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5/12/2020 Assistant Secretary for Financial Institutions Michael S. Barr Remarks to the Mortgage Bankers Association As Prepared for Delivery U.S. DEPARTMENT OF THE TREASURY Press Center Assistant Secretary for Financial Institutions Michael S. Barr Remarks to the Mortgage Bankers Association As Prepared for Delivery 4/13/2010 TG - 638 Just over one year ago, when President Obama took office, the financial system was teetering on the edge. A failing financial system threatened to drag the economy into the depths of another Great Depression. Were it not for the decisive actions of this President, the situation on all fronts would be much worse than it is today. And yet the costs to Americans of the financial crisis have been devastating nonetheless. Many have seen their house values drop precipitously, their savings threatened, their jobs eliminated or reduced, and their small businesses lose financing. This Administration is pursuing a broad array of initiatives to help American families recover from this devastation. Our efforts to stabilize the housing finance markets are bearing fruit . We are seeing signs of stabilization, but the housing market recovery remains fragile. The housing market still depends critically on the Administration's strong support for the stability of Fannie Mae and Freddie Mac and the liquidity contributed by the Federal Housing Administration. A recovery in private mortgage lending is still only nascent. The path to housing recovery will be painful. Despite our best efforts across a wide range of initiatives, there will still be many more foreclosures. Our programs are not designed to reach every borrower, nor should they be. But we will reach millions of homeowners with a second chance. We will continue our efforts to stabilize the housing market and we will stand by our strong commitment to the stability of Fannie Mae and Freddie Mac, which are so critical to home mortgage financing and stability today. Beyond the housing market, in the broader economy, there are encouraging signs that recovery is beginning to take hold. The Administration's decisive steps to restore confidence in the financial system helped lay the groundwork for growth. The Administration's Recovery Act has helped businesses keep their doors open and workers keep their jobs. But a stable and lasting recovery requires comprehensive financial reform. The crisis reminded us painfully how much the larger economy depends on a well-functioning financial system. Our system was unstable, so unreliable it could collapse seemingly overnight. And it was inefficient, funneling trillions of dollars of private resources into a housing bubble instead of into productive investments that would grow the economy over the long term. Reform is about security for families in their savings. It's about laying the foundation for investment in our small businesses and entrepreneurs. It's about promoting the growth we need to create jobs. That is why each month, each week, each day, the legislation that will bring reform is gaining momentum. Reform is coming. Regulatory Failures and the Race to the Bottom As we move to overhaul a broken system of financial regulation, let us remember how we got to this point. We had a near catastrophe because private risk-taking led to a race to the bottom unconstrained by either market discipline or government oversight. Weak and fragmented regulation and enforcement was a recipe for a vicious cycle of deteriorating standards in lending practices. Perhaps nowhere was this degrading dynamic more apparent, or more destructive, than in the mortgage market. markets engaged in self-destructive behavior, blithely ignoring risks for short-term gain. The housing finance There were inadequate rules, inadequate monitoring, and inadequate enforcement on all levels of the mortgage market. On the level of the lenders and brokers that originate mortgages. On the level of the Wall Street firms that packaged and securitized these mortgages and the credit rating agencies that rated them. And on the level of the government sponsored enterprises operating in the conforming market. https://www.treasury.gov/press-center/press-releases/Pages/tg638.aspx 1/4 5/12/2020 Assistant Secretary for Financial Institutions Michael S. Barr Remarks to the Mortgage Bankers Association As Prepared for Delivery Beginning in the under-regulated, non-bank sector, underwriting standards were greatly relaxed. Rather than lending primarily against the credit quality of the borrower and assessing ability to pay, lenders increasingly underwrote mortgages based on the current and future expected value of the home. Borrowers were able to buy homes with no down payment. They were able to buy homes with no documentation of income. They were able to take out mortgages with teaser rates on terms they could not afford when the payment increased. Many borrowers were sold complicated loans they could not understand. They frequently took guidance from originators who were paid more to make or arrange riskier loans and loans with higher rates and fees than the borrowers qualified for. These unsafe practices grew first among nonbank originators because that is where regulation was weakest. The federal government did not supervise these firms and conducted limited enforcement. Many states showed significant leadership, but their efforts were outpaced by the growth of national firms operating across state lines. Independent mortgage lenders and brokers did not act in a vacuum to relax standards. They responded to a strong push from Wall Street. For Wall Street was in its own race to the bottom. Firms were competing to produce mortgage-backed securities from subprime and alt-A mortgages. Then competition led them to create and sell Collateralized Debt Obligations (CDOs) based on these securities. That was followed by so-called synthetic CDOs based on other CDOs. Firms generated increasingly vulnerable and ultimately foolhardy structured finance products where even the triple-A portion would be wiped out if house price appreciation slowed, largely because of the lack of diversification in the mortgage collateral backing these assets. Here too, lax and inconsistent oversight left the system open to this vicious cycle. Supervision of mortgage lending by banks and their affiliates was fragmented over four different agencies, slowing responses to problems and inviting regulatory arbitrage. Parts of Wall Street were crawling with safety and soundness regulators, and parts were not. Major investment banks were allowed to ramp up their leverage without real, consolidated oversight. The largest of them operated under a voluntary oversight regime, an oxymoron if ever there was one. And so the explosive growth of the less regulated sectors of the housing finance system applied pressure on the regulated sector. Some federal regulators imposed different standards than others. Firms that were interested in offering some of the more exotic products, such as Option ARMs or low-documentation loans, generally structured themselves to take advantage of more permissive supervision regimes. Fannie and Freddie were eventually caught up in this destructive race. The GSEs had lost market share as standards deteriorated around them, and they made poor strategic choices to try to gain some of that market share back. The GSEs took on too much risk in order to grow their retained portfolios and increase returns. Some have claimed that Fannie and Freddie's collapse was caused by the government's imposition of affordable housing goals. This claim simply is not supported by the facts. Affordable housing goals did not drive the GSEs to the poor decisions that caused them to fail. The GSEs relaxed standards for the same reasons other market participants relaxed standards: old-fashioned greed and flawed regulation. Their stockholders saw the GSEs losing market share and profits to the churning mortgage machine on Wall Street. They pushed the GSEs to increase their shares and their returns. GSE management complied, because they were rewarded for short-term profits more than for long-term sustainability. The market did not discipline management's decisions because the market assumed Fannie and Freddie had a government backstop. And their regulator lacked standing and authority to substitute the discipline that was missing. Misaligned incentives and weak oversight caused Fannie and Freddie to collapse. By the time Congress enacted the HERA legislation, giving real teeth to the GSE regulator, it was too late. Financial Reform Where do we go from here? Let us remember that the financial regulatory system in place today is virtually the same system that allowed this race to the bottom. The same gaps and loopholes that allowed firms like Bear Stearns and Lehman Brothers to build up excessive leverage and escape meaningful consolidated supervision remain. The same gaps in regulation that permitted AIG to sell over-the-counter credit default swaps on mortgage-backed securities with inadequate capital and weak oversight remain. The same fragmented system of consumer regulation – seven different federal agencies, none looking at the whole consumer market, each looking at just a part of it – remains in place. We cannot let these weaknesses remain lest our new financial system be erected on a crumbling foundation. We must close these loopholes so no major firm escapes serious oversight. We must have comprehensive reform of our financial markets, including for derivatives transactions and securitization of mortgages. We must consolidate federal consumer financial protection in a truly accountable, truly independent body with the resources to maintain standards in every corner of the market. And we must end the perception of "too big to fail". A key test of the sufficiency of any reform proposal is whether it reduces the risk of races to the bottom. Whether it substantially reduces the potential for regulatory arbitrage and the incentives of regulators to lower standards. https://www.treasury.gov/press-center/press-releases/Pages/tg638.aspx 2/4 5/12/2020 Assistant Secretary for Financial Institutions Michael S. Barr Remarks to the Mortgage Bankers Association As Prepared for Delivery The President's reform plan does that. First, the President's plan directly takes on the corrosive problem of "too big to fail." Today, we heard the first in what is sure to be a series of misleading arguments from those who favor the status quo and oppose real reform. This just goes to show that some people will say anything to get the chance to side with Wall Street against American families. The claims that the Senate banking bill would lead to permanent bank bailouts are flatly false. The opposite is true – the government interventions into the financial industry were created by a failed regulatory system that is still in place today. The only way to end "too big to fail" is through real reform. The Senate bill explicitly mandates that a failing financial firm would be sold off, broken apart, and liquidated. Culpable management would be replaced, creditors would suffer losses, and shareholders would be wiped out. In addition, by requiring post-resolution assessments on the financial industry to recoup any losses, Chairman Dodd's bill makes it absolutely clear that large financial firms – not taxpayers – would bear any costs associated with the resolution of a failed financial firm. The bill limits the Federal Reserve Board's emergency lending authority – subjecting it to prior written approval from the Treasury Secretary and explicitly banning any one-off programs for individual companies. Moreover, the bill unequivocally states that the Federal Reserve may not use its 13(3) lending authorities to "aid a failing financial company." Failing and insolvent firms will receive no protection from the emergency lending authorities of the Federal Reserve. Some have said that the creation of tough, accountable supervision of the largest banks and financial firms will encourage the market to view these firms as "too big to fail." In fact, the opposite is true: for the first time, we will have the authority to impose tough standards – capital, liquidity, concentration limits, and heightened disclosure requirements – on the next AIG, Bear Stearns or Lehman Brothers. And by providing the tools to wind down even the largest financial firms, and by prohibiting the Federal Reserve from using its emergency lending power to aid a failing financial company, Chairman Dodd's bill ensures that no firm will be insulated from the consequences of its actions and no firm will be protected from failure. We want to work with anyone who has constructive ideas to end the abuses on Wall Street and make sure that taxpayers are never put on the hook for the irresponsibility the largest financial firms. We invite Congress to establish this principle today by enacting the Financial Crisis Responsibility Fee to recoup every penny of TARP from the financial industry, and to pass financial reform legislation. Second, our plan reduces the risk of races to the bottom in consumer protection. The current system fragments federal authority among seven different federal agencies. It allocates fifteentimes as much federal dollars to overseeing compliance with consumer laws by banks than by nonbank financial service providers. In place of this fragmented, ineffective system, the Senate bill will establish one independent bureau of consumer financial protection with a clear mission: to prevent abusive and deceptive practices and to promote transparency and consumer choice. It will write rules of the road for the entire consumer financial marketplace and ensure they are enforced consistently across the entire marketplace. Consolidation means an end to the risk of shopping for the weakest consumer protection standards. Consolidation means someone is watching over the market as a whole, not just over particular firms. Consolidation means government can act much faster to address emerging issues – months instead of the years it took government agencies to set common-sense standards for subprime teaser-rate mortgages. Consolidation means that anyone that makes or arranges mortgages, regardless whether they are chartered as depositories, will be subject to consistent oversight--including originators, brokers, servicers, and loan modification and foreclosure relief services. Now some have said that consolidating federal oversight of the mortgage origination market makes sense, but they question why the consumer financial protection agency should have jurisdiction over other, non-mortgage markets. Treating consumer products in isolation would be a grave error. Excessive credit card borrowing and auto lending fed an irresponsible wave of cash-out refinancing and home equity loans that have now left millions underwater. We must build solutions that respect these connections among markets and products. Third, we must address regulation of our financial markets, starting with derivatives. Businesses large and small depend on the smooth functioning of the derivatives markets. But today, the market for over-the-counter derivatives operates largely in the shadows. And the derivatives market was right at the center of the financial crisis. In place of the opaque, unregulated market we have today, the President's plan provides for strong regulation and transparency for all derivatives, customized or standardized. Standardized derivatives will be centrally cleared and traded. Over the counter derivative dealers and major swaps participants will be subject to strong prudential standards and regulation, including capital and margin requirements. https://www.treasury.gov/press-center/press-releases/Pages/tg638.aspx 3/4 5/12/2020 Assistant Secretary for Financial Institutions Michael S. Barr Remarks to the Mortgage Bankers Association As Prepared for Delivery The President's plan protects the ability of end users to manage their risks, and secures for end users the benefits of a more disciplined, transparent market. We must not let derivatives markets go back into the dark. Fourth, we need to address the problem of "too big to fail." We need reform so that no firm will be insulated from the consequences of its actions, no firm will be protected from failure, and taxpayers will never foot the bill for Wall Street's mistakes. Large financial firms facing insolvency in times of economic stress will be shut down or broken apart. Management will be replaced. Creditors will suffer losses. Equity holders will be wiped out. And large financial firms, not taxpayers, will be required to bear the costs. At the same time, the President's plan will create the limited tools necessary to protect healthy, solvent firms in times of crisis, so that the failure of even the largest firm does not put the rest of the system – and the broader economy – at risk. When the President signs financial reform legislation, the corrosive, destabilizing problem of "too big to fail" will be a thing of the past. And every American taxpayer has an interest in seeing that happen. Our plan will bring fundamental reform of both safety and soundness regulation and consumer protection regulation. These reforms substantially reduce the chance that we will again see such a destructive race to the bottom as we saw in the mortgage market. Housing Finance Reform We must also reform our housing finance system in a careful and comprehensive manner. It is a system that worked well for many years. It provided credit to households in a reliable and stable manner, setting appropriate standards for mortgage origination, and attracting diverse sources of capital though securitization. But the housing finance system was ultimately unstable. We will propose reforms that seek to keep it stable and well-functioning. As Secretary Geithner said recently, our proposals will be designed to achieve four critical objectives. First, mortgage credit should be available and distributed on an efficient basis to a wide range of borrowers, including those with low and moderate incomes, to support the purchase of homes they can afford. Second, a well-functioning housing market should provide affordable housing options, both ownership and rental , for low- and moderateincome households. Third, consumers should have access to mortgage products that are easily understood, such as the 30-year fixed rate mortgage and conventional variable rate mortgages with straightforward terms and pricing. Fourth, the housing finance system should distribute the credit and interest rate risk that results from mortgage lending in an efficient and transparent manner that minimizes risk to the broader financial and economic system and does not generate excess volatility or contribute to financial instability. These are the core objectives we will seek to fulfill. And we welcome your input to help us determine how best to fulfill them. I look forward to holding an ongoing conversation with you and others in the debate about the future of our housing finance system. Conclusion In the coming weeks and months we will be pressing to finish the job of financial reform. The urgency of reform is increasing--not decreasing--as the crisis recedes. It has now been two and a half years since the crisis started. It has been ten months since President Obama first laid out a proposal for comprehensive reform. And it has been four months since the House of Representatives passed their major reform bill. The Senate is poised to act. We have a chance to enact the strongest, most important financial reforms since those that followed the Great Depression. We need to get the job done so that our country can focus its full attention on healing the damage that has been inflicted and building a sustainable economy for the future. Thank You. https://www.treasury.gov/press-center/press-releases/Pages/tg638.aspx 4/4
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