mortgage market. the enterprises and fhfa work closely with the administration %k%&@ @ @ @ @ @ @ @ @ @ #@ @ @ faha expects to ramp up rabpidly by late summer. in my written testimony, i summarize what went wrong in housing and mortgage p markets, identified some lessons learned, and raised basic questions that policymakers face at this juncture. i will now focus on my thoughts on the potential roles from the federal government in the housing market and some principles i think should guide policy choices going forward. the starting point has to be the future role of the secondary mort market, which connects global investors to local

lenders and borrowers. global investors to local lenders and borrowers. doing so helps to lower borrowing costs for home buyers and in part because large institutional investors may be better able to fund mortgages and manage the risk in the portfolios. whatever options are chosen, the country's financial system will continue to require a vibrant secondary mortgage market including the functions performed by the enterprises. there are three specific roles in the secondary mortgage market. the first role that of a liquidity provider to the secondary mortgage market for mortgage backed securities. the second role is that of a structurer and/or insurer of the credit risks of the mortgage-backed securities. private firms are limited in the ability to insure against catastrophic events, but governmental insurance comes with significant risk and moral hazards.

a third role is to alter the allocation of resources by providing subsidies to attempt to increase supply or reduce the costs of mortgage credit and targeted borrowers. such a role has been central to all of the housing gses and not just freddie and fannie, but a home loan program. but as the crisis shows, it has had mixed results. with these roles in mind, i would like to tourn what i consider some of the basic principles that you have to consider as you are looking at the future and the mortgage market and fannie and freddie. the first principle is this institution should have well define and internally consistent missions. missions that do not encourage excessive risk taking. a second principle is that there must be a much clearer demarcation of the respective

roles of the federal government and the private sector in the secondary mortgage market. any federal risk bearing should be provided explicitly and at an actual real cost. the old hybrid model as many of you said of private, for-profit written under a federal guarantee poses a large systemic risk to the whole u.s. economy as we found out. the third principle is to base any organization that provides mortgage guarantees on sound insurance principle, and that means requires strong underwriting, strong capital positions, risk-based pricing and flexibility to react to changes in the marketplace. the fourth principle is to create a regulatory and governance structure to ensure that it is prudent. on my first day of the job three years ago, i pointed out the folly of allowing the enterprises to have such large

portfolios which we did cap and also the folly of allowing the legally-leveraged on mortgage credit by over 100 to 1 and of course, many others including many in this room did as well. congress did provide a stronger regulatory structure of the housing gses last july, but unfortunately, it was much too late. the fifth and final principle is that the housing finance should be subject to the supervision that seeks to contain the riskiness of individual institutions and the systemic risks associated with housing finance. the latter type are supervision which would include countercyclical and policies and the tendency to generate lending booms and busts. with those principles in mind, there is really three basic structures for the future of fannie mae and freddie mac. one is a government agency, and another is a hopefully much

improved gse, and the third is a fully privatized firm. the first option would be the equivalent of nationalizing the enterprises which i am opposed to, because i believe that the government insurance programs are particularly high risk and rife are moral hazards. the second alternative would be to keep the enterprises as gses building upon hira and they could be a public utility or a cooperative structure, and they could continue with the treasury net worth protection or insurance for catastrophic risk, but extreme care has to be taken to prevent the inherent conflict always present in the gse model. a third option is to establish purely private sector firms to supply liquidity to mortgage markets with or without some form of governance or catastrophic insurance. private funds could provide

competition and however to maintain the level of liquidity that the market has enjoyed under fannie and freddie, a high level of standardization and quality control across the firms would be necessary. i would like the close with a few personal thoughts. having worked at several private sector insurance companies and advised many others and actually run several government insurance programs, i can tell you that the government insurance programs are high risk. they invite the private sector to shift risk to the government. among the other issues, it is often difficult in a political environment to charge an actuarial fair price. it is difficult to resist pressure to broaden the mission, and provide inaccurately compensated increases in risk taking. nevertheless, the government has a role to play in providing certain types of insurance, especially reinsurance against catastrophic risk, but again,

that insurance has to be prefunded and actuarially found, and that is difficult in the government. the enterprises from the federal home loans are playing a vital role to help stabilize housing in the economy today. fannie and freddie's participation in the leading "making home affordable program" is strengthening their own books as the congressman said, it will help to stop the bleeding if we can make this program work. as markets and the enterprises stabilize, there is need to address the complex issues i have outlined in the testimony. it is important to get the mortgage market model right, and the restructuring of the gses right, not for the u.s. economy, but also for all present and future american homeowners and renters. i will be happy to answer any questions as will my colleagues.

thank you. >> thank you very much. mr. lockhart, part of the problem that we have and i would probably like to clear it up very early is that we have never had a definitive set of hearings or commissioner appointed to designate what the cause of the disaster that, the economic crisis over the last year, year and half has been. i hear many of my colleagues as i hear many commentators through our economy asserting that it was caused for several reasons, quite extreme reasons. i never knew that cra were so extensive within our system that they brought down the whole system, but i have heard some people make that charge. i have also heard people make the charge that fannie mae and freddie mac brought down the system. but i want to ask you that question, is that your opinion?

i can express mine in that fannie and freddie fail affidavit the credit crisis occurred, and the credit crisis occurred more in the securitization in the private markets, particularly of subprime loans than of fannie and freddie, and they followed in the destruction of credit in the country. is that relatively true? >> well, there are many, many factors and many people guilty over this bubble that we had and in particular the housing market. there was excess liquidity. as former secretary paulson used to say, risk was mispriced not only in the housing market, but across financial markets and across financial institutions. certainly, in the housing market underwriting standards fell dramatically, and in particularly the subprime market and most of it did go into the private label securities, and i have to admit that fannie and

freddie were big buyers of the securities and not only the aaa ones, but they and everybody else including the rating agencies did not do enough analysis on the securities. certainly, to keep some market share, and their market share actually dropped over a three-year period from 50% to about 33%, they did lower the standards in '06 and '07. they didn't lower it as far as the rest of the market, but they did lower their standards. as i said, there were a lot of reasons for what happened. fannie and freddie, i do not think were the cause, but they like many others institutions and including the poor regulatory structure that falo had, and we froze their assets, and still problems. different reasons and

regulations and too slow to get the new legislation, and the housing marketwas caused by worldwide financial issues and not just fannie and freddie. >> as you know the reform legislation to correct the agency and give you powers of world class independent regulator, that started considerably before it actually became law, if i remember in 2005, we put that legislation forth and it failed to get senate confirmation and therefore did not proceed to the president for the signature, but after that, it wasn't enacted either. and not the place blame, because it is the worst mistake we can make in placing blame, because it was a republican administration or democratic administration or republican congress or democratic congress, but so as we have facts that is leading up to the crisis, and

that is the four or five years of the real estate bubble, the senate and the house were in the control of the other party than they are now, and that is the republican party, is that correct? >> i guess so, yes, sir. >> and the presidency of the united states was in the control of a republican, is that correct? >> that is correct. and that republican was asking for reform from almost day one when he took the job, yes, sir. >> and his party's congress did not respond, is that correct? >> as i understand the history and i wiz not here in '05, so you have to bear with me, but, they wanted stronger legislation than was had. >> no question about it, he wanted stronger legislation, but the people who controlled the house and the senate at that time were his own party, is that correct? >> that is correct. >> now, i don't want to place blame -- [ laughter ] i think that if we could leave today's hearing, i join my colleagues on the other side that they appreciate my

tendency, but i think that we have to finally draw the lines on finding fault, because it won't get us anywhere, but the one thing that does disturb me though as we talked through that, there is a tendency to think that maybe if this had been done in the total in the private market and government had not been involved, do you see that as a viable alternative that we can just let fannie mae and freddie mac dry on the vine and become prunes and forget about them and let the private market go on? or will there be a negative impact in the united states in terms of real estate, ownership of real estate, and so that the history is correct, fannie and freddie were instrumentalities forced upon the american people even though one of them was done in the depression their tiary t

was to fill a void. we didn't have a second market in real estate until the government took the responsibility of establishing fannie mae s that correct? >> that is correct. in the recent decade, the private market through the private label securities did increase their market share pretty dramatically from fannie and freddie and from the fha for that matter. and unfortunately, they did it in an unregulated and unsafe and unfound fashion. >> i wanted to say, they didn't do it in a very superior way, did they? >> no, they didn't. >> so if we had to say anything of making the government creating a second market, and wall street left to its own designs, wall street in the last two or flthree years became an absolute disaster. >> yes, and going forward we need a private sector market, and there is a lot of activity going on -- >> well, we will try wall street again?

>> a much reformed version with much more transparency and much stronger underwriting. last night i had an interesting dinner with mr. simon, who is a financier, and quite renown in the united states. he made a proposal to us. i think it merits consideration. i'd like your opinion. what it roughly is, he feels one of the major blows to the securityization market was the failure of the rating systems to the institutions that were there to create and did infact create all these triple-a ratings that we found out much later on were nonsense. no

at his suggestion and opinion was that we should take upon forming a nonprofit governmentally sponsored and supervised super rating agency that does not make money from tissuer, but gets paid independently and separately with a separate fee and it would have to rate all of the bundled securities or securitized operations. have you given any consideration to that type of thought? >> well, there is no doubt that the rating agencies failed. if you look at the aaas that fannie and freddie bought, about 60% of them now are junk and only 5% are still aaa and not on downgrade. no doubt to be reformed and downgraded, but i have not thought of that, but there is an analogy in the insurance world where the niac does rate for the

insurance companies. whether that works or not, i'm not sure, but it is something that can be considered. i think that more importantly, we need to reform the rating agencies, and we need to again come back to rating and not consulting and getting the fees for structuring the bonds. >> thank you mr. lockhart. i have run over my time and now i would like to recognize mr. garrett of new jersey to provide with his time. >> thank you. i, too, will try not to lay blame or be partisan on any of these things. i appreciate the fact that you are laying tout history of things that it was the reforms did get through the house. they were requested by -- well, you were here sometimes and other people during the bush administrations were here. i remember secretary snow was here and a number of people pushing for limitations on portfolio and other limitations as well to get through the house and it did go to the senate. then senator and not president obama was in the senate at that

time, and not being partisan at all one way or another, but he said that we could not get cloture, as i recall to get the piece of legislation to the president's desk. had we done it at that time, perhaps we wouldn't be sitting here today looking back to say, why didn't the world class regulator do the job, because the world class regulator could have potentially done the job. i find interesting your comment with regard to whether the gses or other federal regulations were in part or parcel the cause of it. quickly, you ran down it was excess liquidity, and that is part and parcel of the excesses by the fed on monetary policy. you taked about lowering of underwriting standard and that is part in parcel of the fed and the boston fed and others who instructed wall street to lower the underwriting standards and with regard to the gses i appreciate your candor to saying they were lowered standards for a period of time, so we cannot

say that this factor is the cause of it, but it further exacerbated a problem when they brought up some of the bad securities with bad underwriting to them. with that all said, wub one of objectives is to lower the risk that the gses have posed to the taxpayer. both enterprises have a significt amount of interest rate risks with a limited number of counterparties in that there are only a few that you can deal with. these are swaps that are basically bilaterally to help manage the portfolio and hedge the riszks. there are new clearinghouses being established, and popping up, and they have a potential to reduce the counterparty risk through the enterprises through the transactions if you were to funnel them through. of course, you know how that

works. so can you elaborate h you are working to reduce the risk to the taxpayers with the clearinghouses for these swaps? >> well, counterparty risk is a big issue in the financial markets today. there is actually over the last year concentration of counterparties as there have been mergers and acquisitions whether it is in the mortgage market and the deposit market and other areas, but certainly as the quality of some financial institutions have suffered that this meant that fannie and freddie and many others have had to concentrate the derivatives activity and fannie and freddie have $1 trillion of derivatives as do to federal home loan banks. and as part of the counterrisk what can be done about it? one of the issues is how to talk with them and start to move in some of the businesses into clearinghouses and exchanges to diversify the risk and lower the

risk. >> the product here is basically a standard product that we are dealing with, right? >> right. >> well, a lot of the fannie and freddie had the prepayment risks and they used swaps and sometimes more interest rate swaps. >> is something holding you back then or a time line? >> well, as you said, these are relatively new vehicles and we are looking at them and we want to make sure it is done in a safe and sound manner. >> on another note with regard to the portfolio which is one of the areas which there is a request for years ago in trying to rein them in, what is the purpose of keeping the portfolio where it is now. it has gone up since the problem began and it is starting to run down starting in 2010, but why don't we start to run it down right now and say, we are going to elaiminate that? >> well, the key thing that the portfolio has been used for

since the conservatorship is to support the securities mortgage-backed market. the securities have been buying a lot and so has the treasury. that is important to get the mortgage rates down. since the conservatorship, we have seen the mortgage rates drop 1.5% from 6.5% to 5.5%. obviously, part of that is the fed and the treasury buying them back, but they have more firing power at this point the portfolios are stagnant. >> well, stagnant -- well, they went up? >> and now they are coming down. >> can you give us a time line projection of when they will be -- >> well, a lot of it depends upon what happens in the mortgage market. to be perfectly honest what we need to do is to stabilize if mortgage market and then figure out what to do with the portfolios. the key job, number one job is to stabilize the mortgage market, and that is by bringing

the mortgage rates down. it is by modifications, and by refinancing. >> and that is the last question, the overall job and one of your comments is what is the job of the conservator, and you said to preserve the assets of the gses and what you didn't say in the paragraph after that is to balance it in the interests of the taxpayer. do you see that actually or are you charged with that and see it as part of the role? >> very much so. the, you know, if the assets of fannie and freddie go down, that means more money from the taxpayer. >> absolutely. >> so that is part of very much part of the job to try to over time limit the draws from the treasury department, and in my view the best way to do that again is to stabilize the mortgage market through modifications and refinancings. >> yeah, and we have had correspondence in the past with regard to the last point, and that is as far as the statutory

authority to the gses to enter into the modifications and some outside experts have said there is not that statutory authority to enter into the modifications, and the fact that in error to the benefit or the taxpayers as a side issue as well. i wanted to comment on the statutory authority. >> well, you are asking about the modifications that are higher than 80% loan to value. >> right. >> my view is that these are risks they already own, and by lowering the repayment through a refinancing, they are lowering the risk and helping the taxpayer potentially going forward and by the way, the guarantee fees on these new mortgages are higher than the ones they are replacing, so it is a benefit to the taxpayer. >> my understanding is that fannie mae's financial statement indicated it would increase chrrisk

for gse? >> not for refinancings, but what they may have said is that remodifications may potentially have tim pact of increasing short term losses, but my view is over the long term, they will be of benefit, and to the gses and to the taxpayer. >> what is your foreclosure rate now? >> the foreclosure rate is relatively low at fannie and freddie at the moment. we are talking in the, you know, they have 100,000 properties -- >> that is on everything, but i am just talking about what we are talking about here on the refinance side. >> well, on the refinance side, it is too early for the refinancings or even mised a payment, let alone -- >> oh, really? >> to re-default. >> so the figure i was thinking about the 75% figure -- >> well, if you are talking about the historical redefault rate at fannie and freddie.

it has been actually relatively low around 35%, but in the last year it has risen rapidly with the downturn in the economy. >> right. but that is what we are talking about with this provision as far as the modifications go? >> well, again, these new modifications are significantly deeper than the once even a year ago. i just saw a chart in the year ago in the first quarter only 2% of the modifications had payment reductions of 20%. this quarter, the first quarter of this year is 52%, so that the modifications have change sod dramatically over the last year, that it is hard to use the historical numbers to say that, you know, we will have those higher redefaults. now the economy is, and you know, still has troubles, and that is certainly the reason for the default, lost jobs and lower income, and the things that are affected by the economy.

>> okay. i appreciate. @= 4 >> the pleating will re-- the meeting will reconvene. >> there is a bloomberg report out today about a letter from then f.c.c. chairman christopher

cox brin written in january of this year with a number of subjects, i guess, including suggestions that perhaps fanny and freddie are being encouraged to make loans that might not be in the best interests of the profittability of that entity or something. are you familiar with this letter? si f the entity or something. are you familiar with the letter? >> we -- we don't really comment on correspondence from board members, but i can tell you that and chairman cox was a member of the new board that was created out of hira. i can tell you that we worked closely with chairman cox over the three years that i was at fao and now faha and he was involved in the fanny fines that we did write about three years ago. the issue that as reported and i

will comment on the issue as reported in the bloomberg article, and the issue i think is if you want to sum it up, it is does modifying mortgages and refinancing them cause damage to fannie and freddie? in my view, as i think i have said earlier, they sit on $5.4 trillion of mortgages. that mortgage book is so large and so important that what if they have, if what they can do to stabilize the markets will be good, but one of the problems is from an accounting standpoint when you modify a loan, they have to take it out of the mortgage-backed securities and write it down as if it weren't modified. so there is a large deduction, so there is a short term cost, but my view is, that there is a, if it goes into foreclosure, the cost is worse on that mortgage,