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RECENT EVENTS IN THE CREDIT AND MORTGAGE
MARKETS AND POSSIBLE IMPLICATIONS FOR
U.S. CONSUMERS AND THE GLOBAL ECONOMY

HEARING
BEFORE THE

COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION

SEPTEMBER 5, 2007

Printed for the use of the Committee on Financial Services

Serial No. 110–58

(

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WASHINGTON

39–537 PDF

:

2007

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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania
MAXINE WATERS, California
CAROLYN B. MALONEY, New York
LUIS V. GUTIERREZ, Illinois
NYDIA M. VELÁZQUEZ, New York
MELVIN L. WATT, North Carolina
GARY L. ACKERMAN, New York
JULIA CARSON, Indiana
BRAD SHERMAN, California
GREGORY W. MEEKS, New York
DENNIS MOORE, Kansas
MICHAEL E. CAPUANO, Massachusetts
RUBÉN HINOJOSA, Texas
WM. LACY CLAY, Missouri
CAROLYN MCCARTHY, New York
JOE BACA, California
STEPHEN F. LYNCH, Massachusetts
BRAD MILLER, North Carolina
DAVID SCOTT, Georgia
AL GREEN, Texas
EMANUEL CLEAVER, Missouri
MELISSA L. BEAN, Illinois
GWEN MOORE, Wisconsin,
LINCOLN DAVIS, Tennessee
ALBIO SIRES, New Jersey
PAUL W. HODES, New Hampshire
KEITH ELLISON, Minnesota
RON KLEIN, Florida
TIM MAHONEY, Florida
CHARLES WILSON, Ohio
ED PERLMUTTER, Colorado
CHRISTOPHER S. MURPHY, Connecticut
JOE DONNELLY, Indiana
ROBERT WEXLER, Florida
JIM MARSHALL, Georgia
DAN BOREN, Oklahoma

SPENCER BACHUS, Alabama
RICHARD H. BAKER, Louisiana
DEBORAH PRYCE, Ohio
MICHAEL N. CASTLE, Delaware
PETER T. KING, New York
EDWARD R. ROYCE, California
FRANK D. LUCAS, Oklahoma
RON PAUL, Texas
PAUL E. GILLMOR, Ohio
STEVEN C. LATOURETTE, Ohio
DONALD A. MANZULLO, Illinois
WALTER B. JONES, JR., North Carolina
JUDY BIGGERT, Illinois
CHRISTOPHER SHAYS, Connecticut
GARY G. MILLER, California
SHELLEY MOORE CAPITO, West Virginia
TOM FEENEY, Florida
JEB HENSARLING, Texas
SCOTT GARRETT, New Jersey
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
JIM GERLACH, Pennsylvania
STEVAN PEARCE, New Mexico
RANDY NEUGEBAUER, Texas
TOM PRICE, Georgia
GEOFF DAVIS, Kentucky
PATRICK T. MCHENRY, North Carolina
JOHN CAMPBELL, California
ADAM PUTNAM, Florida
MICHELE BACHMANN, Minnesota
PETER J. ROSKAM, Illinois
KENNY MARCHANT, Texas
THADDEUS G. McCOTTER, Michigan

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel

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CONTENTS
Page

Hearing held on:
September 5, 2007 ............................................................................................
Appendix:
September 5, 2007 ............................................................................................

1
65

WITNESSES
WEDNESDAY, SEPTEMBER 5, 2007
Bair, Hon. Sheila C., Chairman Federal Deposit Insurance Corporation ...........
Dugan, Hon. John C., Comptroller of the Currency, Office of the Comptroller
of the Currency .....................................................................................................
Sirri, Erik R., Director, Division of Market Regulation, Securities and Exchange Commission ..............................................................................................
Steel, Hon. Robert K., Under Secretary for Domestic Finance, U.S. Department of the Treasury ...........................................................................................

23
21
24
19

APPENDIX
Prepared statements:
Ackerman, Hon. Gary L. ..................................................................................
Brown-Waite, Hon. Ginny ................................................................................
Kanjorski, Hon. Paul E. ...................................................................................
Price, Hon. Tom ................................................................................................
Bair, Hon. Sheila C. .........................................................................................
Dugan, Hon. John C. ........................................................................................
Sirri, Erik R. .....................................................................................................
Steel, Hon. Robert K. .......................................................................................
ADDITIONAL MATERIAL SUBMITTED

FOR THE

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70
71
74
76
98
121
129

RECORD

Frank, Hon. Barney:
Press release dated September 4, 2007 ..........................................................

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RECENT EVENTS IN THE CREDIT AND
MORTGAGE MARKETS AND POSSIBLE
IMPLICATIONS FOR U.S. CONSUMERS
AND THE GLOBAL ECONOMY
Wednesday, September 5, 2007

U.S. HOUSE OF REPRESENTATIVES,
COMMITTEE ON FINANCIAL SERVICES,
Washington, D.C.
The committee met, pursuant to notice, at 10:33 a.m., in room
2128, Rayburn House Office Building, Hon. Barney Frank, [chairman of the committee] presiding.
Present: Representatives Frank, Kanjorski, Waters, Maloney,
Velazquez, Watt, Ackerman, Sherman, Meeks, Moore of Kansas,
Capuano, Hinojosa, Clay, McCarthy, Baca, Lynch, Miller of North
Carolina, Scott, Green, Cleaver, Bean, Moore of Wisconsin, Davis
of Tennessee, Sires, Hodes, Ellison, Klein, Perlmutter, Murphy,
Donnelly; Bachus, Baker, Castle, Biggert, Miller of California,
Capito, Feeney, Hensarling, Garrett, Pearce, Neugebauer, Price,
Davis of Kentucky, McHenry, Campbell, Roskam, and Marchant.
The CHAIRMAN. This hearing of the Committee on Financial
Services will come to order. I’m going to make an opening statement, but then I’m going to leave temporarily. There is a hearing
before the Committee on Education and Labor on a bill that would
ban discrimination in employment based on sexual orientation. I
trust people will understand why I will temporarily absent myself.
You notice that given these two important issues today, I am wearing pinstripes and a lavender tie.
[Laughter]
The CHAIRMAN. I did not want to indicate any set preference for
which issue I was going to deal with. But I will make my statement. There will be other opening statements, and we will then get
back.
Before I get into the substance, I just want to say that I apologize: we originally had been scheduled for a two-panel hearing. I
apologize to my colleagues on the other side because they helped
us to prepare, and I apologize to those who were asked to testify.
We will get to them. But there was some miscommunication and
I take responsibility for that. I was not able to do what I thought
we should be doing.
But secondly, and this is another important reason for the
change. On Friday, as you know, the President announced a new
initiative in connection with the subprime issue. That would have
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2
been part of our second panel. And so, since the President announced that proposal, we will not be getting into that issue today.
We will be focusing today on the question of what happened in
the market situation, and my concern is this: For some time now,
we have seen the subprime crisis. I believe that those in charge
were a little bit surprised that the subprime crisis spilled over as
much as it did into other parts of the mortgage market. And more
specifically, you know, you are supposed to pretend that you don’t
like to say, ‘‘I told you so.’’ But as I have said before, I find that
to be one of the few pleasures that come with age.
In other words, there was an underestimated extent to which the
subprime crisis would spill over into the rest of the mortgage market. But I think the far greater surprise was the extent to which
the residential mortgage crisis had a negative impact on the market in general. I don’t know anyone who was predicting that a failure in subprime was going to lead to a problem in selling commercial paper, and yet it has.
It doesn’t seem that any of us charged with responsibility for
knowing what was going on anticipated this. Now I hope this is
containable, and we will be working together to try to deal with the
subprime part of it and other parts of it. But what we have to address, what I want to focus on today, is an important question.
I guess my initial view of it, in the subprime market, it is clear
that financial innovation outstripped regulation. Twenty years ago
mortgage loans were made by institutions that were regulated by
the Comptroller, by the FDIC, and by the OTS. They have been
doing a good job, and I have acknowledged that the institutions
represented here and the OTS have done a good job.
We then developed a new model for mortgages. Mortgage brokers
and people who sold to the market, what Ben Bernanke called in
his Jackson Hole speech last Friday, the ‘‘originate-to-distribute
model.’’ That was the innovation. And it was an innovation that
brought a lot of good, that increased funding in the market, that
helped a lot of people buy homes.
But it was largely unregulated. And I think we have had a test
case recently about regulation, sensible and intelligent regulation,
which is I think what we get from the Comptroller, from the FDIC
and the OTS, and from the Federal Reserve. Part of our job is to
see if we can extend that sensible regulation, not overdoing it, but
regulating.
Similarly, I think there is some consensus now that what’s gone
on in the secondary market without any regulation at all is problematic. And again, Chairman Bernanke, who is rarely confused
with Ralph Nader, said in his Jackson Hole speech that the originate-to-distribute model must be modified, is being modified, to include more investor protection and disincentive for irresponsibility.
I read today in the Financial Times, Martin Wolf, again, people
who have come from a generally more conservative perspective,
say, mortgages by the stricter regulation—talking about
securitization. The second objective of regulation is to insulate financial markets from the sort of panic seen in recent weeks. The
only way to do that may be to re-regulate them comprehensively.
Restrictions would have to be imposed on products sold or the ability of institutions to engage in transactions.

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You don’t get operation. I understand. But just as it seems clear
now, and I think there’s a consensus, and the President essentially
became part of that on Friday, there is a consensus that regulation
in the mortgage market has not kept up with innovation. And that
when innovation greatly outstrips regulation, then regulation
should catch up, but regulation has to be sensible. Regulation cannot be too negative. But one of the arguments against regulation,
for instance regulation of the secondary mortgage market earlier
was, well, if you do that, you impinge on the market. You will kill
the market. Well, that market is at least in a deep coma, and the
notion that regulation of the secondary mortgage market is somehow going to interfere with a thriving market doesn’t seem so persuasive.
And in fact, and I think this is what Martin Wolf is saying, and
it is what Chairman Bernanke was saying, it is what we know
about mortgages, the right kind of regulation may be able to respond to one of the greatest needs we have today in the market:
investor confidence. What we have is a severe lack of investor confidence, even in things where they shouldn’t lack confidence.
Giving the investor some assurance of quality in what he or she
is being asked to invest in is part of the role of regulation. It’s not
negative. It can help the market. And so, one, there is some consensus that we need to do that in the mortgage market, and I
think the President is saying that and Chairman Bernanke is saying that. The open question for us is, do we now, in the broader
market, have to deal with that? And I notice Secretary Steel talks
about the proposals that will be coming forward.
I think this is the question before us: Has innovation in the
broader financial market been made possible by technology, enhanced by the increased liquidity in the world, with globalization?
Yes. It produces a great deal of advantages. I’m a great believer in
the capitalist system. I don’t think phenomena occur unless they
meet some real need and provide some real good. People are not
fundamentally irrational. And the question is not whether these innovations were beneficial or not but whether or not allowing the innovations to go forward with no regulation on the innovative sector
produces some harm. And can we, if that’s the case, can we come
up with regulation that will diminish the harm without killing the
whole operation? I know there are some who believe that regulation will always just damage the market. And regulation will always just be terrible. And there are people who say, you know
what? You may think that there are abuses. There have been
abuses. But if you regulate this, you’re going to kill it. And if you
really want to read those arguments made passionately and openly,
go to the Congressional Record and read the debates on the establishment of the Securities and Exchange Commission in the 1930’s,
because they are similar arguments.
My understanding is that you can have bad regulation. But I do
think that the subprime market and what we address today is innovation has come and is useful, but there is a problem. And in
particular, as I said, we clearly have a problem with a lack of investor confidence. Maybe that’s short term, but I will say this: I
know that we have tried to talk the investors out of being nervous,
and I don’t think that works very well. I don’t think trying to bol-

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4
ster confidence by talking to them is enough. There have been
steps beyond that. There have been increases by the Fed in money
being available. There are other things that we have talked about
doing.
I guess the fundamental question I hope we would be addressing
today, and going forward, is this, just to repeat. Giving the innovation that we have—and by the way, I should say one other thing.
This does not to me focus on the institutions that are doing the innovating. The institutional form, whether it’s private equity or a
traditional investment bank or a hedge fund, seems to me far less
important than the substance of what they are doing, of the great
growth of derivatives and the fact that technology has made volatility more of a potential problem, because people can do so much
more, leverage.
Those are the issues. And no matter who is engaging in them,
and the question is, yes, they have—the innovations that have
helped in many ways. But they may well have gone beyond reasonable regulation. And the question is what, if anything, should we
do in our regulatory structure to catch up? I will say it does seem
to be clear. I was not pleased that so many of us were surprised
by the impact that the subprime crisis had on the entire financial
system. I don’t want to be surprised. I don’t want the Federal Reserve to be surprised. I don’t want Treasury to be surprised. This
is not an individual failing. It may be that there is a systemic problem here and that we at least need more information.
So that is the area on which I want to focus. As I said, I know
there will be questions specifically about subprime. Members can
obviously ask whatever questions they want, but I do want to reiterate that on September 20th, we will be having a hearing on the
President’s proposal on subprime and other proposals. We will discuss that in great detail then, so I would hope that today we could
focus to a great extent on what the implications of the past few
months are for that broader question: Has innovation in the financial system so far outstripped our regulatory system that the time
has come to examine that regulatory system and try to come up
with ways to catch up without obviously diminishing the advantages?
With that, I am going to leave, and I am going to ask Mrs.
Maloney, the chairwoman of the Financial Institutions Subcommittee, to take over. We will finish the opening statements, and
I hope to be back in time. I apologize again for leaving.
Mrs. MALONEY. [presiding] The Chair recognizes Mr. Bachus for
his opening statement.
Mr. BACHUS. I thank the lady. And I thank the chairman for convening this hearing. This hearing is really about the mortgage market and the disruptions we’ve seen in the mortgage market. But as
we talk about the mortgage market, we all need to understand that
95 percent of the mortgages in America are being paid. They’re in
good shape. So what we’re talking about is some subprime mortgages, and we’re not talking about even a majority or close to a majority of those.
And last week, the President and the Administration and private
institutions talked about beginning to work out some of these mortgages. So, for many of these people who are late on paying their

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mortgages, in fact, all of them who really should have been in loans
in the first place, that had an ability to pay, I think in almost all
cases, they’re going to be given an ability to pay with better terms.
So there is some good news, some news that really ought to shore
up confidence in the mortgage market.
Now the concerns in the subprime market, as the chairman said,
we all know what’s happened. They’ve caused, number one, some
liquidity problems. Some people call it a crisis. This hearing is
called, ‘‘turmoil in the mortgage market.’’ That’s a little overdone.
Because people who have good credit, people who are paying their
bills on time, people who have a downpayment, they’re able to walk
in right now and get a loan at very low rates, lower rates than I
could get when I bought my first home, when the rate at that time
was 12 percent. Today the rate is 6 percent. So there’s an awful
lot of good news out there.
When you look at unemployment, we talk about the markets—
is a recession coming? Unemployment is at a 6-year low. Real
wages are rising. You look at all the figures; they’re all good. I
mean, I can remember times when inflation was 10 and 12 and 14
percent. Senior citizens were seeing their money, their buying
power disappear. It’s very low. It’s under control
Exports continue to be up. So we have a sound economy. I know
that there are some market challenges. There have been some excesses in the market. There have been some deals that probably
shouldn’t have been made. Investors listen. Banks have a tendency
sometimes to pull liquidity in.
But, if anything, I’d say about the mortgage market, you look at
where there are no serious problems, and that’s the vast majority
of mortgages. There are no serious problems. And those are loans
made by banks, thrifts, in some instances credit unions, where they
know their customers or they have become familiar with their customers. They’ve assessed their credit history, and they’ve made
loans according to sound underwriting principles, made loans according to the guidance of the regulators. Those loans are not in
trouble.
Where we have problems is where they push the limit. The chairman says where they’ve used innovative things. I’ll use, by ‘‘innovative,’’ where they didn’t get an appraiser, or they had no documentation on financial information, or the people had no source of
income. Now that is innovation. When you make a loan to someone
with no income, that’s innovation. When you make a loan to someone and they have no income and you tell them they don’t have to
pay the taxes or they don’t have to escrow insurance payments for
a year or 2 years, that’s innovation. And that was bound to fail.
And I will say this. The chairman and I and some other members
of this committee got together a year or two ago and we had really
no resistance from the regulators. And we talked about changing
some things. We talked about the fact that in 95 percent of these
cases, we were dealing with the same mortgage originators, whether they were bankers or brokers. They were being kicked out of one
State, moving to another State, making these same bad loans, and
yet we have a State system that we could incorporate and call for
national registration. We didn’t do it. So these bad actors continued

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6
to go to community after community and do the same thing over
and over, and they left a wake of these bad mortgages.
The Appraisers Association has called for—and I have introduced
legislation to call for—better appraisals, for some standards there.
We ought to do that. We ought to look at when we don’t require
people to escrow taxes and insurance, particularly people who have
no stream of income or no ability to suddenly come up with taxes
and insurance.
But the one thing we shouldn’t do is rush out and change a market that is working and working well, and has brought homeownership to historic highs. We should not panic. This morning we got
some job figures that are low, but they are coming off very high job
creation. We’re going to continue to get times of weaknesses and
strength, but what we do not want to do, what we can’t do, is
panic. We need to take a measured approach.
Characteristic of this Congress in the past has been a rush to
legislation in times of crisis, which has left us all with a hangover
when it was over, because the regulation had unintended consequences. It might have boosted confidence. What do you do, and
do something, do something now. And it may have made people feel
good, but long-term, it resulted in too much regulation. We found
that regulation has costs for consumers, costs for mortgages, and
it eliminates some of the choices that people have made. In fact,
the majority of people who have used new, ‘‘innovative’’ products,
at least where they had an ability to pay, those people are in those
homes, they’re making those payments, and they have homeownership. And if we cut out some of those innovative products, they
wouldn’t have homeownership.
We welcome our witnesses. We look forward to hearing from you.
But I go out there and I find that basically we have a strong economy. We have some investor confidence problems. We have some
liquidity problems. But this economy is strong, and we should not
panic ourselves into a recession.
Thank you.
Mrs. MALONEY. I thank the gentleman. Pursuant to committee
rules, the Chair will extend the time for opening statements for 10
minutes on the Democratic side, and the Republicans will likewise
have an extension of time. And I now recognize Congressman Kanjorski for 5 minutes.
Mr. KANJORSKI. Madam Chairwoman, I commend you for convening this timely hearing. As we begin our fall legislative session,
it is very appropriate for us to examine what transpired in the capital markets during the last month or so. The apprehensions of
many participants in our financial markets about their exposures
to financial products backed by American subprime mortgages
helped to trigger significant volatility in our credit markets at
home and abroad. This instability affected not only housing markets, but it also seeped over into other commercial sectors.
Today’s hearing will help us to understand at least some of the
factors that contributed to this turmoil and the response of our regulators to these problems. It will also help us to discern whether
Congress needs to take further actions to restore the confidence of
investors in America’s dynamic capital markets. Although I have

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not yet arrived at any conclusions, I have already identified at
least three concerns I expect we will begin to address today.
First, I would like to learn more about the transparency of our
capital markets related to subprime mortgage-backed securities,
consolidated debt obligations, credit default swaps, and the parties
that package and hold these increasingly sophisticated financial
products.
From what I have read, it appears that the participants in our
capital markets, as well as their regulators, have had significant
difficulties in determining exposures to subprime mortgages that
have defaulted or will likely default. We know from past experience
that transparency and access to information provide the lubricant
for our capital markets to work well.
Second, I, like you, Madam Chairwoman, am very interested in
exploring the role that credit rating agencies played in contributing
to these events. Many have already criticized their assessments of
the creditworthiness of the financial products backed by subprime
loans. Some have suggested that their actions may have contributed to engineering the faulty financial products.
While we took action last year to reform the oversight of rating
agencies, we may still need to do more. The testimony provided by
our witnesses today will help shape the hearings that the Capital
Markets Subcommittee will hold on these issues in the coming
months.
Third, I am very interested in examining how well the regulators, created in the last century, are responding to the problems
of the new century. Our capital markets have significantly evolved
since the creation of these overseers. After all, no one had conceived of mortgage-backed securities at the time we created the
Federal Reserve and the Securities and Exchange Commission.
Moreover, banks traditionally engaged in the role of making mortgages based on the amount of assets they needed on their books.
Today, financial companies accessing our capital markets often
help families to buy homes. As a result, the traditional lines between prudent regulation, investor protection, and consumer protection have blurred. Regulators now have multiple missions, such
as the Commission’s safety and soundness oversight of investment
banks.
In other instances, regulators are responding to problems in our
capital markets using indirect means such as the decision last
month of the Federal Reserve to lower the discount rate in response to marketplace uncertainty. Consequently, I intend to focus
increasingly on whether our present regulatory architecture can
anticipate and manage the risks of the modern financial system as
the Capital Markets Subcommittee proceeds with its business during the remainder of the 110th Congress.
I look forward to working with everyone interested in these
issues in the coming months and invite them to share their ideas
on these matters.
In sum, Mr. Chairman, we live in an increasingly complex and
interconnected financial marketplace. We need to move deliberately
and strategically to explore whether we need to update the regulatory architecture of our financial system. If we come to the conclusion that we do need to pursue such a change, we must also

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8
move carefully to modify the system in a way that protects investors and ensures the long-term stability and viability of our financial system.
These are complex problems and questions, and I look forward to
exploring them. Thank you, Mr. Chairman.
Mrs. MALONEY. Thank you. Mr. Baker, for 4 minutes.
Mr. BAKER. I think the chairwoman for her recognition. I know
that it has been made clear that the economic fundamentals are excellent outside the mortgage-impacted sector of the market. The
global economy is very strong. Exports are up. There are a lot of
good things to talk about, and the aberrant circumstance we now
face in the mortgage market is certainly disappointing, but not all
that unexpected.
When one looks at the pressure from investors to seek higher
rates of return and the diversification of tools to spread mortgage
risk across broader sections of the market, and to do so in a global
fashion, it created a hunger in the investing world that naturally
the provider of product would going to attempt to meet.
At the same time, the ability to acquire a home loan at historically record low cost enabled people to step into that next level of
home or that first-time home buying opportunity on the belief that
before the adjustable rate trigger was pulled, escalating values
would continue and the takeout would come from the realization of
profit from that sale before income constraints caused the aberrant
result.
It was a good plan. I came from Louisiana in the 1980’s. We had
a thing called an S&L in those days. And you used to walk across
the parking lot and make a deal with your banker on a new development in 20 minutes. It seems like history is repeating itself here
to some extent, in that over-aggressive lending fueled the ability
for more people to buy, which fueled an increase in home prices,
which built the view that this was all very solidly constructed, so
investors were comfortable in throwing more money into the market for the chance of a greater rate of return. And somehow we are
surprised that we now have a correction.
I don’t come to that conclusion. I recognize that business cycles
are cycles, and that at some point, regulatory review or market
pressure, and in this case, I am, to some extent, not surprised that
it’s an international response. Many homeowners are now coming
to an understanding of the definition of LIBOR, not even knowing
that their rate trigger was tied to the London rate. And there is
now for the first time in many years a divergence between treasuries and LIBOR which is uncharacteristic, but to a great extent,
it’s because European lenders are now worried about counterparty
risk. It’s whether or not we will be able to pay our obligations back
to European lenders.
This is not something I believe should cause a great surprise or
frustration with our mortgage market. Certainly we should have
the highest standards of disclosure. We should expect nothing but
professional conduct from mortgage brokers and other originators,
and where we find those practices are deficient, certainly actions
should be taken. But I suggest that most of the tools to respond
to those crises or problems are well within the hands of the Treasury or the Federal Reserve.

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And so I urge great caution in having the Congress hamhandedly interject more risk in the American taxpayer pocketbook
or constructing more constrictive rules that will in essence preclude
a more logical market-based recovery. Certainly there is risk in the
world, and you can’t protect everyone from every conceivable risk.
You should discuss it. You should disclose it. You should do your
best to explain it. But at the end of the day, all you can do is explain it; you can’t understand it for people. And as a result of inappropriate risk-taking, if people lose money, that should not come as
a big market surprise in a capital market system.
This review, I think, is highly appropriate. But before this Congress acts to take on unwarranted response to a market disappointment, we should be very careful to understand the consequences of
our action.
I yield back.
Mrs. MALONEY. Thank you. The Chair recognizes herself for 3
minutes. First of all, I want to thank our chairman, Mr. Frank, for
holding this hearing on really the biggest financial story of the
year: The turmoil in the credit and mortgage markets, and its impact on consumers and the economy.
After Hurricane Katrina, over 300,000 people lost their homes.
About 10 times as many people may lose their homes to foreclosure
due to the subprime crisis.
The response from the Administration has been slow. Therefore,
I was extremely pleased to hear the President’s announcement last
week. His proposed changes at FHA to provide refinancing options
to more homeowners and to help borrowers by refinancing them
into FHA loans is an important first step. I also support his proposed temporary legislative fix to change tax law so that canceled
mortgage debt is not treated as income. Individuals facing foreclosure should not get the double whammy of paying taxes on the
loss in value of their home.
These are helpful actions that Congress can take immediately,
and I support them, but it is not enough. Another item that can
be quickly achieved is GSE reform. Fannie Mae and Freddie Mac
are providing much needed liquidity in the prime market right
now. If there was ever a time when they should expand their activities, even if it’s temporary, it is now. We need to raise the ceiling on the amount of mortgage that can be refinanced and raise
caps temporarily. We passed a GSE reform bill in the House. It
needs to pass the Senate, or the Administration needs to take action to raise the limits.
I have always said that markets depend as much on confidence
as on capital. Right now there is a loss of confidence in rating
agencies, and they deserve it. Large amounts of debt that are or
have been highly rated are headed for default. As with Enron, the
rating agencies have been dead wrong. Investment guidelines and
capital standards need to be more accurate. We need to review the
way rating agencies are compensated by their clients and look for
ways to strengthen regulatory oversight of these agencies.
We also need a uniform national standard to fight predatory
lending. We need to set a single consumer protection standard for
the mortgage market. The Fed has taken important steps in regu-

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lation, but we need to do more. We have a great deal to do, and
I look forward to the testimony from our distinguished panel.
I now recognize Congressman Miller for 2 minutes.
Mr. MILLER OF CALIFORNIA. Thank you very much. I commend
Chairman Frank and Ranking Member Bachus for holding this
hearing today. This is a—if we look back at recessions, this is a lot
different than the mid-1970’s, 1980’s recession. Remember prime
was in the 20’s, so if you could get a 12 percent fixed rate 30-year
loan, people would close your house immediately. I mean, you can
sell them. The 1990’s recession, high unemployment, the same situation. It seems like the press beat this issue to death for several
years before they could get a decent housing recession going, and
finally it really occurred. It’s interesting when you look at buyers.
If there’s a line forming, they’ll get in line to buy a house, yet
they’ll walk by a house that’s a good deal when the bad time occurs
and never even make an offer.
But the situation we’re facing today in the subprime marketplace, we’ve talked about defining subprime and predatory in recent years. And I think today is a good example of what predatory
is when you see it in reality. When you make a subprime loan and
you lend money to a person that they’re never going to be able to
repay on a normal marketplace, that’s predatory. But they have
gotten by with it in recent years because when a house increases
in value 10 to 15 percent a year, when you buy a $200,000 home,
5 years later it’s worth $325,000, you can sell it and still make a
profit even if you can’t make the payment in 5 years. But today we
have a lot of people who are stuck with a loan they made—they
borrowed from a lender, and now they can’t remake the payment.
We spent a lot of time in this committee in recent years worrying
about safety and soundness on GSEs as Freddie Mac and Fannie
Mae, and it seems like in the marketplace today, they’re not the
ones who are having the problem. It seems to be the subprime and
the jumbo marketplace. And if you look at the situation in the
jumbo and subprime, only about 18.2 percent of the loans are fixed
30-year loans. In the GSEs, 82 percent of the loans are fixed 30year loans, and that’s why they’re doing very, very well.
I think we can do something to help the market today, especially
in high-cost areas, in raising conforming limits. You have a liquidity situation occurring out there in these high-cost areas. In my
district, for example, I’ll give you an example, FHA. In 5 years,
from 2000 to 2005, the FHA loans dropped 99 percent. In my district in 2000, they made 7,000 loans. In 2005, they made 80 loans.
If you look at FHA overall in California, it went from 109,000 to
5,137.
Now I’m not talking about going out and making risky loans. But
if you use reasonable underwriting criteria and standards, you can
make a high-cost loan in those areas that’s very safe and very
sound. That’s something that I think we need to look to.
I yield back.
Mrs. MALONEY. I thank the gentleman. The Chair recognizes
Congressman Baca for 3 minutes.
Mr. BACA. Thank you, Madam Chairwoman, and I want to thank
Barney Frank and the minority leader for having this important
hearing. As chair of the Congressional Hispanic Caucus, as a mem-

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ber of the Financial Services Committee, I am especially concerned
about the impact the foreclosure epidemic is having on our families, and all of us are very much concerned. We’ve seen what has
happened nationwide. We’ve seen what’s happened in our area. The
fact is, subprime lending is concentrated in minority populations
and in minority neighborhoods, and that’s a concern to a lot of us
as we’ve seen what has happened.
And I’d like to relate that, especially in my district, minority
homeowners were more likely to receive higher rate loans than
white homeowners, even with the same income level. And when
you look at the same income level, but the disparity in terms of minorities receiving the higher rates, some or most of these families
could have qualified for better or more affordable loans but were
instead steered into subprime loans by the lender or broker to
make a profit, and this continues to go on.
And we need to have accountability. We need to make sure that
this does not happen. Because when someone loses their home, this
is the American Dream for someone to obtain a home, have a
home, and all of a sudden, they are being steered in the wrong direction. And most of these families, you know, need to be in these
homes. According to the Center for Responsible Lending, almost 20
percent out of 375 subprime loans made to Hispanics in the year
2000 are likely to foreclose. And that’s a high number when you
look at it, not to mention the impact it’s also having on the AfricanAmerican community, that more than likely will end up losing
their homes.
In my district, the Inland Empire has the fourth highest foreclosure filing in the Nation among the larger metro areas, and was
the hardest hit in California through the first half of 2007. In San
Bernardino alone, there were 19,185 foreclosures filing in the first
half, representing a staggering 345 percent increase from the previous year.
Overall, there is one foreclosure filing in every 33 households in
the Inland Empire. That’s a lot. One out of 33 households are filing. So if you look at your neighborhood, the market value, the closure, the impact it’s having in our area, that’s a direct impact. And
a lot of us, when you look at the neighborhoods too, within the
area, what is it doing to the rest of the market with a lot of foreclosures that it’s having in our area? So one out of 33 households.
I drive down, foreclosure sign.
No one gains when people are thrown out of their homes, the
housing market falls, and entire neighborhoods are affected. This
is having a terrible impact on our national economy, as I stated,
and also within our neighborhood and the cleanups in the areas.
I look forward to hearing the witnesses’ testimony today. Thank
you very much, Madam Chairwoman.
Mrs. MALONEY. Thank you very much. The Chair recognizes Congressman Hensarling for 2 minutes.
Mr. HENSARLING. Thank you, Madam Chairwoman. And, I, too,
want to thank our chairman for calling this hearing. As we contemplate perhaps some kind of legislative remedy, I once again
want to remind our colleagues we should always be careful about
our unintended consequences. And I want to associate myself with
the comments of our ranking member to put the challenge in the

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proper context. That is, I still believe, last I looked, that subprime
lending was roughly 13 to 15 percent of the entire mortgage market. And of that, 83 percent are still paying on time. So we need
to make sure we put this in the proper context.
Now clearly, there may be broader threats to the economy, and
that’s something that deserves a serious look. We need to also take
a look at why it is that borrowers default on their loans. Well, the
number one reason still continues to be personal setbacks—job loss,
illness, or disability. That’s why we have the social safety net.
Some may fail to understand the consequences of their action, and
clearly there may be more opportunity for this committee in the
area of financial literacy, not to mention more effective disclosure,
since I do believe that on occasion less could be more.
Fraud is certainly out there. Fraud has been there since the
dawn of man, and we need to examine, is there proper enforcement? But there’s another reason that borrowers default, and that
is, is that they do foolish things. And perhaps part of personal freedom is the freedom to do something that may be foolish.
The question is, did some borrowers in the appreciation, in the
housing appreciation, use their homes as a personal ATM machine?
And what does it mean for national policy for us to go and bail
these people out? Will we incent even more bad behavior? So I
think we have to take a very serious look at that for the greater
macroeconomic implications. We do need to see that perhaps the
tools that are available to the Fed and Treasury are not adequate
to the task.
So I would caution us once again, Madam Chairwoman, to be
very wary of unintended consequences, and I yield back the balance of my time.
The CHAIRMAN. I thank the gentleman. I would note that the
hearing has changed, and while we did discuss transgender issues
at the other hearing, we’re back to a more conventional format here
today.
The gentleman from New Jersey is recognized for 2 minutes.
Mr. GARRETT. Thank you. As indicated, we have recently seen a
steep decline in two specific sections of the market. We talked
about the subprime market, and also the jumbo mortgages. However, most housing data shows that these numbers, while they are
rising dramatically, are expected to peak basically in the next several months. And the problems that we see are basically due to bad
prior underwriting practices. And Chairman Bernanke indicated
some of the causes when he stated increased reliance on
securitization has led to a greater separation between mortgages
and mortgage investing.
I think you have to step back for a second and realize that the
push by some in Congress and the Administration and society in
general to increase homeownership rates has led to more lenders
expanding into various segments of the mortgage market, especially subprime, and to be able to better serve this market, there
have been large numbers of newly created and increasingly complex products. And if you add to that the lowering underwriting
standards and incorrect or questionable ratings of borrowers, it increased the risk incurred to that segment of the market and homeownership.

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But you have to ask yourselves something. Owning your home is
an extremely noble goal, is long part of the definition of the American Dream, but not everyone in the current financial conditions is
allowed to have that in their own reality. The Federal Reserve
states that the United States is at full employment when the unemployment rate is between 4 and 5 percent. So we have to ask,
at what point do we define the country at full homeownership?
Now, while it is essential for Congress to examine what led to the
situation and what steps either the Administration or Congress or
both should take to ensure that these problems do not expand into
the rest of the marketplace, we have to, as Mr. Hensarling just
said, put this in perspective. And the perspective is this: The
subprime market makes up around 13 percent of the entire housing market, and the problem in the subprime area is around 12 or
13 percent, so we are looking at dealing with something a little less
than 2 percent of the overall entire market.
And finally, we must remember again what Chairman Bernanke
recently said, that the failure of investors to provide adequate oversight of originators and to ensure that originators’ incentives were
properly aligned was the major cause of the problem that we see
today in the subprime market.
But he continued, finally, and said, in recent months, we have
seen a reassessment of the problems in maintaining adequate monitoring and incentives in the lending practices. In essence, the market has worked itself out to deal with those poor underwriting
practices of the past.
And with that, Mr. Chairman, I yield back.
The CHAIRMAN. The gentleman from Texas is recognized for 2
minutes.
Mr. NEUGEBAUER. I thank the chairman. I want to associate myself with a lot of the remarks that have already been made, but,
you know, one of the things I want to point out is that this is not
an issue that we haven’t seen before. Those of us who have been
in the housing business for a number of years remember the
1980’s, and where we saw some of the similar kind of problems
with, as the gentleman said, an endangered species called savings
and loans. They’re not endangered anymore. They’re not here anymore, and they’re not here anymore because, quite honestly, they
asked for some expanded responsibilities and abilities that they
were not able to manage.
And so where we are faced today is with problems with an industry that got very aggressive, very ‘‘innovative,’’ is the word that has
been used, and now what we need today is to let the marketplace
work this problem out. One of the things we do, though, I think
is a huge mistake, we have some of the players that were a big
help for us in the 1980’s, and that was Fannie Mae and Ginnie
Mae, their ability to come in and provide some liquidity and some
mortgage abilities in the 1980’s really helped keep—mitigate the
1980’s from being any worse than they were, although I don’t know
how they could have gotten much worse than they did.
But I think what we need to look at today, and I’m going to be
interested to hear from the panel, is how we give the marketplace
a little flexibility and liquidity here to work through this process
without, as many of our colleagues have already said, undermining

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the greatest housing system in the world. Countries all over the
world look to America as the leader in how to develop housing and
housing finance, and so I hope that we’ll be able to look at that.
One of the things that I think we have today is Ginnie Mae and
Fannie Mae, because of the limitations. We’ve been having discussions here in this committee over the last few months about putting limitations on the people who probably know more about mortgage lending than anybody in the world, when we probably should
have been talking about limitations on some folks that didn’t know
as much about mortgage lending as Fannie Mae and Ginnie Mae
do.
You know, the term ‘‘subprime’’—I think even my third-grade
grandson understands what ‘‘subprime’’ is. And he can’t go home
and explain to his parents that he got subprime grades because of
the interpretations and criteria that the marketplace was using at
that particular time. And so I think what we have to understand
is that subprime is subprime, and that the marketplace looked the
other way. It took a different view. I mean, those of us in the housing business have marveled at the innovation that has gone on in
the last 2 years of people getting home loans how they could have
never—couldn’t even get car loans in many cases, and were able to
get home loans. And so, hopefully over the next few hours here, we
can hear from the experts and hear some ways that we—how we
fix this without wrecking a very efficient system, one allowed to
work in a market-based way.
The CHAIRMAN. The gentlewoman from California is recognized
for 3 minutes.
Ms. WATERS. Thank you very much. I want to thank Chairman
Frank and Ranking Member Bachus for holding today’s hearing. I
believe this hearing is timely, because of the recent turmoil in financial markets here and abroad related to subprime mortgagebacked securities.
Let me just say, Chairman Frank and members, about a yearand-a- half ago, I was in Cleveland, Ohio, in Congresswoman
Stephanie Tubbs Jones’ district. There was a big town hall meeting
there, and at that town hall meeting, the citizens described that
there were blocks and blocks of boarded-up housing and that those
who remained were at great risk because the boarded-up housing
was under the control, sometimes, of criminals, that the deterioration of those homes was causing the price of their homes to go
down, and on and on and on.
None of us really understood what was going on, and surprisingly, none of our regulators were able to understand what was
going on and to try and inform us so that we could at least try to
provide some assistance to people who were getting into some of
these subprime loans, who did not understand what they were getting into.
Now what is so disturbing about all of this is this: For those of
us who have worked for years to try and open up opportunities for
people who have been locked out of the mortgage market, folks that
we really believed that, given a chance—they may not be able to
have a downpayment. They may have even had some credit problems, but people who work every day, who pay their rent, and who
pay their electric bills, we’ve always wanted them to have an op-

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15
portunity, and we fought with the financial services in order to do
this.
And we welcomed subprime. And we agreed that subprime did
not have to be predatory, that there was a case to be made that
people who presented some risk, not extraordinary risk, should be
afforded a mortgage and that they should be expected to pay on
time, and that the subprime market could charge them a little bit
more for that loan. We all agreed to that. And we thought that the
regulators not only were watching what happened with loans that
were delinquent that were on the books of these financial institutions, we thought that they would know when something went
wrong.
And evidently, they did not know, and we’re all kind of surprised
to find out that once the originators discovered that they could
package anything and have it packaged and securitized and the investors would put money into it, that they could just throw anything into the package.
And so all of these exotic products, it’s not simply no downpayment, but we’re talking about products where you don’t even verify
the employment of the individual, particularly with some of these
jumbos that were going out. And we still don’t know today how
they would get a handle on these products that came into being
that have created this unsettling of the market. And so I remember
when Federal Reserve Chairman Bernanke was here with testimony to the full committee in 2007 on the mid-year Monetary Policy Report, and I raised these concerns, and he did not have any
answers.
So the bottom line is, it seems for those of us who fight for opportunities for people who should have loans, it’s either feast or famine. So now we’re going to get to a point where nobody is going to
be able to get a loan. And I really want our regulators to tell us
why they didn’t know, and what can be done about it, and how we
don’t have to, you know, revert to drying up the opportunities for
everybody because we’ve gone into this situation.
I yield back the balance of my time.
The CHAIRMAN. The gentleman from California. We went a little
long in the opening statements today, but we only have the one
panel, so I think we’ll be able to sustain an attention span through
that. The gentleman from California, for 2 minutes.
Mr. CAMPBELL. Thank you, Mr. Chairman. I want to join the
chairman in saying that I, too, thought some weeks ago that this
subprime problem would be contained, and I represent the district
where it was pointed out that there have been more subprime failures on Jamboree Road in Irvine, California, my district, than in
any other State. So I’m pretty familiar with—and pretty close to
some of what’s gone on here.
And, you know, Chairman Bernanke before this committee several times had said that his greatest concern for the economy in
the future would be a hardfall in the housing market. The housing
market was clearly teetering before the subprime problem spread
to Alt A and through to—through now into AAA housing loans and
credit. And, frankly, from what I understand, it has spread through
into commercial real estate loans and is impacting that, too.

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So I come into this hearing and in fact back to this Congress
today with no preconceived notions on what we should do or what
we shouldn’t do, but in fact to listen. Because I come in with great
concern for this economy and for what effect a hardfall in the housing market led into by this credit problem and/or in commercial
real estate could lead to as far as our national economy.
It seems to me just as an observer that there is a risk premium
that is being put on by investors around the world now on loans,
on packages of loans securitized by real estate in the United
States, and that that risk premium is there because they no longer
trust what is coming out of this market, what these loans are purported to be and what checks have been done or not done, and that
perhaps one of the things—and I’ll be very interested to hear from
the panel—is that—is what can we do to restore some confidence
or to add some confidence or some transparency so that that risk
premium goes down, and so that investors around the world once
again can look at a package of real estate loans from the United
States as being something that is worthy of investing in without
an inordinate risk premium there.
I look forward to hearing the testimony from the panel, and I
thank the chairman.
The CHAIRMAN. The gentleman from Georgia, for 2 minutes.
Mr. SCOTT. Thank you very much, Mr. Chairman. And I, too, am
looking forward to this hearing. But I wanted to just make a few
brief remarks if I could because I’m anxious to hear what you have
to say. I represent the Atlanta region, Atlanta, Georgia, which
right now has the second highest number of foreclosures anywhere
in the United States, and this is not a new phenomenon.
I heard very clearly some of the points that were raised on the
other side about laissez faire, let the market take care of itself, but
this is not something new. This has been going on a long, long
time, certainly in my region, and I think it’s wise of us to look at
some of the basic issues of why this is happening. I think we need
to prepare legislation or initiatives, whatever, in a very calm and
responsive way, but certainly we have to look at what’s causing
this. Number one, what’s causing this is loans are being made to
people who ought not to get these loans. Something ought to be
done about that. Something ought to be done about loan originators
who are sitting and they know that these people do not have the
capacity to pay. They know that they have weak credit histories,
but yet, they are still making the loans to these individuals.
Secondly, we have over-aggressive, eager loan originators. And
then thirdly, we have consumers—and this is really the heart of
the matter—we have consumers in this country, most of whom,
who are just woefully lacking in financial literacy and education
before they sign on the dotted line. And we have moved very slowly—as a matter of fact, we have not moved at all—in putting forward a very aggressive financial literacy program with at least a
toll-free number where people who are on the margins, who are in
these subprime markets, who are most at risk, can at least have
a place to call before signing on the dotted line.
And so it is my hope that in the hearing today, we will be able
to discuss some of these issues. But I also want to put my two
cents in for taking an intelligent look to see what our institutions

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can do that are there. The President has already moved with the
FHA and first-time home buyers and giving them some help, which
I applaud. But we have Fannie Mae and Freddie Mac, whose limits
should be lifted. And let me also commend our banks, that are
doing an excellent job, particularly Atlanta Federal Home Loan
Bank in my hometown, of getting more money into the market to
help with the liquidity problem.
Thank you, Mr. Chairman.
The CHAIRMAN. Finally, I will recognize the ranking member for
a unanimous consent request.
Mr. BACHUS. I thank the chairman. Mr. Chairman, the ranking
member of the subcommittee, Mrs. Biggert, is presently in a conference in the Senate on the student loan bill, and she has played
a significant role in addressing subprime problems, and I would
like to ask unanimous consent to submit her statement into the
record in Mrs. Biggert’s absence.
The CHAIRMAN. Without objection, it is so ordered.
And we will now turn to our witnesses. Before we do, I want to
enter into the record a press release dated yesterday: ‘‘Federal Financial Agencies and Conference of State Bank Supervisors Issue
Statement on Loss Mitigation Strategies for Services of Residential
Mortgages.’’
Catchy title, guys. But it’s a very important statement. It is from
the bank regulators, the Conference of State Bank Supervisors, and
it’s a very encouraging example of Federal-State cooperation and
the National Credit Union Administration. It is really quite important; I think it builds in part on some of the work that we have
done in conjunction with the SEC where mortgages are held in
portfolios of institutions, and you can get workouts at least directly.
A large part of the problem has been that the mortgage is held
after securitization, and it has not gotten enough attention, I think,
that the SEC, to its credit, at our request, got the Financial Accounting Standards Board, to its credit, to make clear that the appropriate accounting standard allows the servicer of securities to
show flexibility if the holders will be better off.
As we know, increasingly now, with increased property values,
with the kind of domino effect, it is better in many cases to forego
every last right of the contract which would lead to foreclosure and
instead do a workout. I very much appreciate what we have here,
and I thank the regulators, some of whom are represented here.
They have now written to the—they’ve issued this statement, and
they are telling the securitizers to please take advantage of the
flexibility. So this is one more example.
And for those who are paying attention to this, to members, this
is something—we’re going to send this around to all members. If
you are talking to people in your districts who have these mortgage
problems, if you are talking to the advocacy groups, many of which
are doing a very good job, the counseling groups, they should know
both about what the Financial Accounting Standards Board just
said, and the fact that all of the regulators have urged them to go
forward with it.
With that—and I ask that this be put into the record. Without
objection, it will be.

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And with that, we will begin the testimony with Secretary Steel.
Well, one last explanatory point. There is one missing face at the
table today, if we look at institutions with responsibility. It’s the
Federal Reserve System. Originally I had invited the Federal Reserve, but there is a Federal Open Market Committee meeting on
the 18th of September. The Federal Reserve System asked us if
they could defer appearing, given how close it is to an FOMC meeting, because they fear that people might draw the inference that
whatever they did at the September 18th meeting might have been
influenced by what was said today. Though, frankly, I will ask for
the indulgence, that seems to me less of a terrible thing than to
others. This is an institution, the House of Representatives, that
can vote on the most intimate and important questions affecting
humanity; war and peace and life and death, and all manner of
other things. But apparently, God forbid we should ever talk about
a quarter percent on the interest rates, because that is beyond the
competence of a democratic institution. I don’t agree with that, but
I have deferred to it in this instance. We will get back to the Fed
later.
The gentleman from Alabama.
Mr. BACHUS. Mr. Chairman, you noted the absence of the Federal Reserve. I also would like to say that the director of the OTS—
The CHAIRMAN. Yes.
Mr. BACHUS. —John Reich, is not here, and of course, they regulate our thrifts, including Countrywide and—
The CHAIRMAN. Will the gentleman yield? The gentleman is
right. I was hoping that this hearing would not focus so much on
subprime, that we would be doing that on mortgages at the September 20th hearing, and that this would get to the broader ones.
And we do have two of the bank regulators because they have regulatory authorities that go beyond that. The thrifts is—the OTS has
done a good job, and I acknowledge that. They will be at the next
hearing.
Mr. BACHUS. And actually, I guess my reason for pointing that
out is that he has done a good job.
The CHAIRMAN. No question.
Mr. BACHUS. You and I have both discussed privately that the
OTS—
The CHAIRMAN. Yes. And OTS is part of this group, and I agree
with that. I would note just for the purpose of symmetry, that they
used to have a practice in the House called ‘‘pairing,’’ where a
Member on one side of an issue and a Member on the other side
of an issue could both be absent, and they would kind of get credit
for canceling each other out.
I would note that while we don’t have the Federal Reserve here
today, neither do we have the gentleman from Texas, Mr. Paul.
And I think from the standpoint of people who know Mr. Paul, having both the Federal Reserve and Mr. Paul not here is a reversion
to the old pairing system, so we have managed to reach some parity there.
Mr. Secretary, please begin your testimony.

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STATEMENT OF THE HONORABLE ROBERT K. STEEL, UNDER
SECRETARY FOR DOMESTIC FINANCE, U.S. DEPARTMENT OF
THE TREASURY

Mr. STEEL. Chairman Frank, Ranking Member Bachus, and
members of the committee, I very much appreciate the opportunity
to appear before you today to present the Treasury Department’s
perspective on the recent events in the credit and mortgage markets and their impact upon consumers and the economy. The
Treasury Department and Secretary Paulson know these events
are of considerable interest to the American people, this committee,
and other Members of Congress.
To give context to the current market situation, let me begin my
remarks today with a brief description of both domestic and global
economic conditions. In the United States, the unemployment rate
is 4.6 percent, closest to its lowest reading in 6 years. Real GDP
growth was 4 percent in the second quarter, supported by strong
gains in business investment and in exports. Core inflation is
under control. Since August of 2003, 8.3 million jobs have been created, more jobs than all of the major industrial countries combined.
The global economy continues to grow at around 5 percent annually with many emerging market economies growing even more
rapidly than the global average. Over the past several years, these
favorable economic conditions—low unemployment, low inflation,
low interest rates—serve to fuel a demand for credit and investment, and the marketplace responded with a vast supply of both
to satisfy consumers and the sophisticated market participants.
At the consumer level, this demand was very noticeable in the
mortgage industry, and in recent years particularly, the subprime
area. For the first time in the early 1990’s, consumers with lower
incomes and challenged credit histories, typical subprime borrowers, were able to access mortgage credit at interest rates a few
percentage points higher than prime borrower rates. Homeownership became more widely available in the United States, growing
from 64 percent in 1994 to 69 percent today.
Mortgage securitization has played a significant role in this
growth. Typically, the mortgage originator distributes its loans to
a securitization sponsor, who pools together the mortgages into
mortgage-backed securities. Investor demand for mortgage-backed
securities provided capital to mortgage originators, who were then
able to use this capital to make more loans.
Throughout most of the 1990’s, annual mortgage origination
stood at approximately $1 trillion. With the historical low interest
rate environment of 2001 to 2003, mortgage origination climbed to
almost $4 trillion in 2003. Infrastructure buildup and the entry of
many new participants into the mortgage industry matched this increase. As interest rates began to rise in 2004, mortgage origination fell to just under $3 trillion. With this decline, there was significant overcapacity in the mortgage industry.
To satisfy continued investor demand for mortgage-backed securities and their excess capacity, some mortgage originators relaxed
their underwriting standards, lending to individuals with a lower
standard of documentation, and thereby selling mortgage products
which for some buyers would become unaffordable.

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The combination of rising interest rates and mortgages resetting
at higher rates, and a decline in house price appreciation, led to
rising delinquencies and defaults among subprime borrowers, first
widely evidenced in the autumn of 2006. In 2007, this trend has
continued.
In turn, the mortgage-backed securities investor has felt the repercussions of the weakness in the mortgage assets underlying
some of these securitized products. Over the past several months,
a small number of U.S. and foreign financial institutions and hedge
funds invested in mortgage-backed securities have reported large
losses. Some have suspended or limited redemptions consistent
with their authority, while others have liquidated or received capital infusions so as to continue.
The uncertainty regarding the future prospects of these mortgage-backed securities compelled investors to reassess the risk of
these securities and subsequently reassess price. This reappraisal
has spread across other parts of the credit market spectrum, first
affecting residential mortgage-backed securities and then spreading
to other asset classes, and in particular, securitized products.
This reappraisal of risk is normal and typically follows periods
of widely available credit when markets have undervalued risk. As
in other times of reappraisal, investors adverse to risk and protective of their capital, have fled to quality assets, demanding and
driving up the prices, and in turn driving down the rates of securities such as Treasury bills.
In early August, this uncertainty and subsequent illiquidity
began to spread to asset-backed commercial paper, typically a highly liquid market. In response, the Federal Reserve took several
measures to increase liquidity and promote the orderly functioning
of financial markets. The Federal Reserve provided additional reserves through open market operations in order to promote trading
in Fed funds markets at rates close to the target rate. The Federal
Reserve also lowered the discount rate and changed the Federal
Reserve’s usual practices to allow the provision of term funding at
the discount window. Such actions have helped to stabilize the
markets.
The ultimate impact of these different events on the economy has
yet to play out. At the time of its discount rate cut, the Federal Reserve noted, ‘‘the downside risks to growth have increased appreciably.’’
The Treasury Department respects the independent action and
leadership of the Federal Reserve. Like the Federal Reserve, the
Treasury Department shares the perspective that recent market
developments pose downside risks to economic growth. However,
the economy was in strong condition going into the recent period
of volatility, and while certain sectors like housing are undergoing
a transition, overall economic fundamentals remain strong. And
while recent difficulties in the subprime mortgage market are having and will continue to have a profound effect for many families,
the underlying strength of the economy should allow for continued
growth.
The Treasury Department closely monitors the global capital
markets on a daily basis. Under Secretary Paulson’s leadership,
the President’s Working Group on Financial Markets will examine

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some of the broader market issues underlying the recent market
events, including the impact of securitization and the role of rating
agencies in the credit and mortgage markets.
The Treasury Department will also be releasing early next year
a blueprint of structural reforms to make financial services industry regulation more effective, taking into account consumer and investor protection and the need to maintain U.S. capital markets’
competitiveness.
Most important, in addition to efforts to fully understand the
current situation in the financial markets, last week, the President
announced a series of market-based initiatives to help homeowners
keep their homes. For example, the Administration, led by the
Treasury Department and the Department of Housing and Urban
Development, has undertaken several actions to provide assistance
to homeowners, including the Administration’s continued pursuit of
legislation modernizing the Federal Housing Administration.
Coordinating with HUD, the Treasury Department will also
reach out to a wide variety of entities, such as NeighborWorks
America, mortgage originators and servicers, and government-sponsored entities like Fannie Mae and Freddie Mac, to identify struggling homeowners and expand their mortgage financing options.
The Treasury Department looks forward to working with Congress
in the days ahead on these important issues.
In conclusion, it is crucial that policymakers understand these
issues and their underlying causes, and continue to enhance the
capital markets’ regulatory structure to adapt to market developments.
I appreciate having the opportunity to present the Treasury Department’s perspective on these important issues and I look forward to your questions.
[The prepared statement of Under Secretary Steel can be found
on page 129 of the appendix.]
The CHAIRMAN. Thank you. Next, we have the Comptroller of the
Currency.
Mr. Dugan?
STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER OF THE CURRENCY, OFFICE OF THE COMPTROLLER OF THE CURRENCY

Mr. DUGAN. Chairman Frank, Ranking Member Bachus, and
members of the committee, I appreciate this opportunity to provide
the OCC’s perspective on recent events in the credit and mortgage
markets.
As you know, we are the primary supervisor for the very largest
commercial banks that play critical roles in virtually all aspects of
today’s capital markets, including the credit markets for mortgages, leveraged loans and asset-backed commercial paper that
have received so much attention. The OCC maintains teams of examiners onsite at each of these institutions to monitor their activities.
More broadly, for the last 20 years, national banks across the
country have become very substantial participants in residential
mortgage markets where they originate, hold, sell, buy, service,
and securitize most types of mortgages. These of course include

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subprime mortgages, but let me emphasize that national banks
have proportionally been less involved in that market, originating
less than 10 percent of all subprime mortgages in 2006, and have
experienced default rates that are significantly lower than the national average.
Given the large aggregate credit exposure of national banks, the
recent volatility in credit markets has clearly been a concern for
both the OCC and the banks that we supervise. These challenging
market conditions affect all market participants, including not just
the largest national banks that participate actively in capital markets, but also the many mid-size and community national banks
that engage in mortgage activities across the country.
Let me be very clear, however, that the worst problems that we
have seen in markets—insufficient liquidity resulting in substantial declines in capital and sometimes in failure of individual
firms—have occurred outside the commercial banking sector. The
national banking system remains safe and sound. Unlike many
non-bank lenders, national banks generally have strong levels of
capital, stable sources of liquidity, and well-diversified lines of business, all of which have allowed them to weather these adverse market conditions.
As a result, national banks remain active in major markets and
continue to extend credit to corporate and retail customers, including mortgage credit.
With respect to general market conditions, I am encouraged by
the recent actions to restore liquidity that have been undertaken
by the Federal Reserve, other central banks, and various market
players, including some major national banks. Nevertheless, the
situation does remain fluid and it may take some time until markets fully stabilize.
We are therefore continuing to watch conditions very closely and
talking on a regular basis with other financial regulators to address issues that may arise. While recent market conditions have
certainly been painful, and may continue to be painful for some
time, we believe they are likely to cause some positive changes in
the longer term as markets re-evaluate and reprice risk.
Part of today’s problems in credit markets resulted from underwriting standards that had relaxed too much, whether in subprime
loans or leverage lending, to pick two examples, which was at least
partly the result of investor willingness to assume greater risk to
achieve higher yields.
In both cases, market participants are now demanding changes
in the form of more conservatism. While legitimate concerns remain about the pendulum swinging too far and too suddenly in the
opposite direction, we remain hopeful that markets will stabilize at
an equilibrium where lending standards are more rational and
pricing more accurately reflects risk.
Such a positive outcome would apply in the future to loans that
are yet to be made. Unfortunately, the same cannot be said for
many loans that have already been made, and in particular for
many homeowners holding subprime mortgages.
For those Americans who may be facing unmanageable mortgage
obligations, recent events are far more serious than a simple mar-

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ket correct. They may instead result in foreclosure and all its potentially devastating effects on families and communities.
The OCC recognizes the need to do all we can to reduce the inevitability of that outcome. We have taken concrete steps to encourage both lenders and borrowers to respond to these situations in
ways that minimize the likelihood of foreclosure while preserving
safety and soundness.
Just yesterday, as the chairman stated, the banking agencies
jointly released a statement encouraging lenders and servicers to
work with borrowers to take appropriate steps to avoid foreclosure
even where loans have been securitized. With the prospect of significantly increasing foreclosures looming on the horizon, we are
fully committed to working with all interested parties to help address the many significant issues that could arise.
Thank you very much.
[The prepared statement of Comptroller Dugan can be found on
page 98 of the appendix.]
The CHAIRMAN. Thank you, Mr Dugan.
Now, the chairman of the FDIC, Ms. Bair.
STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION

Ms. BAIR. Chairman Frank, Ranking Member Bachus, and members of the committee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation on the credit and
mortgage markets.
Events in the financial markets over the summer present all of
us here today with significant challenges. My written testimony
gives details about the developments that led to the current market
disruptions.
I would like to focus my comments this morning on the condition
of the banking industry and the role banks can play in addressing
the current credit challenges. Recent events underscored my longstanding view that consumer protection and safe and sound lending
are really two sides of the same coin. Failure to uphold uniform
high standards across our increasingly diverse mortgage lending
industry has resulted in serious adverse consequences for consumers, lenders, and potentially, the U.S. economy.
Insured financial institutions entered this period of uncertainty
with strong earnings and capital, which put them in a better position both to absorb the current stresses and to provide much needed credit as other sources withdraw. Also in times of financial
stress like these, the full benefit of Federal deposit insurance becomes evident.
Insured deposit accounts give consumers a safe place to put their
money during times of uncertainty, and confidence in the safety of
their deposits helps to preserve the liquidity and integrity of the
financial system.
Last month, the FDIC released second quarter 2007 financial results for the 8,615 FDIC-insured commercial banks and savings institutions. These showed an industry with very solid performance.
Second quarter earnings were the fourth highest quarterly total on
record, only 3.5 percent below the all-time high, and more than 90
percent of all FDIC-insured institutions were profitable.

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While the overall financial results are positive, the data also included some worrisome information. The interest rate environment
continues to be difficult for financial institutions. Of most concern,
credit quality is likely to get worse before it gets better.
Noncurrent one to four family residential mortgage loans represented 1.26 percent of all such loans at the end of June, the highest noncurrent rate for these loans since the first quarter of 1994.
Many credit needs of both businesses and individuals will need
to be funded in the coming months. This will present both challenges and opportunities for FDIC-insured depository institutions.
Among the challenges for the industry are increased credit
losses. If the housing downturn continues, some institutions that
are currently in good shape could face capital challenges resulting
from losses in mortgage-related assets.
At the same time, this situation may create opportunities for insured institutions to expand market share and to improve interest
margins, as funding that was previously provided by the secondary
market begins to shift to banks and thrifts.
Growth of portfolios, if it occurs, would pose a risk-management
challenge for many institutions. Institutions that grow their loan
portfolios will have to maintain sufficient capital to support that
growth, however the currently strong capital base of the industry
puts it in a position to be a more important source of financing for
U.S. economic activity during this difficult period.
The recent events in the financial markets also remind us that
strong capital requirements are essential and that models have
their limitations in the assessment of risk. These are important lessons to remember as we approach implementation of Basel II.
Finally, it is crucial that we use all available tools to assist deserving borrowers who will soon be facing problems as mortgages
reset in the coming months. It is also important that regulators do
all they can to improve consumer protection and make certain that
rules for all market participants are consistent.
I applaud the fact that Chairman Bernanke has promised to propose HOEPA rules before the end of the year to impose more uniform standards on bank and nonbank mortgage market participants.
The uncertainty that now pervades the marketplace, which in
many respects is attributable to underwriting practices that were
sometimes speculative, predatory, or abusive has seriously disrupted the functioning of the securitization market as well as the
availability of mortgage credit for some borrowers.
The FDIC will continue to work with our colleagues and the regulatory community to address these issues. That concludes my testimony. I would be happy to respond to questions. Thank you.
[The prepared statement of Chairman Bair can be found on page
76 of the appendix.]
The CHAIRMAN. We will now hear from Mr. Sirri, with the SEC.
STATEMENT OF ERIK R. SIRRI, DIRECTOR, DIVISION OF MARKET REGULATION, SECURITIES AND EXCHANGE COMMISSION

Mr. SIRRI. Chairman Frank, Ranking Member Bachus, and members of the committee, thank you for inviting me here to testify on

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behalf of the Securities and Exchange Commission about recent
events in the subprime mortgage and credit markets and the Commission’s responses.
There is no question that over the past 2 months, the defaults
by homeowners with subprime credit and mortgage obligations has
had a broad and significant impact. In addition to the difficulties
that this has caused borrowers and others in their communities,
the sharp rise in defaults has reverberated throughout the financial markets.
As default levels on subprime mortgages exceeded expectations,
market participants began to question the value of a variety of financial products. And as valuations came into doubt, liquidity in
these products fell sharply, which further complicated the task of
valuing particularly complex instruments.
Derivative referencing mortgages were not the only instruments
that experienced an unexpected decline in liquidity. A variety of
other complex financial products that involved non-mortgage assets
suffered diminished liquidity as well.
As liquidity for structured products diminished, market participants needing to raise funds to meet margin calls or investor redemptions sold their less complex financial instruments such as equities and municipal securities, placing downward pressure on
prices in these markets.
Overall, these dynamics have significantly impacted a wide range
of market participants from individual investors to systemically important financial institutions.
In this environment, as in more benign environments, the Commission seeks to fulfill its basic mandates: to protect investors;
maintain fair and orderly markets; and facilitate capital formation.
My written statement describes a full range of issues on which
the Commission is engaged, but in my oral statement, I will focus
on three things: our outreach to a variety of market participants
to understand potential exposures to subprime mortgages and related products and to evaluate operational and liquidity issues that
could require regulatory response; our implementation of the rules
governing nationally recognized statistical rating organizations,
NRSROs; and our oversight of consolidated supervised entities.
As a matter of course, the Commission and its staff are in regular contact with the industry to gather information and determine
where regulatory action is needed. This is particularly true now,
given the current state of credit markets. Similarly, we regularly
confer with the President’s Working Group agencies to discuss market conditions and share observations about issues facing those
market participants under the PWG’s members’ respective jurisdictions.
All of this discussion and information sharing has ultimately led
to a more consistent and coordinated response to the credit market
events across markets and their participants. In June of this year,
the Commission adopted rule governing NRSROs. The purpose of
the rating agency act is to improve ratings quality for the protection of investors and to serve the public interest by fostering accountability, transparency, and competition in the credit rating industry.

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The Commission believes that disclosures required by the credit
rating agency act and its implementing rules will assist users of
credit ratings in assessing the reliability of an NRSRO’s ratings
over time and will provide transparency with respect to the accuracy of a credit rating agency’s ratings in connection with structured financial products related to subprime mortgages.
Given recent events in the subprime mortgage and credit markets, the Commission has begun a review of NRSRO policies and
procedures regarding ratings of residential mortgage-backed securities and CDOs, the advisory services that may have been provided
to underwriters and—provided to underwriters and mortgage originators, their conflicts of interest, disclosures of the rating processes, the agencies’ rating performance after issuance, and the
meanings of the assigned ratings.
Also important to systemic health of the financial services sector
is the vitality of the largest financial services firms. The Commission supervises five securities firms on a groupwide basis: Bear
Stearns; Goldman Sachs; Lehman Brothers; Merrill Lynch; and
Morgan Stanley. For these CSE firms, the Commission provides
holding company supervision in a manner that is broadly consistent with the oversight of bank holding companies by the Federal Reserve.
The program’s aim is to diminish the likelihood that weakness in
the holding company itself or any unregulated affiliates would
place a regulated entity such as a bank or a broker dealer or the
broader financial system at risk.
CSEs are subject to a number of requirements under the program, including monthly computation of capital adequacy measure
consistent with the Basel II standard, maintenance of substantial
amounts of liquidity at the holding company, and documentation of
a comprehensive system of internal controls that are the subject of
Commission inspection.
Further, the holding company must provide the Commission, on
a regular basis, with extensive information about capital and risk
exposures, including market and credit exposures. Given the recent
events in mortgage and credit markets and their potential impact
on financial institutions, the Commission’s staff is monitoring the
liquidity available to the CSE parent with greater frequency than
normal during these periods of unusual market stress.
In addition, the Commission staff is also monitoring contingencies that might place additional strains on the balance sheets
of CSE firms. These include the potential unwinding of off balance
sheet funding structures, such as conduit structures. We are also
monitoring the potential funding requirements and certain leverage
lending commitments that are made by the CSE firms, typically to
fund corporate acquisitions or restructuring.
The Commission staff is also engaged in the ongoing oversight on
valuation at the CSE firms. Current market conditions have increased the challenge of marking certain complex positions to market. We are reviewing the valuation methods that are used by each
firm to ensure that they are robust and consistently applied across
all of the firm’s business.
I hope my remarks today have highlighted the Commission’s ongoing and heightened activities. In light of the recent mortgage

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market events, I believe that the regulatory committee must continue to engage with the systemically important banks and securities firms, encouraging additional efforts to improve and expand
risk management capabilities. We will work with our PWG colleagues and other market participants to further this agenda.
Thank you for the opportunity to testify and I would welcome
any questions.
[The prepared statement of Mr. Sirri can be found on page 121
of the appendix.]
The CHAIRMAN. Thank you, Mr. Sirri, and now we will begin the
questioning.
And again, I will remind members—obviously members can do
what they want—but with specific reference to the current
subprime crisis, the potential foreclosures, we will be having a
hearing entirely on that subject on September 20th with Treasury,
HUD, OTS, the bank regulators, and others to talk about the President’s proposal and what we can do.
My own intention is to focus on some of the implications that we
may have for the broader questions. As I said, members are free
to ask what they want, but in fairness to the witnesses, they didn’t
come, I think, briefed to fully talk about the President’s program,
and that will be coming up a little after that.
I am most concerned at this point about the potential broader
implications, and it does seem clear that we have a set of financial
markets today that are very different than they were 10 years ago,
but our regulatory structure is essentially the same as it was 10
years ago.
We are not talking about more regulation necessarily, we are
talking about more appropriate regulation, regulation that responds to what we now have. And again, I was particularly
pleased, Mr. Dugan, in your testimony, and I was glad to see those
figures.
It is clear, with regard to subprime, that the regulated sector of
the mortgage industry clearly has performed in a much more responsible fashion than the unregulated sector. There are a large
number of very responsible people in the unregulated sector. The
difference is that the minority that might be inclined to be irresponsible ran into fewer obstacles there than they did in the regulated sector.
And it is not my impression that the FDIC, the OTS, the OCC,
and the Credit Union Administration, also not here, but part of
this, it’s not in my experience that they refuse loans that should
have been made. In other words, people have said, ‘‘Oh, sure, they
don’t make bad loans, but they don’t let anybody make any good
loans.’’
The fact is that I think the balance of making the loans that
should be made and not making those that shouldn’t be made was
approximated much better thanks to sensible regulation. And
that’s—I want to just talk about—we’ve been told earlier—Mr.
Steel, maybe I’m misreading this a little bit, but I was struck by
your statement, ‘‘The Treasury Department will also be releasing
early next year a blueprint of structural reforms to make financial
services industry regulation more effective, taking into account con-

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sumer and investor protection and the need to maintain U.S. capital markets competitiveness.’’
Maybe I’m overanalyzing this. Maybe this is the old new criticism of years ago in the literary world hanging on. That was big
when I was going to college; they’re all dead now. But it did seem
to me the emphasis on consumer and investor protection getting
equal attention with competitiveness, I’m not sure I would have
seen that earlier.
That is, we did hear a lot earlier this year, last year, about the
need to improve the competitiveness of our financial markets, and
the general argument was—the thrust of it was that we’ve overregulated some. People said, ‘‘Why can’t you be like that nice FSA,’’
that Financial Services Authority. ‘‘Don’t be so nitpicky.’’ ‘‘Why
don’t you talk principles to us?’’ ‘‘Why are you always making all
these rules on us?’’ and ‘‘Why do you have so many regulators?’’
I mean if this was England, this hearing would have been over
because there would have been one of you, so that would have been
much easier. People think that would have been a good deal. We
don’t know which one of you it would be, maybe one of those three.
You’d still be here, Mr. Steel.
But the tone does seem to me to have shifted. The notion that
the overwhelming need is for us to reduce regulation so that we
can be more competitive with less regulatory regimes elsewhere,
particularly England, I think there has been a shift, and I welcome
that. That doesn’t mean we need to be heavy handed.
And indeed, we’re getting that even from England. In the New
York Times last Wednesday, August 29th, there was a quote from
Chris Rexworthy—easy for them to say—director of advanced regulatory services at IMS Consulting, a former regulator with the Financial Services Authority.
Mr. Rexworthy said that regulators talk about the importance of
stress testing; recent development creates concerns that ‘‘institutions are either not investing enough effort in this, getting it
wrong, or just producing things too complex for their risk assessment models to cope with.’’ Continuing the quote, ‘‘greater cooperation on the international stage between regulators is undoubtedly
one of the things we need to see more of.’’ And it says U.S. regulators were.
I quoted Martin Wolfe earlier in the Financial Times saying, ‘‘the
only way to insulate financial markets against the sort of panic
seen in recent weeks may be to reregulate them comprehensively.’’
He then expressed his skepticism about our ability to do that.
And I guess, again, the issue is not increasing regulation of those
things that we have always regulated but addressing the question,
have the markets now come up with new things for which we don’t
have an appropriate set of regulatory tools, the leveraging derivatives. And it is not simply that they have come up with new things
but that precisely because they are leveraged, etc., that the potential negative may be even greater, that people have come up with
the ability to do more, make more money but also perhaps incur
more risk.
And I am particularly driven by that because it does seem clear
that we did not expect the subprime issue to have the broader neg-

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ative issues it has. So I just wonder if any of the members of the
panel—let me ask all of you just briefly to address that.
Mr. Steel, let me begin with you.
Mr. STEEL. I would agree with your description and when Secretary Paulson focused on this issue of competitiveness, then one
of the first things that he raised was the issue of the regulatory
structure in our country. And it’s something that he’s focused on
and has asked people at Treasury to work hard to deliver a blueprint: what we think it should look like if we were starting fresh.
Point two, I don’t view a review of the status quo to mean necessarily less regulation. I think the issue is appropriate regulation.
Business models have changed and the markets have changed.
Really, that’s in the wrong order. Basically, business models have
changed to meet the markets, and as a result, our goal is to look
at this afresh and focus on the issues. And I don’t think that means
less investor protection or less consumer protection, it means having the right lens on these issues. And today, the patchwork nature
of what has developed over decades, since the last century, is just
not as attuned as it should be.
Point two is last Friday the President specifically tasked Secretary Paulson to look at the ingredients of this latest period of turmoil, securitization, rating agencies, and to also have a fresh look
on that. As I said to you in the past on other issues, there should
be no acceptance of the status quo. Innovation acquires adaptation,
and we have to keep moving with the innovation and to present the
right regulatory focus.
The CHAIRMAN. The gentleman from Pennsylvania, the chairman
of the Capital Market Subcommittee, is planning hearings on the
credit rating agencies’ piece of this. It’s an issue that he has been
working on for some time. He has been somewhat pressured to be
concerned about that when some others were not, and so he will
be continuing that fairly soon.
Is there any comment?
Mr. DUGAN. Yes, Mr. Chairman. I mean I think the issue you
raised is the unevenness of Federal regulation and then regulation
in the markets that mortgages were not being provided by federally-regulated entities. I think personally I believe there is a need
for some kind of uniform standard. The question is what is the best
means to get there.
I think right now the market itself has corrected and many of the
most aggressive products are simply not being offered: 2/28s, for example, declined substantially in the marketplace. But I think even
in terms of a standard, Federal regulators have come out with
guidance, as you know. The States have embarked upon a serious
effort to adopt a same kind of guidance. And if they do that on a
uniform basis, that can help address that need. The Federal Reserve has also indicated its willingness to go forward with regulations under HOEPA by the end of the year.
That will be a uniform standard. The question is, do you need
to go beyond that? Will that be enough? I think that’s the question
you’re grappling with and it is a difficult and a delicate balance because of the fear of going too far, but the issues that are being put
into play, you’re having the hearing on on the 20th, I think, is totally appropriate.

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The CHAIRMAN. Thank you. And you said the market is corrected,
and I do think we would agree. Unfortunately, it is over-corrected
right now. And the only thing I’m saying is there is a potential
problem of over-regulation, but among the fears that do not keep
me awake very long are that the Federal Reserve will overdo consumer protection. That one I’m not too worried about.
Ms. Bair?
Ms. BAIR. Well, I think the FSA model does have some advantages in that all financial services regulation is under one umbrella. We compensate for that, though, through our informal communications. The FDIC hosted a series of securitization
roundtables. The servicer statement we issued yesterday was an
outgrowth of that. Those were jointly hosted with the other bank
regulators; they also included the SEC, OFHEO, and Treasury. Bob
Steel was there.
So I think through informal mechanisms, we do a lot of communication. The President’s Working Group on Financial Markets is
also an umbrella group that I think helps ensure that there is appropriate coordination, even though we have these multiple, separate regulatory structures. As I’ve told Bob, we’d love to have a little more involvement of the FDIC in the President’s Working
Group.
But I think they are very competently handling a lot of the policy
and market issues that are arising in this context. So I think overall it’s not perfect. If you were starting from scratch, you might do
something different, but overall, it works pretty well.
The CHAIRMAN. Mr. Sirri?
Mr. SIRRI. Chairman Frank, you make an important point that
innovation and regulation have a tough time together, and as a
regulator, we sense that, I think, on a regular basis.
We do have some tools at our disposal. So for example with systemically important, large broker-dealers, we meet that challenge
with liquidity. We require tremendous amounts of liquidity at the
holding company level, so when there’s uncertainty, when we don’t
know what’s going to happen, there’s liquidity available to ensure
the solvency of those firms and to protect against defaults.
But there are also things that have changed here. Congress, for
instance, provided us new authority into the Credit Rating Agency
Reform Act. This will for the first time give us the ability to register, regulate, and inspect credit rating agencies. That’s new for us
and I think it’s an appropriate piece of legislation and we look forward to implementing it.
The CHAIRMAN. Thank you.
The gentleman from Alabama is recognized.
Mr. BACHUS. Thank you.
I’d first like to start by commending Chairwoman Bair.
Congressman Scott mentioned earlier the importance of financial
literacy and Mr. Hinojosa and Ms. Biggert and Mr. Scott have
talked about the importance of that. I want to commend you on
your book for elementary school children where you used the two
animal figures to really teach planning ahead and setting aside.
It’s a very good book.

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One of the positive things that may come out of all this is that
book, or something like it, may be offered in elementary schools.
It’s something I probably should have read earlier, too.
Let me also say, we talked about the credit rating agencies and
I’m going to direct this to Director Sirri. The three main credit reporting agencies, Moody’s, S&P, and Fetch, receive substantial revenues from their structured finance businesses. Unfortunately, it
appears that in this instance, the rating agencies failed to re-evaluate the ratings given to mortgage-backed securities until their
losses were already widely known in the market.
In some cases, these securities received ratings that made them
appear safe as Treasury bills. As the principal regulator of the rating agencies, what is the SEC’s plan to deal with the conflicts of
interest inherent in a system where rating agencies are compensated by the issuers of the securities being rated? And I know
the President’s Working Group worked on that too, and if you have
a comment, Secretary Steel?
Mr. SIRRI. Thank you.
We are charged under the statute with looking at issues relating
to conflicts of interest. There are two important conflicts of interest
that I think merit particular attention. The first is the one that you
cite, how credit rating agencies are paid. Typically, they’re paid by
the underwriter or the issuer. That presents a conflict, but we believe that conflict is manageable.
Firms should have credit rating agencies policies and procedures
in place and they should adhere to those policies and procedures
when they evaluate deals. We are going in to look at those firms
now, to look at their policies and procedures and to look at the actual ratings and their practices to understand what was actually
done.
The second important conflict is one that could arise with respect
to the disclosure of their methods and the meaning of ratings.
Again, credit rating agencies should be clear about those and they
should adhere to those practices as they rate particular securities.
If we see conflicts, if we see that they’re not following their procedures with respect to information, then again we would be empowered to follow-up there.
Mr. BACHUS. Secretary Steel, Friday, when the President and the
Secretary outlined their proposal on helping homeowners, one of
their proposals was a plan supporting the State-based efforts to
create a comprehensive mortgage broker registration system. Mr.
Scott earlier said something about it twice. He mentioned mortgage
originators. I will tell you that not all of these bad loans are mortgage brokers; a lot of them are mortgage bankers. They are people
inside banks, so they are federally-regulated.
I’ve introduced, along with Mr. Gillmor, Mr. Price, Mr. Miller,
and Ms. Biggert, legislation to establish a national registration system for all mortgage originators. It is very similar to what I think
the President outlined last Friday, but would you comment on the
need for the creation of such a system? And I think Mr. Scott in
his opening statement pretty much told you about the problem we
had with just a small group of mortgage originators.
Mr. STEEL. Well, sir, I think that as the President said on Friday, and I would confirm to you today, this is an issue that re-

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quires attention and people shouldn’t be able to move from jurisdiction to jurisdiction. And bad actors need to be catalogued and followed. I am familiar with your legislation and others, and we at
Treasury would be completely consistent with the ideas of what
you’re trying to accomplish. I think that what we need to work on
and consult with you and other people on the table today is what
is the best way to accomplish that. And the devil is in the details
on this, but you should rest assured that the idea of cataloguing
and being on top of this so people cannot move, bad actors cannot
pack up and move to a new jurisdiction and act badly again, it is
something we should track down and eliminate.
Mr. BACHUS. Well, the States already have a system that works
if we required it in all States as opposed to establishing something
all new. And it applies to both originators and brokers, and I know
that the Federal regulators have resisted that. But let me tell you
that a lot of people have suffered as a result of not having a national registration that people can go to and quickly see. I know
that Chairman Frank talked about the need for this, and we’ve discussed it, and it’s in our legislation. It was in the legislation that
he and I proposed last year.
Mr. STEEL. Thank you.
Mr. BACHUS. My final question.
Comptroller Dugan, you were over in the Senate. You were a
lawyer at the Senate Banking Committee during the S&L crisis.
You were heavily involved in the government’s response during the
first Bush Administration to the savings and loan crisis in the late
1980’s. Based on that experience, I know earlier you talked about
unintended consequences and the government making things
worse, and I think that certainly happened with savings and loans.
Would you like to share any advice for us as we attempt to address these issues on how we might avoid some mistakes of the
past?
Mr. DUGAN. Certainly, and I do think this situation today is
quite a bit different than the one that we had with the savings and
loan crisis.
Mr. BACHUS. Oh, absolutely, and let me say, I’m not in any way
equating the seriousness of that situation. The economy is very
strong today. The fundamentals are very good, so I associate with
Secretary Steel in his talk about how strong the fundamentals are.
And I know that we’ve all talked about the strength of the banking
system.
Mr. DUGAN. I think there were some good things that the government did when it got to the point of responding to that problem.
There were some things that were issues. I think one of the lessons
learned was when we waited so long to respond, and when I say
we, I mean the entire Federal Government. Whether it was Congress or the regulators, it meant that the reaction in some cases
wasn’t overcorrection and resulted afterwards in allegations of a
credit crunch and people being too conservative in the kind of credit that they were willing to provide to consumers.
And that’s why I do think in the current environment, we have
tried to stay on top of this at the Federal level, at the supervisory
level, to impose guidance and new standards. We have to be sensitive not to pushing that too far so that people don’t stop alto-

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gether providing the kind of credit to creditworthy subprime borrowers over time. We don’t want that to happen.
And so I think staying on top of things in an orderly way and
addressing problems as they arise instead of waiting too long to
react, I think, is absolutely critical.
Mr. BACHUS. Thank you.
The CHAIRMAN. Thank you. Actually, I’d forgotten that you had
been counsel to the Senate Banking Committee and any advice you
can give us on how we can improve our relations with that entity
would also be very good.
[Laughter]
Mr. DUGAN. Where you stand is where you sit. I’m not touching
that one.
The CHAIRMAN. I’m not saying that. I’m just saying, since you sit
where you sit after they voted, I don’t expect you to answer the
question as a confirmed appointee.
The gentleman from Pennsylvania.
Mr. KANJORSKI. Thank you, Mr. Chairman.
Having been in recess for the month of August, it was interesting
to see the credit crisis unfold, and, with our not being in Washington, unable to get any responses or understandings, I suspect all
of us have come up with different conclusions of what caused the
problem, what some of the solutions may be, and what I am most
interested in—the long term ramifications of what may happen if
other things exacerbate the situation.
For instance, if the real estate prices were to continue to fall precipitously, if we were to move into a recession, if the resets in the
mortgages will come due in 2008 and 2009, are we doing an analysis to come up with a methodology of how to handle those problems or are we just going to breathe more simply within a month?
The credit crunch seems to be over and we go back to the normal
state that we were in before the past 2 months?
As regulators, what are your intentions along those lines?
Mr. STEEL. Oh, I’ll start sir. From the seat that I occupy, I think
of this just exactly along the same lines as you do. I think there
are four issues that are the gating points for us.
Number one, there are principles that should drive what we
think about in the near term. And number one, the first and foremost thing to focus on, is how to have the most successful efforts
to keep American homeowners in their homes. Number one.
Number two is in the process of doing that, we should be sure
not to provide any rescue or bailout to investors or lenders who
made these loans.
Number three, we should quickly get at the issues that seem to
be party ingredients of these challenging market conditions:
securitization; rating agencies; and things like that.
And the fourth thing is to take what we learn in the third bucket
and apply it to the longer-term perspective of what the right, regulatory framework is for the financial system. Those would be the
four ways that I would think through the issue, and that’s the time
sequence too. First and foremost is how can we help people who
were facing the resets stay in their homes?
Mr. KANJORSKI. Okay, let me, along those lines, suggest something because we mentioned the historic nature of the S&L crisis,

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which I do see a parallel to, although the panel does not seem to
see it. I don’t see that it is nearly the nature of the same crisis,
but the solutions that are being batted around, perhaps in the Administration, sound somewhat similar to the S&L crisis.
If you recall, in the late 1980’s, somebody came up with the brilliant scheme of supervisory goodwill. Does anybody remember that
dirty word? And we took the good S&Ls and forced them to put supervisory goodwill on their books and forced them to take bad
S&Ls. And I think there has been some analysis of the S&L problem at the late period of the 1980’s showing that it would have
been only a $20 billion problem if we had addressed it at that time.
For $20 billion from one source or another, all of the bad mortgages
and bad situations in the S&Ls could have been resolved. But instead, we used the supervisory goodwill concept, and we infected
good S&Ls with bad S&Ls and bad paper. And, ultimately, within
2 or 3 years, the problem became a $200 billion problem.
Now, I hear people talking about those two great institutions, or
three great institutions already out there, but particularly Freddie
Mac and Fannie Mae. The people are suggesting we get these folks
involved and have them empowered to buy some of this bad paper
or bad mortgages. I have great fear in doing that because the very
same scenario, which I suggested in my earlier question, should we
do that, would put them at risk and certainly strain their positions.
And then we would have the real estate market really go awry and
have us go into a recession. And then all hell is going to break
loose and we are going to have a multi-trillion-dollar disaster or
perhaps a systemic failure on our hands.
Are the regulators talking about that? Are you discouraging, in
the Administration, the talk of using Fannie Mae and Freddie Mac
as the lone ranger here?
Mr. STEEL. I guess it’s back to me. I think that dealing with this
issue in my mind is a three-part process. Number one, working
with the servicers to identify those loans that are facing resets and
basically getting direct line of sight early for borrowers who are
facing resets. Number one.
Number two is getting those borrowers, once they’ve been identified, connected with qualified counselors, for example
NeighborWorks, so they can get good, impartial advice on where
they stand and what the best solution is to their situation. And the
third part is trying to develop innovative products, both with private sector participants, public sector, like FHA, and also with the
GSEs. At Treasury, we have reached out to GSEs to talk about specific products that they can offer. These are products that should
be based on marketplace values, not in a subsidy form. And I’m
convinced that by focusing on these three aspects: one, servicers;
two, counseling; and then three, new products that actually can
allow them to work, will be the right way to focus on it.
Mr. KANJORSKI. Mr. Steel, I appreciate that, and I have a great
deal of respect for you, as an individual. But, one, your Administration is not going to be in office when the full impact of our financial
crisis hits, probably in 2 years, 21⁄2 years, or 3 years from now. And
two, I find it very hard to believe that somebody sitting somewhere
in a position of regulatory authority did not start to raise the question that liars’ loans may not be the best banking practices anyone

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ever heard of, or that 110 percent financing of mortgages may not
be the most positive thing that people ever heard of.
The excesses that were allowed to build up and occur strike me
as almost panic, get on board, and get all you can while the good
days last. And I do not have a great deal of confidence that you’re
all going to be able to predict what is going to happen over the next
2, 3, 4, or 5 years to the safety of the system if you have missed
identifying that we are on our way to a very serious problem when
all this occurred.
I mean, I am not at all surprised that it happened. As a matter
of fact, it is probably more delayed. I thought that it was going to
happen a little sooner than it has happened. I still can’t conceive
of people buying securities based on 110 percent financed loans of
applications made by people who did not have the capacity to pay
the initial loan. I have only sat on a small bank board, but I can’t
ever remember that type of loan getting the approval of the board
of that bank. But apparently, it got the approval of some of the regulators.
Is that correct, or not?
Mr. DUGAN. Well, I would just say from the point of view of the
SEC, and I think it’s true of the other Federal regulators, there
were concerns registered by the regulators that we advised the institutions we supervised. We did have concern with a number of
the practices that you just described, and particularly the combination of those practices.
And that is the kind of advice that we begin giving our examiners that then spread to the guidance that we put into place with
the non-traditional mortgage guidance which began in 2005 and
then was ultimately adopted last year and then the subprime guidance. There has been a process about that. I think it goes back to
something Chairman Frank said earlier. More of that was being
done by the Federal banking regulators than was going on outside
of the bank regulatory system.
The CHAIRMAN. Ms. Bair, do you want to respond?
Ms. BAIR. Yes. I think the bank regulators have issued very
strong guidance, both with regard to non-traditional mortgages as
well as subprime, requiring things like underwriting at the fullyindexed rate, and placing severe restrictions on stated income
loans. The Fed now has a very unique opportunity to extend those
types of rules to the non-bank sector, and that is exactly what
Chairman Bernanke has proposed. They will be moving with it before the end of the year, so I think we are moving ahead with the
tools that we have.
The CHAIRMAN. The gentleman from Louisiana.
Mr. BAKER. Thank you, Mr. Chairman.
Mr. Steel, I read with great interest your narrative about the
process which has led us to the current circumstance and with regard to regulated financial institutions, there appears to have been
guidance issued by regulators and apparent exposure and actual
losses are significantly less than other sectors of the market that
were non-traditional lenders. But now we see the contagion moving
over to the commercial paper side, because of much of the collateral
being provided by real property. And we’re not sure how far the li-

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quidity squeeze will actually go, thereby denying people access to
credit, not even mortgage borrowers, just traditional businesses.
I read with some concern that a vacuum cleaner company withdrew its intended plans for a debt issuance because of market conditions, and it’s one after another that are now reigning in their
expected growth plans. And that will have another layer of effect
with lack of jobs that would have been created, construction opportunities, and so this will continue to have some effect, unknown to
one extent.
My question is, isn’t it generally true that market operatives are
going to act on that information much more quickly than a regulatory regime and the regulators’ role is to observe, watch, and advise. But it’s to stem the contagion as best we can once it starts,
because the guys who were putting their money up and writing the
check, who were looking across the table at the guy who’s selling
them the product, are the ones to be asking the right questions before the contractual obligation is entered into.
My observation is that there is very little, I think, that the
United States Congress could put into effect to keep people from
making bad business judgments unless we’re going to require Federal Government representatives on corporate boards. I mean,
where are we going with this?
I understand that businesses make money. I also understand
businesses lose money. Our job is to just watch and make sure it
doesn’t get into innocent third parties who had no participation, no
judgment, did not condone, have knowledge of, and make sure
they’re not hurt. But as to gains or losses within the normal world
of businesses, is there a role, in your view, for the Federal Government to step beyond where we are today?
Mr. STEEL. Well, Congressman, I think the way that I would reference back my comments earlier that I made with regard to
Chairman Frank’s opening observations, and that is that the regulatory structure we have to our view could use a fresh relook.
That’s what we at Treasury plan to do, and I can’t tell you where
that will go. Let’s do the work before we have the conclusions.
Mr. BAKER. But in the world of lending, if you wish to come to
my institution, and you have a poor credit history, and you’re buying a modest home, and I choose to make you the loan, and you
signed the deal, there’s not a governmental role in prohibiting that
activity. Certainly, we should make the borrower aware of what
he’s getting into. We should condone professional conduct by the
lender, but we can’t prohibit somebody from entering into an ill-advised deal.
Mr. STEEL. Judgment and risk taking are part of the process and
people exercise good judgment and sometimes less good judgment.
Mr. BAKER. Is there anything that we could require in the way
of disclosure between business participants in the mortgage world
because of the significant implications to the broader economy that
is now not disclosable to parties to transactions?
Mr. STEEL. Well, I think that the regulators, both Federal and
State, have given several different examples since earlier this year.
Whether it’s the issue about the subprime standards that should
be used for underwriting and just lately, yesterday, the way in
which modifications and refinancings can be reviewed.

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I think in the same basis, the Federal Reserve Board intends to
provide comment by the end of the year on both TILA and HOEPA,
and these are forward looking reviews of how we’re doing currently.
And I would think that those are the right places to place the bets
for the best feedback on these issues.
Mr. BAKER. Well, I just hope we will use our best financial judgment in moving forward with such recommendations. I want to join
with my colleague from Pennsylvania with regard to the expression
of concern about the expansion of responsibility of Fannie and
Freddie, and Federal Home Loan Bank for that matter.
I would add on to his observation about the S&L crisis, the next
step in resolution was to create the RTC, the Resolution Trust Corporation, whose mission in life was to take a dollar’s worth of assets and sell them for 13 cents. It was a heck of a job and it only
ensured that we had inordinately larger taxpayer losses than we
would have had, had we used I would call common sense asset disposition methodologies.
And this is bad stuff. People are losing money. Homeowners will
be denied access to credit. Businesses are going to be adversely impacted and I think it is a business lesson learned that when you
go too far out on the risk of chasing greater return, there are consequences. And, unfortunately, I think that’s what this episode is
teaching us.
One last thing: from the early identification of defaults which I
think you alluded in your testimony was October or November of
last year, until the time the broad market liquidity crunch occurred, how quickly did one follow the other?
Mr. STEEL. Well, I think that all of us—excuse me. Let me speak
for myself. I think that the way in which the credit questions
spread from subprime mortgages to other types of collateralized
mortgages into other types of securitized product was faster and
swifter than I would have imagined. And so that happened more
quickly. But we had talked and I feel as though there was a lot
of voice given to the fact that in general, the economy, people had
become quite risk-comfortable in lots of ways. In almost every asset
class you go through, people were demanding less and less return
for accepting marginal risk.
So I think the tinder was dry for something like this to begin,
and where it would begin and how it would spread is pretty unpredictable. But I think the risk premium and the way that was being
priced made it apparent that we were at risk of people having
taken too much risk and then retrenching from that risk-taking
process, which is where we are now. But now there are signs that
the risk-taking is beginning to come back into the system.
Mr. BAKER. But it wasn’t an irrational jump to risk. It was more
of a slide into risk over a period of time.
Mr. STEEL. Yes, and I think as I said in my written testimony,
usually the ingredients to this are increasing comfort with risk and
periods of economic activity, low interest rates, etc., make people
comfortable. Investors, basically, are stretching for return and
therefore accepting more risk, and borrowers take advantage of
that situation and you have this cycle that works in that fashion.
The CHAIRMAN. The gentleman from North Carolina.
Mr. WATT. Thank you, Mr. Chairman.

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Actually, we got exactly to the point where I wanted to pick up
anyway, because Mr. Dugan has on a couple of occasions used the
benchmark as the conventional institutions that the Comptroller of
the Currency regulates have done much, much better in terms in
this foreclosure process than others, which I think is a relevant criteria, but leaves open the question of how have those institutions
done in this crisis in comparison to prior times?
Is the level of foreclosures as a result of this comfort with taking
more and more risk, how has that played itself out, not in comparison to subprimes, but in comparison to historical patterns?
Mr. DUGAN. So the question is on foreclosures, generally, across
the whole mortgage market. Well, I would say that clearly the
trend line is up overall. It is not at the record levels that we have
seen in the middle of recessions like we had in 2001, for example.
Mr. WATT. But the President told me we weren’t in the middle
of a recession. So in comparison to like times, did this comfort that
Mr. Steel has described with taking more and more risk, did it result in the traditional mortgage market accepting more and more
risk in comparison to like periods of time in history?
Mr. DUGAN. Well, I think if you look at, and I have a graph here
that I actually could show you, if you look at the actual aggregate
level of delinquencies and defaults, it hasn’t gone up that much historically. The real spike has been more on the subprime area. But
you are right that the level has gone quite a bit higher than it has
been in non-recessionary times, which is an indication of the nature of these products, the lax risk underwriting that Secretary
Steel was just referring to.
So, it’s sort of a combination of both. We have not seen the same
leakage of problems to other parts of the prime.
Mr. WATT. You made that point several times. I just wanted to
make sure that in saying that we don’t hide the fact that across
the market the acceptance of risk has been, I guess, in the former
Secretary’s words, there was an irrational exuberance in the mortgage or lending market for a period of time.
Is that generally accepted now?
Mr. DUGAN. Well, I guess I would say that there were certainly
parts of the market, not including the subprime that we tried to
address in the non-traditional mortgage guidance where there were
certain features about negative amortization and interest-only
loans, and somewhat lower downpayments that we were raising
concerns about that we hadn’t seen previously.
So, to that extent, I would agree with you.
Mr. WATT. Okay. And one of the concerns that some of us have
expressed and tried to get to the bottom of is the extent to which
institutions that are regulated by the OCC at some level are owners or investors, or have subsidiaries that deal in subprime mortgages substantially.
To what extent are you all monitoring that, because one of the
concerns I had with one of my own institutions—two of my own institutions—from my congressional district buying into Countrywide, for example, was that they were going into an area of the
market that might not be subject to the same level of regulation.

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Mr. DUGAN. Well, if it’s a national bank or a subsidiary of a national bank, we regulate it the same. We regularly give it fullblown, on-site banking supervision.
If it’s an affiliate of the bank through the holding company, then
that’s regulated by the Federal Reserve. And in the case of Countrywide, that’s a thrift, and the entire organization is subject to
regulation by the Office of Thrift Supervision. So I can only speak
specifically to the ones that we regulate directly.
Mr. WATT. All right, my time has expired, apparently. So I’ll
leave that alone.
Mr. KANJORSKI. [presiding] The gentleman from Texas.
Mr. HENSARLING. Thank you, Mr. Chairman. Again, I share the
concern of many on this committee with the broader capital markets’ reaction to what we see in the subprime mortgage market.
To ensure that we have the facts, since in some previous testimony it has been mentioned in several opening statements, but as
I understand it, subprime borrowing accounts for roughly 13 percent of the outstanding mortgage debt in the United States, and
the latest data that has come across my desk show that 83 percent
of all subprime borrowers are paying on time, which means 17 percent were either delinquent or in foreclosure.
I think somebody, and perhaps it was Ranking Member Bachus
or another member, I do not recall, did the math and said that we
have roughly 2 to 3 percent of the mortgages that are in foreclosure.
I would like to ask anybody on the panel, do you have a different
set of facts? I am just trying to assess the scope of the problem
within the subprime mortgage market. Are those roughly accurate
facts?
I see a nodding of the head in the vertical position.
Mr. DUGAN. Yes.
Mr. HENSARLING. Those are roughly the facts. I do not want to
put words in anybody’s mouth. I think I heard, Secretary Steel, you
say something along the lines that we have seen some positive
changes in that market, and something along the lines of investors
are demanding changes. I think I heard the Comptroller say the
market has corrected some of the worse abuses.
Is that an accurate assessment of what I heard earlier today?
Can you give us a little bit of greater detail on exactly what market
players are doing?
Mr. DUGAN. Yes. I guess there would be two aspects. If you look
at underwriting standards in the subprime market, I think there
clearly has been a move away from low documentation mortgages
to demand more documentation.
There has been a move towards going away from low or virtually
non-existent down payments to higher down payments.
There has been a move away from the shorter dated 2/28 and 3/
27 mortgages to longer term mortgages.
Just to be clear, that was happening but in the most recent liquidity situation where so much of the subprime market depended
on the securitization, there really are not many subprime loans
being originated that cannot be held on the balance sheet of depository institutions at the moment.
Mr. HENSARLING. Mr. Steel?

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Mr. STEEL. I think your characterization is correct and there is—
let’s pick one more example. It has been written about to a great
degree, that there were a large amount of leverage loans that were
in the process of being distributed that basically did not get distributed because of the market turmoil.
Those loans came to rest on the balance sheets of institutions
and now, just as we sit here today, they are beginning to move and
be distributed at prices different, lower, than they were originally
bought by the financial institutions. That is happening, to use my
words earlier, as credit is being re-priced and returns are being offered at a more appropriate level as opposed to the level where people might have hoped they could be distributed earlier.
That seems to be happening in that example in an orderly way
and just beginning. There will be losses by the financial institutions that took them onto their books, but the distribution should
happen over the weeks and months ahead and in what I would describe as an orderly way.
I defer to the regulators because they are looking at their books.
That would be my description of the situation.
Mr. DUGAN. I would agree with that.
Mr. HENSARLING. I think there is general acceptance from most
people on the committee that risk based pricing of credit in certain
innovative products within the mortgage market have helped lead
to some of the highest rates of home ownership that we have had
in the history of our Nation.
I know there are some advocacy groups who have come to this
committee to essentially outlaw certain mortgage transactions, like
the 2/28, that they think are particularly abusive to the consumers.
Are there certain mortgage products that you see that have such
a threat perhaps to our economy that this committee should just
consider outlawing certain mortgage products, and if so, what
standard of judgment should we use? Whomever would like to answer that one.
Comptroller Dugan?
Mr. DUGAN. I guess I will start. I, for one, would be quite reluctant to outlaw any particular product normally speaking. Having
said that, I do think there are some terms which we thought were
so potentially questionable and abusive, we did add it to our guidance on subprime, for example, having prepayment penalties that
extend beyond reset periods to me is something that goes beyond
the pale of what a normal market should operate.
Secondly, I think there is a very good case that a lot of these
loans with these features were not being adequately disclosed, and
I think it is absolutely critical that they be disclosed and there be
a competent system for disclosing them.
In terms of actual products, I think there are many different
kinds of innovations that have led to positive things and sorting
out which ones are the most positive and somewhat less positive
is generally not something that the Federal Government is good at
doing.
Ms. BAIR. If I could, back to your earlier question, those statistics
are certainly ones I would agree with and have used myself.
I do think it is important to understand the context. A lot of
those current loans are current at the starter rate of these 2/28s

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and 3/27s. We will be having a lot of resets, which is why we got
the servicer guidance out. We think there will be about 1.5 million
mortgages throughout this year and next that will be resetting
where borrowers cannot make the higher payment. That is one of
the reasons we got the servicer guidance out.
I would agree with John. I think it is very problematic to just
try to prohibit products. I do not think that is particularly helpful.
The approach we used in the subprime and the NTM guidance
regarding adjustable rate or so-called teaser rate mortgages, is requiring underwriting at the fully indexed rate. So you can make
the loan, but just make sure that the borrower can re-pay the loan.
I think that is a pretty basic underwriting standard. For banks,
it is certainly familiar. I think it will be helpful and should be applied across the board.
Certainly, prepayment penalties have been subject to a lot of
abuse and that might be one good area where you might just want
to add certain categories of inappropriate practices.
Mr. HENSARLING. Thank you. I am out of time.
Mr. KANJORSKI. The gentleman from New York, Mr. Ackerman.
Mr. ACKERMAN. Thank you, Mr. Chairman.
I am one of those who are surprised that everybody seemed surprised with what has happened in the market. While I would agree
with the math that several of our colleagues have cited of the very
small percentage of subprime loans that have evidently set off the
chain reaction of things that have happened, one percent of one
percent of a problem with a clot in your bloodstream causes the
end of the total system.
Despite the fact that the math might argue that it is only a small
percent, the consequences in certain systems can be absolutely
dire. I think that is what we have here.
I am really surprised at the surprise. If we had allowed State
motor vehicle bureaus to operate and have an independent system
of basically unregulated originators of driver’s licenses, and they
went out and had advertising to potential drivers who wanted licenses that said, ‘‘Need a driver’s license, cannot drive? No problem. No test needed. Road rage convictions? Legally blind? Do not
worry.’’
Then we were shocked to see accidents up and down the highway, most of them involving a lot of good drivers, all caught up in
a catastrophic situation.
We have all seen the ads, yet, I do not know if alarm bells went
off in people’s heads or they just ignored it. I do not know if anybody has taken a look at where the problem is with the small percentage as cited of subprime borrowers who cause the problem
versus others and whether these so-called subprime loans were
originated by bank banks or non-banks to see where we should be
focusing our attention.
I guess the first question I would ask is, when these people advertise, whom are they trying to reach? I guess it is a question that
is more rhetorical than anything else, when you advertise ‘‘Cannot
get credit, no problem. Bankrupt? No problem. No background
check. No income verification.’’
You see this in ad after ad after ad. Then we are wondering why
these people who have been seduced by the very important lure of

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home ownership wind up in the tragic situation of losing everything, besides the damage that it has done to the financial markets.
My first question would be, who is supposed to do the oversight
of the people who are doing this kind of advertising, the results of
which should have sounded the alarm bells?
Ms. BAIR. I think the Federal Reserve Board has the authority
for unfair and deceptive acts and practices which can include deceptive communications. That is shared jointly with the FTC.
I share your concern. I still see them. I have some friendly mortgage originators who spam fax me at least twice a week; I am still
getting them.
Mr. ACKERMAN. Which agency has done anything about it?
Ms. BAIR. I think the Federal Reserve, under its HOEPA and
TILA authority, can address unfair and deceptive communications
to consumers.
Mr. ACKERMAN. They can, but have they?
Ms. BAIR. And the FTC may, as well.
Mr. ACKERMAN. ‘‘Can,’’ but have they?
Ms. BAIR. I do not know that they have specifically addressed
teaser rate advertising, but we are certainly hoping that will be
one area they will be looking at as part of this package of rules
they are currently working on under HOEPA.
I think advertising a teaser rate without fully disclosing the fully
indexed rate compared to a 30-year benchmark comparison is
something that is highly problematic. In our guidance to our own
banks in terms of consumer communications, we have said that the
communications need to be balanced, that you should not disclose
a teaser rate without also disclosing the fully indexed rate.
Mr. ACKERMAN. It is not just disclosing. If they are advertising
no background checks, if they are advertising if you do not have
good credit, do not worry about it, we are going to get you a mortgage, it is obvious that they are marketing to people who are going
to have problems.
They are not trying to deceive anybody necessarily. They think
they are going to be able to make the mortgage payments and do
not understand what is going to happen in the market when the
interest rates go up.
Ms. BAIR. Those are bait-and-switch tactics, and we see these. I
ask my staff sometimes to follow up, to find out what is going on.
Frequently, it is a bait-and-switch, where they say you can get the
credit under these circumstances, and of course, you cannot, once
you call.
That type of bait-and-switch is generally regulated by the FTC.
If they are not banks, we really cannot do much about it. I do not
think those are banks that are doing those types of communications.
Mr. ACKERMAN. I suspect you are right on that. Just to get an
idea, what do you think if your agency has some oversight responsibility in this area?
Ms. BAIR. For non-banks?
Mr. ACKERMAN. For anybody that—

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The CHAIRMAN. Will the gentleman try to phrase his question in
a way that the recorder can more accurately capture it? I do not
think hand raising makes its way into the record.
Mr. DUGAN. I think all of us have the power to take action for
unfair and deceptive practices on an enforcement basis.
Mr. ACKERMAN. Have we?
The CHAIRMAN. If the gentleman would yield, is that not only for
banks? You can do it for national banks, FDIC, the State banks,
but the issue is if they are not a bank.
Mr. DUGAN. That is right. If they are a bank, we can, but we cannot write rules about it. That is the other issue.
Mr. ACKERMAN. If they are not a bank, who oversees this?
Mr. DUGAN. The Federal Trade Commission.
Ms. BAIR. Right.
Mr. ACKERMAN. And they are not here?
Mr. DUGAN. Correct.
Mr. ACKERMAN. I see my time has expired.
The CHAIRMAN. I do want to make it clear that the Federal Reserve asked not to be here today. They will be here after the hearing on September 20th, 2 days after the Open Market Committee.
It would be about as far away from an FOMC meeting as we could
get.
The Federal Reserve is the one agency to whom we would ask
those questions. Maybe it should be the FTC, too. Primary jurisdiction of the FTC is with our friends in Energy and Commerce. They
agreed before that they would not object if we had them here. We
should probably add the FTC for the September 20th panel.
Mr. ACKERMAN. I thank the chairman. I ask unanimous consent,
I have an opening statement that I would like to place in the
record.
The CHAIRMAN. Yes, so moved.
The gentleman from California.
Mr. CAMPBELL. Thank you, Mr. Chairman. I am going to focus
my questions less on the damage that has been done and more on
the potential damage that could be done, which would be much
much greater if this whole thing leads to an economic slump.
Secretary Steel, you mentioned the same thing I mentioned in
my opening statement, about this risk premium that exists out
there for all kinds of loans now, commercial real estate, residential
real estate, etc.
If people coming into the market cannot get new loans or the
loan rate to buy that house that has been foreclosed or whatever
is too high, then that is the sort of thing that will lead to a drop
in housing prices which can then lead to lots of undesirable things.
Do we want to do anything to try to deal with that risk premium
and is there anything we can do to try to deal with that risk premium in this committee?
Mr. STEEL. Let me comment, to try to answer the question, in
a broad sense, and then I am not sure about this committee, but
let me just speak—
Mr. CAMPBELL. Yes, I should have made it broader.
Mr. STEEL. My experience would suggest that this is a process
that basically has to work itself through. Right now, as I tried to
say earlier, when the questions about the subprime market spread

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to other securitized products, then at some point people just said
I do not care for any risk right now, I will take a time out. The
market effect was that when you saw the price of Treasury bills
move up dramatically and rates go down, people chose to kind of
find the safest harbor to be part of.
What we are seeing now—that went on for a short period of time.
Now what we are seeing is liquidity return to the market and
begin to look to take on risk, but at different prices with greater
returns than they might have had 6 weeks ago.
The example I gave of the leverage loans that were issued at 100,
bought at 98, and maybe now will be distributed at 95.
What happened is that asset is still a good asset but it is a more
attractive asset at the clearing price as the market digests all the
ingredients and goes to a new level of risk premium.
Mr. CAMPBELL. I guess my question, to delve further into it is,
is there adequate transparency on the real risk? Some of what I
have heard is people say we thought this was AAA paper, we
thought this, we thought that, we did not know you were not using
docs, we did not know this, we did not know all this other stuff.
Therefore, they are now making that risk which may or may not
be appropriate into virtually everything that is out there.
Mr. STEEL. This might be unpopular but that is okay. I think
there is also some attention needed on investors. Investors basically were at the scene of the situation and maybe they should
have asked for more information. I think what you will see in addition to the re-pricing of risk will be a re-basing of information and
diligence on behalf of investors, which will also be a good thing to
have develop here.
I think it is quite logical that as the market evolves and adapts,
people might decide they want better—investors might decide they
want better line of sight on descriptions, on characteristics, and on
understanding before they invest, and move to the strategy of
maybe investigate before you invest, and do it more directly as opposed to third party verifiers.
Do not take somebody else’s perspective, maybe look yourself to
see what is under the portfolio as opposed to taking somebody
else’s word. I view that as a good and logical process, and the investors not doing their work is consistent with what I tried to describe of the syndrome that developed—
Mr. CAMPBELL. Can we help that process?
Mr. STEEL. I think the things we are trying to do in the Administration were basically to look at some of the root causes, and my
third point to Mr. Kanjorski’s question was what are some of the
issues here where better diligence, where we can be helpful,
securitization, rating agencies, and things like that, and trying to
bring diligence to those audiences.
Mr. CAMPBELL. I am running out of time. If I can quickly get one
more question for Mr. Dugan and Ms. Bair.
Relative to the regulated entities, my question is broadly what
level of concern should we have relative to the financial health of
regulated entities with questions like do any of the regulating entities, banks and so forth, have recourse on some of the loans that
they packaged and sold?

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Did they have resource with originators who no longer exist perhaps for things that were packaged and sold, and do you analyze
or look at any regulated entities’ loan portfolio, how much of it is
resetting and to what degree it has a greater percentage of resets
with maybe Alt-A or some other sort of credit risk that bears a risk
to their portfolio?
Ms. BAIR. We have been closely monitoring this on a number of
fronts. The first thing we did several months ago was to identify
our institutions that had significant and direct exposure to
subprime and Alt-A.
Again, as indicated earlier, a lot of this lending, especially the
very weak underwriting, was done outside the banking sector. We
had some banks. We identified a couple of banks. Those have undergone heightened monitoring and examination processes. There
have been some put-backs of loans that had early defaults or violated covenants or whatever. We closely monitored that.
I think the good news and bad news of securitization was that
the risk has been more dispersed. A lot of this lending was done
outside banks, and even when the banks were doing it, it was
securitized, and most of it now has been put back.
There is not a lot of concentration on the balance sheets of the
banks for which we are the primary regulator.
We are closely monitoring. We are doing special exams of those
that we think have particular exposures. Overall, we think the
banks are in pretty good shape.
Mr. CAMPBELL. They are not holding recourse on paper that is
not on their books?
Ms. BAIR. Are you referring to the ABCP market? John might
want to address that. If you are talking about the commercial
paper market, there are liquidity and credit supports that large
banks provide. In the asset-backed commercial paper market, there
has been a lot of press about some of those assets coming back on
the balance sheet of the larger banks.
Mr. DUGAN. I think there are some circumstances in which there
are contingent funding lines, for example, that may need to be
drawn down. Banks do have to hold capital even on that contingency. They would have to hold more capital to the extent they
brought it directly back on their balance sheet.
With respect to some of the subprime loans that you were asking
about which were originated and sold by them, in most cases, we
believe there is no legal recourse that would require them to take
the mass of those assets back on their balance sheets.
It is something that we look at, and as Chairman Bair indicated,
we do think it is a manageable level of credit exposure to subprime
loans that the national banks now have.
The CHAIRMAN. If the gentleman would yield, does that have any
relevance to the entities that you supervise under your consolidated supervision?
Mr. SIRRI. I think from our point of view, we are mostly concerned again about issues about liquidity at the holding company
level. Right now, as we have gone into these firms and looked at
them, we have been quite content that they have adequate risk
management procedures and liquidity in place.

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The CHAIRMAN. The ones you supervise are not threatened by
this?
Mr. SIRRI. No.
The CHAIRMAN. The gentleman from California.
Mr. SHERMAN. Let’s talk about these no income verification
loans. There are kind of two financial worlds out there, the world
of securities that you folks represent, and the world of taxation
that Mr. Steel may bump into if he walks down the hall of Treasury.
The question is why have you, as regulators of the financial markets, turned a blind eye to the fact that those you are regulating
were facilitating tax fraud or at least insulating those who chose
to commit tax fraud from any inconvenience when they went to get
a loan?
Did you take into account in deciding to allow and to continue
to allow these no income verification loans the effect that has on
whether paying taxes continues to be the norm in our society or
more and more taxpayers just begin to think that they are suckers
for filling out an honest return?
I will start with Mr. Steel. You had a chance to make it more
difficult for those who chose to commit tax fraud, did you take into
consideration the effect of your decision on the overall tax system?
Mr. STEEL. At Treasury, we are not making the specific rules
that—
Mr. SHERMAN. Let’s move on, to Mr. Dugan.
Mr. DUGAN. I just want to be clear about the question. When you
say ‘‘tax fraud,’’ I am not quite sure what you mean.
Mr. SHERMAN. When you have a no income verification loan, this
is basically a loan for those who have decided to commit tax fraud,
those who decided not to file, those who decided to file phony returns. People saying I have money to pay the mortgage, I just have
not told the IRS about it.
Why do the folks who regulate the financial field—why did they
not take into consideration the effect on our tax system of allowing
the very kind of advertisements that Mr. Ackerman was talking
about and the general impression that those who commit tax fraud
will not be impeded in their effort to get a home with no credit?
Mr. DUGAN. I guess our view on this is a little bit different. If
there is no obligation to collect income in order to make a loan
ever, theoretically, if someone had $1 million and they wanted a
$10,000 loan, and they had it in their bank account, you would
never have to look at their income.
On the other hand, there are many in most cases where income
really is quite important to—
Mr. SHERMAN. If I can interrupt. These are all stated income
loans. It does not say income, we do not know. There is a standard
number that is not subject. They are not asking about a no income
stated loan. I am asking about no income verification loans.
The loan docs have a number and you deliberately advertise that
you are not going to verify it, this is a loan packaged for those who
choose not to complete an accurate tax return. Why did you allow
it?
Mr. DUGAN. I think our concern is more that people would pretend or potentially invite them to pretend they made more income

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than they actually made in order to get a bigger loan that they
could not repay, and that is something—
Mr. SHERMAN. That is what you also invite with this.
Mr. DUGAN. That is where we look at, will this loan get repaid?
It is something we have very strong concerns about. I gave a
speech about this about 6 months ago.
Mr. SHERMAN. Strong concerns. Did the agencies prohibit those
under their umbrella from buying and holding and processing these
no income verification loans?
Mr. DUGAN. I think what we would say is that this practice
began to creep into the mortgage underwriting practice as a more
and more standard practice, particularly in the subprime and the
Alt-A area, and over time, we began issuing stronger and stronger
directives against it, culminating in the most recent subprime guidance.
Mr. SHERMAN. After the hurricane hit, you decided to issue something saying they should be built to standard. You could have prohibited this practice 10 years ago. It was going on 10 years ago.
Why did you not?
Mr. DUGAN. I am not sure actually that it was going on, to a
great extent, 10 years ago. It has developed over a period of time
where some lenders maintain that they can determine the repayment capacity solely from—
Mr. SHERMAN. Ms. Bair, are you going to tell us that we did not
have no income verification loans until just the last couple of
years? Have you been looking at this at all?
Ms. BAIR. In the interest of self-defense, I have only been here
a little over a year in this job. John is relatively new as well. I
would say John has been one of the leading critics of stated income
and was very active in making sure we had very strong standards
against stated income in our guidance.
Mr. SHERMAN. They were still making stated income loans 3
months ago. A strong press release is not action.
Ms. BAIR. Not in banks. Not in our banks. If we find out, we do
not allow it. We have cited banks. I do not think those are banks
that are doing it now.
Mr. SHERMAN. Let me go to Mr. Sirri. Why do we allow the financial markets to trade in no income verification loans and why
do we allow them to be highly rated?
Mr. SIRRI. The one thing that we do not tolerate in securities
markets is fraud. What we have to be clear about is what is the
disclosure that surrounds these instruments.
Our authority is limited. We will not tolerate fraud and we will
follow through where that appears to be the case. For there to be
fraud, there has to be some type of misrepresentation or omission
associated with the offering of the security.
Mr. SHERMAN. Is not misrepresenting a security—when it is
backed by quite a number of loans issued by people or taken out
by people who are attracted by lenders who advertise if you want
to lie about your income to either the IRS or to us, please come in,
you are the kind of customer we want, why would such loans be
part of A rated pools?
Mr. SIRRI. It is a difficult question. The issue evolves around the
facts of the particular offering. It depends upon the disclosure. For

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example, the underwriter may state, we do not attempt to verify
any of the characteristics about the collateral. Where they state
that, the case for fraud may be more difficult.
It is very, very difficult to make a general statement about this.
Mr. SHERMAN. I believe my time has expired.
The CHAIRMAN. I thank the gentleman. The gentleman from
North Carolina.
Mr. MCHENRY. Thank you, Mr. Chairman. Thank you all for
being here today.
What the chairman said in his opening remarks, the discussion
on a disincentive for irresponsibility, and when we see not those
that many of you regulate but some in the subprime mortgage sector going bankrupt, I think that shows the real disincentive for irresponsibility. Bad judgments. Bad business calls.
This discussion about the income and everything else, that is an
area where the marketplace is regulating itself and righting itself.
The question is, what do we do as a body, as a Congress, as a
government, do we overreact in this time and further clamp down
credit which will, I believe, exacerbate the problem going ahead
when people are going through these resets and trying to access
the credit markets again.
To make sure the market can actually work and function so we
can get some of these folks when the reset comes, get them into
mortgages that they will not automatically default on again, or just
simply default on the mortgages they currently have.
I think we actually need to make sure that when and if we do
act, we have to do it in a sensible way and a measured way. We
cannot overreact.
Ms. Bair, in your testimony you state that non-traditional loans
‘‘invite unscrupulous lenders to impose onerous terms on less sophisticated borrowers who might not fully understand the true
costs and risks of these loans.’’
In June, the Federal Trade Commission released a very interesting study, and I think an important study about mortgage disclosures, including, ‘‘The current disclosures fail to convey key
mortgage costs to many consumers,’’ and ‘‘In both prime and
subprime, borrowers failed to understand key loan terms.’’
In their study they found, as you well know, that about a third
of borrowers could not identify their interest rate; half could not
correctly identify the loan amount; two-thirds could not recognize
that they would be charged a prepayment penalty; and nine-tenths
could not identify the total amount of up-front charges.
I know there is some corrective action taken from the Fed and
other Federal agencies. What is happening on that? How is that
working? What can be done?
Ms. BAIR. I think, clearly, mortgage disclosure needs an overhaul. I do not think we can solve it all with disclosure. I think
there are certain basic core underwriting standards that need to be
affirmed across the market, not just with banks.
The disclosure clearly needs to be more understandable and more
meaningful. I think this needs to be joint with the Fed and HUD
because HUD has part of the jurisdiction over this.
To the question earlier as well, about misleading teaser rate advertising, we not only need to make sure we affirmatively require

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helpful and understandable disclosures, but also get more aggressive in terms of prohibiting marketing practices that are deceptive.
Mr. MCHENRY. I am just asking about mortgage disclosures. This
is a huge component of it. When you have a stack of paper in front
of you, you are signing a legal document for the largest financial
transaction most Americans will ever make in their lives, and people walk away not having any inkling of what they signed.
What can be done administratively to correct this mortgage disclosure issue or what should be done constructively, legislatively,
to ensure there is real disclosure?
Ms. BAIR. The Fed has jurisdiction over this under HOEPA and
TILA, and HUD under RESPA, for closing documents. It is something again for insured banks. We certainly require they make balanced fair disclosures in terms of clear disclosures, understandable
disclosures. A lot of this is in the non-bank sector and we do not
have jurisdiction.
Mr. MCHENRY. My time is running out. Mr. Steel, the President
announced his policy on Friday, that I am sure you were a major
part of constructing.
What is being done within the regulatory process to actually fix
that issue or should Congress act to ensure there is a key amount
of disclosure so people understand the key terms of the loans they
are making or they are signing and agreeing to?
Mr. STEEL. I think this idea of understanding really, the President charged the Secretary of the Treasury to focus on this and
come back and report. The Federal Reserve is also working on this.
This is another aspect also that has been part of the program mentioned on Friday of financial literacy.
The Secretary of the Treasury has been charged to look into this.
The Federal Reserve is working, and financial literacy is part of
the same issue. We look forward to collecting ideas, working with
Congress, and figuring out the best way to bring light on this issue.
Mr. MCHENRY. Thank you.
The CHAIRMAN. As I recall, it was part of the President’s plan to
do a re-do of RESPA, so on September 20th, we will get some more
answers. We will hold the parties on notice that there is interest
on that piece of it, improvement to convey information. That will
come before us again on September 20th and HUD will be here
then.
The gentleman from Kansas.
Mr. MOORE OF KANSAS. Thank you, Mr. Chairman.
Mr. Steel, the Fannie Mae portfolio is currently capped at $727
billion, according to the consent decree by Fannie and its regulator,
OFHEO; is that correct?
Mr. STEEL. Yes, sir.
Mr. MOORE OF KANSAS. Can you explain the factors that were involved in determining this dollar level? What was the rationale or
what is the significance of this $727 billion cap?
Mr. STEEL. I was not here at the time, but let me tell you what
I know from having studied this. Basically, there were several factors and there were a list of seven or eight that went into the calculation. This was negotiated between the safety and soundness
regulator, OFHEO, as you correctly described, and the two entities.

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There were adjustments made to the capital required, a premium
capital was required. There were specifics as to the business model
they could pursue and limitations on growth in the portfolio until
certain conditions were met. This was negotiated between the safety and soundness regulator and the entities themselves.
Mr. MOORE OF KANSAS. Do you know what kind of conditions you
are talking about here?
Mr. STEEL. Specifically, I can give you an example of one. There
was a premium of capital required, where the normal amount of
capital would be ‘‘X,’’ then in this case it was ‘‘1.3X’’ until certain
conditions were met, so as to allow them to move back into a more
normalized state.
Mr. MOORE OF KANSAS. As you just indicated, the consent decree
says that since this portfolio cap for Fannie Mae, it lays out several
scenarios that might warrant temporary flexibility. One of the scenario’s is for market liquidity issues; is that correct? Do you know?
Mr. STEEL. I do not know that specific language, but that sounds
correct, sir.
Mr. MOORE OF KANSAS. There appears to be a real problem of liquidity in the secondary markets right now and we are seeing
many lenders change their credit criteria for the loans they will
make, some to the point where it is even affecting the terms and
availability of credit for customers with good credit histories.
I think it is important that we improve the regulation of the
GSEs and I hope the Senate will soon vote for legislation like the
House has passed that would accomplish this goal, but I also think
the GSEs could play a positive role in helping alleviate some of the
problems that we are experiencing in the market today.
Given the Administration’s position against a temporary increase
in the cap, should the committee conclude that your position is that
our Nation is not facing a market liquidity issue that could be benefitted by Fannie refinancing more of these loans? Should there be
more flexibility there?
Mr. STEEL. There are three or four questions. Let me try, and
please help me if I do not speak to the issue on your mind.
Mr. MOORE OF KANSAS. I will.
Mr. STEEL. The issue of the size of the portfolios is an issue for
the independent safety and soundness regulator. I am not privy to
the request that was made or to the response provided by the independent regulator to the regulatee. I know what I have read just
as you have.
There is the ability—the issue of increasing the caps on performing loans really lies with Congress. That is the issue.
There are flexibilities that Fannie and Freddie can decide relative to their business model and they have announced initiatives
to try to be helpful.
The last point I would make is that at Treasury, we have had
a constructive dialogue with Fannie Mae and Freddie Mac about
the issues going on in the mortgage market and how they might
be helpful, given the current guidelines under which they operate.
They are constructive people, and we are trying to work with
them to imagine when I described earlier what I view as the threepart dance of identification, counseling, and products; hopefully,

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51
the GSEs can be part of this product solution within the current
construct of how they are allowed to operate.
Mr. MOORE OF KANSAS. Can Fannie and Freddie help improve liquidity through an increased cap to refinance more mortgages? Do
you believe that is a possibility?
Mr. STEEL. I think the area they are prescribed to operate in, the
conforming loan market, has been one that has been working
among the best of the different markets, and that one has been
working well.
Mr. MOORE OF KANSAS. Thank you, sir.
The CHAIRMAN. Interesting point. You say the area where they
are allowed to operate has been working well and the areas where
they are not allowed to operate have not been working so well.
Would not the logical thing be to suggest that maybe we should expand the area of their activity so that other places could work well,
like in the jumbo area?
Mr. STEEL. I think that your question is a fair one and I thought
about it a great deal. I think the issue here, sir, is a balance between—
The CHAIRMAN. I like that. That is good. I will take it. The gentleman from New Mexico.
Mr. PEARCE. Thank you, Mr. Chairman.
Mr. Steel, I do not want to spend too long on this, if we are to
look at risk reward and the opposite of reward is pain, if we could,
and I do not think we can, but if we could categorize all the pain
that has been felt from the situation, that is the opposite of reward,
who has borne what percent of the pain?
In other words, loan originators have probably experienced some
of the pain. Capital market investors feel some of the pain. Probably some of the large funds.
If you can kind of categorize how much pain has been felt by
what sector and do not leave the consumer out either.
Mr. STEEL. I think that was going to be my starting point, sir.
If you look at this issue, the people, as I said earlier when I walked
through the focus of the Administration, the first issue is to focus
on homeowners.
Mr. PEARCE. No, I am not asking what we are going to focus on.
I am asking where the real pain has been experienced in the past
in this circumstance that has already occurred. Is that even too
complex to even address?
Mr. STEEL. I will do my best. I wanted to make the first point
that I think the most pain is being felt by the homeowners. Now
I will move onto the question in the marketplace, who has been affected.
I think we saw this first spread in mortgage backed securities
where basically the market has re-valued those types of assets, and
in particular, those dominated by subprime. That is where the
most market value has been re-evaluated. If you looked at that,
that would be second. We know the size of that relates to the different pieces of the mortgage market.
Secondly, you would have to say that the next risky category of
mortgages has felt some distress also, but there have been ripple
effects out into other parts of the system, as I alluded to earlier in
leveraged loan areas.

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Mr. PEARCE. Mr. Dugan, if I go to your report and I am looking
on page two, I read a very straightforward comment that insufficient liquidity has occurred outside the commercial banking sector
and the national banking system remains safe and sound.
For me as a pilot, vibrations are something that sometimes you
get a little tremor and that is it, that is the last you feel of it. Your
wing might be about to fall off, but it is the only indication you are
going to have.
When I go to Ms. Bair’s page 20, she gets to the real concern I
have that this tremor indicates maybe our banking system is not
quite so sound. She talks about the lower capital levels required
under Basel II, and she begins to say on page 21 that the entire
assumption is insufficient given poor performance, and in fact the
risks and stresses are impossible to quantify.
What we have done under Basel is we have scooted the risk derivatives and all those things that none of us know exactly about
except you guys at the table, we have scooted those outside the
measurement criteria.
I do not think it is possible for us any longer to say that our
banking system is really in good shape, because the risk criteria is
not measured by you all in the banking system. It is someone else’s
problem just outside there.
Long term capital management brought us very close to a realization that the system is very high-strung, it is very highly-wound,
and small tremors can mean large problems.
Mr. Sirri also addresses that same problem, the diminished liquidity, on page one of his testimony.
We hear your testimony saying everything is great, the banking
system is really sound, but I see these warning signs from the others. Can you address that if you would, please?
Mr. DUGAN. Sure. I guess what I was trying to say in the testimony is that the liquidity issue that we have seen in the market
has been far more pronounced outside the banking system than it
has been inside the banking system because inside the banking
system, you have insured deposits. You have a federally regulated
scheme. You have the Federal Reserve’s discount window standing
behind certain kinds of loans. All of those things have meant that
institutions that are banks have had far greater access to liquidity—
Mr. PEARCE. I am about to run out of time here.
Ms. Bair, if we are going to take that, that the liquidity is sound
inside the system, is it possible for illiquidity, non-liquidity, whatever we are going to call it, to transpose itself right through those
barriers, that is the banking system, is that possible or is that a
fear that I have that is just not possible?
Ms. BAIR. I would not say it is impossible. I would not want to
suggest it would happen either. I think all institutions are being
challenged right now. There is no doubt about it.
But one advantage banks have over non-banks is the ability to
access deposit funding as well as other sources of liquidity such as
the Fed’s discount window. I think those are tools that put banks
in a better position. But everybody is being challenged right now.

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Mr. PEARCE. They have access to capital based on the capital requirements and the capital requirements continue to drop and
drop.
Ms. BAIR. Not yet. We are still on Basel I. Regarding Basel II implementation, we will do a parallel run next year and then start
up implementation a year after that. So we are still on Basel I. The
leverage ratio is over 8 percent, which is historically a very strong
high level. Banks have $255 billion in excess capital. That is a level
above an aggregate that they—
Mr. PEARCE. Is Europe on Basel II?
Mr. BAIR. Europe is implementing now.
Mr. PEARCE. I think it was Mr. Sirri’s comments that we are in
an international market. Their illiquidity is going to transpose
right across the system.
Maybe this tremor was just a slight tremor and maybe the wing
is not going to fall off. I hope, Mr. Dugan, you are correct. I am
going to lie awake at night for a while longer.
Thank you, Mr. Chairman.
The CHAIRMAN. The gentleman from California.
Mr. BACA. Thank you very much, Mr. Chairman.
The first question I would like to ask is for Sheila Bair. Please
describe the law that prevents brokers from selling people loans
that are mostly costly when borrowers could qualify for better
loans? This also applies to Mr. Dugan. Could you also respond?
Do mortgage brokers have any duty to offer consumers the best
loan available to them? Question number one. What Federal safeguard should mortgage brokers and lenders put in place to ensure
that all subprime borrowers are not taken advantage of and receive
substantial loans.
The next question will be to all of you. Are any of you concerned
that mortgage brokers are not federally regulated?
Ms. BAIR. I think a lot of these issues can and will be addressed
by the Fed. We do not, but the Fed does have rulemaking authority
for all participants in the mortgage process, whether it is banks or
non-banks. I think there is latitude to address practices by brokers,
even though they are not lenders.
I think disclosure, if you are going to do a teaser rate loan, requiring disclosure of the fully indexed rate as well as a 30-year
benchmark is absolutely essential. Safeguards against steering are
absolutely essential.
The thing that frustrates me about the hybrid ARM market is if
you look at the rate sheets of a lot of these subprime lenders, the
30 year fixed rate is not that much higher than the starter rate of
the 2/28, and I think a lot of these folks could have qualified for
a 30 year fixed without the payment shock, maybe $50 or $100
more a month, which I think would have been manageable and
preferable to having these payment shock loans that were underwritten under the premise that they would just refinance in a couple of years.
I think the guidance that we put out for subprime is a starting
place for standards that should apply across the board and I think
that can address a lot of the abuses that we have seen going forward.
Mr. BACA. Mr. Dugan?

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Mr. DUGAN. I agree with those remarks. We have tried to address what we believed were the significant abuses as it relates to
the institutions that we regulate.
I think the issue that has come up in a number of contexts about
the most aggressive, most egregious practices, were occurring outside of the federally regulated sphere, and I think the central question confronting the Congress and the public policymakers alike is
how to get a uniform standard in place so that the regulation
matches what we now have at the Federal level.
As we were talking earlier, I think the notion is the States are
trying to implement something new in that area to come up to that
standard. I think the question of when the Federal Reserve will act
by regulation, which I am sure you will talk about, and then the
further question is, is that enough, whether you will need additional legislation, and I think that is the question that will be very
much on the committee’s mind.
Mr. BACA. Is there an oversight that looks at when you identify
a subprime or mortgage loaner that actually gives the higher loan,
is there some kind of an oversight to make changes to protect that
consumer as well that may have signed on, once they have signed
a contract?
Ms. BAIR. I think there are some short term rescission rights, but
I think longer term, again, the ones I have seen were underwritten
based on the assumption of continued low interest rates and home
price appreciation, so there is never an expectation that a borrower
could make the payment when it reset.
I think our push has been to try to encourage responsible
subprime lending. Fixed rate mortgages are more appropriate, I
think. Subprimes by definition are likely to have had less experience, or trouble with their financial management. To give them a
product that makes them make guess about the direction of home
prices as well as the direction of interest rates, I do not even want
to do that. I think that is pretty challenging.
I think the direction is we want to encourage responsible
subprime lending and come up with standards that will make the
market more conducive to fixed rate products that are more appropriate.
Mr. BACA. I know I asked the question of all of you but I am just
about to run out of time. I want to ask the following question.
What is your response to the home mortgage disclosure data that
show that over half of African Americans and nearly half of Latinos
are in subprime loans compared to 17 percent of white families,
and have you looked into the cases of this, and are you concerned
about its implication, and what do you think the Federal banking
regulators, such as yourselves, or the Federal enforcement agency,
could make more of an impact in fighting discrimination against
Latinos, African Americans or protected classes?
Mr. DUGAN. Congressman, there was a hearing here last month
about home mortgage disclosure and this very issue was front and
center. It is a concern for all of us when we see that raw data suggesting that African Americans and other minorities are receiving
a disproportionate share of higher-priced loans.

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I do think it is quite important and it is part of our job to get
behind that initial data, to make sure you are comparing people
who are similarly situated to see the same kinds of loans.
We have not found the kind of discrimination that initial data
would suggest, but it is something that every time we see that
data, we need to re-double our efforts to make sure we are looking
at the right loan characteristics.
Mr. BACA. Thank you.
The CHAIRMAN. The gentleman from Texas.
Mr. NEUGEBAUER. Thank you, Mr. Chairman.
Before I get started, I know most of the people here know, but
we lost a dear colleague today, a member of this committee, Congressman Gillmor. My prayers and thoughts—and those of everyone on this committee and this Congress, I am sure—go out to his
family.
I want to change direction a little bit and talk a little bit about
how we fix some of the current situations that are involved in the
marketplace today.
One of the things I said earlier was if we provide enough liquidity and capital into the market, that will give the marketplace time
to work this out.
In the 1980’s, we formed the RTC and we did some things which
ended up being very costly for the American taxpayers and brought
quite a bit of disruption to the real estate marketplace.
What I think we want to try to do is let the marketplace clean
this up with the least amount of disruption to really a very important part of our economy, and that is our real estate economy.
One of the things that I know is different between now and the
1980’s is we were dealing with financial institutions, and now we
are dealing with people who are holding pieces of paper, and in
many cases, people holding pieces of pieces of paper.
As we have these people who would probably be in the marketplace to buy some of these individual mortgages or pieces of these
tranches and so forth, because of the documents and the relationships between the master servicers and the trustees, there is probably not a lot of flexibility.
We certainly do not want to go down the road of the Federal Government un-doing agreements in the marketplace that would cause
a tremendous amount of disruption.
What I am wondering is, in the banking and financial marketplace today, are there any things that would be in place or inhibitions for the banking system to be able to help facilitate and finance, breaking these pieces up, because there is tremendous opportunity up side for people that are buying some of these discounted mortgages, if you can get them back into a conforming situation, and obviously that increases the value of that underlying
mortgage, and then obviously the security as a whole.
What I am told is because of the different pieces, that a lot of
these master agreements do not allow a lot of flexibility for the individual mortgages in the underlying paper to be worked out or
payment modifications or rate modifications.
If there was liquidity in the marketplace, say for the banking industry or something like that, to help finance some of these entities
that are willing to go in and look at being able to break out por-

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tions of those mortgages, is there anything that would be prohibitive in the current structure that would cause a bank to say, I do
not want to get involved in that because that is going to be a classified loan, or it is going to change my capital structure?
I throw that out as a question.
Mr. DUGAN. That was one of the reasons why the agencies put
out the recent guidance. I think there has been a lot of mis-information about the flexibility that servicers have to restructure individual loans once they have been sold.
I think this committee sent letters to the SEC and the SEC and
the FASB have responded to clarify there is flexibility. We as bank
regulators issued a statement to servicers under our jurisdiction
jointly to urge them to take advantage of that flexibility more generally.
I think once you go beyond that, it is always governed by the
terms of the service agreement, that contract with investors, and
sometimes they do impose limits beyond the kinds of limits I was
just describing.
I think to the extent that there are not such limits, there is quite
a bit of flexibility. I think in some cases loans can be restructured
in ways that the lender, or in this case the investor, would end up
losing less money than they would if there was a foreclosure, so
there is an economic incentive to do so.
I think in other circumstances, there will be some creative thinking required about different kinds of products, and I think that is
what the Administration has been talking about, something they
are going to be looking at very hard.
Mr. STEEL. I would only add that I think you are on exactly the
right track. We need to encourage the servicers to take full advantage of the flexibility that might be in their documents and to pursue that, and the guidance provided by the regulators has encouraged that.
Then we need to look for additional ways to try to have as many
of these loans reorganized to a market-based level as we possibly
can, and put a thumb on the scale on behalf of the homeowner,
would be our perspective.
The CHAIRMAN. There are going to be some votes fairly soon, so
we are going to hold strictly to the 5-minute rule.
Mr. Lynch?
Mr. LYNCH. Thank you, Mr. Chairman.
I just want to go back to the other gentleman from Texas, Mr.
Hensarling, who basically laid out a scenario that suggested that
this problem was somewhat contained, and that most people, 87
percent of the people are still paying their mortgages, and that this
problem is contained. He did not want to put words in your mouth,
as he said, but he looked for your assent and he seemed to get it.
Mr. Dugan, your testimony does not seem to say that. It says
that more recent data indicate that 90 day or more delinquency
rates for securitized subprime mortgages have increased to over 13
percent in June 2007, and your testimony also says that increased
foreclosure activity continues to spread and intensify, and according to RealtyTrac Inc., new foreclosure filings across the Nation, including default notices, auction sale notices, and bank repo’s, increased to 180,000 in July 2007; that is 93 percent higher than re-

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ported in 2006. There is a fair degree of alarm here, and it is at
odds, that exchange between yourself and the gentleman from
Texas.
I just want you to tell me if you think this thing is contained.
You also say if problems in the general housing market continue,
we expect to see a further increase in mortgage delinquencies.
Where are we?
Mr. DUGAN. I would say two things, and I am sorry if there was
a misunderstanding. I think with respect to the standards for new
loans to be made to new borrowers, I think there has been something of a market correction, even an overcorrection, about the
kinds of standards that would be put in place.
Where I do think there is still an issue are people who have
loans now, and I do think you are absolutely right that we are seeing a trend line in which more foreclosures are increasing, delinquencies are increasing.
If you think about the way we look at it, a huge part of the
subprime market where the most aggressive underwriting was taking place involved these 2/28 loans, and the period in which the
standards were most lax was at the end of 2005 and all through
2006.
If you fast forward 2 years from those dates, you will see that
this quarter coming up, you are going to see more resets, extending
all through next year. That is the period, I think, that we are all
concerned about seeing an increase in foreclosures that we are trying to get our arms around.
Mr. LYNCH. Let me ask you, in comparing mortgage activity, it
seemed that the riskier, the more innovative mortgage products
that were out there were being written largely by private mortgage
companies, and when you look at the performance of the GSEs,
Fannie Mae, Freddie Mac, you saw a smaller share of those riskier
mortgages being written, the subprime mortgages in general, being
written by the GSEs.
With respect to their portfolio cap, would it not be helpful, and
I know it has been suggested by some that there be a modest increase in what their portfolio cap is right now by about 10 percent,
would that not help the liquidity problem, to have them step in, in
some way, to provide some relief there?
Mr. STEEL. The area that Fannie Mae and Freddie Mac focused
on, the conforming loan market, as described, has been the area
that has been working the best. They had the ability to help out
in the top part of the subprime loan area.
Someone has suggested here—people have suggested on a couple
of occasions that a large number of subprime borrowers could have
qualified for prime borrowing, and in those cases, the GSEs could
help.
They are operating under negotiated limits, if safety and soundness issues would have failed—the area in which they are proscribed to operate has been the one that has been operating best.
Mr. LYNCH. The negotiated limits were not made with a recognition of the situation we have right now. That is all I am asking for,
some flexibility here. We have some proven entities here that could
be helpful, yet we have an arbitrary limit that has been adopted
largely by the President.

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I just think there is some relief here that could be had if we lifted that cap. That is all.
Mr. STEEL. Those limits were negotiated between the regulator
and the regulated entities, and they also related to certain requirements have to be met and then the caps are lifted. Those characteristics are being worked through, and I think Fannie and Freddie
are moving towards compliance.
The CHAIRMAN. If the Senate were to take up the bill that passed
the House, we would then have all those conditions satisfied.
The gentleman from California.
Mr. MILLER OF CALIFORNIA. Thank you, Mr. Chairman.
It seems like a lot of the problems that are created in the marketplace were caused by the huge amount of dollars coming out of
the stock market that lenders wanted to take advantage of, and
they used it for subprime.
Chairman Bair, on page five, I really enjoyed your comment. You
said, ‘‘In the absence of GSE sponsorship,’’ that means there was
a lack of GSE product out in the stock market to buy. ‘‘ABS’s,’’
which are asset backed securities, ‘‘were able to enhance marketability and obligations by restructuring theirs.’’
You also say there are trillions of dollars from investment grade
mortgage backed securities that would have been better suited for
hedge funds.
Would you please explain that a little better?
Ms. BAIR. I think we were just trying to put this in historical
context. I think the enhanced returns and enhanced risks of the
private label securitizations, lower rated tranches—
Mr. MILLER OF CALIFORNIA. The rates they would give to normal
GSE sponsorships, they were able to get to these other forms.
Ms. BAIR. These are non-conforming loans. They did not meet the
criteria that Fannie and Freddie had.
Mr. MILLER OF CALIFORNIA. Absolutely. There is a huge demand
in the marketplace for those types of loans.
Ms. BAIR. Certainly for the returns that were provided. Those
loans now are not so popular.
Mr. MILLER OF CALIFORNIA. What normally would be sponsored
by a GSE, there was a huge demand for those, and there was a
huge void because they were not able to put out as many as they
did so the private sector filled those with very questionable risky
loans to basically get a return.
Secretary Steel, you and I, I know we had a great conversation
about what we thought the market should be and who should be
playing in it. What do you think about the President’s current position on raising FHA limits, when we talked last time, that was not
even on the table?
Do you think that is an appropriate move at this point in time?
Mr. STEEL. There are two or three parts to the proposed FHA
modernization bill that the Administration has been supporting. It
relates to risk based pricing and other aspects which will allow
FHA to do more and to be more active. That is really the proposal
that is—
Mr. MILLER OF CALIFORNIA. They have to have reasonable underwriting criteria, so these are very safe loans we are making.

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The problem I have, and many in this House have today with the
GSE situation is, we think that it is being absolutely unfairly applied. What I mean by that is there are some members in whose
districts the median home price is $150,000 and a GSE loan in that
area is $400,000. That is almost triple what it should be, yet there
are areas of the country that are high cost, like my area, for example. I gave statistics that in 5 years, FHA loans dropped by 99 percent because they are high-cost areas.
I am going to ask you a fair and reasonable question, and I
would like a reasonable answer based on the criteria.
Do you think GSEs’ underwriting criteria is adequate and their
appraisal criteria to meet safety and soundness requirements
today?
Mr. STEEL. I’m sorry.
Mr. MILLER OF CALIFORNIA. Do you think the underwriting criteria that GSEs apply to their loans and appraisal criteria are adequate for safety and soundness purposes?
Mr. STEEL. The loans that they are doing today are appropriate
for safety and soundness, yes.
Mr. MILLER OF CALIFORNIA. Then my question is, when you look
at areas of the country that have risen in price uncharacteristic of
other parts of the country, but it is just because of supply and demand and the cost of land in the regions and stuff, do you not believe that if we apply the same safety and soundness criteria currently applicable to all other GSE loans, in those high-cost areas,
there might be room to move up?
The reason I am asking that is because one thing the market
needs is immediate liquidity, but it needs long-term liquidity, to
deal with the housing problems we are facing in this country today
and the foreclosure problems, money for a year or two does not
benefit anybody, the long term criteria loan is what the market
needs.
When you look at the GSE criteria, what they have done, they
have lent money to people on 30 year fixed rate loans. It is what
we need in the marketplace instead of these exotic loans that are
out there.
Do you not think there is room if we applied good underwriting
standards and appraisal standards to move up in some of these
areas?
Mr. STEEL. You were good enough to explain to me the last time
I was here with visuals about the prices and how it affected your
constituents, and even first responders in your area, and made that
clear.
I accept the point. When we worked through the GSE bill that
passed the House, we worked with you to try to understand these
issues.
Our goal is to work with the Senate and together to have a GSE
bill—
The CHAIRMAN. Let me just interrupt. In fairness, when we outlined what we were talking about, we did agree, and it was last
minute, I understand, the President did make these proposals. On
September 20th, we are going to go over these in detail. I would
hope that by September 20th, we can get some of these answered
more.

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We did basically ask them to be ready to come and talk about
this more on September 20th.
Mr. MILLER OF CALIFORNIA. Some of us, and I know Chairman
Frank and I even believe that FHA should be higher in some of
these areas. We would like to see that approach.
I am just throwing it out. The GSE comment was not a matter
of trying to be argumentative. In our areas, the high-cost areas, we
are looking at if a GSE loan goes up to the amount we propose,
people save about $175 to $180 a month in their payment. That is
huge for people who might lose their home. I just wanted to throw
that out as something for you to think about.
Mr. STEEL. I do not think that question is argumentative at all.
I look forward to continuing the discussion.
Mr. MILLER OF CALIFORNIA. Thank you, sir.
The CHAIRMAN. We will all stipulate this is one time the gentleman was not being argumentative.
The gentleman from Georgia.
Mr. SCOTT. Thank you, Mr. Chairman.
I would like to ask very quickly each of you if you could respond
to this first question. Who has been hurt the most by the subprime
mortgage crisis?
Mr. STEEL. I will start, sir. I think as I answered the question
for Mr. Pearce, that if you applied who would be most affected, I
think it is the homeowners who were in the most perilous position.
If I might add, relative to your opening statement, HUD does
have a national hotline for subprime assistance, and that is available for people who want help with subprime issues.
Mr. SCOTT. What we had in mind in terms of our hotline was a
human being at the other end of the line, the people who were targeted most in predatory lending are largely unsophisticated and
uneducated. They are people who need to call the hotline but have
somebody ‘‘hot’’ at the end of the hotline.
Mr. STEEL. This has been connected to counseling services at
HUD to try to help these people.
Mr. SCOTT. Is that consistent with the others, the homeowners?
[Panel nods affirmatively]
Mr. SCOTT. What I cannot understand is this reluctance to provide at least in a moderate way Fannie Mae and Freddie Mac from
having the flexibility in this area. It is particularly true when you
look at the fact that it is a part of their charter obligation to provide liquidity and stability to the secondary mortgage market, particularly during periods of market dislocation.
They have a consent order with OFHEO that allows for adjustments to the portfolio cap to address market dislocations.
It is particularly needed, I think, and it could be temporary. It
could be 10 percent. It could be 12 percent. It could be targeted.
I think for the Administration to just clamp down and say no concerns me.
The CHAIRMAN. Would the gentleman yield? This may have been
my fault. I want to ask if we can defer that until the 20th when
we have the hearing on the President’s plan in context. Maybe I
am hoping I will get an answer I will like more later. In fairness,
we did say we would expect answers to that on September 20th.

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Mr. SCOTT. All right. With that in mind, that was basically the
gist of my concern. I will wait until September 20th.
The CHAIRMAN. I thank the gentleman. That was my cause of the
confusion. The gentleman from Texas. I apologize for rushing you,
but I would like to get to everybody.
Mr. GREEN. Yes, Mr. Chairman. I will accelerate the pace. Let’s
talk quickly if we may about the risk layering that has been mentioned by you, Ms. Bair. Who is going to regulate this when you
have all of these various and sundry risks being placed on top of
each other?
Right now, there is nothing regulating it. Who would you propose
regulating this?
Ms. BAIR. We do regulate bank lending and we have through our
guidance and supervisory activities put a lot of constraints on risk
layering. Again, in the non-bank market, those are state regulated
entities. The Federal Reserve does have the ability to impose national standards on the non-banking—
Mr. GREEN. If I may, you mention in your paper, and it is very
well done, by the way, I enjoyed reading it, are you saying there
is more that you will do in the area of risk layering?
Ms. BAIR. I think the risk layering was addressed, and I believe
we are hopeful that the Fed will be able to address it as well under
the HOEPA rules for non-bank lenders. We can only reach risk
layering lending practices in the banking sector.
Mr. GREEN. Who is going to deal with the 2/28s and 3/27s and
the onerous prepayment penalties? Who will eventually step in and
regulate that or deal with that?
Ms. BAIR. For the non-bank lenders, the States do have some authority. They worked with us in developing our guidance and are
trying to apply it.
The Federal Reserve Board, I think, is really going to be key
here. They are undertaking a rulemaking right now.
Mr. GREEN. If I may quickly, we have pension funds that are investing in hedge funds, hedge funds are investing in the subprime
market fronts. Many of these pensioners do not really understand
how at risk their pensions are.
Who is going to look at this and make some determinations that
maybe this area needs some sort of scrutiny because of the risk
that the pensioners are placed at by virtue of the way this
connectivity has developed?
Mr. STEEL. I can start if you wish and maybe defer to the SEC.
This is an issue of private pools of capital that has been a focus
of the President’s Working Group. We believe there are four different actors in this situation.
There are the regulators, the regulated entities that finance the
private pools of capital, the managers themselves, and investors.
All four need to be diligent and vigilant with regard to their responsibilities.
When I spoke about this issue to Chairman Frank before, I said,
and I remember quite clearly, the status quo is not acceptable. We
are working hard now to increase the focus on this and develop
best practices for each one of these people.
Mr. GREEN. Thank you very much. I yield back, Mr. Chairman.
I would like to say that I think the President has stepped up to

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62
the plate. I think the Fed Chair stepped up to the plate. People are
expecting the Congress to step up to the plate as well. People understand there is a crisis notwithstanding what is being said.
Thank you.
Mrs. MALONEY. [presiding] Thank you. The gentlelady from Illinois.
Ms. BEAN. Thank you, Madam Chairwoman.
Mr. Steel, during the month of August, both the President and
the Treasury Secretary publicly opposed raising the portfolio level
for GSEs, which seems at odds with the President’s recent announcement of lacking illiquidity, but is clearly inconsistent with
the overwhelming bipartisan support of GSE reform earlier this
year.
Given there is general consensus about the importance of a
strong independent GSE regulator and yet it was the President,
not OFHEO, who publicly stated that the caps would not be lifted
until Congress passed GSE reform, should we be concerned that
Administration policy might be influencing or interfering with what
is supposed to be an independent safety and soundness regulator’s
authority?
Mr. STEEL. I do not think so. I do not remember the exact timing,
but if my memory is correct, OFHEO had already announced their
decision and communicated it to the regulatee at the time this
question was asked of the President.
Ms. BEAN. Thank you. Second question, does the Treasury have
broader concerns about the impact of what started in the subprime
space on the overall economy, not just for those who have subprime
loans and those who are unfortunately dealing with foreclosures,
but for those in our districts who historically have good credit but
have in many cases taken their credit card debt and then gone and
gotten a home equity loan at a better rate or they have refinanced
their home by borrowing against the equity to reduce that debt and
that has helped stimulate our consumer spending, given that now
the value of homes has come down so there is less equity to borrow
against, there is less credit available now in the new space of access to credit, and you also consider some of the recent articles
about how incomes in many cases are below levels that they were
in 2001.
For many again who are historically good credit consumers, what
is your concern about how that may affect the overall consumer
spending?
Mr. STEEL. I think the second paragraph of my statement that
I provided at the beginning really focused on the fact that the overall condition of the economy is quite good. If you pick any area,
growth, inflation, employment, these are constructive things.
We had a period in the marketplace that has been unsettling.
There are some signs now that this unsettled feeling is beginning
to improve. There will be other issues or challenges that I am sure
will develop as this process continues of improving, but I would be
optimistic that while there may be some penalty to growth, because
of this turmoil in the markets over July and August, we are still
on a projectory to have good solid growth in the second half of the
year.

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Ms. BEAN. No concerns that what could be a short term problem
in the B to C space could roll into the B to B space long term?
Mr. STEEL. I promise you I am concerned every day, but I think
the specifics of this in terms of basically trying to understand what
the likely effect will be on the real economy, I would stand with
the description I have provided.
Ms. BEAN. Thank you.
Mrs. MALONEY. Thank you. The Chair notes that some members
may have additional questions for this panel which they may wish
to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to
these witnesses and to place the responses into the record.
The Chair recognizes herself for 1 minute, and then the gentleman for 3 minutes. I just have to ask a question about my home
State, New York. In July, Governor Spitzer announced a very aggressive program. He announced $100 million to help at-risk families keep their homes, through partnering with Fannie Mae and
Freddie Mac, who will be financing this initiative, the State of New
York hopes to be able to refinance literally hundreds, possibly thousands of at-risk homeowners from the 2/28s and 3/27s and the 30
and 40 year fixed rate mortgages at competitive interest rates and
keep them in their homes.
I understand that several other States have entered into relationships with Fannie and Freddie to do the same thing, specifically Ohio and Massachusetts.
We are concerned that we are going to be right up against the
cap, and this would hinder the ability of New York to work on a
local level to help people stay in their homes.
Again, it is a question that has been asked many times, but if
there was ever a time that we should have more liquidity in the
market and have more flexibility for Fannie and Freddie, it seems
to be now.
Secondly, I support the initiatives that have come forward from
the President and the Administration, but by even your account,
this will only help 80,000 borrowers stay in their homes. There are
at least two to three million who face foreclosures in the next 2
years, by even the Administration’s accounts.
What are we going to do about them? We are concerned that because of Hurricane Katrina, 300,000 people lost their homes, but
10 times as many people may lose their homes in the subprime crisis. And what about the new guidance that came out, and it really
responds to a letter from Congress on the servicers having more
flexibility.
That in no way is going to take care of all of this problem. First
of all, the problem of New York and Massachusetts and Ohio,
where they have this relationship that can help keep people in
their homes, but they need the flexibility if Fannie and Freddie are
up against the cap to be able to keep them in their homes through
this refinancing program.
Mr. Steel?
Mr. STEEL. Thank you. Let me try to start at the back and go
forward. I am not familiar with the specifics of the New York proposal, so I look forward to learning about that and coming back to
you.

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Mrs. MALONEY. Very quickly, working with Fannie and Freddie
that are financing that to help people stay in their homes, but they
are going up against their cap, which means they may not be able
to refinance them, to help them stay in their home.
It is a big problem. We need to raise those caps even if it is temporary.
Mr. STEEL. I think we are meeting with Fannie and Freddie, too,
to talk about creative solutions for how to deal with this. There are
other alternatives besides just buying loans yourself, and there are
other ways in which they can increase their capacity.
With the second issue, 80,000 is the number of incremental FHA
by the changes we have suggested. The total number is closer to
300,000.
Also, there are two million resets we are facing over the next 18
months, roughly two million. That includes things that are speculators, and it includes numbers that are not owner-occupied. We
are focused on the homeowners basically themselves, individual
single family owner occupied. That number is less than two million.
The third point is there are lots of things we are working with
to focus on the servicers, the counselors, and other products to attack the rest of them.
I am optimistic that we will be successful to a great degree.
Mrs. MALONEY. Thank you very much. The Chair recognizes the
gentleman from the great State of New York for 3 minutes.
Mr. MEEKS. I will only take 1 minute. Mr. Steel and Mr. Sirri,
a quick question. This is the general market I am trying to find out
about. Has the market reaction to holders of the subprime loans affected AAA rated money market mutual funds to your knowledge?
Mr. SIRRI. Money market mutual funds by definition have to hold
very liquid paper. Under rule 287, which governs those funds, at
a minimum, 95 percent of assets has to be in the highest rated
paper, the other 5 percent can mean one notch lower. That is only
a minimum. Besides that, the advisor has to go through their own
credit analysis.
I think at the moment, events have not had a substantial effect
on money market funds. Were that to have an effect, we have rules
in place that would allow advisors to purchase some of that paper.
In addition, our staff stands ready to work with those funds in case
there is any dislocation in that market.
Mr. MEEKS. So far, it seems safe. Someone told me some people
are putting money in there as a safe haven, investing in these.
Mr. SIRRI. So far, we have detected no serious problems.
Mr. MEEKS. Thank you. Last question of the day.
Mr. STEEL. I agree with Mr. Sirri.
Mr. MEEKS. I have been hearing this for a long period of time
now. Are we heading for a recession given what is happening? Are
we headed for a recession, in your opinion?
Mr. STEEL. Our view at Treasury is that the economic growth
that has been going on in the second quarter will continue at a
positive projectory into the third and fourth quarters and the economy seems strong.
Mrs. MALONEY. That is a good point to end on. The meeting is
adjourned. We have missed a vote. The economy is strong.
[Whereupon, at 2:07 p.m., the hearing was adjourned.]

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APPENDIX

September 5, 2007

(65)

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