The powerful subcommittee chairman in the House with jurisdiction over Fannie and Freddie talks about reform of the secondary mortgage market.
Mortgage Banking
June 2012
By Robert Stowe England
Rep. Scott Garrett (R-New Jersey) has represented New Jersey’s 5th Congressional District along the wealthy northern tier of the state since his election in 2002. Since early 2011, he has served as chairman of the Subcommittee on Capital Markets and Government-Sponsored Enterprises (GSEs)--part of the larger House Financial Services Committee.
Garrett’s subcommittee has jurisdiction over the Securities and Exchange Commission (SEC), Fannie Mae and Freddie Mac. The subcommittee also handles all matters related to capital markets activities, such as business capital formation and venture capital, as well as derivative instruments.
Garrett holds other leaderships posts in Congress: vice chairman of the House Budget Committee, chairman of the Budget and Spending Task Force for the Republican Study Committee, and chairman of the Congressional Constitution Caucus.
An avid outdoorsman, Garrett is a leading congressional supporter of open space and protecting natural treasures in his state, including the New Jersey Highlands, the Musconetcong River, and the Wallkill River National Wildlife Refuge.
Prior to his election to Congress, he served in the New Jersey General Assembly from 1990 to 2002, as the senior assemblyman for the 24th legislative district, assistant majority leader and chairman of the Banking and Insurance Committee. In Trenton, while in the General Assembly, Garrett also served on the Education; Transportation, Public Works and Independent Authorities; Agriculture and Natural Resources committees, as well as the Joint Committee on the Public Schools.
He earned his bachelor of arts degree from Montclair State University in Montclair, New Jersey, and his juris doctorate from Rutgers School of Law in Camden.
Congressman Garrett has been on the forefront of efforts to pass GSE reforms and legislation to bolster free capital markets and to revive the private-label mortgage-backed securities (MBS) market.
Mortgage Banking caught up with Garrett at his office in the Rayburn House Office Building recently, and asked him to discuss activities in his subcommittee.
Q: You have made reforming the GSEs a key priority for your subcommittee in this Congress. You introduced a bill to limit executive compensation and at Fannie and Freddie to the level offered senior government officials, while Rep. Ed Royce [R-California] introduced legislation to permanently abolish the affordable-housing goals at Fannie and Freddie. What do you hope to achieve with your reforms? When do you think broad GSE reform might be possible?
A: What we are attempting to do with GSE reform is address what we thought was a driving cause of the collapse of the mortgage market in 2008. The goal is to allow the development of the private-sector opportunity for providing funding for mortgages going forward.
I didn’t just take up this issue in 2008. I’ve been working on addressing GSE reform and have been involved since I first arrived here back in 2002 and 2003, when [former chairman of the House Subcommittee on Capital Markets] Richard Baker [R-Louisiana] was inviting a review of the GSEs. We saw that the GSEs had the potential for systemic failure--but none of us saw the magnitude of the impact it could have.
We tried to get GSE reform through Congress all those years, but reform didn’t come until July of 2008--on the eve of the crisis. We have been pursuing reform in this Congress to make sure the taxpayer is not put on the hook again for potential future systemic collapse.
In the subcommittee we have held 26 or 27 hearings since the beginning of last year. There have also been a number of mark-ups, and 14 have been moved by the subcommittee to begin the process of reforming the GSEs.
The last major piece of legislation, the Private Mortgage Market Investment Act [H.R. 3644], is a companion effort with GSE reform that completes the puzzle by answering the question of what will come after the GSEs? This bill addresses the question of what will the market for loans look like without the GSEs? We moved that piece [of legislation] through the subcommittee.
Q: What will the private market legislation accomplish?
A: This legislation is designed to get the securitization market going again, which is obviously essential to [rebuilding] a private mortgage market. Bank balance sheets can’t take it all--that is, they are not large enough to support a private sector big enough to fund mortgage needs.
One thing I’ve learned is that now is never the time to delve into difficult legislation. We have some hard choices to make over the next two years. Sooner rather than later, these issues need to be addressed.
The GSEs have been in conservatorship since 2008--almost four years. I’m here to begin the process of moving forward to address their future and the future of the mortgage market. If a bill [was] passed in the House and signed into law today, and a turnkey oversight regime phased in over a period of time, it would be another five years before GSE reform would begin to take place. That would be 10 years from the date of the collapse before any real action would take place.
I am always encouraging [the House Republican] leadership to take this up. One part of the GOP platform the leadership points to from time to time is ‘no more bailouts--take the taxpayer off the hook.’ The only way to meet that pledge is to pass the GSE reform and Private Mortgage Market Investment Act legislation that we have moved through the subcommittee.
Q: What do you think will be the ultimate price tag for the GSE bailout?
A: The Federal Housing Finance Agency was saying originally the ultimate price tag could be $400 billion, but now they are saying it’s closer to $300 billion. So far, it’s $187 billion.
Q: What is your own view?
A: It’s hard to say. The numbers that we have assume you don’t have another significant event in the housing marketplace. There could be crisis brought on by events in Europe or China, and [if there is such a crisis, it] could require another bailout in housing.
Q: If Congress passed the Private Mortgage Market Investment Act, what would its impact be on the mortgage market?
A: In a sentence, it will reinvigorate private incentives and investment to re-energize private-label securitization and the housing market. How does it do all that? It empowers the FHFA to create standards in two areas--underwriting and securitization--that will facilitate the re-emergence of the market.
There will be standardized models that will allow for different types of products with different levels of requirements for down payments, FICO® scores and other characteristics. With a clear rule of law and clarity about the rules on such things as reps and warrants and arbitration, investors will be more attracted to new issues.
Q: Will there be greater transparency?
A: Yes, the standards would facilitate transparency. It should make it easier for investors to drill down into the details of securitization deals.
Q: Even if this legislation is passed into law, there are [other] issues created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010--such as defining a Qualified Mortgage--that many see as an impediment to revival of the mortgage market.
A: You’re absolutely right. There are a couple of levels--the level that we address and some of the levels we don’t address. You can’t address everything in Dodd-Frank--you mentioned Qualified Mortgages. We address that in the Private Mortgage Market Investment Act [under standards for underwriting and securitization]. If you fall into the definition of the Qualified Mortgage, then you get the advantages of a better regime--as far as dealing with the SEC filing requirements, just as they are right now for the GSEs. Why that is important is that you want to be able to have a TBA [to-be-announced] marketplace. So, we believe the relevant pieces of it, combined, help facilitate that TBA market going forward. Without that, people say the market won’t be able to set pricing.
So, to your point, we do address some of the concerns in Dodd-Frank--but Dodd-Frank is 2,300 pages, so not all the impediments in Dodd-Frank are addressed.
Q: Does your private mortgage market legislation address anything pertaining to the 20 percent down payment of the proposed Qualified Residential Mortgage?
A: The different types of underwriting that you have under the first part of the standardization [provisions] would be left to the FHFA to create. You could have several levels of [different underwriting segments in the standards]. You could have [a standard for a market with] 20 percent down payment, with high FICO or credit scores, and that would be one of the safest ones that investors would look at. Or you could come up with [standards for] a 3 percent down payment, with different FICO scores, and that would obviously have a different attractiveness to investors as well.
What we try to do [is create the potential for] homogeneity in the different rules, or silos [of defined standards for market segments], so that investors will know that there will be enough liquidity in that particular marketplace. One of the reasons why GSEs trade as well as they do, [beyond just having] the government guarantee, is the degree of uniformity in the GSE marketplace. So, I can go out and buy GSE securities and know that the pool is liquid. If I’m not going to be able to sell them, then I’m less inclined to buy them, right?
Q: So basically this is going to be a more flexible market than the one we can currently foresee based on the regulations that are coming out under Dodd-Frank. The securitization market, then, will be able to better adapt to the actual needs of the mortgage market and the different parts of the market.
A: Right.
Q: Because the way the market is going now, a lot of people couldn’t get a mortgage in the future--and a lot can’t get one now.
A: Right--under Dodd-Frank, absolutely. As the rules begin to be implemented under Dodd-Frank, yes, the market for mortgage credit will tighten up even more. There are a whole host of different reasons for this. I was in a meeting with people earlier today [on April 17] on the Volcker Rule and what that means to institutions. The institutions say, “We’ll just have to stop this whole line of activity we do right now.” What does that mean to the mainstream consumer who doesn’t even know what [the banks are currently doing in providing credit and liquidity]? It just means my availability to get a loan or credit has probably shrunk as well. It may not be clear why. It may not be so apparent, but it’s a result of Dodd-Frank.
You can go down the whole list. It’s not just Dodd-Frank, but the multiplier effect of Dodd-Frank, with new capital rules for banks under Basel III. [All of this] could cause a trillion dollars in collateral shock [to the mainstream economy]. This is something we talked about back during Dodd-Frank hearings.
Q: What do you think of the overall job done by Ed DeMarco, acting director of FHFA? What do you think of efforts by many to get Fannie and Freddie to reduce mortgage principal?
A: What do I think of him? I think he’s done a great job of trying to deal with a very difficult situation. He’s done a great job of trying to do what he’s charged with doing--and that is to protect the taxpayer. But, unfortunately, he continues to come under attack and pressure from outside forces, which are being done, in my book, for purely political reasons.
Q: And what do you think of efforts to require Fannie and Freddie to reduce principal in loan modifications?
A: [DeMarco’s] looked at it and his guys have run the numbers on it, and if it would help taxpayers to reduce principal, then he would have implemented it. It’s not going to take a financier to figure out that if you are cutting down the principal, then the amount of money that gets paid back is less. We’re putting the bill to the taxpayer and the taxpayer is the one that is going to take a look at this and say, “Hey!”
Q: When he spoke at the Brookings Institution recently, DeMarco said there might actually be some small savings with principal reductions because some mortgages would then be paid that might otherwise go to foreclosure with bigger losses. But he also pointed out that the analysis made no effort to measure losses that might be created by moral hazard.
A: We already saw the effects of moral hazard from 2008 on, when you had these other government [foreclosure prevention] plans that were out there. People would be calling up [my office and] saying, “Can you help us?” Then, when we’d try to put them in touch with the appropriate people, then they would call back and say, “Well, we don’t qualify.” And then they would say, “We’ll qualify if we stop paying our mortgage. Then in six months we’ll be in arrears and then we’ll qualify for this program.” That’s the short-term moral hazard. The consequence of that moral hazard is that investors look at that and say, “Why do I want to get into this marketplace if I know that is the way consumers may be encouraged to look at things?” Moral hazards have consequences.
Q: What do you think of the role of the credit rating agencies in the financial crisis, and what did Dodd-Frank do or not do to address this problem? Do you think more needs to be done?
A: I don’t think anyone can look at them and not scratch their head and wonder what were the credit rating agencies thinking when they were doing their analysis and doing their opinions on these securities. What has been done? One of the provisions in Dodd-Frank was mine--which is to take them out of statute and regulation so that they would not any longer have the imprimatur of the federal government saying, “Yes, this company or that company is somewhat blessed by the federal government and you could therefore buy any security that they put their stamp [of approval] on.”
So that was a provision that was put in [Dodd-Frank]. It was done in a bipartisan manner. It remains to be seen what all the consequences of that will be on the marketplace. The regulators are still attempting to grapple with and implement that as well, come up with an alternative mechanism. I guess part of the goal is [to figure out how to] instill market discipline back into the marketplace, [where] market discipline means investors doing their own appropriate due diligence.
Q: Do you think the investors relied too much on the credit rating?
A: Right. They would say, “Why do I need to look at anything? Why do I need to drill down into the book at all? It says it’s triple-A. And the government says it needs to be triple-A, and they are Nationally Recognized Statistical Rating Organizations [NRSROs]--so I guess I can trust them.” People didn’t do their due diligence. So, what you need to do when you craft legislation, like we do, is to try to figure out what you need to do to encourage due diligence again. Obviously, right now there is a lot of due diligence going on. But we’ll see how long that lasts.
Q: Do you think the appointment of Richard Cordray to head the Consumer Financial Protection Bureau [CFPB] was a violation of the president’s authority to do recess appointments?
A: Yes. There’s an old YouTube video of me giving my comments to him when he was before our committee--I gave comments there saying, “You should not be here testifying.” It was an unconstitutional action by the president, making that so-called recess appointment. The language was intended for appointments during a recess, and the Congress defines what a recess is--and it is not for any president of any party to be able to skirt the issue. That’s why my comments were that he should not have even been coming before Congress to testify, because it was an inappropriate appointment in the first place.
The [legislative design of] CFPB [in Dodd-Frank] obviously has other fundamental flaws in it--chief among them is the funding process, which is basically outside of the overview of Congress since it does not go through the appropriations process.
Q: Do you think that should be changed?
A: We want to change that. But the only fail-safe to that [in Dodd-Frank is], “Don’t worry, because the head of the CFPB would only get there after the Senate gives him confirmation.” Obviously that didn’t happen. The president got to pick his guy. The president gets to fund the organization without any checks by the Congress.
Q: That’s part of the governance problem.
A: That’s a third problem. This is an agency of one, as opposed to a board or a commission arrangement like they have with other independent agencies [such as] the Commodity Futures Trading Commission and the SEC. We don’t have that. We just have one guy saying, “This is what I think and so this is what I’ll do.” There are no checks and balances [within] the agency structure. There are no checks and balances as far as the appropriations and the funding. And there are no checks and balances on the appointment process if the president sidesteps the confirmation process.
Q: So it would seem that anything they do--
A: Should be challenged in court. Unless the court finds it to be extra-judicial . . . we have some basis for a challenge. MB
bio: Robert Stowe England is a freelance writer based in Arlington, Virginia, and author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger and available at Amazon.com. He can be reached at
Copyright © 2012 Mortgage Banking Magazine
Reprinted with Permission
