanced by 12 the capabilities of the organization. 13 So I think the notion of, if you had 14 entities like this, they would be supervised and 15 regulated to attain mission goals has to make sense. 16 To my judgment, the flaw in the -- in the 17 -- I guess it's now an old goals regime, because it 18 doesn't apply anymore, the flaw in the goals regime 19 was that it was set without respect to the market, 20 which effectively put the companies in a position of 21 having to outstrip the market. 22 23 24 25 COMMISSIONER THOMPSON: The goals should have been more? MR. MUDD: The goals -- the goals should have been floating with respect to where the market 103 1 was -- 2 COMMISSIONER THOMPSON: 3 MR. MUDD: But they -- -- on a periodic basis, as 4 opposed to straight-lined under the numbers that 5 Mr. Wallison described. 6 COMMISSIONER THOMPSON: 7 MR. LEVIN: Mr. Levin? My view on the housing goals is 8 that numbers just for numbers aren't useful. Then 9 what would have been more useful would have been to 10 identify what really were the problems in the housing 11 and mortgage markets and then to direct the companies 12 to address what were really considered real -- real 13 problems. 14 And so, for example, if policy makers would 15 determine that there was a problem with new rental 16 housing for seniors, just making up an example, which 17 would direct -- to direct the enterprises to help fix 18 that problem would make sense to me because it was, 19 you know, if that was a problem, then it was a problem 20 worth fixing. 21 problem, then to have us address that other problem, 22 but not numbers for numbers' sake where there might 23 not be a problem. 24 25 And if the next year there was another COMMISSIONER THOMPSON: Was there an opportunity, perhaps, to reprioritize your charter and 104 1 focus on those things that were most relevant in the 2 marketplace that would have made the institution more 3 sound? 4 5 MR. LEVIN: That wasn't done at my pay grade. 6 COMMISSIONER THOMPSON: Well, Mr. Mudd, I 7 guess you've got the only pay grade that it might have 8 been done on? 9 10 MR. MUDD: It comes with the territory, which seem -- I'm sorry, could you -- 11 COMMISSIONER THOMPSON: Could you have 12 reclassified or changed your charter to go focus on 13 the things that would have made this institution more 14 sound? 15 MR. MUDD: I think that the thing that 16 would have made the institution more sound or have 17 produced a different outcome would have been for it to 18 have become over time a more normal financial 19 institution able to diversify, able to allocate 20 capital, able to be long or short in the market, able 21 to operate internationally. 22 And if the trade for that would have been, 23 you know, a cut in the so-called implicit ties with 24 the government, I think that would have -- that would 25 have been a better solution. 105 1 That -- that -- the items that were 2 discussed earlier, the work that Citibank and McKenzie 3 did was, in part, to evaluate -- evaluate that course. 4 In my experience there was never any 5 genuine interest, on the part of government, in -- in 6 pursuing that or allowing that to happen. 7 8 COMMISSIONER THOMPSON: much. 9 10 CHAIRMAN ANGELIDES: Mr. Thompson. Thank you, Mr. Hennessey? 11 VICE CHAIRMAN THOMAS: 12 CHAIRMAN ANGELIDES: 13 VICE CHAIRMAN THOMAS: 14 Thank you very Mr. Chairman? Yes. Thirty seconds prior to moving to the Commissioner? 15 EXAMINATION BY VICE CHAIRMAN THOMAS 16 VICE CHAIRMAN THOMAS: My understanding is 17 that, Mr. Levin, was in your response to the question 18 asked by Commissioner Holtz-Eakin -- oh, it was 19 Thompson that asked the question -- it was above your 20 pay grade? 21 22 MR. LEVIN: No, that was sloppy language. Let me -- let me -- 23 VICE CHAIRMAN THOMAS: It was quite clear. No, it wasn't 24 sloppy. My understanding is 25 between 2000 and 2008, you made 45 million dollars? 106 1 So only people above 45,000 -- 45, excuse me -- 2 million dollars, between 2- and 2008 could answer that 3 question? 4 MR. LEVIN: What I meant by the -- what I 5 meant -- what -- what I was addressing was the 6 question of could we have affected the Charter Act. 7 VICE CHAIRMAN THOMAS: 8 above your pay grade? 9 MR. LEVIN: 10 And -- and my language VICE CHAIRMAN THOMAS: No, it wasn't sloppy. 13 MR. LEVIN: 14 VICE CHAIRMAN THOMAS: 15 And it was was sloppy. 11 12 Yes. Right. And what I meant by that -It was flippant, if you want that as a choice. 16 MR. LEVIN: What I meant by that, sir, was 17 that was in the purview of the Congress, not the 18 company. 19 20 VICE CHAIRMAN THOMAS: Oh, Mr. Chairman, I'll get to those questions in a minute. 21 CHAIRMAN ANGELIDES: 22 COMMISSIONER HENNESSEY: 23 24 25 Mr. Hennessey? Thank you, Mr. Chairman. EXAMINATION BY COMMISSIONER HENNESSEY COMMISSIONER HENNESSEY: Mr. Mudd, in your 107 1 testimony you said, let me quote here, I believe that 2 in retrospect there was overinvestment in housing; 3 origination standards slipped; there was too little 4 skin in the game; homeownership rates probably rose 5 too high. 6 I -- I agree with that assessment and I 7 want to better understand your view about whether 8 Fannie's actions contributed to each of these four 9 outcomes. 10 My personal views is I believe the policy 11 makers on both sides of the aisle contributed to each 12 of these four problems, and I would like to ask about 13 the contribution of your decision to guarantee roughly 14 350 billion dollars of Alt-A mortgages. 15 So let me go through each of the four, 16 quickly, in turn. 17 overinvestment in housing, but Fannie is not just a 18 market follower. 19 become a market leader just because of their size. 20 You said there was an When Fannie takes an action, they Do you think that your decision to increase 21 participation in the Alt-A market caused this market 22 to expand further? 23 to overinvestment in Alt-A mortgages? 24 25 MR. MUDD: Did Fannie's guarantees contribute I think Fannie Mae's investments, at large, given that it was in the 108 1 chartered purpose of increasing homeownership and 2 increasing affordable housing, did both of those 3 things: 4 affordable housing. 5 and therefore when the collapse came, more people were 6 exposed to the collapse. 7 It increased homeownership and it increased And therefore made the pie bigger COMMISSIONER HENNESSEY: Okay. And then 8 you said that origination standards slipped. Now, I 9 understand your point that you had lower default rates 10 than your competitors, but did Fannie's origination 11 standards slip on Alt-A mortgages? 12 MR. MUDD: We tried to be very prudent and 13 procedural in the process and -- and -- and -- and 14 you've already mentioned the point about the 15 comparison to the -- to the market at large. 16 I think that in -- in retrospect, there was 17 a -- there was -- there were kind of three factors 18 around the Alt-A mortgages that probably deserved 19 greater examination, although it's data that I don't 20 have access to anymore, where the state concentrations 21 in Alt-A tended to be the states with the least 22 affordable housing. 23 affordable housing also happened to be among the 24 biggest states, California and Florida, among them, 25 one. The states with the least 109 1 And then, two, a proportion of that 2 business, a high proportion of Alt-A business, came 3 through broker channels. 4 channels, the broker channel, by and large, allowed a 5 lot of leakage into the system of loans that were not 6 underwritten to a higher quality. 7 I -- what I had in mind, there. And I think that the broker So that was what 8 We charged higher fees, we charged adverse 9 market overrides on the Alt-A, on the Alt-A book, but 10 because of its vintage being as close as it was to the 11 collapse in home prices those also tended to be the 12 first ones to get -- 13 COMMISSIONER HENNESSEY: I think what I'm 14 hearing from you there is, yes, the standards slipped 15 but you did your best to manage it; is that fair? 16 MR. MUDD: Well, under the -- 17 COMMISSIONER HENNESSEY: Or maybe -- or 18 maybe it slipped, but it wasn't intentional and you 19 did your best to manage it? 20 MR. MUDD: I think that that's -- that is 21 a -- I think that that's a fair statement, that it -- 22 that it was not our intention to slip it but it -- 23 and, in fact, it was our intention to tighten the 24 standards around Alt-A. 25 And, in fact, they were tighter, as you 110 1 pointed out, than the private market at large. 2 if -- if you go back and look at it in retrospect, 3 they weren't tight enough. 4 COMMISSIONER HENNESSEY: Okay. You said 5 that there was too little skin in the game. 6 Fannie lower its down payment requirements for 7 subprime and Alt-A mortgages? 8 MR. MUDD: 9 the way that you're describing. But Did Not in the -- not directly in The participation in 10 those markets -- if -- there was something -- there 11 were -- there were credit grids that had a 12 multiplicity of factors on them that sort of 13 sum-totaled down to a number about whether a loan 14 would be approved or not approved in the -- in the 15 Fannie Mae system. 16 So to the extent that a LTV ratio was 17 higher, somewhere else in the underwriting there would 18 have to be a compensating factor that would -- that 19 would move those up. 20 21 22 COMMISSIONER HENNESSEY: I got it, let me try, then, let me rephrase a little bit. Did Fannie Mae understand that they were 23 guaranteeing mortgages that had higher LTV ratios and 24 lower down payments? 25 MR. MUDD: Yes. 111 1 COMMISSIONER HENNESSEY: Okay. And then 2 you said that homeownership rates probably rose too 3 high. 4 participation in subprime and Alt-A markets 5 contributed to these homeownership rates rising too 6 high? Do you think that Fannie Mae's increased 7 MR. MUDD: 8 COMMISSIONER HENNESSEY: 9 Contributed? I would say so. Okay. Next, in your testimony, different topic here, you said, a 10 mono-line GSE structure, asked to perform multiple 11 tasks, cannot withstand a multi-year 30 percent home 12 price decline on a national scale, even without the 13 accompanying global financial turmoil. 14 And you mentioned several times that 15 because you were a mono-line firm, because you 16 couldn't diversify, that was a significant 17 contribution to the firm's failure, it seems to me 18 that the key phrase there is, asked to perform 19 multiple tasks. 20 a severe shock if it does an excellent job at risk 21 management and if -- if it is sufficiently well 22 capitalized. 23 24 25 Because a mono-line firm can survive Yes? MR. MUDD: Yes. I thought about those words carefully and you've interpreted them correctly. COMMISSIONER HENNESSEY: Okay. So it's 112 1 not -- I am concerned. 2 diversity high in the reason for failure. 3 I'm just reading something that's implicit, but it 4 seems to me that having these extremely high leverage 5 ratios and the inability to manage the risks was 6 probably more important to the firm failing than a 7 lack of diversification, would you agree? 8 9 MR. MUDD: You seem to be ranking lack of And maybe Well, the lack of diversification left the GSEs exclusively exposed to 10 the one market that cratered the worst. 11 respectfully, I don't know how I can distinguish 12 those, the -- the -- the two factors from each other. 13 I would be happy to try. 14 COMMISSIONER HENNESSEY: Okay. So, And then, 15 if I could, I just want to follow up on Mr. Georgiou's 16 line of questioning, because what you said about not 17 being aware of the firm trying to lobby Congress on 18 the appropriation for the regulator just completely 19 contradicts my experience over the past probably ten 20 years. 21 And, Mr. Chairman, I would just suggest 22 that it's an important area for us to understand, 23 because we've heard several times that Fannie Mae was 24 in compliance with the regulatory capital standards, 25 but if Fannie or its proxies were at the same time 113 1 trying to keep those capital standards from being 2 raised to something more like what a national bank or 3 another large financial institution would have used, 4 then there's a problem. 5 I remember back to political science class, 6 we learned about iron triangles right between a 7 regulated firm, the Congress, and the regulator. 8 I just think we need to understand, now that the 9 taxpayers in effect own these firms, to what extent And 10 were these firms trying to influence both legislative 11 and executive branch policy makers to not just keep 12 the funding for the regulator low, but to prevent 13 stricter capital standards and to prevent the 14 regulator from having stronger authority over the size 15 of the portfolios. 16 CHAIRMAN ANGELIDES: All right. We'll note 17 that for the record and also instruction to staff, and 18 I know they've already provided some information on 19 lobbying expenses, which I think were cited by 20 Mr. Georgiou as accumulating to 80 million dollars 21 over the timeframe referenced. 22 COMMISSIONER HENNESSEY: 23 CHAIRMAN ANGELIDES: 24 25 Mr. Hennessey. Thank you. Thank you, Ms. Born. COMMISSIONER BORN: Thank you very much. 114 1 EXAMINATION BY COMMISSIONER BORN 2 COMMISSIONER BORN: And thank you both for 3 being willing to appear before us and help us with our 4 work. 5 In the written testimony of James Lockhart, 6 who was the director of OFHEO from 2006 and 2008 and 7 who is going to appear before us this afternoon, he 8 said that Fannie and Freddie had very large 9 derivatives positions in connection with their 10 11 portfolios of mortgage interest. And I understand from our staff that Fannie 12 held about 1.2 trillion dollars in notional amount of 13 derivatives in the summer of 2008 prior to the 14 conservatorship, and that Freddie had an additional 15 1.6 trillion dollars in notional amount of 16 derivatives. 17 If you can -- if you have knowledge of 18 this, could you tell us what kinds of derivatives were 19 being held by Fannie Mae? 20 MR. MUDD: They were -- they were 21 principally in the form of options swaps and swaps, 22 there on plain vanilla, used for the purpose of 23 extending the match on the debt to the underlying 24 mortgage assets. 25 COMMISSIONER BORN: So they were basically 115 1 being used for hedging purposes? 2 MR. MUDD: Yes. 3 COMMISSIONER BORN: And they were trying to 4 hedge the interest rates risk that you had; is that 5 right? 6 MR. MUDD: Yes, ma'am, the -- the feature 7 of the 30-year fixed rate mortgage is that the 8 individual consumer can pay it off anytime they want 9 to, and ideally you would match 30-year funding to a 10 11 30-year asset. But because of that option, you have to 12 understand what the -- what the likely actuarial 13 statistical life of the book of the mortgages was 14 going to be. 15 And therefore it was -- it was generally 16 most efficient to -- to fund components of the 17 portfolio with short-term paper or bullet debt or 18 other forms of straight debt and then use the 19 derivatives market in order to create the optionality 20 to match the term of the mortgage and then to adjust 21 that book depending on if interest rates were going up 22 and the book was extending or interest rates were 23 coming down and the book was paying off. 24 COMMISSIONER BORN: 25 rate risk and prepayment risk? So was both interest 116 1 MR. MUDD: 2 the same root cause. 3 4 Yes, ma'am, which are derived of COMMISSIONER BORN: Right. Did you also hedge against default risk in the portfolios. 5 MR. LEVIN: Not in the form of derivatives. 6 We would, you know, purchase credit enhancement in the 7 form of mortgage insurance, was the -- was the way we 8 would do it. 9 10 COMMISSIONER BORN: kind of speculation with derivatives trading? 11 12 Did you engage in any MR. MUDD: No. It was, to my knowledge, it was all in the book, not for speculative purposes. 13 COMMISSIONER BORN: Mr. Lockhart suggested 14 that there were concerns during the time he was the 15 director of OFHEO, about the derivatives position with 16 respect to Fannie Mae's and Freddie Mac's exposure to 17 counterparty risk and also, he said, interest rate 18 risks. Can you explain what those concerns were? 19 MR. MUDD: I can explain how -- how I 20 thought about them from the standpoint of counterparty 21 risk. 22 Lockhart's testimony but, as a general matter, as -- 23 as I suspect you know, the risks on the derivatives 24 book is the failure of one of the counter-parties to 25 perform. I'm not sure -- I was not able to read Mr. 117 1 So within the risk management function, 2 we -- we built out a team that was focused on 3 counterparty risk and aggregate exposure with limits 4 to each of those counter-parties. 5 And we actually, in the cases of Fannie 6 Mae, had to look at it across the book because we -- 7 it -- it would have been possible for us to have an 8 exposure on the derivative side, on the debt side, 9 on -- and as well as the institution could have been a 10 customer of ours on the credit side of the business. 11 So that function was created to enable us 12 to look across an entire counterparty and understand 13 what the exposure was there. 14 think, enabled us to reduce the exposure in both the 15 Bear Stearns and the Lehman's situations in advance, 16 so it proved fortuitous. 17 And that actually, I COMMISSIONER BORN: Did you experience any 18 default to -- defaults in connection with Bear or 19 Lehman or otherwise during, say, 2007 or 2008 -- 20 MR. MUDD: 21 COMMISSIONER BORN: 22 portfolio positions. 23 MR. MUDD: 24 access to the place. 25 I -- I --- on the derivatives I don't know. COMMISSIONER BORN: I don't have The Wall Street 118 1 Journal, on Tuesday, April 6th, reported that Fannie 2 Mae and Freddie Mac currently have more than 2 3 trillion dollars in notional amount of interest rate 4 swaps on their books. 5 largest participants in that market. 6 And they are thereby among the And evidently the Federal Housing Finance 7 Agency is considering requiring that all those 8 instruments be centrally cleared through a 9 clearinghouse in order to diminish counterparty risk 10 11 12 13 and also to obtain improved pricing information. Would you have considered that a good move while you were at Fannie Mae? MR. MUDD: I -- I -- I find it hard to -- 14 hard to reposition myself in the past, but I think my 15 concern would have been that -- that putting 16 limitations on the markets where Fannie and Freddie 17 could hedge that didn't -- as very large users of 18 derivatives, would put them in a different position 19 with respect to the rest of the market. 20 And that could either advantage others at 21 the expense of Fannie and Freddie, or it could 22 disadvantage Fannie and Freddie at the expense of not 23 having as wide a palette of tools to use. 24 25 My observation of reading the article was that, as I note in my testimony, the companies were 119 1 being used in some ways to effectuate changes in 2 public policies and public markets, and so there may 3 be other reasons to do that that I'm not aware of 4 anymore. 5 6 7 COMMISSIONER BORN: Mr. Levin, do you have a reaction? MR. LEVIN: I -- I -- I would be interested 8 in the proposal. 9 it's difficult, without seeing it, to respond. 10 I've not seen the proposal. COMMISSIONER BORN: But Let me just follow up a 11 little bit on some questioning that you had from 12 Commissioner Georgiou and Hennessey about the 13 political power and influence that Fannie Mae 14 exercised prior to the conservatorship. 15 Fannie Mae certainly had a reputation of 16 exercising very significant political power in 17 Washington through both extensive lobbying and 18 government relations expenditures, and also hiring or 19 retaining high former government officials to conduct 20 its government relations and lobbying. 21 Does it seem unusual to you that millions 22 of dollars were being spent each year during the time 23 you were CEO for lobbying expenses? 24 MR. MUDD: No, it does not. 25 COMMISSIONER BORN: Why not? 120 1 MR. MUDD: There -- there -- in premise, I 2 would agree that there was a time when there was -- 3 there was -- there were too many of the behaviors or 4 activities that you described. 5 COMMISSIONER BORN: 6 MR. MUDD: So this was -When was that? Prior to -- prior to my time as 7 CEO, certainly. 8 list upon -- upon accession to the job was to -- to 9 get that right. 10 And one of the things that was on my And my thought was that -- but at the same 11 time, there were a number of complicated issues that 12 went fundamentally to the existence of the companies 13 before Congress, and secondly, there were inbound 14 calls from Congress and other branches of the 15 government, that had to be responded to, and they had 16 to be responded by somebody that understood what the 17 lobbying rules and the interaction rules of government 18 are, and those people happen to be called lobbyists. 19 My determination was that the thing to do 20 was to bring them inside the company so they were 21 under -- under my direct supervision. 22 understood what the company was doing, and instead of, 23 you know, schmoozing, they were actually working on 24 the issues of the day. 25 But they also But with the regulatory bill, which 121 1 changed, I hoped, the fundamental nature under which 2 the company was going to operate, I thought and I 3 still think to this moment that it was very important 4 to get that exactly right and for us not to be on the 5 field having our voice heard in terms of this 6 provision will have this specific impact on what the 7 company can and can't do, how we do and don't run the 8 company, what our effect on the capital markets will 9 and won't be; didn't seem like the appropriate way to 10 do it. 11 Last sentence on that is that, as you may 12 know, the lobbying numbers are derived as a head count 13 percentage multiplied by the overall expenses of the 14 firm. 15 expensive restatement, which made that denominator 16 higher than it would have been in the ordinary course. 17 The numbers, excuse me, have to be used with some 18 degree of caution. And during the period, we were going through an 19 CHAIRMAN ANGELIDES: 20 any more time on this matter? 21 COMMISSIONER BORN: 22 25 I would like to ask one more question. 23 24 Ms. Born, do you need CHAIRMAN ANGELIDES: All right. Two minutes? COMMISSIONER BORN: That would be fine. 122 1 CHAIRMAN ANGELIDES: 2 COMMISSIONER BORN: Whether -- yes. I would just like to 3 ask whether Fannie Mae had a PAC that its officials 4 would contribute to and that would be used to make 5 contributions to public officials? 6 MR. MUDD: 7 COMMISSIONER BORN: 8 And what was the name of the PAC. 9 10 Yes. MR. MUDD: Fannie PAC or something like that. 11 COMMISSIONER BORN: Do you have any 12 recollection of how large that PAC was and how large 13 the contributions to it were? 14 15 MR. MUDD: public record. I don't, I know it's a matter of I can find that, I think. 16 COMMISSIONER BORN: 17 MR. MUDD: 18 COMMISSIONER BORN: 19 find it. 20 I'm sure it is. But I don't know. I'll just have to go Thank you. CHAIRMAN ANGELIDES: All right. 21 Mr. Hennessey I'm going to move back to you because 22 you did have one minute and fifty seconds. 23 going to give you two minutes because of, you know, 24 our generosity with time. 25 question? But we're But you had another 123 1 2 COMMISSIONER HENNESSEY: Mr. Chairman. 3 4 You are too kind, CHAIRMAN ANGELIDES: I know, but don't forget it though. 5 COMMISSIONER HENNESSEY: 6 I certainly won't. EXAMINATION BY COMMISSIONER HENNESSEY 7 COMMISSIONER HENNESSEY: Frankly, I'm just 8 stunned by these comments, because as a White House 9 official over the past decade, I was directly lobbied 10 by outside consultants who were -- who told me they 11 were hired by Fannie and who told me that in fact 12 Fannie had gone through the White House staff who they 13 thought were working on the issue and targeted a 14 specific lobbyist at each one of those staff. 15 experience is just different than what you're 16 describing. So my 17 My question, you talked a lot about the 18 balance between your fiduciary responsibilities to 19 your shareholders and the need to fulfill your public 20 purpose. 21 earnings the GSEs would not have been able to attract 22 capital, to post reserves, to finance affordable 23 housing projects or to perform the function of 24 channeling global capital flows into U.S. 25 homeownership. And in your testimony, you said, without 124 1 So earnings are key to both those private 2 goals and those public goals. 3 the public purpose of buying, guaranteeing about 350 4 billion dollars of Alt-A mortgages. 5 And I'm confused about Was there a direct benefit to the housing 6 market from these, these guarantees, or was it 7 indirect through higher profits for the firm? 8 MR. MUDD: 9 COMMISSIONER HENNESSEY: 10 11 Well, I think -- I think both. And what was the direct benefit? MR. MUDD: The direct benefit is that 12 there -- there were, as Mr. Levin mentioned earlier, 13 there were -- there were loans in the Alt-A category 14 that were -- that were obviously conventional 15 conforming loans, but for want of some traditional 16 part of the non-Alt-A loan underwriting. 17 Just to pick an example, at one point we 18 looked at providing loans to teachers. 19 teachers wouldn't have 12 monthly amortizing payments. 20 Could they have nine months of payments and then three 21 months of nonpayment when the teacher's not working? 22 A loan to Now, that would -- that -- you might or 23 might not agree that that would be a laudable purpose, 24 but in either case, that would be an Alt-A loan. 25 that's just an illustration of my thinking in terms of So 125 1 how Alt-A could serve the mission as well as the 2 financial side of the business. 3 COMMISSIONER HENNESSEY: 4 CHAIRMAN ANGELIDES: Thank you. Mr. Georgiou, you have 5 the same amount of place on the record before we go to 6 the Vice Chair. 7 8 9 10 11 Microphone, please. EXAMINATION BY COMMISSIONER GEORGIOU COMMISSIONER GEORGIOU: I'm sorry, I just want to finish briefly on the list of what I would regard as potential accounting improprieties. The FHFA and OCC noted that Fannie did not 12 recognize losses until a loan had been delinquent 24 13 months and that Fannie made unsecured loans to 14 delinquent borrowers. 15 that allowance methodologies must be revised to 16 recognize inherent losses in their portfolios 17 regardless of the timing of the loss event. 18 OCC noted, in their report, And it was critical, given the extremely 19 liberal attitude with respect to loss recognition and 20 compounded by significant business initiatives 21 undertaken by the GSEs to defer losses. 22 There are three areas, and I guess I just 23 state it for the record, and maybe you could respond 24 in writing, thereafter. 25 Did Fannie make unsecured loans to 126 1 delinquent borrowers under the HomeSaver Advance 2 Program or any other program where the underlying 3 loans thereafter no longer reported as delinquent 4 loans? 5 as -- so it would not have to repurchase the 6 underlying loans and record mark-to-market charges? 7 Thank you very much. 8 9 10 And did Fannie make those unsecured loans so CHAIRMAN ANGELIDES: And you would like -- and we're going to ask you for written responses to those questions, all right, gentlemen? 11 COMMISSIONER GEORGIOU: 12 CHAIRMAN ANGELIDES: 13 14 15 16 17 18 19 20 21 Thanks. All right, thank you. Mr. Wallison? COMMISSIONER WALLISON: Mr. Chairman. Thank you, Just a few minor matters, I think. EXAMINATION BY COMMISSIONER WALLISON COMMISSIONER WALLISON: Just for those who are watching. CHAIRMAN ANGELIDES: Two minutes, Mr. Wallison. COMMISSIONER WALLISON: Those who are 22 watching on television, it would be important for you, 23 if you want to take a look at our website, where there 24 is a staff report on Fannie and Freddie. 25 And on page 8 of that report, there is a 127 1 chart which shows Fannie and Freddie's compliance with 2 the affordable housing guidelines and how that rises 3 just above the requirements that HUD was imposing as 4 it went on. 5 So it would be useful to see how 6 influential those guidelines were in Fannie's purchase 7 of subprime and Alt-A loans. 8 whether Alt-A loans are, in fact, goals-rich. 9 there is some information on that. A question came up about And In 2000 HUD 10 adopted a rule which said new -- and what they -- as 11 they describe their rule -- new provisions clarify 12 certain other provisions of HUD's rules for counting 13 different types of mortgage purchases towards goals, 14 including provisions regarding the use of bonus points 15 for mortgages that are secured by certain -- by 16 certain single-family rental properties. 17 That's why an Alt-A loan would be a 18 goals-rich loan, because it allowed a non- -- 19 non-owned investment to be rented. 20 property did provide housing for the groups that were 21 supposed to be included within the affordable housing 22 loans. 23 And a rental So that explains it. And we do have some information that was 24 turned over by Freddie, Freddie Mac, that on balance, 25 they say, Alt-A loans were net positive for the 128 1 housing goals. 2 And, finally, I want to talk about this 3 question of private label securities which, in fact, 4 Fannie and Freddie did purchase in -- in substantial 5 numbers. 6 purchases. 7 were high-interest loans, unlike many of the loans 8 that Fannie had made, and they were not as good 9 quality. 10 11 This was a significant element of their And they were profitable because these They were -- they were -- there was not as good quality as the loans that Fannie was making. So when you made the point, Mr. Mudd, that 12 it was -- it -- your loans were performing better than 13 other loans, this is exactly right. 14 loans that underlay the -- the private label 15 securities were much worse in terms of their quality 16 and have a much higher delinquency rate. 17 part is that -- 18 19 20 CHAIRMAN ANGELIDES: would just wrap up. Those subprime And the odd Mr. Wallison, if you We're over time. COMMISSIONER WALLISON: I will. The odd 21 part is, in buying these pools, you were in fact 22 advancing your competition's position, because they 23 would assemble these pools of conforming loans and 24 sell them to you, and they helped you with your 25 affordable housing guidelines. And they were also 129 1 profitable. But it also helped Wall Street do more of 2 the securitization that they were doing. 3 CHAIRMAN ANGELIDES: 4 VICE CHAIRMAN THOMAS: 5 CHAIRMAN ANGELIDES: All right. Thank you. We'll leave that, and 6 if you would like to respond, we'll ask you do that in 7 writing. 8 Mr. Thomas? 9 VICE CHAIRMAN THOMAS: 10 Thank you, Mr. Chairman. 11 EXAMINATION BY VICE CHAIRMAN THOMAS 12 VICE CHAIRMAN THOMAS: Much of the 13 questioning that we've heard today is based on the 14 fact that you obviously were dealing in, quote, 15 unquote, investments, which look a lot like some of 16 the other folk who were in front of us in dealing in 17 investments, unfortunately with much the same outcome, 18 but in fact, you folks really aren't a business at 19 all. 20 I mean, when you -- when Ms. Murren asked 21 you about compensation and the companies that you 22 compared yourself with, those really are companies. 23 They -- they have articles of incorporation, a lot of 24 them in Delaware because of their rules. 25 basically have to make a profit. They If they don't make a 130 1 profit, at some point, they cease to exist. 2 But you didn't have to have articles of 3 incorporation. 4 So in any of those discussions, I'm going to spend a 5 little time to bring it back into what I would 6 probably say more so than any other Commissioner, my 7 world. 8 Washington. 9 And you didn't have to make a profit. For more than three decades, I've been in People look at Washington, D.C., as a 10 national capital, international capital. 11 Brokaw, in his book, talked about Washington, D.C., as 12 being a small town. 13 here, I can tell you that, in spades, it's also a 14 company town. 15 But Tom And in the time that I've been I'm looking at a 2002 paper, put out by 16 Fannie Mae, under the heading, Fannie Mae papers, 17 headline, title, implications of the new Fannie Mae 18 and Freddie Mac risk-based capital standard. 19 Again, this is `02. It says down in the 20 corner, Fannie Mae papers is an occasional series on 21 policy issues of interest to the housing community. 22 And the conclusion of the paper, and not unsurprising 23 or probably wouldn't have seen the light of day, this 24 analysis shows that, quote, based on historical data 25 the probability of a shock as severe is embodied in 131 1 the risk-based capital standard is substantially less 2 than one in 500,000 and may be smaller than 1 in 3 3 million. 4 Given the low probability of the stress 5 test shock occurring and assuming that Fannie Mae and 6 Freddie Mac hold sufficient capital to withstand that 7 shock, the exposure of the government to the risk of 8 the GSEs will become insolvent appears quite low. 9 Commissioner Hennessey talked to you about 10 the fact that as there was an attempt to get Fannie 11 Mae to increase its capital levels, there was 12 resistance from Fannie Mae. 13 upon that assumption, was put out, I assume, to try to 14 attract business under your concept of your business 15 model. 16 Yet this document, based But probably as important as the content of 17 this is who wrote it. 18 The one that I was drawn to was a fellow by the name 19 of Peter R. Orszag, who's currently the director of 20 the Office of Management and the Budget. 21 There are three names on here. I want to talk about small town/company 22 town. Franklin Raines was Fannie Mae's Vice Chairman 23 from 1991 to 1996. 24 Fannie Mae to be the director of the Office of 25 Management and the Budget, from `96 to `98. In 1996 he moved directly from When he 132 1 left the director of the Office of Management and the 2 Budget, he became CEO at Fannie Mae, 1999 to `04. 3 In my more than 30 years, I don't recall, 4 because in yesterday's panel former comptroller of the 5 currency, Mr. Hawke, talked about the advantage of 6 going in and out of government and the 7 cross-fertilization and the benefit. 8 that, with certain limitations, but I have never seen 9 the in-and-out-of-government revolving door quite so And I agree with 10 focused on a position of significant importance in an 11 administration from your, quote, unquote, business 12 back to your, quote, unquote, business. 13 I look at lobbying slightly differently 14 than I think most people here. 15 wanted to make sure that you had people on the field. 16 I think you and I both know it's a whole lot better if 17 you have people in the locker room. 18 You said that you And I think there's just overwhelming 19 evidence. When you look at those people that were 20 employed for lobbying, once again, I probably read 21 this book differently than others, I'm shocked at the 22 virtual 100 percent content of the profile of the 23 lobbying firms. 24 Congress, members of Congress-to-be, or spouses of 25 members of Congress or, depending on who's in control, They're either former members of 133 1 a significant staffer who had been with the majority, 2 when Democrats were in the majority, or with the 3 Republicans, if they were in the majority, or back 4 again. 5 I mean, it is a clear indication that 6 notwithstanding their knowledge, there may have been a 7 secondary reason, and maybe the knowledge might have 8 been secondary, as to why these people were employed, 9 in my opinion. 10 Commissioner Born asked you about the 11 involvement in the political process, political action 12 committees. 13 I'm a little more interested in a slightly 14 different way, because you really have, as a kind of a 15 board of directors, based upon your origin, that is, 16 by statute, that's why you didn't have to incorporate, 17 and that the money that is your life blood in terms of 18 structured movement is actually appropriated by 19 Congress. 20 And over my 30 years, I got to know -- I 21 never wanted to be on the appropriations committee, 22 but I got to know those who were, and I think it would 23 be fair to say that given the size of the 24 appropriations committee, it breaks up into 25 subcommittees that look at specific areas of the 134 1 federal government that need the appropriations from 2 those specific areas, both in the House and the 3 Senate. 4 And they take a very proprietary attitude 5 towards those areas. 6 mentioned -- Senator Kit Bond was mentioned, Senator 7 from Missouri, as, at that time, chairman of the VA 8 apropos subcommittee, ranking member Senator Mikulski 9 from Maryland. 10 They're theirs. You It's true in the House as well and we'll 11 hear some testimony with the panel following yours to 12 reflect more on those particular activities. 13 I just want to ask a simple question of you 14 about what went on behind closed doors. 15 you were there longer than Mr. Mudd. 16 were you ever present at a meeting in which there was 17 a discussion about how a particular member of Congress 18 might be approached in attempting to advance the 19 quote, unquote, business model of Fannie Mae? 20 MR. LEVIN: Mr. Levin, Did you ever -- My recollection is -- stems 21 from the days that I ran the Housing and Community 22 Development Organization in Fannie Mae, which was the 23 organization that made -- 24 25 VICE CHAIRMAN THOMAS: little time. I -- I've got very Really, a yes or no would be sufficient, 135 1 because you can follow it up with comments to 2 elaborate. 3 4 MR. LEVIN: VICE CHAIRMAN THOMAS: I'll try it again. Yes or no? 7 MR. LEVIN: 8 VICE CHAIRMAN THOMAS: 9 CHAIRMAN ANGELIDES: -- and we made a -Mr. Chairman? I was going to say, 10 Mr. Levin, can you answer the question? 11 pretty straightforward question. 12 VICE CHAIRMAN THOMAS: 13 It was a I just lot a minute of time. 14 CHAIRMAN ANGELIDES: 15 VICE CHAIRMAN THOMAS: 16 We made a big effort to try to do important things in communities -- 5 6 I'll be short. Well, you'll get -I don't have a lot of time because I conceded it to others. 17 CHAIRMAN ANGELIDES: 18 back. 19 Mr. Levin. Yeah, I'll give it I think it's a pretty straightforward question, 20 MR. LEVIN: Yes. 21 CHAIRMAN ANGELIDES: About whether you were 22 in a meeting or not in which the subject of 23 approaching a member of Congress was raised with 24 respect to advancing the interests of Fannie Mae. 25 think that's a fair characterization. I I think a yes 136 1 or no would be appropriate. 2 MR. LEVIN: Five words. We wanted a -- we 3 wanted members of Congress to be awarded -- 4 VICE CHAIRMAN THOMAS: 5 MR. LEVIN: 6 VICE CHAIRMAN THOMAS: 7 come on, yes or no. 8 9 You've gone -- As a goodwill in the community. -- five words. The answer's yes, right? CHAIRMAN ANGELIDES: Please answer the question. 10 MR. LEVIN: 11 CHAIRMAN ANGELIDES: 12 VICE CHAIRMAN THOMAS: 13 COMMISSIONER HENNESSEY: 14 VICE CHAIRMAN THOMAS: 15 16 No, Yes. Thank you. Mr. Mudd? Yes. Yes? Not that hard. See, once you get in the rhythm, it's easier. Did you ever attend an event which was 17 classified as a political event for a then-sitting 18 member of Congress in either the House or the Senate? 19 MR. LEVIN: I don't recall if I ever did. 20 VICE CHAIRMAN THOMAS: You don't recall if 21 you ever did? They're pretty boring so you wouldn't 22 have remembered going to an event for a particular 23 member of Congress. Mr. Mudd? 24 MR. MUDD: Yes. 25 VICE CHAIRMAN THOMAS: You did. So that's 137 1 what I mean by not having to worry about who's on the 2 field if you have access to the locker room. 3 I don't know why people focus on paying for 4 lobbyists. So I guess what I'm trying to point out to 5 you is, in reference to Commissioner Born's statement, 6 there were a lot of people, including myself, who were 7 well aware of the intimate access by Fannie Mae, both 8 through your political action Commission and direct 9 involvement, that was designed, to a very great 10 extent, to promote your, quote, unquote, business 11 model. 12 In testimony that we're going to hear very 13 briefly, in reference to Commissioner Murren's 14 question, there's a quote, and it's attributed to 15 Fannie Mae's internal auditor, focused on the last 16 decade, in the effort to double earnings in five years 17 to 6.46, and I assume that's billion. 18 The quote is, by now you must have 646 19 branded in your brains. You must be able to say it in 20 your sleep. 21 and backwards. 22 belly that burns away all doubts. 23 breathe, and dream 646. 24 After all, thanks to Frank, we all have a lot of money 25 riding on it. You must be able to recite it forwards You must have a raging fire in the You must live, You must be obsessed on 646. 138 1 There was a book and a movie, and it 2 occurred when I was relatively young and had a big 3 impression on me, it was called Bridge Over the River 4 Quai. 5 involved in their work that at the uh-huh moment, it 6 was what have I done, in terms of building a really 7 good bridge to help the Japanese move their supplies 8 in Southeast Asia during World War II. In terms of someone so enthusiastically 9 The idea that you would ask someone here, 10 how much would you give to make sure that government 11 had its program tweaked toward homeownership? 12 on, how much would you give back to help the taxpayers 13 with their burden left by the way in which you and 14 cohorts ran this particular, quote, unquote, company? 15 Because I think you lost your way to a certain extent. 16 It was, more than it ever should have been, Come 17 focused on the amount of money that you folks could 18 earn. 19 decisions that ran the company in the ground were 20 above the 45-million-dollar markup, which was your pay 21 grade. 22 And I’m just amazed, Mr. Levin, if the kind of Thank you, Mr. Chairman. CHAIRMAN ANGELIDES: Thank you, Mr. Vice 23 Chair. I have some just very quick concluding 24 questions, and they're really clarifications, so very 25 brief answers. And then I have one question for you, 139 1 2 Mr. Mudd, in conclusion. When you talk about mission, I just want to 3 be clear that obviously there's the -- the business, 4 the profit mission, and I mentioned the affordable 5 housing goals, did you -- would liquidity be included 6 in mission, liquidity for the housing market, okay, 7 just for the record? 8 MR. MUDD: 9 MR. LEVIN: 10 Yes. Yes. CHAIRMAN ANGELIDES: Again, for the record, 11 as I understood the interchange with you Mr. Wallison, 12 and I think I'm characterizing it, that all lines of 13 business were pursued with an eye towards making money 14 but there may have been differential profit goals for 15 those various lines of business; correct? 16 MR. MUDD: Yes. 17 MR. LEVIN: 18 CHAIRMAN ANGELIDES: Yes. Okay. So, all right, 19 I just want to be clear. 20 in which you deliberately engaged with the idea, even 21 though obviously it turned out such, but in which you 22 engaged or underwrote them in which would you do 23 cross-subsidization to the extent of loss in a 24 particular business unit? 25 MR. MUDD: But there were no businesses Not to my knowledge. 140 1 CHAIRMAN ANGELIDES: 2 VICE CHAIRMAN THOMAS: Okay. Mr. Thomas? Mr. Chairman, I want 3 to clarify. 4 burning in their belly, that 646, it was a goal of 5 earnings per share, which really brings it home. 6 In the quote that talked about what was CHAIRMAN ANGELIDES: 7 long a question. 8 comments or questions. 9 Thank you. It's too All right, here are my final two In 2007 you bought -- as the market's 10 beginning to crash, really, you bought 21 billion 11 dollars of private label securities in that year when 12 most of the markets were trenching pretty 13 traumatically. 14 I'm just going to ask you -- were you -- 15 was there any pressure brought on you to do that by 16 folks, for example, in political positions and without 17 regard to party administration or Congress to support 18 Wall Street? 19 So you guys got to move in and continue to 20 buy PLS, or in 2007, were you buying private label 21 securities because you still thought they were a 22 reasonable bet? 23 I mean, did anyone ever come to you and 24 say, look, Wall Street's -- in 2007 -- things are 25 beginning to -- they're pulling out of the market, a 141 1 lot of the firms on Wall Street have very significant 2 private label securities, we want you to help offload 3 some of that, was that ever -- did that ever occur? 4 MR. MUDD: No one ever said that to me. 5 MR. LEVIN: 6 CHAIRMAN ANGELIDES: Same. Okay, good. Final 7 question, and that is, that March 19th, there's a 8 press release, Fannie Mae, Freddie Mac, OFHEO, in 9 which you had your portfolio limits lifted, you had 10 your capital surplus reduced, and you commit to raise 11 some more capital. 12 Why on God's earth in 2008 would you be 13 position yourselves to do more in the market as a 14 straight business enterprise? 15 MR. MUDD: The -- the capital override that 16 the regulator had in place at that time was set up as 17 a hard line. 18 we had a concern that on account of nothing that we 19 did, but external market volatility, we could go under 20 the capital line and therefore be in technical 21 violation. 22 And with the volatility in the markets, So our -- our -- our ask was to give some 23 flexibility around that line on the capital 24 requirements but to ameliorate the logical concerns 25 that would come out of that by expressing our 142 1 interests to maintain those levels of capital if not 2 raise capital. 3 We thought, at that point in the market, 4 with ARMs resetting, subprime loans not being 5 financeable, that there was some good that we could do 6 by helping to finance borrowers coming out of those 7 loans who otherwise would have qualified for a 8 conventional conforming-type loan. 9 CHAIRMAN ANGELIDES: All right. 10 question was March of 2008, though. 11 you're referring to in the response? 12 13 MR. MUDD: My Is that what The -- the -- the discussion went on before that and after that, but that's the -- 14 CHAIRMAN ANGELIDES: But you had sought 15 also to lift your portfolio caps so you could do more, 16 correct? 17 you? 18 Or was that something that was suggested to MR. MUDD: We had -- we had taken the 19 portfolio down below where it was actually required to 20 be because -- 21 22 23 CHAIRMAN ANGELIDES: So why were the portfolio caps lifted? MR. MUDD: That would be a topic you would 24 have to talk about with the regulator but I think the 25 general concern -- 143 1 CHAIRMAN ANGELIDES: 2 MR. MUDD: 3 You didn't ask for it? I think that we were in favor of doing it because it gave us more flexibility. 4 CHAIRMAN ANGELIDES: All right. Because it 5 seems odd to me that as the markets most 6 business enterprises are looking at a market in which 7 value are decreasing, risk is -- risk is increasing, 8 and what Fannie Mae is doing and announcing with OFHEO 9 is -- and Freddie -- you know, concerted action is 10 these two business enterprises are increasing their 11 portfolio caps, i.e., the ability to do more business 12 and lowering capital. 13 understand why it happened. 14 MR. MUDD: So I'm just trying to I think at least a component of 15 it is that it was seen as an indication that -- that 16 there would be some -- there's liquidity crisis, 17 right? 18 would be liquidity available in the marketplace. 19 So there would be some expectation that there But it did not imply that we were going to 20 do anything that was outside prudent standards with 21 that liquidity. 22 widened up and made that more attractive. 23 CHAIRMAN ANGELIDES: 24 revisit this. When everybody else left the spreads Well, we can have I don't want to take anymore time. The 144 1 regulator will be here, and obviously the regulator 2 was very involved in that, in that transaction, so we 3 can explore that more. 4 We may have some written questions for you 5 to fully understand exactly what happened, why, and 6 what were -- who were the parties engaged in those 7 discussions. 8 MR. MUDD: Yes, sir. 9 CHAIRMAN ANGELIDES: 10 thank you very much, Mr. Levin. 11 Mr. Mudd. 12 VICE CHAIRMAN THOMAS: 13 CHAIRMAN ANGELIDES: 14 Okay, Commissioners, Thank you very much, Thank you very much. We will break, Commissioners, until 12:25.Thank you. 15 (Recess.) 16 CHAIRMAN ANGELIDES: The meeting of the 17 Financial Crisis Inquiry Commission will come to 18 order. 19 with us today. 20 Thank you, Mr. Falcon, Mr. Lockhart, for being As we have done throughout the course of 21 our hearings, for all the folks that came before you 22 and will come after you, we swear all our witness. 23 I'm going to start off by asking each of you to stand 24 and be sworn. 25 Do you solemnly swear or affirm, under So 145 1 penalty of perjury, that the testimony you're about to 2 provide the Commission will be the truth, the whole 3 truth and nothing but truth, to the best of your 4 knowledge? 5 MR. LOCKHART: 6 MR. FALCON: 7 CHAIRMAN ANGELIDES: 8 Now, gentlemen, we do have your written 9 I do. I do. Thank you very much. testimony, but as you know, we would also invite you 10 to make comments today -- comments to us today. 11 in that regard we would ask that you make an opening 12 statement of no more than ten minutes. 13 what I'll do in kind of chronology of service to this 14 country, I will start with you, Mr. Falcon, and ask 15 you to go first and then, Mr. Lockhart, turn to you. 16 So, Mr. Falcon, proceed. 17 MR. FALCON: And I think Thank you, Mr. Chairman, 18 Mr. Vice Chairman, and members of the Commission, 19 thank you for having me here today. 20 And The failure of Fannie Mae and Freddie Mac 21 will be a case study in business schools for decades. 22 How do you operate a business with the most generous 23 government subsidies, which confer very powerful 24 market advantages, and run the business into the 25 ground? 146 1 Ultimately, the companies were not 2 unwitting victims of an economic down cycle or a 3 flawed products and services of theirs. 4 was deeply rooted in a culture of arrogance and greed. 5 Their failure I should be clear that this was a failure 6 of leadership. 7 the ranks of both companies. 8 issues raised in the invitation letter by explaining 9 the activities of OFHEO and overseeing Fannie Mae and 10 There were and are many good people in I would address the Freddie Mac and the challenges we face. 11 I remain proud of what a small and 12 dedicated group of people at OFHEO accomplished. 13 stood up to the full political onslaught of Fannie 14 Mae, Freddie Mac, and their allies all over town, and 15 we did our jobs as public servants. 16 We accomplished much despite the fact that 17 OFHEO was structurally weak and almost designed to 18 fail. 19 other safety and soundness regulator. 20 areas, such as enforcement powers, capital 21 requirements, funding mechanism and receivership 22 authority. 23 We OFHEO lacked the statutory powers of every And the key At one point we attempted to stop bonus 24 payments to departed executives responsible for the 25 accounting misconduct only to be rebuked by a Federal 147 1 Judge for exceeding our authority. 2 end of my tenure as director, I took every opportunity 3 to press for legislation to fill these important gaps 4 in OFHEO's authority. 5 From beginning to The lack of flexibility on setting capital 6 requirements was especially troubling. 7 enterprise's minimum capital requirement was set at 8 2.5 percent, which permitted them to operate at a 9 highly leveraged level with very little margin for 10 11 By statute the error. We never received the regulatory discretion 12 to raise this standard. 13 increase capital and reduce leverage was in connection 14 with the supervisory agreements to remediate the 15 accounting violations. 16 Our only opportunity to Only then was I able to impose a 30 percent 17 capital surcharge on both enterprises. 18 OFHEO was the only safety and soundness regulator that 19 was required to obtain its funding through the 20 appropriations process. 21 our funding was provided by assessments on Fannie and 22 Freddie and not derived from taxpayer funds. 23 In addition, This was despite the fact that The result was that the agency was starved 24 for resources for many years. To illustrate this 25 point, I recall that when I first took office, I 148 1 received briefings from the exam staff on their work 2 schedule and latest examination findings. 3 When I inquired about some key areas that 4 they had omitted they responded that due to staff 5 limitations, a review of that particular risk area was 6 put off until the following year's exam cycle. 7 In response, I asked exam staff to conduct 8 a study and tell me how many examiners would be 9 assigned to examine Fannie and Freddie, if they were 10 regulated by another federal safety and soundness 11 regulator. 12 Their conclusion was that the other 13 regulators, with their funding outside the 14 appropriations process, would maintain a team of at 15 least 30 or so examiners per enterprise. 16 By contrast, at the time OFHEO had a total 17 exam staff of less than 20, perhaps less than 15, to 18 cover both companies. 19 Despite that kind of data to support a 20 funding request, we had a very difficult time getting 21 meaningful budget increases. 22 Before OFHEO's budget request even went to 23 the Congress for consideration, the agency’s request 24 first went to the office of management and budget for 25 review and approval. 149 1 We received very large budget cuts at OMB, 2 until about 2003, when our requests began to receive 3 more favorable consideration. 4 A few years later, when OFHEO needed 5 additional resources to conduct a special examination 6 of Fannie Mae's accounting practices, we encountered 7 more difficulty and delay. 8 9 10 11 Fannie's lobbyists were on the Hill spreading misinformation about my motives and asserting that the special exam was unnecessary. We eventually received the funding and 12 finally we had the resources to dig deeply into Fannie 13 Mae's accounting. 14 that Fannie Mae's problems were even worse than 15 Freddie Mac's. 16 It wasn't long before we realized The enterprise's arrogance manifests itself 17 into many efforts to obstruct the regulatory process. 18 Let me describe just a few. 19 circumstances around my forced resignation, on 20 February 4th, 2003, a year and a half before the 21 expiration of my term. 22 The first involves the At that time the agency was preparing to 23 release a new research report that analyzed the 24 systemic risks created by the enterprise's growing 25 portfolios, debt, and role in the mortgage market. 150 1 2 We needed to be sure the agency and others in government fully understood the nature of their 3 systemic risks, how to minimize it, and how to deal 4 with it if the companies ever experienced financial 5 problems. 6 The enterprises did not want the agency 7 conducting such a study and certainly did not want it 8 released to the public. 9 everything possible to convince the public and policy At that time they were doing 10 makers that their operations did not pose any systemic 11 risk to our financial system. 12 A few days before the agency was scheduled 13 to release the systemic risk report, the Chairman of 14 Fannie Mae, Franklin Raines, called me to protest 15 about the release of the report and its conclusions. 16 He urged me to not to release it, and when I 17 reaffirmed my plans, he threatened to bring down me 18 and the agency. 19 Our call was over and I soon received 20 another call from a Treasury official who stated that 21 Fannie Mae's lobbyists were calling other agencies to 22 urge then to press OFHEO not to release the systemic 23 risk report. 24 25 He asked for a copy, which I provided, and he respected my decision not to delay its release. A 151 1 few days later, on February 4th of 2003, I was in New 2 York to give a speech on the findings of the report, 3 which was being released that day. 4 In the morning, as I was waiting to give my 5 speech, I received a call from the White House 6 personnel office, who informed me that the White House 7 was issuing an announcement on the nomination of 8 someone to replace me as director of OFHEO. 9 way, it was not Director Lockhart, it was someone in 10 By the between. 11 I informed the personnel official that 12 their announcement would seem odd since there was not 13 a vacancy in the position. 14 withhold the announcement for a day while I considered 15 my options. 16 letter later that day. 17 I asked the official to They declined and I issued a resignation The next day's news emphasized coverage of 18 the personnel change and gave very scant coverage to 19 the findings of the systemic risk report. 20 of course, exactly the result intended by those who 21 engineered the timing of the announcement of my 22 replacement. 23 nominee and I remained in office for two more years. 24 25 This was, The White House eventually withdrew its In 2004, as OFHEO began its special accounting examination of Fannie Mae, the political 152 1 attacks and efforts at obstruction intensified. 2 Fannie was uncooperative with document requests and 3 they engaged their supporters in Congress for 4 assistance. 5 And as described in OFHEO -- in the 6 OFHEO -- OFHEO special exam report, in April of 2004, 7 Fannie Mae executives acted on a plan to have a key 8 senior -- key senator initiate an investigation of 9 OFHEO by the HUD Inspector General. The goal was to 10 try to discredit the agency in advance of its report 11 on Fannie's accounting practices. 12 The intrusive nature of the IG review was 13 clearly designed to intimidate OFHEO personnel and 14 distract them from their work. 15 concluded that the agency had done nothing improper 16 but wrote a very biased report designed to curry 17 favor. 18 The IAG eventually Later, in September of 2004, the Senate 19 Appropriations VA HUD subcommittee passed the bill that 20 provided funding for OFHEO's budget in 2005. 21 included specific language stating that 10 million of 22 the agency's 2005 budget could not be spent until I 23 was removed from office. 24 removed from the final appropriations bill. 25 The bill The language was later Also in that same month, OFHEO released its 153 1 risk report on the accounting misconduct at Fannie Mae 2 and we took supervisory actions to correct the 3 problems. 4 I was summoned before the House Financial 5 Services Committee to testify on the findings of the 6 report. 7 was met with a well-orchestrated effort to discredit 8 the report and my character. 9 It was a vast understatement to say that I One member of the committee even accused me 10 of conducting a, quote, political lynching. 11 shameful day in the committee's history, which I 12 worked at that committee for eight years and another 13 example of the dangerous political power Fannie Mae 14 had amassed. 15 It was a While all of this political power satisfied the 16 egos of Fannie and Freddie executives, it ultimately 17 served one primary purpose: 18 accumulation of personal wealth by any means. 19 The expedient Of course, we all support the American 20 dream of wealth accumulation as long as it is done 21 within the rules. 22 Fannie Mae began the last decade with an 23 ambitious goal. 24 $6.46. 25 Double earnings in five years to A large part of the executives’ compensation was meeting that goal. tied to 154 1 The internal auditor of Fannie Mae made a 2 famous quote, which was detailed in the OFHEO special 3 report of examination, which Vice Chairman Thomas 4 mentioned earlier, so I will not repeat it, but it 5 just went to the heart of how much 646 and these 6 earnings per share targets were so important to the 7 personnel within the companies and the compensation 8 that they would receive as a result of meeting those 9 goals. 10 And they did receive a great deal of 11 compensation. 12 collected over 90 million dollars in total 13 compensation from 1998 to 2003. 14 million was directly tied to achieving 15 earnings-per-share goals. 16 In the case of CEO Franklin Raines, he Of that amount, 52 However, the earnings goal turned out to be 17 unachievable without breaking the rules and hiding 18 risks. 19 persuade investors that mortgage-related assets were a 20 riskless investment, while at the same time covering 21 up the volatility and risk of their own mortgage 22 portfolios and balance sheets. Fannie and Freddie executives worked hard to 23 The OFHEO special exam reports go into 24 great detail on how this was done over the years. 25 One, very telling -- 155 1 CHAIRMAN ANGELIDES: Mr. Falcon, can you 2 wrap up? 3 you can quickly just, very quickly, make the points of 4 the balance of your statement so we can stick to our 5 schedule. 6 7 I know this is your written statement but if Is that okay? MR. FALCON: Thank you. I will, Mr. Chairman. Sorry, I thought I could get this done in 10 minutes. 8 CHAIRMAN ANGELIDES: 9 MR. FALCON: 10 That's okay. Okay. One very telling example of how greed drove 11 the accounting violations was a 200-million-dollar 12 maneuver in the fourth quarter of 2004, by shifting 13 200 million dollars into future years, they were able 14 to obtain 100 percent of the bonus compensation that 15 year as opposed to zero if they had properly accounted 16 for that 400-million properly. 17 Your letter also asked me to talk about the 18 impact of the affordable housing goals on their 19 financial problems. 20 the cause of the enterprise's demise. 21 In my opinion, the goals were not The firm's not engaged in any activity, 22 goal-fulfilling, or otherwise, unless there was a 23 profit to be made. 24 turnover at both companies, cultural problems 25 persisted. In the end, despite management The companies could not accept their 156 1 diminished role in the mortgage market and reduction 2 of profitability. 3 So they made a fateful decision to make big 4 investments in subprime and Alt-A assets. This 5 certainly accelerated their demise when the housing 6 bubble burst. 7 In summary, the Fannie and Freddie model of 8 publically traded and privately chartered companies is 9 inherently flawed. The market and political power 10 that it confers breeds arrogance, greed, excessive 11 risk-taking and abuse. 12 If Fannie and Freddie are allowed to 13 continue in any variation of the current form another 14 Commission, at some future date, will again be asking 15 the question of what went wrong. 16 of this Commission is so important, and I appreciate 17 the opportunity to be here to testify today. 18 19 20 CHAIRMAN ANGELIDES: Mr. Falcon. That is why the work Thank you very much, Mr. Lockhart? MR. LOCKHART: Thank you, Mr. Chairman, for 21 inviting me to testify about Fannie Mae's and Freddie 22 Mac's role in the housing market, the flaws in the 23 regulatory structure, and the actions we took prior to 24 conservatorship. 25 I served as director of OFHEO and then FHFA 157 1 from May 2006 to August 2009. 2 mission is to provide stability, liquidity, and 3 affordability to the housing market. 4 over 4.3 billion of debt at that point and being some 5 of the largest financial institutions, Fannie Mae and 6 Freddie Mac were both very troubled as they were 7 unable to produce timely financial statements and had 8 serious deficiencies in systems, risk managements and 9 internal controls. 10 The enterprise's Despite having OFHEO was finalizing its special 11 examination report of Fannie Mae and also a consent 12 agreement as I arrived. 13 dollars and imposed about 80 remedial action items. 14 Very importantly, we froze the growth of Fannie Mae's 15 mortgage portfolio and continued the 30 percent 16 minimum capital requirement. 17 We fined them 400 million The report quoted an e-mail from 18 then-Fannie Mae's CEO, COO, Dan Mudd, at that point, 19 and the quote is, the old political reality was that 20 we always won. 21 able to write or have written rules that worked for 22 us, that was really the key flaw as the weak 23 legislation that created OFHEO in 1992 was a product 24 of that old political reality. 25 We took no prisoners. We used to be I endorsed, strongly, in three 158 1 congressional hearings, three recommendations from the 2 report that removes the caps to Freddie as well as 3 Fannie. 4 in the agency and we needed to strengthen our 5 regulatory infrastructure. 6 Freddie's board and asked them to voluntarily freeze 7 their portfolios. 8 9 We would support legislation to affix the -- In June I met with The portfolios, as you know, have been a major target of advocates of GSE reform because of 10 their interest rate risk. 11 uses of derivatives. 12 And that required extensive Their portfolios were a major source of 13 income even though half the portfolios were in their 14 own mortgaged-backed securities. 15 in Triple-A private labeled securities and whole 16 loans. 17 heard. 18 The other half were And that compounded the credit risk, as we've At the Freddie board meeting, I went 19 through a long list of issues, and we mentioned credit 20 risk. 21 intense, but they did agree to the freeze. 22 And on credit risk, the push-back was extremely In retrospect, capping the growth in 23 portfolios prevented tens of billions of dollars in 24 more losses. 25 President Bush had been pushing for GSE 159 1 reform for many years, the need for the legislation 2 was obvious, and so OFHEO is regulating two of the 3 largest, systemically important U.S. financial 4 institutions, which -- which would require 5 extraordinary powers for the regulator. 6 And we had just the opposite. The key 7 components we asked for finally got into law only 38 8 days before we had to put them into conservatorship. 9 First issue was capital. Both minimum capital and 10 risk-based capital requirements were weak and 11 outmoded. 12 The minimum capital standard actually 13 allowed them to get leveraged to over 100 to 1. 14 definition of capital itself was inflexible, but 15 it excluded large losses. 16 conservatorship, both Fannie and Freddie published 17 financial statements that showed that they were in 18 excess of the legal adequately capitalized standard, 19 even though in the case of Freddie, they had a 20 negative fair value of equity. 21 The Just one month before the The portfolios, as mentioned, compounded 22 the mortgage credit risk and then introduced large 23 interest rate and derivative counterparty risk. 24 There were no mission-related reason why the 25 portfolios had to be 1.5 trillion dollars. 160 1 HUD was the enterprise's mission regulator. 2 In retrospect, HUD pushed the housing goals too high 3 and erred by giving credit for the underlying 4 mortgages in private label mortgage-backed securities. 5 Both CEOs told me that one of their worst 6 fears was missing their affordable housing goals. 7 high affordable housing goals plus their drive for 8 market share and profits were major reasons why they 9 lowered their underwriting standards. 10 11 The But I must add that they were still much higher than the marketplace. If you look at Fannie's acquisitions from 12 2001 to 2007, the percent of subprime mortgages 13 actually remained relatively stable at 16 to 18 14 percent even though the subprime market was tripling 15 or more than that and represented about a third of the 16 market at the end. 17 However, as mentioned this morning, their 18 purchases of Alt-A's went up dramatically. 19 indirectly encouraged lower standards by purchasing 20 those private label securities and also by not 21 aggressively forcing originators to repurchase 22 noncomplying mortgages for fear of offending major 23 customers, such as Countrywide. 24 25 They also As OFHEO's budget was subject to congressional political process, OFHEO's growth was 161 1 constrained and subject to annual freezes. 2 issue, major issue was receivership. 3 that in the original legislation, we got it in the new 4 legislation. 5 The other We did not have However, at the end, we did decide to put 6 them in conservatorship rather than receivership 7 because we felt it was critically important to keep 8 the enterprises running to prevent a total collapse in 9 the mortgage market and potentially the U.S. financial 10 systems. 11 Without Treasury authority to fund the 12 enterprises, which was inserted into the legislation 13 in really the last few weeks, is my belief the 14 conservatorship would have failed. 15 The company's opposition to legislation for 16 so long was a major mistake. 17 maximizing shareholder profitability. 18 they failed both the shareholders and the taxpayers. 19 The boards focused on In the end, Our third goal was to strengthen our 20 regulatory oversight. 21 and Freddie, and we continued to add skilled 22 examiners. 23 We had large teams at Fannie I met monthly with the CEOs. We sent an annual report to Congress on the 24 enterprises which detailed the many problems in the 25 remediation efforts. 162 1 In the 2006 report, we rated -- we rated 2 -- we rated them significantly supervisory concerns. 3 We met with the boards annually to discuss the reports 4 and at other times. 5 rating to our lowest category. 6 And midyear 2008, we lowered the Although the enterprises never violated 7 even in OFHEO's directed extra capital requirements, 8 as the markets began to deteriorate, they hit triggers 9 in our prompt corrective actions regulations. OFHEO 10 made escalating requests in [inaudible] capital, including 11 detailed capital plans, dividend constraints, and 12 increased capital requests. 13 OFHEO created the first government 14 regulation on mortgage fraud. 15 new ratings scheme called GSEER, which stands for 16 government solvency earnings and enterprise risk, 17 market credit and operational, and we reorganized our 18 operation or examination teams around those areas. 19 In 2008 we adopted a On the compensation side, our authority was 20 relatively weak but we did successfully pressure the 21 boards for some moderation and created broader 22 performance metrics. 23 The enterprise's management and the credit 24 models they relied on failed to identify how badly the 25 mortgage market was deteriorating. Many others failed 163 1 to understand how bad the toxicness was: 2 then falling house prices, abysmally low underwriting 3 standards, plentiful and then disappearing financing, 4 and Wall Street's destructive creativity. 5 Booming and The enterprises believed that they could 6 save the troubled market that began to erupt in 2007. 7 We constrained Fannie Mae from construction lending 8 and from buying less than Triple-A private label 9 securities. 10 By mid-2007 they were putting extreme 11 pressure on OFHEO, backed by members of Congress, for 12 us to remove the portfolio caps and the 30 percent 13 extra capital constraints. 14 request as it would impair their critical need to 15 support the conforming mortgage market. OFHEO turned down their 16 From the fall of 2007, to the 17 conservatorships, it was a tightrope with no safety 18 net. 19 delinquencies in foreclosures were rising, and 20 mortgage credit was drying up. 21 House prices were continuing to fall, We encouraged the enterprises to cut their 22 dividends, and they raised 17 and a half billion 23 dollars in preferred stock in 2007. 24 about 75 percent of the market at that point, but 25 sitting on over 5 trillion dollars -- in market -- on They represented 164 1 mortgages, and razor-thin capital, it was critical for 2 their country's financial future that the mortgage 3 market stabilize. 4 a self-fulfilling credit crisis. 5 Their withdrawal would have created As the enterprises struggle with mounting 6 losses, our communications with them, Treasury and the 7 Fed grew, in February we published -- they published 8 timely financial statements and, as agreed, we removed 9 the portfolio caps. 10 We also mentioned at that point that we 11 looked at lowering the capital's requirements, and we 12 did in March, slightly, and also did that only because 13 they agreed to raise significantly more capital and to 14 keep capital well in excess of requirements and support 15 GSE reform. 16 Fannie Mae actually did raise capital but 17 Freddie was unable to, and by August it was obvious 18 that they could not. By August the confidence to the 19 enterprises plunged. Working with the Treasury and 20 the Federal Reserve, we made a recommendation, my 21 staff made a recommendation to put them in 22 conservatorship, which we did in September, and they 23 voluntarily consented. 24 25 Before concluding, I would just like to thank the team at OFHEO, FHA, for their extraordinary 165 1 2 work during that period. Although OFHEO warned repeatedly of the 3 systemic risk that Fannie Mae and Freddie Mac 4 presented to the financial markets and took many steps 5 to help lessen the damage, everybody, including OFHEO, 6 could have done more. 7 There was a strong emphasize -- such a 8 strong emphasize on remediating -- remeding -- 9 remediating their operation -- operational risk and 10 monitor their interest rate risk, the credit risk was 11 not emphasized as much as it should have been in 2006. 12 We did require them to adopt the bank 13 regulator's nontraditional mortgage guidance and 14 subprime guidance and even extended it to those 15 private label securities. 16 But the foremost failing was the 17 legislative framework, especially the capital rules. 18 The GSE structure allowed them to be so politically 19 strong that they resisted the very legislation that 20 might have saved them. 21 The only silver lining was that legislation 22 was finally passed and allowed the conservatorships to 23 function fairly smoothly. 24 continuing to fill their mission. 25 The enterprises are CHAIRMAN ANGELIDES: Thank you. Thank you, 166 1 Mr. Lockhart. 2 now, to the vice chair to start this session, so 3 Mr. Vice Chairman. 4 5 VICE CHAIRMAN THOMAS: EXAMINATION BY VICE CHAIRMAN THOMAS 7 VICE CHAIRMAN THOMAS: Mr. Falcon, when did you come to Washington? 9 10 Thank you, Mr. Chairman. 6 8 So, I'm going to actually defer, right MR. FALCON: It was in 19 -- it was in 1999. 11 VICE CHAIRMAN THOMAS: 12 MR. FALCON: 13 VICE CHAIRMAN THOMAS: 14 MR. LOCKHART: 15 VICE CHAIRMAN THOMAS: Fess up, fess up. 1989, I believe. 1989. Mr. Lockhart? 1989, as well. 1989. I'm reminded 16 of the movie, (inaudible) actually, which basically 17 has a story but then it's seen from various 18 participants as to what they saw. 19 So your testimony is one view of what 20 happened. 21 of us, decidedly it was somewhat of a different view 22 in terms of attitudes and relationships. 23 And if you were privy to the panel in front I just have to say, I was there for the 24 movie as well, and I think your version tends to have 25 a greater degree of credibility about relationships 167 1 2 than the one that I heard earlier. To bolster this, we're trying -- I say we, 3 staff and Commissioners are trying to work out a 4 timeline with specific events, some of which are 5 public, others are much more private, including 6 e-mails between individuals and statements from 7 individuals. 8 the voracity of it but I -- eventually, Mr. Chairman, 9 plan to place it in the record to let people in a 10 relatively brief almost visual way take a look at 11 those events. And we're going to continue to work on 12 And the first date we have down is 13 September 19th, 2007, with a press release on 14 portfolio caps and liquidity, where I think you -- 15 would you agree that the significance was basically 16 the recognition that safety and soundness is probably 17 more important than the liquidity mission based upon 18 the circumstances that we were in? 19 MR. LOCKHART: What I was trying to say in 20 that is safety and soundness was critical and 21 liquidity was critical, as well. 22 VICE CHAIRMAN THOMAS: 23 MR. LOCKHART: Right. And they couldn't provide 24 liquidity to all the housing market. 25 have the capital to do that. They did not 168 1 VICE CHAIRMAN THOMAS: And then we passed 2 through the end of December of `07, into February of 3 `08, and then some of it's interesting, but for the 4 sake of time, move on into early March, where things 5 start to happen fairly quickly. 6 aware -- we're aware of an e-mail exchange between 7 Mr. Mudd, the CEO, and Mr. Steel, who is the 8 undersecretary of the Treasury. 9 On March 7, we're And my understanding is that Mudd writes to 10 Steel that OFHEO, having unrestricted capital 11 authority will as ever be the sticking point. 12 writes to Levin, quote, it's a time game, whether they 13 need us more, sooner, to show administrative action or 14 if we hit the capital wall first, be cool. 15 know about this communication? 16 MR. LOCKHART: Mudd Did you I didn't see the e-mail but 17 I knew that Secretary Steel and Dan Mudd and Dick 18 Syron were talking, as they were talking 19 with me, at the time. 20 VICE CHAIRMAN THOMAS: Well then, the next 21 day I have, and this is easier for you to refer to, an 22 e-mail from you to Undersecretary Steel in which you 23 write that the Freddie board is against raising equity 24 but it may be possible if timed with some capital 25 relief. 169 1 2 Why didn't Freddie want to raise equity? Is that a question that -- 3 MR. LOCKHART: They did not want to dilute 4 their shareholders. 5 shareholder-centric, at that point, and they really, 6 in discussions I've had with that board over the 7 years, they were very, very reluctant to raise equity. 8 9 I mean, they were still VICE CHAIRMAN THOMAS: Is that an indication of a partial lose of focus as to who they 10 were and what their fundamental underlying goal is, 11 notwithstanding making a profit is always nice? 12 MR. LOCKHART: Well, as I said in my 13 written testimony, the boards were much more focused 14 on profitability. 15 fiduciary responsibility to the shareholders. 16 mission was a distant, not even second, and it -- that 17 was my view and certainly had many conversations with 18 the boards on that topic. 19 They felt that that was their VICE CHAIRMAN THOMAS: And the My assumption is 20 there was virtually no discussion about taxpayers 21 rather than shareholders. 22 that. 23 You don't have to answer Obviously background ended that first week 24 in March, March 11th the Barrons article comes out 25 suggesting that Fannie Mae is insolvent and predicting 170 1 that the government will bail the company out. 2 March 16th, Undersecretary Steel e-mails to 3 others at Treasury, Lockhart needs to eliminate -- 4 that's you, Lockhart needs to eliminate the negative 5 rhetoric. 6 waiting to hear back. 7 Bill Dudley, official at Treasury. I have e-mailed and called Syron and I was leaned on very hard by 8 MR. LOCKHART: At New York Fed. 9 VICE CHAIRMAN THOMAS: 10 MR. LOCKHART: 11 VICE CHAIRMAN THOMAS: Pardon? He's at the New York Fed. 12 Fed. 13 it has not been part of my conversation with anyone 14 else. 15 above, we've heard this before, my pay grade to double 16 the size of the U.S. debt in one fell swoop. 17 To harden substantially. He's at the New York I do not like that and I viewed it as a very significant move, way Since it was directed toward you, what -- 18 what do you think was meant by eliminating the 19 negative rhetoric? 20 MR. LOCKHART: Well, I think it's well 21 known that I was pretty strong against some of the 22 things the two companies were doing. 23 strong in supporting legislation. 24 25 And I was very And what, you know, as I said in my testimony, we had a fine line here. We had to force 171 1 the companies to get more capital or they weren't 2 going to make it. 3 was using the press, occasionally, but more often just 4 talking to the two CEOs about the need to raise 5 capital. 6 7 VICE CHAIRMAN THOMAS: And the same day, March 16th, 2008, Bear Stearns collapses? 8 9 The legislation was flawed, so I MR. LOCKHART: Right. I mean, that weekend there was a lot obviously going on in the 10 administration. 11 Treasury and the Fed that weekend. 12 concern was that Fannie and Freddie could be next. 13 And certainly I did talk to the And, you know, our And so we thought it was critical to raise 14 capital. 15 an agreement with them. 16 significant amount of capital and committing to keep 17 the capital well above the minimum standards that we 18 start to lower their capital. 19 And to do so we basically, as you know, did And in return for raising a very VICE CHAIRMAN THOMAS: Well, but on March 20 17th that was the subject of an e-mail from -- talking 21 about OFHEO releasing capital surplus in the 22 consent order and GSEs commit to invest 300 billion in 23 market to raise capital. 24 25 What -- what was your opinion of that particular deal? 172 1 MR. LOCKHART: 2 VICE CHAIRMAN THOMAS: 3 the deal. 4 the time? 5 6 I did the deal so I -I understand you did But what was your opinion of the deal at MR. LOCKHART: I thought it was necessary because we needed to stabilize -- 7 VICE CHAIRMAN THOMAS: A number of us take 8 out garbage but that doesn't mean that that's our 9 ideal. 10 MR. LOCKHART: We -- we had to play the 11 cards that we were dealt with, and we had a capital 12 structure that didn't work. 13 that didn't work, and we had a 11-trillion-dollar 14 mortgage market that would have cratered if we hadn't 15 done something. 16 We had a GSE structure VICE CHAIRMAN THOMAS: Okay. Then 17 obviously, after that, what you did, which you felt 18 was absolutely essential, not perhaps ideal, March 19 19th timeline, Graham-Fisher, GSE analyst Joshua 20 Rosner states, that quote, any reduction in capital is 21 a comment not on the current safety and soundness of 22 the GSEs but on the burgeoning panic in Washington, 23 end of quote. 24 25 We believe that OFHEO Director Lockhart took this action results in the destabilizing of the 173 1 GSEs. OFHEO will go from being the only regulator who 2 had prevented their charges from getting into trouble 3 to a textbook example of why regulators should be 4 shielded from outside political pressure. 5 Do you feel that the decision that you 6 arrived at was substantially based upon the outside 7 political pressure that you received or, in your 8 professional judgment, absent any pressure, that it 9 was okay? 10 MR. LOCKHART: In my professional judgment 11 it was the necessary step. 12 benefit guarantee corporation, Bush 41, made a lot of 13 life-and-death decision for corporations, at that 14 point, so I had a lot of experience. 15 example, Pan Am, there are a whole series of them, LTD 16 Steel, so I had a lot of experience on working with 17 financial markets. 18 it was necessary. 19 I had run the pension TWA was an And in my professional judgment, Now, I would have loved to have more 20 capital. 21 capital in the structure so that they would have had 22 the capital at that point to do what was necessary. 23 They didn't so they had to raise it. 24 25 I would have loved to have countercyclical VICE CHAIRMAN THOMAS: Mr. Chairman, full disclosure, I worked with Mr. Lockhart on the PBGC, in 174 1 a number of ways, and we wound up finally, I think, 2 rewriting the structure which allows corporations to 3 not short commitments that they make. 4 But it would have been useful to have 5 capital at an earlier time. 6 and others clearly indicate there was great resistance 7 because you'd have to go through Congress to achieve 8 that, and we've heard from Mr. Falcon's testimony, 9 Mr. Falcon's testimony that there was constant 10 I believe your testimony pressure from Congress. 11 And I just want to reaffirm the argument 12 that that sounds a whole lot more like the Washington 13 that I was in for three decades, especially when they 14 have the ability to communicate to you through the 15 appropriations process. 16 Thank you, Mr. Chairman. 17 CHAIRMAN ANGELIDES: All right. I'm -- 18 let's do this; I'm going to defer for a moment. 19 Ms. Murren? 20 21 22 COMMISSIONER MURREN: Thank you. EXAMINATION BY COMMISSIONER MURREN COMMISSIONER MURREN: And thanks to you 23 both for being here today and for your testimony. 24 I have, in an interest of looking more 25 broadly at the regulatory processes, and the framework 175 1 that really are the -- the basis for which 2 shareholders and taxpayers rely on the ability for the 3 financial systems to be transparent. 4 I'm interested in the -- in some instances 5 in the mechanics and the practical realities of that, 6 so I would like to ask a couple questions to begin 7 with on your daily interactions with the people or 8 that of your staff at Fannie Mae. 9 And the way you described the relationship, 10 obviously, is it seems very tense, certainly at the 11 senior levels. 12 Could you talk a little bit about whether 13 that type of tension was also evident when you carried 14 out or when your staff carried out their daily duties 15 in interacting with the line staff there? 16 you could each comment on it? 17 MR. FALCON: Maybe if On the -- sorry -- on the 18 daily the level, there's much interaction between the 19 examination staffs, research staffs, legal staffs, 20 basically there's a lot of interaction down at the 21 staff level of both entities. 22 Part of my responsibility as leading the 23 agency is to try to make sure the people in the agency 24 had what they needed to do their jobs properly. 25 so I was often in the position of seeing deficiencies And 176 1 with our structure and funding. 2 So taking the responsibility, as the head 3 of the agency, to try to seek broader policy changes 4 to help the agency. 5 And -- and those were certainly in the 6 realm of what I tried to accomplish, among other 7 things at the agency, and there were tensions. 8 there were tensions between the senior executives and 9 myself and my senior staff on those issues, I wouldn't And 10 say that that filtered down below us to the people 11 doing their day -- their job day-in and day-out at the 12 agency. 13 COMMISSIONER MURREN: Would you say that 14 the people that worked for you found that when they 15 reached out to their counterparts at the company that 16 they were -- they found that there was a cooperative 17 mindset on the other side? 18 sort of resistance that you described filter down to 19 the lower ranks over at Fannie Mae? 20 MR. FALCON: In other words, did this I think, yes, many times we 21 did have difficulties in the lower ranks, as well. I 22 recall one of the early meetings with my staff, and it 23 was an issue of we needed some data, and I was told 24 that it would be difficult to get the data because we 25 would get resistance from the companies. 177 1 We had another pending request, and they 2 didn’t like to have two requests at the same time, and 3 then so they said we don't know if we can deal with 4 this now. 5 So there was these all sorts of, at the 6 staff level, these cultural problems. 7 try to change all of that and I insisted to my staff 8 that go make this request; we're going to get this 9 data; if they had to assign more people to the 10 And so I had to agencies reporting these, they need to do so. 11 But at the very beginning there was always 12 a very deep relationship issue about the agency not 13 having problems getting full cooperation out of the 14 companies on something as minimal as a data request, 15 and that had to change. 16 MR. LOCKHART: From my standpoint we 17 actually put a lot of that into the consent agreement. 18 And so we actually wrote it in that they had to 19 cooperate. 20 They had to change their tone at the top. And we really worked hard with the board 21 and the management team do that, and they did actually 22 make progress on a lot of that over that period. 23 fact, they really, by the end of the period, actually 24 had complied with the consent agreement. 25 In There always has to be some tension between 178 1 a regulator and a regulatee. 2 where you had the two firms that couldn't produce 3 financial statements on a timely basis, that didn't 4 have good internal controls, you had have a regulator 5 that was in there all the time, working with them, 6 trying to fix the problems. 7 And in this situation, On the staff level, the cooperation was 8 good. I would have meetings with, you know, quite a 9 few of their people, down three or four levels, 10 occasionally, on a topic. 11 cooperative, you know. 12 issue that we just disagreed on and we couldn't come 13 to an agreement on, but the key thing, to me, was that 14 we had to have a professional approach and my team 15 really did. 16 And I always found it Occasionally there was an COMMISSIONER MURREN: So would it be fair 17 to say, then, that sometimes if the response that you 18 get from one of these entities that you supervise or 19 that you're requesting data or information from that 20 says, gosh, the nature of your request is too vague or 21 it's just too much for us to do in a particular 22 timeframe, that really that reflects a resistance at 23 the top to the work that they're doing in producing 24 this information? 25 MR. FALCON: I think there was that 179 1 resistance, as I pointed out. 2 I was dealing with were much different than the 3 agencies that Director Lockhart had to deal with by 4 the time he came into the office. 5 Now, the agencies that So perhaps he didn't encounter the same 6 kind of issues that I had at the time that I was 7 director of the agency but we did have those problems. 8 9 MR. LOCKHART: I think that's right. I think it changed somewhat because of the consent 10 agreement, because of all their problems. You know, 11 there's still arrogance at that company and, you know, 12 certainly their fighting of legislation over that 13 period was probably the worst set of arrogance and the 14 biggest mistake that they made. 15 COMMISSIONER MURREN: Generally speaking, 16 how did you convey any concerns that you might have to 17 the management of Fannie Mae? 18 documented or did you attempt to have an oral 19 discussion beforehand, before you would send an e-mail 20 or a formal document? 21 MR. LOCKHART: Was everything From my standpoint, I was 22 meeting with the CEOs monthly. And in those 23 conversations, we tended to have very frank 24 conversations about what the key issues was, were. 25 would give them some heads up on some examination I 180 1 reports that were about ready to put out and really 2 try to work with them to, you know, help move the 3 organizations ahead. 4 You know, at the time we were there, Fannie 5 Mae probably had 5,000 employees and maybe two or 6 three thousand consultants trying to fix their 7 problems. 8 companies. 9 those operational and financial and accounting 10 11 It was a major, major problem with those And so we were all working to try to fix problems. COMMISSIONER MURREN: And you both 12 mentioned the fact that you felt that your own 13 resources and your ability to manage this was -- it 14 was less than ideal. 15 the greatest amount of resources to be able to address 16 the problems that you just described. 17 You didn't have, necessarily, How, then, did you allocate your resources? 18 How did you think about the way that you would take 19 what was fairly precious and make sure that it was 20 allocated properly to be able to perform the duties 21 with which you had been entrusted? 22 MR. FALCON: I think you prioritize. And 23 that's a painful process. When you have a list of 24 many priorities, and all very important to fulfilling 25 your mission, and you realize that you can only fund a 181 1 handful of them, it's not an easy thing to do, but you 2 have to prioritize and hope that you can at least give 3 some amount of coverage to the other issues. 4 not in the same depth as others, you try to stretch 5 your resources as thin as you can. 6 MR. LOCKHART: While We were -- had less problem 7 with resources because Director Falcon had made such a 8 big issue of it that Congress had backed down and we 9 were getting our requests through. 10 The real problem with us was every 11 September there was a freeze. 12 three or four months. 13 the staff level you wanted. 14 And so you go through So you can never build up to And -- but we set priorities. We put the 15 resources on the examination side as much as we could. 16 But we also had a capital team. 17 capital model team. 18 need to be improved in the company at that point, the 19 companies. 20 We had the risk-based There was a lot of things that COMMISSIONER MURREN: This is the final 21 question, and in reading your testimony and listening 22 to what you have to say, it sounds as though this 23 doesn't sound like an especially enjoyable position to 24 be in. 25 pressure. It sounds like there was an enormous amount of 182 1 Can you talk about, why did you continue to 2 do what you were doing? 3 know, would have made that same decision. 4 MR. FALCON: A lot of people, I don't Well, in my case, I had worked 5 for the House Banking Committee under Chairman Henry 6 Gonzalez for eight years. 7 when the law creating OFHEO was enacted and understood 8 the motivation behind it following the savings and 9 loan crisis. 10 And I was at the committee So I did understand and believe in the 11 agency's mission and why it was created. 12 agency was struggling at the time that I -- I was 13 approached about running this agency. 14 So the And given my background with the banking 15 committee, I thought here’s an opportunity to take 16 on a challenge and try to help build this agency and 17 help it fulfill its mission, because it was struggling 18 very much. 19 something that I believed in because of why it was 20 created. And so it was a challenge and it was 21 COMMISSIONER MURREN: 22 MR. LOCKHART: And you? Well, I would -- I would 23 echo that. This is sort of my third major job in the 24 government, and -- but I'm really from the private 25 sector. 183 1 And each time it was a challenge, PBGC, 2 Social Security, and OFHEO. 3 the housing market is so important to the U.S. 4 economy, and Fannie and Freddie were so important to 5 the U.S. economy, and they were struggling at that 6 point, that I seized the challenge. 7 And certainly, you know, Sometimes it was fun, sometimes it was very 8 difficult but, you know, we made progress until the 9 housing market just fell apart. 10 COMMISSIONER MURREN: 11 Thank you. I am -- I cede my time. 12 CHAIRMAN ANGELIDES: Thank you, Ms. Murren. 13 EXAMINATION BY CHAIRMAN ANGELIDES 14 CHAIRMAN ANGELIDES: I'm actually going to 15 take the opportunity, now, to ask a set of questions, 16 because I want to -- I want to build on a line of 17 questioning that Mr. Thomas engaged in with you. 18 And I really want to, I think, set a 19 context here. 20 housing markets are in substantial trouble, Bear 21 Stearns has collapsed, and I think it's fair to say 22 that liquidities drying up in the housing market 23 dramatically. 24 25 It's March of 2008, obviously the So there is a big challenge posed here of the safety and soundness and solvency of these 184 1 corporations, and then, obviously, liquidity, a larger 2 mission, in the sense that there's probably no time 3 when this dual mission clashes or it comes together so 4 dramatically. 5 MR. LOCKHART: Well, it clashed and it 6 didn't clash. Because they were sitting on 5 trillion 7 dollars in mortgages. 8 that mortgage market, the safety and soundness was not 9 going to work. And if we couldn't stabilize I mean, basically, they were going to 10 fall if we couldn't stabilize the mortgage market. 11 it was a tightrope we were walking. 12 13 CHAIRMAN ANGELIDES: All right. So So I do want to ask you a couple more questions about this. 14 You know, Mr. Thomas laid out a timeline, 15 and he referenced, on March 17th, a press release that 16 was proposed. 17 actually did respond to that first draft press 18 release, and I just want to get your thinking, because 19 you're there on the ground, and I will have a 20 follow-up. 21 to Mr. Mudd, who sent you a draft press release, and I 22 believe there was a quote where you -- they have 23 proposed a quote for you, that said, let me be clear, 24 both companies are well capitalized and have adequate 25 reserves. And then there was one other item. You When you responded, I think on March 17th, 185 1 They also have quote for Secretary Paulson, 2 which is -- these are draft quotes, it is important 3 that the housing GSE step-up to provide liquidity in 4 the critical mortgage markets. 5 part of the solution. 6 They must be a key You wrote back, say it at first read appears that 7 OFHEO is being asked to be first, last, and only with 8 no firm commitment by the GSEs, and that's in 9 brackets, to raise capital. And the idea, quotes, 10 strikes me as perverse as it assumes it would seem 11 perverse to the markets that a regulator would agree 12 to allow a regulatee to increase its very high 13 mortgage credit risk leverage, not to mention 14 increasing interest rate risk, without any new 15 capital. 16 We seem to have gone from 2 to 1 right 17 through to 1 to 1 and zero to 1. 18 not comfortable with this. 19 issued two days later, your quote has changed to -- 20 let me be clear, both companies have prudent questions 21 above the OFHEO directed capital requirements and 22 they'll increase their reserves. 23 Obviously you are Now a press release is I'm just trying to probe to see, as a 24 regulator, what kind of pressures you were under and 25 how you're balancing out this need for national 186 1 liquidity with obviously some pretty grave concerns 2 you have about the conditions of these GS -- of these 3 two entities, Fannie and Freddie, and then I have a 4 larger follow-up question. 5 MR. LOCKHART: Well, it was definitely a 6 balancing act, but that press release you quote was a 7 draft one and did not reflect the deal that we had 8 cut, and that's why I responded the way I did. 9 I mean, they had to commit to raise 10 capital. That's the only way we would have ever 11 lowered that capital requirement, failing them, 12 meaning the consent agreement requirements, which was 13 actually the test for the whole 30 percent to come 14 off. 15 So, from our standpoint -- 16 CHAIRMAN ANGELIDES: 17 Can I ask you a question on that, Mr. Lockhart? 18 The ultimate deal or transaction or 19 agreement was that you would lower the capital 20 standard for Fannie in exchange for their willingness 21 to raise or their commitment to raise new capital, 22 right, and Freddie? 23 without a money raise? 24 25 Was there any capital relief MR. LOCKHART: There was a -- went from 30 percent to 20 percent, without the money raise, but 187 1 with a promise from the board of directors that they 2 would do it. 3 CHAIRMAN ANGELIDES: So for both of them, 4 it was a commitment and Fannie Mae fulfilled its 5 commitment, Freddie Mac did not; correct? 6 MR. LOCKHART: 7 CHAIRMAN ANGELIDES: 8 Exactly. Okay. But go ahead, I interrupted you. 9 MR. LOCKHART: So I mean, from my 10 standpoint, what we were trying to do, as I said 11 before, is to stabilize the mortgage market, stabilize 12 the two firms, and the only way we felt we could do 13 that was to get them to raise significant capital and 14 also agree to keep capital well above the minimum 15 levels. 16 And they did do that, and so -- they did 17 agree to it -- and so that's the reason we lowered 18 from 30 to 20 percent. 19 CHAIRMAN ANGELIDES: So in the large 20 picture, here's what I'm trying to understand. 21 it's March of 2008, was the view -- because obviously 22 you're a participant, was the view of the depth of the 23 crisis in subprime lending at this point was that it 24 would stabilize? 25 So Because if you viewed it would stabilize -- 188 1 I guess I understand this transaction the hope was it 2 would, at which point you've lowered capital, I mean, 3 in normal circumstances, as Mr. Thomas said, a normal 4 business may have acted differently. 5 wouldn't be lowering capital, moving into the breech 6 like this. 7 They probably In fact, everyone else was retreating. MR. LOCKHART: Well, they didn't lower 8 capital. 9 fact, at the end of the period Fannie actually still 10 I mean, we lowered the standard but, in had 30 percent, more than 30 percent extra capital. 11 We lowered their requirement but the 12 capital really did not come down because they actually 13 raised more capital. 14 15 CHAIRMAN ANGELIDES: In terms of real capital? 16 MR. LOCKHART: Yes. 17 CHAIRMAN ANGELIDES: 18 MR. LOCKHART: Freddie? Freddie's capital came down. 19 They were still above the 20 percent limit at the 20 period, probably about 25 percent. 21 CHAIRMAN ANGELIDES: Okay. But was the 22 view at that time that we think this market will 23 stabilize, this makes sense, or was it also the view 24 that perhaps what would happen, at this time, is there 25 was an acknowledgment that at some point, at some 189 1 point these institutions might have to be seized? 2 MR. LOCKHART: Well, we were hoping to 3 stabilize the mortgage market, there's no doubt about 4 it. 5 were going to do it, and -- but we felt the 6 combination of the Bear Stearns trend, purchase by 7 J.P. Morgan, and this would help stabilize the markets 8 and we might be able to get through it. 9 work, as we all know. We did not, you know, have, assuredly, that we 10 CHAIRMAN ANGELIDES: It didn't All right. Couple of 11 other quick questions, just about -- about your 12 reviews. 13 You did mention you noticed credit risk in 14 2006. 15 I think you had said there's credit risk but I think 16 you felt reasonable. 17 about the quality of the assets? 18 Did you note credit -- and -- but, at the time, Is this a fair interpretation I think, at that time, high-risk loans were 19 about 20 percent of the book, but they were still 20 pretty darn substantial in terms of percentage of 21 capital, you know. 22 percent of capital. 23 For Alt-A loans, they were 750 You know, they were -- the amount of 24 high-risk loans were anywhere from, you know, 500 to a 25 thousand percent of capital depending on the category. 190 1 They were very substantial. 2 In 2007 and early 2008, at least my 3 recollection is, you didn't focus much on credit risk. 4 I guess my larger question is, you said you didn't do 5 it enough. 6 missed the depth of the credit risk? 7 Looking back on it do you feel like OFHEO MR. LOCKHART: We started a task force in 8 2007, a unified task force of Freddie and Fannie 9 examiners, the credit teams to look at credit, and we 10 were continually working with the companies, looking 11 at their credit risk models, and -- and -- and 12 continuing to look at -- take a look at the credit 13 risk and those private label mortgage-backed 14 securities that, you know, Freddie was the biggest 15 buyer of those securities by far; Fannie was the 16 second biggest buyer. 17 So we spent a lot of time on the credit 18 risks in those books. 19 than temporary impairments, we proposed a new approach 20 to that, so we were focused on credit risk. 21 We forced them to take, other You know, I think the failure was a failure 22 that no one understood how bad it was going to be. 23 You know, the models, whether they were the rating 24 agency models, the Wall Street models, Fannie and 25 Freddie's models or our models never really got that 191 1 really downside in the models. 2 forecast what happened. 3 CHAIRMAN ANGELIDES: And we really did not All right. Did you 4 ever -- did you ever ask them to cut back on their 5 level of high-risk lending? 6 say, enough is enough here? 7 8 MR. LOCKHART: Did you ever weigh in and We -- we did ask them, obviously, to freeze their portfolios and -- 9 CHAIRMAN ANGELIDES: 10 MR. LOCKHART: Right. A total cap, right? And that really 11 stopped a lot of the private labels securities. 12 certainly looked at their, Fannie's, expended authority. 13 And my examiners were always talking to them and 14 asking them and probing them to try to slow it down. 15 CHAIRMAN ANGELIDES: 16 MR. LOCKHART: 17 In writing or -- Probably mainly verbally. There were some reports though. 18 CHAIRMAN ANGELIDES: Because one thing that 19 strikes me is the language of the conservatorship 20 memo. 21 MR. LOCKHART: 22 CHAIRMAN ANGELIDES: 23 We Right. I think the memo from Mr. Dickerson to you; is that correct? 24 MR. LOCKHART: That's correct. 25 CHAIRMAN ANGELIDES: Is -- it's pretty 192 1 dramatic. 2 quite comport with the other examinations I see along 3 the way. 4 I mean, it's very stark and it doesn't MR. LOCKHART: Well, as you heard Mr. Mudd 5 say, there wasn't anything new in that report. 6 knew it all. 7 morning. 8 9 He I think that's what he said this What we did was we compiled it all, because what we were trying to do is make a case to the board 10 of directors that they had to voluntarily agree to a 11 consent agreement. 12 than have the regulator have to do it and all the 13 nasty lawsuits that might happen. We wanted that to happen rather 14 So we made a -- you know, we pulled it all 15 together to make a very strong case so that the board 16 of directors did not have a choice. 17 CHAIRMAN ANGELIDES: All right. 18 Mr. Falcon, last question before I moved to 19 Mr. Georgiou. 20 What did you see in terms of the ramp-up 21 of -- why did each of you, just very quickly, why did 22 you see Fannie, in particular, moving into the 23 subprime breech? 24 25 Competitive pressure? I mean, if you were to weigh these on a scale, competitive pressures, affordable housing 193 1 goals, what were the driving forces, profit, 2 compet- -- you said profit? 3 MR. FALCON: In my opinion, I think the -- 4 it was driven by a desire to once again regain their 5 dominance in the market and to try to increase 6 profitability to what it had been in its heyday. 7 given this is where the market's going this is where 8 they thought they had to go to try to achieve that. 9 10 CHAIRMAN ANGELIDES: MR. LOCKHART: And All right. From my standpoint it was 11 really a combination, partially because those goals 12 had increased so rapidly over the period since 13 Director Falcon had left. 14 And the 55 percent goal almost is 15 mathematically impossible. 16 to hit that mission goal. 17 could put them on a consent agreement. 18 also importantly, it would have incurred the wrath of 19 Congress if they had missed their goals. 20 So that drove them a lot And partially it was HUD But I think Profit was very important to them and 21 market share was very important to them, so it was 22 really all three. 23 24 25 CHAIRMAN ANGELIDES: in your view? MR. LOCKHART: Yes. It was the trifecta, 194 1 CHAIRMAN ANGELIDES: Did you ever call 2 these loans -- in your conservatorship memo, you 3 referred to the high-risk loans as imprudent, unsafe, 4 and unsound. 5 Prior to September, did you ever flatly 6 just say, this stuff is beyond the level of risks we 7 should be taking? 8 9 MR. LOCKHART: Certainly we talked about some of those loans over time. Whether we put it in 10 writing or not, I have been away too long and I 11 haven't been able to see the papers. 12 CHAIRMAN ANGELIDES: All right. We may 13 follow up and ask you further questions on it. 14 Mr. Georgiou? 15 16 17 18 19 20 COMMISSIONER GEORGIOU: Mr. Chairman. EXAMINATION BY COMMISSIONER GEORGIOU COMMISSIONER GEORGIOU: And thank you gentlemen for joining us this afternoon. I want to ask you a provocative question, 21 right out -- out of the box here. 22 a little warning. 23 Thank you, And I'm giving you As of 12/31/09, these two 24 government-sponsored enterprises cost the taxpayers 25 111 billion dollars. And in the first quarter of '10 195 1 another 15.1 from Fannie. 2 number is for Freddie, so it's at least 126 billion 3 dollars. 4 And I'm not sure what the Given your perspectives on the 5 circumstances, can you give us any estimate on how 6 much money ultimately the taxpayers will have to pay 7 to -- to back up the losses that were suffered by 8 these -- that will be suffered by these two agencies? 9 MR. LOCKHART: The losses will be 10 significantly more than that -- what -- what we'll 11 see, actually, is because the way Fannie and Freddie 12 had their investment portfolios and their -- actually 13 how they got to their affordable housing goals were 14 quite different. 15 And also because Fannie is about a third 16 larger than Freddie, that we'll see continually higher 17 losses at Fannie and Freddie for a while. 18 So I would think over the next year we'll 19 see significantly higher losses, and then hopefully it 20 will trail off. 21 22 23 COMMISSIONER GEORGIOU: Can you give me any estimate? MR. LOCKHART: I've been away too long. 24 You know, I can give you a two-year-old estimate but I 25 don't think that would be very relevant today. 196 1 A lot of it really depends on what happens 2 to the mortgage market. 3 mortgage market, if we can prevent foreclosures, that 4 will have a pretty dramatic impact on how big the 5 losses will be to the taxpayers. 6 If we can stabilize the COMMISSIONER GEORGIOU: It doesn't appear 7 that we are really preventing foreclosures now, does 8 it? 9 MR. LOCKHART: The administration has the 10 HAMP rogram and, you know, it's starting to take some 11 traction, but it was slower than anybody wanted. 12 going to take time. 13 there is going to be many million more foreclosures. 14 15 16 It's I mean, it's -- it's -- it's -- COMMISSIONER GEORGIOU: Okay. Do you want to hazard a guess, Mr. Falcon? MR. FALCON: I don't. I can't give you an 17 estimate of what I think the number would be, but 18 obviously one dollar is too much. 19 unconscionable. 20 COMMISSIONER GEORGIOU: I think it's And 126 billion is 21 126 billion more too much than a dollar, but do you 22 have any thoughts? 23 MR. FALCON: I think it will go up. I 24 think the trend in the prime book certainly indicates 25 that given that it's a much bigger pool of assets than 197 1 the subprime and the Alt-A pool, the trends in the 2 sub -- and the prime assets they have are showing 3 deterioration. 4 So it may be one indication for people on 5 the inside was when Treasury decided to lift the 6 200-billion-dollar cap on capital assistance to both 7 companies. 8 concern or that it could go over that amount. 9 Perhaps that was their statement of COMMISSIONER GEORGIOU: Right. Okay. Let 10 me -- and then I want to try to go back to what you 11 each tried to do, respectively, to beef up the capital 12 of these institutions during your respective tenure as 13 the head of the regulator. 14 Mr. Falcon, could you outline what you 15 tried to do and what you were basically prevented from 16 doing in that regard? 17 MR. FALCON: Well, we -- the capital 18 standards are hardwired in the legislation. 19 and a half percent on balance sheet, 45 basis points 20 off-balance-sheet. 21 requirement didn't give us discretion to increase it 22 in any way. 23 It's 2 And that minimum capital So we, from the very beginning, we sought 24 the flexibility in statute, just the same kind of 25 authority that every other safety and soundness 198 1 regulator had to have full discretion to raise that 2 amount if we thought it was necessary. 3 We could never get that authority. And as 4 I said in my testimony, finally we -- after the 5 accounting scandals, we were able to get the companies 6 to agree to holding a 30 percent capital cushion in 7 reaction to that. 8 statutory authority, but they agreed to it and so we 9 did it. 10 11 12 That wasn't based on any clear COMMISSIONER GEORGIOU: Okay. Mr. Lockhart? MR. LOCKHART: Well, certainly what we 13 tried to do is we had a very large campaign going 14 really basically to make it clear to everybody that 15 their capital was too low. 16 legislation. 17 because it was hardwired into the legislation. 18 And we worked to get And so that was probably the key thing We did work somewhat on the risk cap, base 19 capital models, to try to strengthen that, but 20 unfortunately the legislation that built that was too 21 weak as well. 22 and which we kept telling Congress repeatedly. 23 unfortunately, you know, by the time the law passed in 24 July 30th, 2008, it was much too late. 25 So we really didn't have a good tool COMMISSIONER GEORGIOU: Right. And, And, of 199 1 course, at that point it would be almost impossible to 2 raise the capital under these circumstances. 3 MR. LOCKHART: Yeah, it would have been 4 impossible even to put a new regulation in place. 5 know, it would probably would have taken six months to 6 a year. 7 COMMISSIONER GEORGIOU: 8 MR. LOCKHART: 9 10 11 You Right. To even do it, so, I mean, you know, it was much too late. COMMISSIONER GEORGIOU: And you took them over, too, a couple months later, after that? 12 MR. LOCKHART: Yeah. 13 COMMISSIONER GEORGIOU: Did -- did you ever 14 have any issues of capital arbitrage in com- -- when 15 things were moved off-balance-sheet to have the 16 reduced capital associated with off-balance-sheet as 17 opposed to on balance sheet treatment, Mr. Falcon? 18 MR. FALCON: I think, at one point the 19 enterprises would come to us with some novel ideas 20 about treating some new kind of product as capitalist, 21 Tier 1 capital, and they wanted us to -- I guess they 22 were sold some innovation about how to better receive 23 more return on their capital. 24 be able to count that as core capital. 25 And they wanted us to I think that would have diluted the quality 200 1 of core capital. 2 we always told them no. 3 with ideas on some innovative kind of products that 4 should be counted as capital. 5 it. 6 If we had agreement to do that, so MR. LOCKHART: But they were coming to us And we never agreed to They really didn't, despite 7 what you may have heard, they really never thought 8 that they didn't have enough capital. 9 And in my experience, they could have very 10 easily raised capital by -- they had 700, 800 billion 11 of their own mortgage-backed securities on their 12 portfolios. 13 COMMISSIONER GEORGIOU: 14 MR. LOCKHART: Right. Two and a half percent, they 15 could have reduced their capital requirement by 80 16 percent by selling them. 17 COMMISSIONER GEORGIOU: 18 MR. LOCKHART: 19 20 Exactly. So they had the ability they just didn't do it. COMMISSIONER GEORGIOU: Right. And -- but 21 if you keep them on and they're earning -- and they're 22 earning a nice spread -- 23 MR. LOCKHART: 24 COMMISSIONER GEORGIOU: 25 Right. -- if you're getting credit at a government -- this effectively 201 1 government-guaranteed rate, you're making a nice 2 spread, then you're making more profit, more earnings 3 on the capital that you have, which then leads to 4 bigger bonuses, does it not? 5 6 MR. LOCKHART: That's certainly one way to look at it, yes. 7 COMMISSIONER GEORGIOU: 8 CHAIRMAN ANGELIDES: 9 Mr. Vice Chair? Would you mind if you yield? 10 11 Okay. COMMISSIONER GEORGIOU: I would love to, I invite the Vice Chair to enter. 12 VICE CHAIRMAN THOMAS: I was just trying to 13 figure out what the other one -- other one would be, 14 is all. 15 with one. 16 17 CHAIRMAN ANGELIDES: I couldn't come up Back on your time, Mr. Georgiou. 18 19 It ran through my mind. COMMISSIONER GEORGIOU: I think that would be the main one, Mr. Vice Chair. 20 Let me go back, I want to ask you about a 21 few accounting issues, because both of these 22 institutions were, at one point in the past, cooking 23 their books, basically, or so they were found to have 24 done. 25 And I -- I -- I understand from your 202 1 testimony that part of the reason why you didn't have 2 the opportunity to evaluate credit risk as well as you 3 might otherwise have done is that you were spending a 4 lot of time cleaning up the appropriateness of the 5 accounting. 6 Mr. Falcon? 7 8 9 10 11 Is that -- wasn't that your testimony, MR. LOCKHART: I think that was my testimony. COMMISSIONER GEORGIOU: Mr. Lockhart. I'm sorry, I apologize. MR. LOCKHART: What I was saying is that in 12 2006, that first six months I was there, we were so 13 focused on market risks and operational risks that we 14 were only starting to focus inasmuch as we should have 15 on credit risks. 16 2007 to intentionally look at the credit risk. 17 And we did set up a task force in COMMISSIONER GEORGIOU: Right. Well, let 18 me just ask you about a few things that have been 19 brought to our staff's attention. 20 Fannie wasn't recording losses on 21 delinquent loans until they were 24 months delinquent; 22 is that correct? 23 MR. LOCKHART: 24 COMMISSIONER GEORGIOU: 25 could edify. Not entirely correct. Well, maybe you 203 1 2 MR. LOCKHART: Let me try to explain what happened. 3 Fannie, in their mortgage-backed 4 securities, when a loan became delinquent, they had 5 the option to take them out after 120 days and rework 6 them and modify them. 7 would have to write it down. But if they did that, then they 8 COMMISSIONER GEORGIOU: 9 MR. LOCKHART: Correct. So they changed their 10 approach to leave them in the securities until they 11 had the modification ready. 12 from 120 days to 20 -- you know, two years. 13 they did not take that fair value cap. 14 to look at them from a credit standpoint though. 15 And that meant anywhere COMMISSIONER GEORGIOU: They -- They still had Right. But they 16 didn't have to mark down their books to recognize the 17 loss on that particular delinquent loan; is that 18 right? 19 MR. LOCKHART: That's how the accounting 20 worked. 21 year, so now they would have to do that. 22 Actually, the accounting was changed this COMMISSIONER GEORGIOU: Right. And weren't 23 they also actually lending -- providing 24 uncollateralized loans to some of the people who were 25 delinquent to extend it and then treat it as -- treat 204 1 it as a performing loan to extend the deadline for its 2 recognition as a loss? 3 MR. LOCKHART: They had the HomeSaver, I 4 think it was called, HomeSaver Advantage Loan or 5 something like that. 6 COMMISSIONER GEORGIOU: 7 MR. LOCKHART: Right. Which was the idea that 8 oftentimes when you cure a loan, you just sort of wrap 9 up the principal and interest that hasn't been paid 10 back into the principal balance. 11 COMMISSIONER GEORGIOU: 12 MR. LOCKHART: Right. Instead of doing that, they 13 actually just took that amount and gave an unsecured 14 loan for it. 15 probably 10 percent, because they knew they were not 16 going to get value for them. 17 18 They actually wrote those loans down to COMMISSIONER GEORGIOU: down the advanced loan? 19 MR. LOCKHART: 20 COMMISSIONER GEORGIOU: 21 22 23 They just wrote Right. But they didn't write down the underlying loan? MR. LOCKHART: Until it looked like it wasn't going to cure. 24 COMMISSIONER GEORGIOU: 25 MR. LOCKHART: Right. I mean, the idea was they 205 1 only did that if people were starting to make their 2 payments again. 3 COMMISSIONER GEORGIOU: But those were 4 relatively modest loans that they treated as 10 5 percent. 6 MR. LOCKHART: Right, it was a process that 7 was delaying the inevitable. And we put a lot of 8 pressure on them to start modifying those loans more 9 realistically. 10 COMMISSIONER GEORGIOU: 11 MR. LOCKHART: Right. And when they did start 12 modifying the loans more realistically, there was less 13 default. 14 COMMISSIONER GEORGIOU: Right. Did you -- 15 did you ever talk to the OCC or the Fed about this 16 practice, anybody, either of you? 17 MR. LOCKHART: That would be you. No, I did not. By the time 18 that the OCC and Fed came in in August of `08, I think 19 the practice may have been lessened. 20 exactly. 21 down that unsecured loan to a value that we were 22 comfortable with. 23 I can't remember But certainly from our standpoint they wrote COMMISSIONER GEORGIOU: Okay. And the 24 practices, as you understand it, has been modified by 25 the legislation effective 1/1 of 2010? 206 1 MR. LOCKHART: The way that you account for 2 securities now, they're all on their balance sheet and 3 they have to account for them as if they were a loan. 4 COMMISSIONER GEORGIOU: Right. Okay. Let 5 me ask you, let me turn, if I can, briefly, to this 6 lobbying business which everybody seems to think. 7 I take it this was an equal opportunity 8 bipartisan lobbying push over the years that Fannie 9 and Freddie were engaging in this practice? 10 I mean, that is, they were well-connected 11 people, who were either former legislators or former 12 staffers, and others, from both parties, who were 13 retained by these institutions to lobby. 14 you characterize it in that way, Mr. Falcon? 15 MR. FALCON: 16 COMMISSIONER GEORGIOU: 17 Mr. Lockhart, have you seen that? 18 19 20 MR. LOCKHART: Would Yes, I would. Yes. Okay. They had big groups of lobbyists on both sides of the aisle, yes. COMMISSIONER GEORGIOU: And were you -- did 21 you -- I mean, obviously, the experience that you had, 22 Mr. Falcon, in connection with your -- which the 23 announcement of your successor before there was any 24 vacancy certainly was an extreme example of -- of the 25 influence that was exercised, was it not? 207 1 2 MR. FALCON: Yes, it was one of the extreme examples, absolutely. 3 COMMISSIONER GEORGIOU: Can you tell us 4 about any other efforts that -- that were significant 5 by these two agencies? 6 MR. FALCON: At one point they -- they 7 worked hard to try to kill our risk-based capital 8 rule. 9 to come up with a risk-based capital requirement. And we designed a very detailed cash flow model 10 And while it was at OMB for review, they 11 worked very hard to try to kill it, and had OMB send 12 it back to us and promulgate a new rule that relied on 13 their own internal models for -- for setting 14 risk-based capital. 15 Ultimately that OMB rejected their 16 position, and we were able to get that rule out. 17 they, at the peak of their political power, they 18 weren't shy about flexing their muscles on not just 19 big issues but small ones. 20 any issue. 21 But They gave no quarter on COMMISSIONER GEORGIOU: But, I mean, isn't 22 this a particularly egregious lobbying abuse in that 23 at least when the private sector is lobbying, 24 theoretically, if they are putting at risk their own 25 shareholder returns by spending lobbying -- advancing 208 1 lobbying expenditures which may or may not advance 2 their private interests. 3 But here you had effectively a taxpayer 4 buttressed two institutions, who were spending 5 taxpayer money to lobby the administrations and the 6 Congress, who were responsible for their oversight, 7 which ultimately rebounded back to the detriment of 8 the taxpayers themselves. 9 absolutely astonishing. 10 MR. FALCON: I mean, it strikes me as I think it is astonishing, 11 especially -- and, of course, we all respect an 12 individual's right to voice their opinion, but their 13 tactics frequently involved misinformation, character 14 attacks, questioning people's motives, just brutal 15 strong-arm tactics that none of us would think is 16 acceptable. 17 unseemly. 18 I think that's what made it very MR. LOCKHART: From our standpoint, as you 19 know, one of the first -- when we announced the 20 conservatorship, we closed the lobbying shops down. 21 We also had in our consent agreement -- 22 23 24 25 CHAIRMAN ANGELIDES: Just hold it, I'm going to add two -- how much time do you need? COMMISSIONER GEORGIOU: Thank you, that's fine, that will be fine, two minutes will be fine. 209 1 MR. LOCKHART: In our consent agreement in 2 `06, we had them do a study of best practices for 3 lobbying and institute it. 4 most of it. 5 I think they instituted So where we saw the lobbying from our 6 standpoint was they drug their heels on the 7 legislation. 8 a fatal flaw, as I said before. 9 of `07 when they felt they could save the market, They -- they -- and, you know, that was Also, in the summer 10 they were lobbying very hard against us from a 11 standpoint that they wanted us to remove the portfolio 12 caps and also to lower the capital requirement and, 13 you know, we resisted it. 14 COMMISSIONER GEORGIOU: But that's the 15 point that others had made as well, and I want to 16 reiterate. 17 Why would you go into a market that's 18 collapsing, that's presenting greater credit risk, 19 except for the purpose in the -- I'm talking in the 20 late stages, now, except for the purpose of 21 essentially making more and more money on the spreads 22 between your cost of capital, which is effectively 23 taxpayer subsidized, and the returns you can get in 24 the market? 25 MR. LOCKHART: To be fair, they actually 210 1 thought that they had the power to do it, I mean, they 2 used to quote to me long-term capital situation where 3 they came into the marketplace and stabilized it. 4 They thought that just their ability to come in there, 5 their big balance sheets, unfortunately they didn't 6 have the capital to go with those big balance sheets, 7 could stabilize the market. 8 9 10 And in summer of `07 it was really starting to happen, so it wasn't at the end that they were talking about this. 11 COMMISSIONER GEORGIOU: And they were able 12 to postpone this legislation for almost two years, 13 were they not? 14 15 MR. LOCKHART: probably go five years. 16 17 Oh, I think you could COMMISSIONER GEORGIOU: Five years? years? 18 VICE CHAIRMAN THOMAS: 19 COMMISSIONER GEORGIOU: Four. Four years, well, 20 that's -- that's -- that's an awful long time. 21 thank you very much gentlemen. 22 CHAIRMAN ANGELIDES: Okay, I appreciate it. Thank you very much, 23 Mr. Georgiou. 24 end of three days, I was confusing myself. 25 Five Mister -- yes, Mr. Holtz-Eakin. COMMISSIONER HOLTZ-EAKIN: Thank you, At the 211 1 2 Mr. Chairman. EXAMINATION BY COMMISSIONER HOLTZ-EAKIN 3 COMMISSIONER HOLTZ-EAKIN: 4 both Mr. Falcon and Mr. Lockhart, for both your 5 service and coming here talk with us today. 6 And thank you, I think this is of interest not just 7 because of the particular business model that these 8 institutions followed, which I have an openly failing 9 malignant opinion on, and I'll come back to that, but 10 also their role in the larger crisis, where their 11 failure occurred during that window, September 6th, 12 September 15th, when we saw the transmission of this 13 crisis from what was originally a housing and housing 14 mortgage-related event into a financial crisis that 15 spanned the breadth of all financial markets and 16 ultimately the economy, as a whole. 17 I wanted to ask you a couple of questions 18 about both. 19 illustrative in painting a pictures of two 20 institutions who had that narrow housing 21 market-related product line that suffered from poor 22 internal controls, that had risk management systems 23 that were below the industry standard, that were 24 poorly capitalized. 25 You know, I think today has been pretty And I guess my question is, if you have 212 1 institutions like that, how do they get so big, 2 Mr. Falcon? 3 MR. FALCON: Well, I think growth really 4 began in the late `80s, perhaps, as they began to build 5 their mortgage portfolios. 6 COMMISSIONER HOLTZ-EAKIN: How could they 7 do that given the flaws that both that OFHEO and 8 others have chronicled under your guidance? 9 MR. FALCON: Well, the growth in the 10 mortgage portfolios, as long as we -- we did not have 11 discretion to stop them from doing those mortgage 12 portfolios as long as they were hedging that risk of 13 those portfolios. 14 And so we paid very close attention to the 15 issues like their duration gap, as you understand. 16 And so -- but it was that growth of that portfolio 17 under ability just to earn the spread. 18 they grew those portfolios the more spread -- profit 19 they made off of the spread. 20 COMMISSIONER HOLTZ-EAKIN: So the more And they were 21 able to continue access credit markets despite these 22 poor characteristics and risky portfolios? 23 MR. FALCON: Well, until the bubble burst, 24 everyone was willing to buy their debt, whether it was 25 straight bullet debt or their mortgage-backed 213 1 securities. 2 MR. LOCKHART: They were -- had a Triple-A, 3 I talked to the rating agencies, asked them the exact 4 same questions actually, and their answer was that 5 they had such a large market, almost turning your 6 question on the head, they had such a large market 7 share that the Triple-A was very strong. 8 besides, the U.S. government had the implicit back 9 support because they couldn't let something that big 10 And, fail. 11 COMMISSIONER HOLTZ-EAKIN: Mr. Falcon, would 12 you agree that the -- the -- the implicit guarantee was 13 an important part of the business model? 14 MR. FALCON: Absolutely. 15 COMMISSIONER HOLTZ-EAKIN: The panel before you 16 disputed this, and I wanted to get you both on the 17 record in that regard. 18 MR. FALCON: 19 COMMISSIONER HOLTZ-EAKIN: Yes, sir. Was the large 20 portfolio part of their public service mission to 21 provide liquidity, and just that, as the panel argued 22 before? 23 MR. FALCON: I think they certainly tried 24 to argue that the portfolio was essential in order to 25 promote liquidity in their products. 214 1 2 COMMISSIONER HOLTZ-EAKIN: Is that the only purpose it served? 3 MR. FALCON: There was -- it did serve 4 somewhat -- a very small portfolio, I think, was 5 essential basically to warehouse mortgage loans until 6 they were able to turn around and securitize them. 7 But for that kind of a function, they did 8 not have to grow anywhere near the size that they did. 9 I mean, the overwhelming amount of mortgages they held 10 in those portfolios were simply to earn that spread. 11 COMMISSIONER HOLTZ-EAKIN: 12 MR. LOCKHART: Mr. Lockhart? I would have to agree that 13 the portfolios didn't need to be anywhere near as 14 large. 15 private labeled securities, at all. 16 they did primarily was this spread and the affordable 17 housing goals, both. 18 In retrospect they didn't need to buy those And the reason The -- so my view is that the portfolios in 19 any going-forward structures should be minimal, if at 20 all. 21 COMMISSIONER HOLTZ-EAKIN: So we have these 22 fundamentally flawed institutions that are allowed to 23 become so large as to be systemically dangerous. 24 as the regulator did you not stop this? 25 MR. FALCON: Why We had bifurcation of mission 215 1 and safety and soundness regulation. 2 an opinion that the portfolios were improper. 3 long as they were managing the risk of the duration 4 between their assets’ liabilities in those 5 portfolios, we were not in a position to be able to 6 tell them no in that bifurcated oversight structure. 7 COMMISSIONER HOLTZ-EAKIN: HUD was not of As And your own 8 records having said in many ways you tried to post 9 that? 10 VICE CHAIRMAN THOMAS: 11 COMMISSIONER HOLTZ-EAKIN: 12 13 Yes. I stopped you. Mr. Lockhart, do you agree? MR. LOCKHART: We certainly leaned about -- 14 against their growth in any way we could, dividends, 15 raising more capital. 16 that the legislation wasn't there and we couldn't get 17 it through Congress to give us the power and 18 particularly the capital. 19 But the key thing, again, was You know, we keep talking about the 20 portfolios, but in retrospect, the MBSs with only 45 21 basis points of capital was also a very tricky 22 situation, and certainly they've gone through that. 23 COMMISSIONER HOLTZ-EAKIN: So let me now 24 turn to the moment when the legislation actually 25 finally does pass. And in the course of the debate 216 1 over the hero legislation, Secretary Paulson says 2 something to the effect of, I, you know, want to have 3 a bazooka although I will never have to use it. 4 then not long before conservatorship became the path, 5 I believe you, Mr. Lockhart, OFHEO, FHFA, at that 6 point, issued a letter saying they were well 7 capitalized; is that right? 8 9 10 11 12 MR. LOCKHART: I said that they were legally adequately capitalized and they were. COMMISSIONER HOLTZ-EAKIN: And why did you send out that letter? MR. LOCKHART: I'm not sure if it was a 13 letter or a public statement. 14 mean, I did say it. Was it a letter? 15 COMMISSIONER HOLTZ-EAKIN: 16 MR. LOCKHART: 17 And I We can check. But, either way -- oh, I know what you're talking about. 18 COMMISSIONER HOLTZ-EAKIN: 19 MR. LOCKHART: Yeah. What you're talking about is 20 when we capitalized them, when we grade them every 21 quarter, we send off a preliminary letter that says 22 what we're going to capitalize, what we're going to 23 grade them at. 24 COMMISSIONER HOLTZ-EAKIN: 25 MR. LOCKHART: I see. And the numbers were that 217 1 they were adequately capitalized. 2 letter, and this is a preliminary letter, that we had 3 the right to downgrade them so that we put them on 4 notice on that letter that we might downgrade them. 5 6 I also said in that COMMISSIONER HOLTZ-EAKIN: And this was August 22nd? 7 MR. LOCKHART: Right. 8 COMMISSIONER HOLTZ-EAKIN: 9 characterization letter. 10 MR. LOCKHART: 11 COMMISSIONER HOLTZ-EAKIN: That's a fair Right. My -- thank 12 you -- my question then, is, now, shortly thereafter 13 on September 6th, it is apparent that they are failing 14 and that they are a danger, when was this recognized? 15 Were you the first to recognize this? 16 MR. LOCKHART: We were working all through 17 August through that period. And we were particularly 18 looking at their reserves. 19 at the issue of the deferred tax asset, which was 20 allowed to count for capital, the other than temporary 21 impairments on the private label securities. 22 going through a whole exercise, with the help of the 23 Fed, the OCC and Treasury to look through it. But we were also looking We were 24 By August 22nd we -- we -- our view was 25 that it was going to be very difficult for them to 218 1 make it. 2 capitalized based on the numbers that they put out in 3 early August. 4 But factually, they were adequately COMMISSIONER HOLTZ-EAKIN: And I understand 5 that. 6 somewhere in there the realization arise that this 7 can’t go on, that realization that -- 8 9 10 I'm just trying to -- from the 22nd to the 6th, MR. LOCKHART: No, the realization happened actually potentially before the 22nd. COMMISSIONER HOLTZ-EAKIN: What I would 11 like to ask next is, you know, the decision's made, 12 they go into conservatorship, as lifetime participants 13 in financial markets and those quite expert in this 14 area, what is your estimate of the impact more broadly 15 of having these two institutions, which the Secretary 16 of Treasury has said he's got a bazooka but he's not 17 going to need to use it, and which have been 18 implicitly backed by the taxpayer, as part of their 19 business model, what is the market impact of seeing 20 them fail in this way? 21 MR. LOCKHART: My view is, at least for 22 that first week, before Lehman hit, it actually helped. 23 And you can see the spreads come in 24 dramatically. 25 pretty Certainly the foreign investors and their 219 1 securities, which were putting a lot of pressure -- 2 3 COMMISSIONER HOLTZ-EAKIN: securities of Fannie and Freddie? 4 MR. LOCKHART: 5 COMMISSIONER HOLTZ-EAKIN: 6 Helped the Yes. And the markets, more generally? 7 MR. LOCKHART: I can't make a judgment on 8 the markets more generally at that, but, you know, 9 there was some stabilization starting to occur and 10 then, you know, the Lehman weekend. 11 COMMISSIONER HOLTZ-EAKIN: And that would 12 be because the guarantees been hardened as hard as 13 even Bill Dudley could want? 14 MR. LOCKHART: 15 COMMISSIONER HOLTZ-EAKIN: 16 MR. FALCON: 17 20 Mr. Falcon? I would just concur with what Director Lockhart said. 18 19 Yeah, right. COMMISSIONER HOLTZ-EAKIN: Thank you, Mr. Chair. CHAIRMAN ANGELIDES: Can I just, I would 21 like to take a moment on my time to really just follow 22 up on this line of questioning, because I am struck, 23 and I don't know if -- I'm trying to get to the 24 essence of what happened here, is it a little -- 25 remember when we were kids, they had these little toy 220 1 guns that would shoot out the darts that had the 2 little rubber tip; and whether you were in the 3 position of trying to bring down an elephant with one 4 of those or whether you were wrestling with a 5 mattress. 6 But, you know, in `05, `06, `07, there are 7 exams done. You mention in `07 there's a task force. 8 You do issue letters and I understand they are legally 9 capitalized, but it's not as though the alarm bells 10 are going off in very visible ways that danger is 11 coming. 12 And, you know, there is a little element 13 when the conservatorship occurs, and whether it's a 14 Claude Rains moment, I'm shocked, I'm shocked, there's 15 gambling going on here. 16 get to is that you didn't -- it just couldn't -- 17 didn't frankly have the political heft to move this 18 ball or was -- what was happening at Fannie Mae and at 19 OFHEO much of what was happening, also on Wall Street, 20 which is that no one really calibrated the magnitude 21 of risks that had been taken. 22 I guess what I'm trying to It's just something that has been gnawing 23 at me. And when Mr. Holtz-Eakin asked those 24 questions, that's what I'm trying to drive at, which 25 is, of course, we're in that moment. What's the 221 1 essence of this story, from your perspective, each of 2 you? 3 MR. LOCKHART: My belief is we -- no one 4 had really calibrated the risk. 5 economy in the market just continued to deteriorate 6 from that March period we were talking about through 7 September, and just people lost faith in Fannie and 8 Freddie. 9 that they were insolvent. 10 And that risk and the There was a lot of speculation at that point There was a lot of articles written. There 11 was a new accounting principles announced that was 12 going to put all their mortgages-backed securities on 13 their balance sheet and people were afraid that their 14 capital requirement was going to be five times as 15 high. 16 There was just a lot of things happening 17 that really caused spreads to widen dramatically. 18 August they couldn't borrow long anymore; they had to 19 borrow short. 20 there was problems in `06 and `07 starting to build. 21 But by the summer of `08, it was obvious that they 22 couldn't make it in August. 23 24 25 Everything started to pile up. CHAIRMAN ANGELIDES: In Yes, I know you weren’t around-- VICE CHAIRMAN THOMAS: Mr. Chairman, on this point-CHAIRMAN ANGELIDES: Yes, absolutely, Mr. 222 1 Vice Chair. 2 VICE CHAIRMAN THOMAS: But the one thing that's really hard for 3 people to appreciate, for example, your reference to 4 Casablanca. 5 middle of the cafe because he was the authority. 6 He could say that with impunity in the When you've had the ability to control 7 Congress in producing legislation and -- and think 8 you've got a fallback, while others around you are 9 looking at the world as it falls apart, you're slow to 10 come to the realization that it's you too, because at 11 some point they're still thinking they've got this 12 reserve available to them which has always pulled them 13 out. 14 So even they, notwithstanding all the 15 market symbols, were looking at the world like they 16 normally looked at the world. 17 their back pocket. 18 They've got that in CHAIRMAN ANGELIDES: Well, I’ll just ask, and I do 19 want to move on to the other members, but do you think 20 it was also this situation here? 21 much said you're on the scene. 22 you this, because you're an observer. 23 I mean, you pretty I'll probably just ask But -- so you really say, okay, very much 24 like much of the world didn't see the magnitude of 25 what had come, hadn't prepared in the right ways, but 223 1 perhaps this is exacerbated, as Mr. Thomas suggests, 2 by the company itself thinking at the end of the day 3 there is no downside because they -- do you think that 4 -- do you think that that exacerbated the situation, 5 the implicit, slash, explicit? 6 MR. LOCKHART: Well, I think they thought 7 there was a downside here. 8 didn't realize how big the downside was. 9 They, like everybody else, You know, another important thing is, when 10 you look back at it and you can only sort of do this 11 in retrospect, that I don't think we could have put 12 them in conservatorship before that legislation passed 13 on July 30th. 14 CHAIRMAN ANGELIDES: 15 MR. LOCKHART: We could have legally but 16 there would have been chaos. 17 Fannie and Freddie. 18 and Freddie. 19 Legally. There was no FDIC to back There was no money to back Fannie CHAIRMAN ANGELIDES: Well, I guess in May 20 they raised 7 billion. So I guess that's some market 21 indication that some people did believe that this 22 entity would survive? I assumed that -- 23 MR. LOCKHART: 24 CHAIRMAN ANGELIDES: 25 Yes, absolutely. Unless -- unless, and this is not an accusation, unless the representations 224 1 made by the entity in doing the raise were not 2 accurate, to which I cannot speak nor would I allege. 3 MR. LOCKHART: 4 investors. 5 exercised the Greenshoe. 6 percent too. 7 that point. 8 9 They were buying it. And they actually So they got the extra 15 So they had people that did believe, at CHAIRMAN ANGELIDES: All right. Let's now go now to Ms. Born. 10 11 They had sophisticated COMMISSIONER BORN: Thank you. Thank you very much. 12 EXAMINATION BY COMMISSIONER BORN 13 COMMISSIONER BORN: And thank you both for 14 appearing before us. 15 thank both of you for the public service that you gave 16 the American people during your years as the director 17 of OFHEO in trying to do your best against very 18 powerful interests that were aligned against you. 19 And I personally would like to I noticed that Mr. Falcon, you say in your 20 testimony, the Fannie and Freddie political machine 21 resisted any meaningful regulation using highly 22 improper tactics. 23 And I'd like to discuss how Fannie and 24 Freddie used their political power to resist 25 meaningful regulation. 225 1 You testified as to a number of steps that 2 they've taken, resisting reform legislation, for 3 example, which wasn't really put in place in a timely 4 fashion in order to save the organizations. 5 These institutions had an implicit 6 government guarantee. So they were benefitting 7 financially in their dealings in the marketplace from 8 that guarantee. 9 because of the guarantee. They were getting very low-cost money And they were then turning 10 around and putting an enormous amount of their 11 resources into making sure that there was really no 12 effective government oversight to protect the American 13 public. 14 I know that you were both doing the best 15 you could with the powers you had, but it raises a 16 question, in my mind, of this undue political power 17 that a financial institution can obtain and how it can 18 be used to resist the actions that government needs to 19 take to rein in excesses and to make sure the 20 institutions are safe. 21 I wonder how we can protect against this in 22 the future, and I would like each of your 23 observations. 24 you have thought about this. 25 I'm sure because of your situations, MR. FALCON: Thank you. Thank you very 226 1 much. 2 any kind of model where you have a privately held and 3 publically traded stock company that has these kind of 4 government subsidies. 5 model is just prone to the abuses, as we saw with the 6 Fannie/Freddie. 7 I do feel strongly that we cannot go back to I think that that kind of a And so if there's going to be any kind of 8 government subsidization or role in our housing 9 finance system going forward, I think it should be 10 with a clear separation of a government role by 11 entities fully -- being full government entities and 12 in the private sector and have any government subsidies 13 be through government entities and not through some 14 institution like Fannie Mae and Freddie Mac. 15 I think that's a very clear lesson. 16 Otherwise you do get the kind of abuses that we saw 17 with these two companies. 18 COMMISSIONER BORN: 19 MR. LOCKHART: Mr. Lockhart? Well, certainly the power 20 that they had, from the lobbying standpoint was abused 21 and abused a lot over the years. 22 The GSE models fought, it didn't work, and 23 it needs to be totally restructured. But I have to 24 tell you, I've also run some other government agencies 25 that the models were flawed over the years. 227 1 And that is a problem, you know, I mean, 2 you know, legislation can be a messy process and we 3 don't always get the best part of it, so I think we 4 need to take some of this and put it back into the 5 private sector. 6 At the moment, a hundred percent virtually 7 of our secondary mortgage market is in the government 8 sector. 9 the right incentives back into the marketplace. And we have to undo that and we have to get 10 There was no debt discipline for these two 11 companies. 12 out financial statements for five years. 13 didn't care that, you know, they were starting to lose 14 money until the very end. 15 People didn't care that they couldn't put People So we need to restructure the whole 16 mortgage market in this country. 17 should start, what do we want the mortgage market to 18 look like, what do we want the new mortgage-backed 19 securities to look like. 20 you decide the future of Fannie and Freddie. 21 And that's where we To me, that's critical, then COMMISSIONER BORN: I wonder if you have 22 any views as to whether this problem that you faced of 23 an institution that has government subsidies in 24 effect, government support, but ineffective government 25 regulation because of their political power has any 228 1 broader relevance to the financial services industry, 2 as a whole. 3 benefit of deposit insurance and other support by the 4 government. 5 You know, for example, banks get the Certainly they're getting a lot of support 6 now. 7 to spend resources on lobbying campaign contributions 8 through PACs and other activities that has given them, 9 over the last decade or so, a great deal of political 10 And yet I think they, too, have been very ready power in resisting regulation. 11 MR. FALCON: I think the difference with 12 the bank, the banking system and their regulation is 13 that if there were any flaws in the regulation of the 14 banking system, I would say it would -- whether there 15 are or not, I would say it is the result of policy 16 judgments made by regulators. 17 In the case of OFHEO, we didn't even have 18 the authority to make poor policy judgments. 19 forced to do the best we could with the authorities that 20 we had, I think that's a very key difference there. 21 COMMISSIONER BORN: We were Well, you certainly did 22 not have anything like the powers of a banking 23 regulator. 24 soundness supervisor of an enormous financial 25 institution, like each of the GSEs were, without And that you can't really be a safety and 229 1 significantly additional powers. 2 Mr. Lockhart, do you have any -- 3 MR. LOCKHART: That's very true. You know 4 lobbying, per se, is not a bad profession to the 5 extent that they're informing members of Congress 6 about what's going on. 7 were using it to constrict what should have happened. 8 In the banking case, at least, the FDIC fund is 9 pre-funded, at least there's money there, and they've 10 What happened was that they already paid for some of the insurance. 11 In this case they're getting the implicit 12 guarantee for free, and the taxpayer was paying the 13 whole cost. 14 flawed and we have to recreate something. 15 But moving forward, again, the model's COMMISSIONER BORN: Mr. Lockhart, you 16 testified that the mortgage portfolios of Fannie Mae 17 and Freddie Mac were a concern because they posed 18 interest rate and prepayment risk and other risks. 19 And that those risks required an extensive 20 use of derivatives and that some officials, including 21 I think you said the Federal Reserve, Chairman 22 Greenspan, expressed concerns about the large 23 derivatives positions. 24 25 And I understand that Fannie and Freddie held about 2.8 trillion dollars in notional amount of 230 1 derivatives during the summer of 2008, what were they 2 using these derivatives for? 3 MR. LOCKHART: They were hedging their 4 portfolios. 5 fluctuate pretty widely and especially the spreads 6 between their borrowing costs and treasuries, they really 7 beefed up the derivative activities. 8 close them out, they just kept them in place. 9 would just do another derivative, replace the 10 And as interest rates started to And they didn't So the derivative, and keep growing, growing. 11 Now historically they used to claim that 12 they used callable-debt, and they really didn't need a 13 lot of derivatives. 14 them extensively. 15 As it turned out, they needed They had very sophisticated risk managers 16 on the interest-rate side. 17 that prepayment risk that Mr. Mudd talked about a lot. 18 And, you know, that -- that required very 19 sophisticated approach and lots of derivatives. 20 And they tightly managed And we were concerned and we had market 21 risk teams that were all over them on what was going 22 there. 23 risks as well as, you know, those derivative books 24 grew and grew. 25 But we were also concerned about the credit COMMISSIONER BORN: Well, I was going to 231 1 ask you, were they adequately hedging their credit 2 risk? 3 CHAIRMAN ANGELIDES: 4 couple more minutes, Ms. Born? 5 COMMISSIONER BORN: 6 CHAIRMAN ANGELIDES: 7 Please. Two more minutes, please. 8 9 Would you like a MR. LOCKHART: credit risks. They didn't hedge their And they didn't hedge their 10 counterparty risks. 11 they used mortgage insurance because, by law, they 12 couldn't make a loan, an 80 percent loan to value, so 13 they used mortgage insurance to cover up that gap. 14 The only thing, as was mentioned, COMMISSIONER BORN: So despite the fact 15 that they were hedging some of the risks in their 16 portfolios, the risk that really hit them the most, 17 credit risk, both on the underlying in the portfolio 18 and on the credit and on the derivatives part, were 19 not hedged, and that's where they suffered; correct? 20 MR. LOCKHART: Yes, that's where they 21 suffered. Whether they could -- they probably could 22 not have hedged a 5.5-trillion-dollar housing mortgage 23 credit risk. 24 represented so much of the mortgage market, at that 25 point, it was probably not possible. I mean, they -- you know, they 232 1 And as soon as they went into the market to 2 start hedging, they probably would have tanked the 3 whole market. 4 they, you know, they were too big to fail. 5 So that they were in the position that COMMISSIONER BORN: Well, there were 60 6 trillion dollars worth of credit default swaps out 7 there. 8 MR. LOCKHART: Right. 9 COMMISSIONER BORN: But even for that 10 enormous of market, this would have been a very 11 significant -- had a very significant impact. 12 MR. FALCON: 13 COMMISSIONER BORN: 14 17 Thank you very much. Yes, Mr. Falcon? 15 16 Ma'am? CHAIRMAN ANGELIDES: Do you have a comment, Mr. Falcon? MR. FALCON: I would just say that there's 18 one thing to hedge their credit risk, and that's to 19 hold more capital. They chose not to do that. 20 COMMISSIONER BORN: 21 CHAIRMAN ANGELIDES: 22 COMMISSIONER HENNESSEY: 23 24 25 Good point. Thank you. Mr. Hennessey? Thank you, Mr. Chairman. EXAMINATION BY COMMISSIONER HENNESSEY COMMISSIONER HENNESSEY: Mr. Lockhart, can 233 1 we talk a little bit about the failure of Fannie and 2 Freddie and, specifically, why you felt they had to be 3 put into conservatorship. 4 talk about what might have happened to mortgage 5 markets had you not done that and why you drew the 6 line with Secretary Paulson between equity and debt? 7 8 MR. LOCKHART: In particular, could you Okay, some good questions, there. 9 We put them into conservatorship because we 10 felt and as we really laid out in those various 11 reports, which I think you all have seen copies of, 12 that their -- their capital was eroding extremely 13 quickly. 14 They -- we saw credit losses that were 15 significantly more than their capital. 16 the deferred tax asset was not going to be worth 17 anything. 18 credit would, therefore, not be worth anything, 19 because they're going to be losing money far into the 20 future, and that their private label securities were 21 really suffering badly. 22 23 24 25 We saw that We saw that the low-income housing tax COMMISSIONER HENNESSEY: So why not -- why not just let them fail? MR. LOCKHART: Why not let them fail? Well, we felt that if we let them fail, that what 234 1 happened after Lehman would have been very small 2 compared to these 5.5-trillion-dollar institutions 3 failing. 4 So we felt that the best thing to do, and 5 we actually, you know, I've gotten some questions 6 about why conservatorship versus receivership, and we 7 made the decision, there were some legal reasons, but 8 I think also market reasons, we wanted to keep some 9 faith in those institutions. 10 And we had foreign sovereign governments in 11 their securities. 12 country invested in their mortgage-backed securities 13 and their preferred stocks, which gets me to your 14 second question of where we drew the line on the 15 conservatorship. 16 We had a lot of the banks in this One would have thought that we would have 17 let this subordinated debt go. 18 thought we were going to do it. 19 And that's where I The preferred stock and the common stock, 20 to my mind, if you're an equity owner and your 21 institution fails, you should lose it. 22 they're worthless at this point in my mind. 23 And -- and But the issue was the subordinated stock, 24 for many years people talked the subordinated stock as 25 being one of the -- 235 1 COMMISSIONER HENNESSEY: 2 MR. LOCKHART: Subordinated debt? Debt, debt, yeah, sorry, 3 sorry. 4 sort of being a cushion and would actually give some 5 market discipline. 6 They had talked about subordinated debt as As we looked into the structure of that debt -- and 7 the intertwining with the law, if we had let that debt 8 go down, it would have defaulted all their debt, and 9 that would have pulled down the whole institution. 10 So we had to keep it in place. 11 COMMISSIONER HENNESSEY: Okay. Just a 12 follow-up on that, as I understand it, if I'm running 13 a bank, I cannot hold all of my assets in the debt of 14 IBM or General Motors or Caterpillar, right? 15 are, as I understand it, there are banking rules, per 16 se? 17 18 MR. LOCKHART: There 10 percent or whatever the rule. 19 COMMISSIONER HENNESSEY: You can't put all 20 of your eggs into the -- into one basket where that 21 basket is the debt of a particular company, but the 22 same is not true for so-called agency debt; is that 23 correct? 24 25 MR. LOCKHART: Yes, agency debt, which I never liked that term because they were not government 236 1 agencies, they were enterprises, that was treated very 2 much like Ginnie Mae debt, that had the full faith and 3 credit of the United States government on it, and they 4 had to hold very little capital against it, and 5 unfortunately, you know, some of the buyers of that 6 preferred stock were banks, and they took very -- they 7 took a hundred percent hit on it. 8 9 COMMISSIONER HENNESSEY: lot about lobbying. Okay. We talked a Capital standards, minimum 10 capital standards, risk-based capital standards, and 11 then the ability to consider systemic risk in the size 12 of the portfolio. 13 Do you have knowledge of Fannie Mae and 14 Freddie Mac lobbying on any of those points, either 15 from a legislative standpoint or from a regulatory 16 standpoint? 17 MR. LOCKHART: I do not have direct 18 knowledge but I have indirect knowledge that they 19 certainly had people up on Capitol Hill talking 20 through the issues of legislation and the harm it 21 might do to the housing market. 22 COMMISSIONER HENNESSEY: Okay. Were you, 23 then, indirectly aware that they were lobbying against 24 you having the authority to raise capital standards 25 and against the authority for you to be able to 237 1 consider systemic risks? 2 MR. LOCKHART: In our monthly meetings with 3 the CEOs, we often talked about legislation, needless 4 to say. 5 those and especially the capital ones. 6 And certainly, to me, they resisted some of So as no doubt in my mind that if they were 7 resisting to me that they were probably resisting up 8 on Capitol Hill. 9 COMMISSIONER HENNESSEY: Okay. And 10 Mr. Falcon you were considered to be an aggressive 11 regulator when you were in this job but you were 12 limited in terms of the authorities that you had. 13 As you look at the legislation that was 14 enacted in 2008, which provided now FHFA with 15 significant authorities, can you give us a sense of 16 what you think you might have done with those 17 authorities had you had them in, say, 2004 and 2005? 18 Now, I know you have the benefit of 19 hindsight in knowing what happened, but based on the 20 kinds of things that you were pushing for, can you 21 give us a sense, had you had the ability to set 22 minimum capital, risk-based capital, even effect the 23 size of their portfolios? 24 have been consistent with your actions at the time? 25 MR. FALCON: What do you believe would Well, in the 2004-5 time 238 1 period, if we had those authorities, I think we would 2 have had more flexibility to deal with the capital 3 issues and try to deal with the leverage issue. 4 I think we would have moved towards having 5 them increase their capital, have a plan to increase 6 capital, even above the 30 percent that we had imposed on 7 them, we probably would have moved aggressively to 8 begin to shrink that portfolio, the portfolios that 9 both of them had, and we might have moved more 10 aggressively on even considering some form of a 11 conservatorship to deal with the cultural issues that 12 continued to exist at both companies. 13 COMMISSIONER HENNESSEY: Okay. If I could, 14 I would like to ask a couple of questions that I asked 15 Mr. Mudd this morning. 16 purchased in `05, `06, `07, do you believe that there 17 was a public purpose, a mission-related purchase for 18 those, or do you believe that they were primarily 19 driven by profit motives or market share? 20 MR. LOCKHART: The Alt-A mortgages that they Jim? Okay, sure, would be happy 21 to. 22 did not want to be left out of that segment of the 23 market. 24 had mission affordable housing. 25 The -- I would say it was both. They certainly There was certainly a portion of them that I'm not sure that on average that they met 239 1 the 55 percent. 2 probably less than 55 percent of the Alt-A's that they 3 had that would have met the mission goals. 4 I would have guessed that there was So the other piece was obviously the profit 5 component and the market share component. 6 they were seeing some of their biggest suppliers go 7 elsewhere, to the private label marketplace or 8 whatever, and I think that they felt that they wanted 9 to be a player. 10 COMMISSIONER HENNESSEY: Okay. You know, And 11 Mr. Mudd raised the issue, he seemed to be suggesting 12 that one of the reasons why Fannie failed was that 13 they were, in effect, a mono-line firm that lacked the 14 ability to diversify risk. 15 And I was asking, it seemed to me that a 16 more realistic explanation is that they didn't have 17 enough capital and they were poor at managing their 18 risks. 19 Can you each give us a sense of your 20 perspective on the mono-line argument that we heard 21 this morning? 22 MR. LOCKHART: Well, I'll start. First of 23 all, they were a mono-line insurance company. That's 24 really what they were, the mortgage-backed securities 25 they were insuring. They doubled up that risk, unlike 240 1 the other mono-line insurance companies, by having 2 giant portfolios. 3 risk, and that was a problem. 4 So they actually doubled up their But the key problem, they did not have 5 anywhere near as cap- -- capital -- enough capital as 6 they needed. 7 understand, and we talked about it today, that no one 8 understood how bad the mortgage market was going to 9 be. And, in retrospect, I think we all 10 When you really think about it, Congress, 11 when they set OFHEO up, only putting 45 basis points 12 of risk on mortgage credit risks, you just have to 13 scratch your head. 14 COMMISSIONER HENNESSEY: 15 MR. FALCON: Yes, sir. Mr. Falcon? I think that's a 16 convenient argument to make now. But throughout the 17 existence of these companies, they often touted about 18 how, in their opinion, they were the best risk 19 managers of any firm out there. 20 And to now say that they couldn't manage a 21 single risk, mono-line risk, I think is just contrary 22 to what they were saying. 23 The fact is that they had the ability to 24 control the risk that they took. 25 underwriting standards. They set their They didn't just buy whatever 241 1 their servicers sent to them. 2 guidelines, themselves. 3 They set those And if they had ability to better hedge 4 risk. 5 capital if they thought that was essential to manage 6 their credit risks. 7 of anyone in the private sector. 8 clearly a failure of management to properly run these 9 two companies. 10 11 They had ability to voluntarily hold more They had the lowest cost of funds I think this was COMMISSIONER HENNESSEY: Thank you, Mr. Chairman. 12 CHAIRMAN ANGELIDES: Thank you, 13 Mr. Hennessey. 14 risk manager in the world was a shared prize, 15 apparently, from what we've heard in our hearings 16 today. 17 18 19 20 By the way, the claim to be the best Yes, Mr. Thomas? VICE CHAIRMAN THOMAS: Just quickly on the follow-up to Mr. Falcon's last statement. EXAMINATION BY VICE CHAIRMAN THOMAS VICE CHAIRMAN THOMAS: You said that you 21 thought it was basically the management and their 22 failure to run the company properly. 23 the profile or the understanding or the assumed 24 purpose of the company. 25 company, in terms of profit and the argument about the It depends on And if you're a private 242 1 shareholders and the rest, I'm trying to see if you 2 could focus on the fact that they came to understand, 3 for them, the basic value and purpose of the company. 4 And in that score, notwithstanding their 5 failure, they really did a pretty good job of managing 6 it up until it became, as with everything else in that 7 market segment, unmanageable. 8 9 I mean, I see a pretty clear movement towards the self-interest. That may have been one of 10 the reasons they were structuring the operation the 11 way they were. 12 regard for quite a while? 13 Weren't they pretty successful in that MR. FALCON: Well, except for the fact that 14 through their accounting misconduct, they were masking 15 many problems within the companies. 16 VICE CHAIRMAN THOMAS: Well, then, you ask 17 yourself, what would motivate someone to mask some of 18 the problems, because it would get in the way of their 19 focus of what they were doing, wouldn't it? 20 MR. FALCON: Well, they were trying to mask 21 volatility in their business. 22 mask the risk in their balance sheets. 23 the political process trying to manage OFHEO's ability 24 to actually go in and dig deep and find these things. 25 They were trying to VICE CHAIRMAN THOMAS: Yeah? And through 243 1 MR. FALCON: 2 VICE CHAIRMAN THOMAS: 3 Yeah. It may not have been that that mismanaged based upon their focus and goal. 4 MR. FALCON: 5 MR. LOCKHART: I think they were -Well, excuse me, we're 6 working within a legal framework that didn't work. 7 And they -- you know, before I arrived they were 8 definitely mismanaged from the accounting and all 9 those areas. 10 They finally got that actually in pretty good shape after all those consultants I mentioned. 11 But the fatal flaw, really, was the 12 legislation. The management teams and the board of 13 directors could have gotten that legislation through 14 very quickly if they wanted to, and they didn't. 15 MR. FALCON: I understand your point. 16 VICE CHAIRMAN THOMAS: 17 MR. FALCON: 18 VICE CHAIRMAN THOMAS: 19 MR. FALCON: Thank you. And I agree with you. Yeah. Mismanagement implies that 20 they incompetently -- that they didn't know what they 21 were doing. 22 23 They knew what they were doing. VICE CHAIRMAN THOMAS: Yeah, that's the point I wanted to -- thanks. 24 CHAIRMAN ANGELIDES: Mr. Thompson? 25 COMMISSIONER HENNESSEY: Mr. Chairman, 244 1 just, if I could, just ten seconds. 2 3 COMMISSIONER THOMPSON: can't. 4 No, not now, you I'm sorry. COMMISSIONER HENNESSEY: Mr. Georgiou had a 5 question earlier just about the costs, and I just want 6 to add a CBO wrote, in January of this year, quote, in 7 its August 2009 baseline, CBO projected that the 8 operations of Fannie Mae and Freddie Mac would have a 9 total budgetary cost of 389 billion dollars between 10 2009 and 2019. 11 CHAIRMAN ANGELIDES: 12 or the economic? 13 191. 14 Is that the budgetary I thought the budgetary cost was COMMISSIONER HENNESSEY: That is their 15 estimate of the budgetary cost, which is the subsidy 16 for budget experts. 17 sure Doug could tell us a lot more about it. It's a credit subsidy model. I'm 18 CHAIRMAN ANGELIDES: I’ll await the tutorial. 19 COMMISSIONER HENNESSEY: 389 billion. 20 CHAIRMAN ANGELIDES: 21 22 I would like to go to Mr. Thompson. COMMISSIONER GEORGIOU: I wanted to 23 follow-up on that point. Maybe I can make it later 24 but I just wanted to add to what Commissioner 25 Hennessey said, which is that in addition to the 26 dollars that were lost, there also were and are 245 1 significant investments in both the preferred 2 securities, which Mr. Lockhart has told us that he 3 thinks may be may never be worth anything, that the 4 Treasury has purchased 75.2 billion of Fannie 5 preferred stock, and in addition, the Federal Reserve 6 has been purchasing mortgage-backed securities and has 7 purchased 1.026 trillion of Fannie and Freddie MBS, 8 and Treasury has purchased 254 billion of 9 mortgage-backed securities, of course hoping that they 10 won't reduce in value, but certainly there's a serious 11 question whether they will under the circumstances. 12 MR. LOCKHART: Well, they're backed by that 13 preferred stock, effectively those mortgaged-backed 14 securities. 15 government is effectively backing those 16 mortgage-backed securities. 17 put another one and a trillion dollars into it to help 18 solve this problem, and it's just amazing how bad it 19 got. 20 21 24 25 But, you know, they have CHAIRMAN ANGELIDES: All right. Go to Mr. Thompson. 22 23 So if there's further losses, the U.S. COMMISSIONER THOMPSON: Oh, I don't want to do it now. CHAIRMAN ANGELIDES: extraordinarily patient. You've been 246 1 2 VICE CHAIRMAN THOMAS: an additional five minutes. 3 4 5 Yield the gentleman COMMISSIONER THOMPSON: I don't think I'll take that long now. EXAMINATION BY COMMISSIONER THOMPSON 6 COMMISSIONER THOMPSON: As you well know, 7 gentlemen, our mission here is to try to explain to 8 the American people what caused this crisis and what 9 almost brought our economy to its knees. 10 And, as such, we are asked to look at the 11 issues and the institutions. 12 said Fannie and Freddie are failed enterprises. 13 also acknowledged that you were outmaneuvered 14 politically, your budget was inadequate, your staff 15 was too small, you were under skilled for the task 16 that was before you. 17 And you, Mr. Falcon, You You are the fifth regulator we've had 18 before us in the series of hearings that we've 19 conducted. 20 mission being within the SEC or OCC or one of those 21 other regulators, if you were in such bad shape? 22 Why do you exist, as opposed to this MR. FALCON: Well, I think if we were originally-- OFHEO was 23 set up as an independent regulatory entity. 24 make it independent and not subject to the political influences of being 25 part of the Treasury Department or some other government entity. 26 I think the idea was try to I think that was sound except for the lack 247 1 of authorities and resources on par with every other 2 safety and soundness regulator. 3 COMMISSIONER THOMPSON: Couldn't another 4 safety and soundness regulator have done this work? 5 Given that you got outmaneuvered politically, that you 6 were underskilled and understaffed, I mean, I just 7 don't get why you exist. 8 9 10 MR. FALCON: Created, I think the law was in the 1992 Act that created the agency. 11 12 Well, the agency was COMMISSIONER THOMPSON: I understand that, but couldn't someone else have done this work? 13 MR. LOCKHART: Someone else had done it 14 before, the Federal Home Loan Board, was 15 responsible for Freddie and the S&Ls. 16 so out of that they decided that they needed an agency 17 that could focus on these two giants. And, you know, 18 And, you know, Fannie and Freddie didn't 19 want it at the time and they had made sure that the 20 legislation, at the time, was very weak. 21 And that was, to me, again, the problem, 22 here. Actually, it makes a lot of sense. I think the 23 new legislation that gave us the responsibility not 248 1 only for Fannie and Freddie, but the federal home loan 2 banks now, actually does create a regulator that has 3 the power to really oversee the whole secondary 4 mortgage market in this country. 5 MR. FALCON: But I think the answer to your 6 question is, yes. 7 not create OFHEO and give this authority to the OCC or 8 the Federal Reserve or some other safety and soundness 9 regulator. 10 The congress could have decided to That was always a possibility. COMMISSIONER THOMPSON: Well, it seems as 11 if you were inadequate in skills and capabilities that 12 there was a heck of a lot more capability for similar 13 instruments to be evaluated and assessed sitting 14 inside the SEC or the OCC, but be that as it may. 15 MR. LOCKHART: 16 examiners came from the OCC or OTS. 17 did raid that talent pool to build up the agency. 18 Well, actually, most of our COMMISSIONER THOMPSON: So we actually But my point is 19 there are economies of scale to be derived from 20 consolidation of organizations as opposed to 21 fracturing and splintering the organizations 22 throughout an enterprise. 23 24 25 VICE CHAIRMAN THOMAS: Commissioner, if I might, for just a minute? COMMISSIONER THOMPSON: Sure. 249 1 2 CHAIRMAN ANGELIDES: Mr. Thomas, on his own time. 3 VICE CHAIRMAN THOMAS: None of those other 4 regulatory agencies would have been subject to the 5 appropriations process. 6 7 COMMISSIONER THOMPSON: have helped. 8 9 Maybe that would VICE CHAIRMAN THOMAS: Let me explain this. I was new to the Ways and Means Committee, and I came 10 up with the proposal to make this adjustment that 11 President Reagan had asked for, all in one year, it 12 was a 30-billion-dollar proposal. 13 I was taken aside and explained, you don't 14 do things that way; we will make it in three 15 10-billion-dollar amounts because then they will have 16 to come to us three different times. 17 18 19 COMMISSIONER THOMPSON: And that's supposed to be good? VICE CHAIRMAN THOMAS: From the position of 20 the chairman of the Ways and Means Committee, 21 apparently it sure was. 22 COMMISSIONER THOMPSON: Well, Mr. Lockhart, 23 you described the future of this industry and you gave 24 a very rational view of what might happen. 25 asked the question, what happens to OFHEO when, if in I then 250 1 fact that were to evolve, is this a regulatory body 2 that in a repackaged industry we really need? 3 MR. LOCKHART: 4 repackaging goes, no. 5 recreate new GSEs, yes. 6 structure, maybe not. 7 Depending on how the It could be, depending, if we If we go to some other I think the key thing though, is whatever 8 we have, we have to have a group that really 9 understands the mortgage market and has oversight of 10 it. 11 Our -- the mortgage market was very 12 fractured from a regulatory standpoint. 13 nontraditional mortgage guidance that the bank 14 regulators put out, we weren't even involved in, and 15 yet we were the biggest player in the mortgage market. 16 The So the key thing in regulatory reform, to 17 me, is you've got to pull people together. 18 agencies you end up with is not as important as you 19 have to have those agencies work very closely 20 together. 21 COMMISSIONER THOMPSON: How many Well it -- it 22 certainly would cost the American taxpayers a lot less 23 money if we aggregated the infrastructure that 24 underpins these agencies that oversee the financial 25 soundness of our economy. 251 1 MR. LOCKHART: One could argue that. On 2 the other hand, I think actually our ability to work 3 on just a few agencies has actually helped in some 4 areas. 5 I mean, you know, a big bank regulator may 6 have a thousand different entities that it has to 7 regulate, and that could be cumbersome as well. 8 9 COMMISSIONER THOMPSON: organization then. 10 11 It's all about All right, I yield my time. CHAIRMAN ANGELIDES: Thank you, Mr. Thompson. 12 Just one observation, I was going to ask a 13 question, but I am going to ask the question related 14 to Mr. Thompson's questioning about the need for this 15 regulator. 16 And it really does go to 2008, just in all 17 candor, do the -- did the Federal Reserve and OCC, when 18 they came in, I believe in, what, July/August? 19 MR. LOCKHART: Yes. 20 CHAIRMAN ANGELIDES: Did they find things 21 that you had not found, or were they affirming what 22 you had already found? 23 24 25 MR. LOCKHART: Some of both, they found some things that we hadn't found. CHAIRMAN ANGELIDES: And you hadn't found 252 1 it just because of their capability, the breadth or 2 depth of their bench, or why is that? 3 MR. LOCKHART: Well, one thing, is they 4 actually, the bank regulators, had a somewhat 5 different approach to reserving than Fannie and 6 Freddie did, and when we ran -- run the portfolios 7 through their approach, the losses got bigger. 8 9 10 CHAIRMAN ANGELIDES: All right. So they did have a different perspective that you did not have. 11 MR. LOCKHART: Yes. 12 CHAIRMAN ANGELIDES: Okay. Mr. Mudd 13 earlier today noted the delinquency rate of GSE, of 14 Fannie and Freddie loans, versus the Wall Street or 15 private market was definitively less. 16 He noted that, you know, the risk of coming 17 with -- by being a big mono-line insurer, and I do 18 wonder, and I only say this because I'm picking up on 19 your comment, in the end, you know, so many mono-line 20 entities went down; mono-line insurers, large thrifts 21 went down, because when the market turns against you 22 and that's your only business it's very hard to 23 sustain it. 24 had been extraordinarily well capitalized, because at 25 some point you have to have a return on equity for He made the observation that even if they 253 1 investors, so there's a balance here. 2 can't be so well-capitalized there's no return. 3 I mean, you He essentially made the point we would have 4 had levels of -- needed levels of capital such that 5 they were not feasible in the marketplace to have 6 sustained this way; do you agree with that? 7 MR. FALCON: At some point too much 8 capital, right, doesn't serve the entities. 9 that level, 2.5 percent, I think it was very, very 10 But at highly leveraged then. 11 CHAIRMAN ANGELIDES: So they would have -- 12 agreed, they were -- they were 61 -- well, they 13 weren't even at 2 and a half percent. 14 off-balance-sheet they were effectively at one and a 15 half, 60 to 1, 70 to 1 ratio. 16 mention it is it reinforces your observation, that 17 there is part of this market that can legitimately be 18 served by the private markets and some that cannot be 19 and therefore we shouldn't have the false promise that 20 it can be. They were But the only reason I 21 Because what turned out to be it was a 22 massive false promise to the American people that 23 somehow that these activities could be sustained 24 without subsidy in the end. 25 MR. LOCKHART: If you look at the number 254 1 Commissioner Hennessey just put out, that would have 2 been well less than 10 percent of their risk. 3 we're now asking banks to put up capital around 10 4 percent. 5 6 And And what really happened here is we subsidized homeowners by that very low capital charge. 7 CHAIRMAN ANGELIDES: And also compen- -- 8 well, we subsidized homeowners, shareholders, and 9 executives? 10 MR. LOCKHART: 11 CHAIRMAN ANGELIDES: 12 I agree. Okay. Is that a fair statement? 13 MR. LOCKHART: That's a fair statement. 14 CHAIRMAN ANGELIDES: Yeah, we did more -- 15 there was a fair -- it turned out to be a relatively 16 inefficient way to subsidize homeowners. 17 18 19 20 21 MR. LOCKHART: Right. And now the taxpayers' paying all that subsidy back. CHAIRMAN ANGELIDES: Because there's some barnacles, there were some barnacles on the whale. COMMISSIONER HOLTZ-EAKIN: I will simply 22 note for the record that the CBO actually broke apart, 23 who got the subsidies that were implicit in 24 separation, and the homeowners got a de minimus part 25 of the subsidy. The vast majority went to 255 1 shareholders and management. 2 CHAIRMAN ANGELIDES: Mr. Holtz-Eakin, would 3 you be willing to provide that information to the 4 Commission, under oath, or under subpoena, or voluntarily? 5 6 COMMISSIONER HOLTZ-EAKIN: One can get it from the CBO website. 7 CHAIRMAN ANGELIDES: Thank you. I want to 8 talk, just for minute, as we wrap up here about the 9 affordable housing goals, because I want to understand 10 a little bit about how the process worked. 11 HUD would propose them, how iterative a 12 process was this; in other words, was it a process in 13 which Fannie and Freddie would say here's where we 14 legitimately can meet, or do they really flow out of 15 HUD? 16 soundness? 17 And would you look at them for safety and MR. FALCON: I was not -- OFHEO -- the 18 OFHEO director is not directly involved in setting the 19 goals. 20 familiar with how it works. 21 But we do play a role and I am a little And my understanding, it was a sort of a 22 back-and-forth that the goals were frequently proposed 23 by HUD, there was push-back by Fannie and Freddie, and 24 eventually they came out with a number where HUD 25 thought it showed advancement, and higher goals and 256 1 Fannie and Freddie were of the opinion that they could 2 meet them. 3 4 And this typically is the way this negotiation happened as I understand the process. 5 CHAIRMAN ANGELIDES: Because in our 6 interviews with Fannie staff, according to our staff, 7 no one of the Fannie folks, Fannie Mae folks we 8 interviewed recalled that they raised concerns that, I 9 guess, there was an iterative process. 10 But at the end of the day, no one said this 11 is going to jeopardize safety and soundness. 12 question is, did you ever comment on them? 13 MR. FALCON: My Yes, HUD would run the 14 goals by OFHEO, and we would examine them and opine 15 whether or not we thought they could -- 16 CHAIRMAN ANGELIDES: 17 So under your tenure, which ended in 2005; 18 correct? 19 MR. FALCON: 20 CHAIRMAN ANGELIDES: 21 22 23 24 All right. Yes. Did you ever voice an objection to them on safety and soundness grounds. MR. FALCON: No. But – CHAIRMAN ANGELIDES: Go ahead. I don’t want to cut you off. MR. FALCON: But we also always told the 25 enterprises that if situations ever changed and we -- 26 and they thought that they couldn't meet the goals 257 1 without taking on an excessive risk, then we made it 2 clear to them that they should not take on that excessive 3 risk. 4 5 CHAIRMAN ANGELIDES: circle back to you and say we've got a problem here? 6 MR. FALCON: 7 CHAIRMAN ANGELIDES: 8 MR. LOCKHART: The goals were set I think CHAIRMAN ANGELIDES: MR. LOCKHART: 14 CHAIRMAN ANGELIDES: Yes, they did. So this is the first time I think they began to nudge above 50. 16 MR. LOCKHART: 17 CHAIRMAN ANGELIDES: 18 And they did escalate in 2004; correct? 13 15 Okay, Mr. Lockhart, in 2004 for a four- or five-year period. 11 12 No. same set of questions? 9 10 And did they ever Yeah. In which you were talking about? 19 MR. LOCKHART: Yes. They kept pushing them 20 and pushing them, but that whole set of decisions was 21 made in 2004, I think. 22 involved in the goal-setting while I was there because 23 they were just about ready to be reset when everything 24 started. 25 And so we never really got CHAIRMAN ANGELIDES: So they weren't 258 1 annualized, there weren't annualized renewals of those? 2 MR. LOCKHART: It was cast in concrete, if 3 you will, and it was not market-related, which was 4 really the fatal flaw. 5 6 CHAIRMAN ANGELIDES: set them on an escalator. 7 MR. LOCKHART: 8 CHAIRMAN ANGELIDES: 9 10 Exactly. Did you have the ability, statutorily, to, like in 2005 or `6, to express safety and soundness objections? 11 12 And so in 2004 they MR. LOCKHART: I could have talked to the HUD secretary but I didn't have any authority. 13 CHAIRMAN ANGELIDES: But did you? Or did 14 you -- or did you -- did you ever express concerns 15 about them? 16 parties felt about them. 17 I'm just trying to get to what -- how And, of course, I can see in an up market, 18 where everyone's feeling like we can get there. 19 I'm just curious about whether or not you expressed 20 objections or concerns about them. 21 22 MR. LOCKHART: Internally, but I don't think we talked to HUD about them. 23 CHAIRMAN ANGELIDES: 24 MR. LOCKHART: 25 But them a lot. Okay or to Fannie? Fannie talked to us about 259 1 2 CHAIRMAN ANGELIDES: And we'll explore -- they talked to you about them in what regard? 3 MR. LOCKHART: Well, how tough they were. 4 As I said before, the CEOs were very afraid of missing 5 them, they missed part of them, I guess, in `07. 6 missed them by a mile in `08. 7 They And part of the legislation, you know, we 8 did get authority for that, and while I was there, we 9 changed that structure pretty dramatically. 10 CHAIRMAN ANGELIDES: So they were -- they 11 were expressing concern they weren't going to get 12 there? 13 MR. LOCKHART: Yes. 14 CHAIRMAN ANGELIDES: Okay. Because I 15 understand HUD did lower some standards at their 16 request, but we'll look at the record. 17 18 19 MR. LOCKHART: I think what they did is when they missed them they allowed them to miss them. CHAIRMAN ANGELIDES: They missed them and 20 then, in a sense, excused the miss. 21 MR. LOCKHART: 22 CHAIRMAN ANGELIDES: 23 VICE CHAIRMAN THOMAS: 24 CHAIRMAN ANGELIDES: 25 VICE CHAIRMAN THOMAS: Yes. All right. Mr. Chairman? Yes. The expressed 260 1 concerns, were they on safety and soundness? 2 were the grounds on expressing concern? 3 MR. LOCKHART: What The underlying was safety 4 and soundness. 5 were just not going to meet the goals, that it was 6 just not possible. 7 But the real concern was that they There were some years, you can look in the 8 historical record, that they did transactions right in 9 December to make those goals. 10 The goals not only were a single-family but 11 they were -- multi-family added a lot to the goals. 12 So you can see some years they did some very large 13 multi-family transactions just to hit the goals. 14 VICE CHAIRMAN THOMAS: So they knew what 15 the targets were and they sometimes shaped their 16 behavior -- 17 MR. LOCKHART: 18 VICE CHAIRMAN THOMAS: 19 Yes. specific targets? 20 MR. LOCKHART: 21 VICE CHAIRMAN THOMAS: 22 23 -- to meet those Yes. Thank you, Mr. Chairman. CHAIRMAN ANGELIDES: All right. 24 all very much. 25 by, first of all, thanking the witnesses. Thank you So let me just conclude this meeting Thank you 261 1 for your time. 2 Thank you for being here today. 3 Thank you for your public service. I want to thank Vice Chairman Thomas for 4 his continued work with me and the other commissioners 5 as we, as a bipartisan Commission with a nonpartisan 6 mission, really try to do the best job of examining 7 what happened here in this event of tremendous 8 consequence or series events of consequence for this 9 country. 10 I want to thank all the members of the 11 Commission. 12 commissioners on this research and investigation 13 project on subprime lending securitization, this 14 hearing, Mr. Wallison, Mr. Georgiou, and Ms. Murren. 15 I want to particularly thank the lead I want to thank our staff, who has provided 16 an exceptional amount of information, literally 17 hundreds of interviews to date, hundreds of thousands 18 of documents, for their excellent staff work and their 19 very long hours. 20 And thank you, the public, who has joined 21 us. And I also want to remind everyone, as the Vice 22 Chairman reminded me to, that you folks should go to 23 our website at FCIC.gov. 24 that website, background, staff reports, preliminary 25 staff reports that have not been adopted by this We have posted papers on 262 1 Commission, and they are available for comment. 2 we encourage comments or would like comments by May 3 15th. 4 And Mr. Thomas? VICE CHAIRMAN THOMAS: Mr. Chairman, in 5 continuing the bipartisanship that we have displayed, 6 on behalf of the Commission I would like to thank the 7 Chairman of the Energy and Commerce Committee, 8 Mr. Waxman and his staff, for providing us 9 accommodations. 10 I would have liked a couple more degrees 11 down on the thermostat but it's -- understanding what 12 our options were, we do appreciate and thank them. 13 For those who have never tried to run these kinds of 14 hearings outside of a congressional hearing room, it's 15 really, really hard to do, and I want to thank them 16 for their courtesy. 17 CHAIRMAN ANGELIDES: Thank you all, I would 18 like to ask if the commissioners would gather 19 extraordinarily briefly in the anteroom right after 20 this meeting. 21 22 23 24 25 Thank you all very much. (FCIC Hearing adjourned at 2:45 P.M.)
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