expanded as fannie mae and freddie mac began issuing mortgage-backed securities. this market has evolved, and today it is one of the deepest and most liquid markets in the united states with average daily trading volume in excess of $320 billion, a market second only to the markets the united states treasury securities. naming the market to be announced comes from the way the market functions. unlike a traditional marketplace, investors did not know the specific collateral or pools of loans they are agreeing to purchase until months later. accordingly, the collateral is designated to be announced at a date in the future. the ability to lock in an interest rate by the closing mortgage.

eight securities in the market, guaranteed by fannie mae, freddie mac, the tva also services as the benchmark for privately issued securities, relative to the cda price. -- adjustable-rate loans and a jumbo loans. as we continue to explore different approaches, it is important that we understand how this market works and what impact reforms would have on this market. how will any changes affect the availability of the market by consumers. characteristics of this market, if any, should be preserved. a four to year in from any of our witnesses this morning. this is a very technical but

very vitally important part of our mortgage industry. we have to understand the basis before moving forward. we need to accumulate the information on the inside, so that we can start dealing with major issues with respect to the house. i would like to make introductions with that. >> thanks very much. i appreciate your kind words as well. i enjoyed our working relationship. i appreciate the opportunity for us to have this hearing on the t be a market -- tba market. we need to better understand the mechanics as remove on with housing reform. we will be able to explain how this market allows originators to hedge the risk of a change in interest-rate at a time when the mortgage is locked in and

when it is secured. the main components are the guarantee of their timely payment. the deep liquidity of mortgage- backed securities cannot be attributed solely to the implicit government guarantee of mortgage-backed securities. the 14, the question is, -- going for it, the question is how it might develop without a fannie mae or freddie mac. what are the tradeoffs that we need to consider. to be able to answer that question, we have to enter the feasibility of acquiring a private ." ."

market. >> i look forward to hearing from the witnesses. thanks for calling this panel. >> he joined barclays capital in to us and for after 15 years at citigroup, where he was the managing director. he has held his current position for 70 years. prior to forming -- he has worked extensively looking and loan portfolios for loan institutions.

developing pricing models for loans, and analyzing the prepayment risk in mortgage- backed products. thanks. andrew davidson is the president of his new york firm, specializing in developing analytical tools for the mortgage-backed securities market. he has written extensively on mortgage-backed securities, violation, and hedging. he worked at merrill lynch, where he was a managing director and systems analysts. we begin with mr. hamilton. your written testimony has been a part of the record. phil free to summarize and make points. >> good morning -- feel free to

summarize and make points. >> good morning. i am responsible for securitized products business. housing is a critical component of our economy. it is at the center of a virtuous circle. the u.s. mortgage market is enormous. the home mortgage market is equal in size to the total size of the u.s. bank balance sheets. their balance sheets alone cannot meet the country's need for mortgage credit. fannie mae, freddie mac, and private institutions use the process of securitization to allow for the growth of mortgage lending beyond the capacity of bank balance sheets. private securitization and agencies finance home mortgages.

securitization knees to play a key role in the finance system. in this agency market, tba market is the largest component. it is key to funding mortgage lending. it is a critical role in housing in the u.s. economy. the enduring liquidity of the market, in contra press -- in contrast to other markets, preserves the availability of mortgage credit in the recent -- recent crisis. the ability to maintain liquidity during stress * is key. the liquidity and resilience of the markets attract a wide range of investors that provide fast capital that is cycled into

mortgage lending. the vast liquidity and the nature of the market provides key benefits to consumers, such as the availability of 30-year fixed mortgages. significant inconsistent liquidity in the second mortgage market. it results in a stable funding source for lenders and longer- term great walks for borrowers. it will enable another round of mortgage lending. in this market is facilitated by the guarantee of the agencies. the support of the government stands behind them. over 90% of mortgages are a final answer of one of these agencies. this level of support as possible, because it does not

expose investors to credit risk. it is attractive and risk averse and has vast sums of capital available for investment. we believe for a majority of this capital will be directed elsewhere. raising the costs of mortgage lending. we believe that maintaining a liquid and viable market should be considered as congress addresses reform. the reality is that this was the role of the government is not sustainable over the long term and should be reduced. this should shrink as private markets shrink over time. these can be complicated on a national and personal level. it should not be 90% of the

market. significant uncertainty faced by people. the rules aren't not clear for both sides. until they are, it will be challenging for issuers and investors to see eye to eye. being able to withdraw the government from mortgage markets will require a careful plan in sequence transition, which can take many years. it is essential to remember that the necessary volume of non- agency investors will not appear because we like them to. there must be drawn back in, have private-label securitization. we believe that it is critical that the planning and execution

of significant change to mortgage loans be done with the attention to detail, be based on sound analysis of costs and benefits, be mindful of unintended consequences, and create long-term, beneficial environment. we cannot predict the future but use the past as a guide and apply lessons learned and mistakes made, the good and the bad, to design a system that will stand the test of time. we hope the testimony we have presented today will be helpful and educate policymakers, and the critical role of tba market and the critical roles needed to move forward. >> thanks. turn on the microphone. >> thanks. good morning. thank you for the opportunity to

testify before this subcommittee today. in my written testimony, i offer a detailed description on how the current market and tracks with the mortgage industry and prospective borrowers. it is a complex process. these markets provided the exit a price for a long fixed rate mortgages. it helps get capital that otherwise would not be available. any news solution must preserve the liquidity to allow borrowers to access this effectively. the causes of the failure are the under-capitalized gse's,

requiring them to underwrite u.s. credit risks. the loosening of loan underwriting standards and the lack of independence of political goals. a fully functioning housing system should share the goals of the administration option one. reduce small hazard and drastically reduce taxpayer exposure -- the state of concern is that the mortgage credit risk will be transferred. i disagree with this conclusion. the credit risk providers can

affect government guarantor's. g these's provide regionthe gse's are in a factor. this guarantee is a classic example of a credit default swap. a mortgage company pays them a fee for a timely payment of principal and interest. a difference between this and an actual cds is the latter trades in an actual market with actual traded discovery. the amount of credit risk of

mortgages that have a diaz the guarantee is enormous. i think there is ample room for a private market to -- this has is enormous. with such a mechanism to price and a trade credit risk, thetba investor will be protected. -- tba investor will be protected. we in create markets that will be so the private. the development of a so the private market will take time and involve continual oversight. exist today.

should a private solution be developed, they future tba market would be sufficient. -- >> thanks very much. mr. davidson, please. >> chairman reed, you have heard rom other witnesses that they tba market place and a central role. -- plays a central role. it has made loans available during the financial crisis. i appreciate the opportunity to discuss this.

i'd like to highlight some of the key points in the next few minutes. while we can point to features of the market to make it useful, it is not easy to predict which market innovations will succeed. much of the success depends on the continent of the participants. a shift in confidence -- depends on the confidence of the participants. a shift in competent can affect the market. this confidence is not just the result of good institutional design, but also a long history of successful adaptation to change. whether or not the tba market can adopt to changes in the structural market is a difficult to predict with complete accuracy. i can provide you with a definitive answer. i can give you my views on several proposed changes, based on my 25 years of experience. the most important to the proposed changes would be the

elimination of government guarantee on conventional loans. the guarantee has played an important role in the structure of the tba market. i do not think this market could survive the loss of a government guarantee. other mechanisms will be developed to facilitate funding in hedging of these loans. fixed-rate mortgages would be more expensive, less available and more subject to market disruption. my proposal suggests increasing the number of guarantees. what will issuance would increase competition. such a proposal has other benefits. negative tohould be-to th the tba market. some proposals recognize this

problem and recommend a single government issuer with multiple insurers. such a proposal is probably consistent with the survival of the tba market. a single government program for all mortgages does run the risk that this will enable -- it will be unable to change to the conditions. many proposals require any guarantee not the end of the obligations of the guarantor. if a thegse or successors are focus on ite gse and the successor is focused on liquidity, then it will have and effect.

-- an approach is likely to be consistent with the tba market. but they must not face credit risk. it must be absorbed by private capital outside of the tba mechanism. the approach i favor is to find additional capital in the form of bonds. it would be private capital while the government could provide the guarantees on senior bonds. it could facilitate liquidity. such a program would be structured for the tba market. given the weak state of the housing market and the lack of a viable alternative to government guarantees, it would be

disruptive to move too quickly to eliminate fannie mae and freddie mac and replace them with an alternative structure. even if it were better designed and economically sound. inaction also poses dangers, as most of the mortgage loans are still relying on government guarantees in conservatorship is not a viable long-term option. week instead of not taking any action at all, it is possible to toansform the existing gse's a new system. i recommend that it encourage or require to seek forms of private capital to stand in form of the taxpayers. they can experience with mortgage insurance and be used as templates for the longer term. thanks for your interest in my comments. i look forward to your questions.

>> thanks for your excellent testimony about a challenging topic. i would be happy to entertain a second round if there are more questions. we have excellent panelists. a question to all of you. you have highlighted the fact that tba market affects the availability of certain mortgage products. changes that we are talking about, how would it affect these characteristics? is this going to be a trade-off in terms of what we expect of a

mortgage today? fixed rate, locked in, 30 years? how will this interact. -- how will this interactive down the road? >> there is a trade-off. we are able to get these 30-year mortgages and keep payments low. the elimination of that will force us into a floating grain market or something with shorter duration and more volatility for the homeowner and their payments. >> the government guarantee is necessary to enable the risks to be absorbed by the investor and transferred from the homeowner. the guarantee is functioning today. the powers in the market -- they

take the information. if they have an outlook to sell the loans, they will use the mechanics in play. having a liquid market and output for 30-year mortgages is the means by which they can execute that transaction. >> we are likely to have a far fewer fixed-rate mortgages. the stability and availability of mortgage credit would be much lower. you see that when you go through a shop in the financial system to step back for a while. it takes them some time to recover. during that time, mortgages would be less available. >> a lot depends on what goals

we have when we go into it. if the goal is to maintain what people assume is the american mortgage, long term, 20 years -- a fixed rates, and relatively low monthly payments, can we do that without a guarantee? >> it is much less likely that we would have the number of percentages in 36 year mortgages without the government guarantee. there are some investors that want to buy risks, but do not want to deal with credit risk. they want to engage in transactions with they can buy multiple hundreds of millions of dollars of security at one point in time. without moving the credit risk, it is difficult to see how we

would create that kind of market. >> if we said tomorrow, let's start a market, it would fail to transfer the risk involved in 30-year mortgages. if we can develop a process, it would be transferred into private holders of the risk. everything comes down to a price. we do not know what the price would be at this point. the government would be assuming that risk in subsidizing it. the market would have to take years to develop in order for that risk to -- for the markets to develop, before we could understand what the potential investors would require and see to absorber that risk. >> your comments? >> the market will develop for what ever the rules are

appropriate for them. the 30-year mortgage would be less available. the credit availability would, that you would be able to access would be at a significantly higher price. >> let me ask another question, about all of your testimony. there is a lot of capital going into this market, because of the way it structures the guarantee, the credit risk aspects. the presumption that the conclusion from your comments as in some respects, the capital will not go longer if the guarantee is changed. where does the capital go? you may not know. is it a good or bad thing? in terms of the overall economic

performance of the country. it is very speculative. >> there is a lot of a foreign investment and capital. insurance company, money- management, retirement funds, putting large amounts of the dollar into the u.s. mortgage market. it is due to the fact that they do not want to take a credit risk. is day -- is there a market for that credit risk? i believe there is. we are talking about a very large transition determined by race -- rates. those that care about rates versus credit. we are talking about 10 or 15 years. it is not an easy scenario. >> my time is done. >> anytime you subsidize

anything, you get more of it. the government is subsidizing the housing sector in many ways. we probably get a little more and access to consumer credit and then we would otherwise. it is hard to quantify these things without price discovery to figure out what a private institutions would pay for that risk and part of the transition phase would be this process. >> if we could develop credit markets and transfer it to private financial institutions, we can begin to understand what the costs are, and what they are willing to pay for the risk and move the credit risk across the world instead of localizing it and concentrating it on the government's analogy. >> it is important to separate the liquidity functions of the

in guaranteeing a from the credit functions of the guarantee. the credit risk should be moved into the private market. it was supposed to be there before but did not have enough capital. liquidity fund in is a lot like some deposit insurance. it is deposited in the base, even when there is uncertainty in the system. it serves a valuable purpose. rather than moving more the financial system into the banks, this is another method of providing liquidity guarantee to important financial sectors. you can have the economic benefit without having significant cost to the command. >> thanks. to follow up on that, in your testimony, you indicated that the liquidity combined with the government guaranteed serves to lower the rates on agency by 25-

50 basis points in relationship to the non-agency alternatives in the normal market. can you isolate and estimate a subsidy without the buyer of liquidity in the market? >> those pieces are combined. most of that benefit is liquidity guaranteed and credit guarantee. the credit risk that should have been done by fannie mae and freddie mac is very small. 5 basis points a year. most of the advantage we are loans is note gse for the liquidity aspect. >> could you explain in more detail how you feel a mix of private mortgage concerns

companies in private default swaps can take on some of the credit risk that government guarantees currently provided? >> right now the government has a sort a lot of credit risk. the credit default swap market has wanted to take that risk. the mechanics of it would be a involving a feature entity that now lays off their risk through credit default swaps and this mediation process of that market. they can get pride discovery on where the market pricing credit risk is and if there are no bits of the guarantee. the government can decide we

will subsidize that and it has imported policy goals and we still have a 30 year guarantee. what i am envisioning is that we can develop a system with the leadership and right now, gse's cannot lay off some of their risks. >> -- there is an overwhelming market share that fannie mae and freddie mac have. what would transfer some of that credit risk? to move it away from fannie mae?

>> there is no reason why the gse's can start working to set up these markets. there is the reason they cannot set up a credit default swap markets. they sell off some of those credit risks. as a transition, we can start building by the capital markets even within the current structure. >> some of the technology already exists that some of the agencies.

the fact that to transfer that technology and transfer it into the markets. transparency in, the agency spent 40 years building that up. the reason we should not use that same information to create a market to disperse the credit market on the other side and reduce the burden on the taxpayer. >> these would be ancillary new markets as opposed to disrupting the tba market. if not disrupt the current process. >> thanks. no further questions.

>> people care about this issue. the market is really nothing different than a futures market that exists. why is it that we must have this government guarantee year there to make it work, when it worked so well with corn, coffee, and everything else. tell me why that would not work. >> i do not think anyone would say it could not work. what i would say is you cannot create a tpa market with someone else who is creating a homogeneous market from residential markets that already exist. it would be at a significantly higher rate to the homeowner and impact the u.s. housing market in a significant way. it would take years to produce a liquidity --

>> it would be fairly -- >> one would hope. >> it would be fairly priced. >> i think the market has proven that doing market depressed pricing across the credit spectrum has not been perfect. if the private market was to take over credit pricing, i would argue that people of good credit would get a very could rates and mediocre credit would not be able to get a mortgage. >> go ahead. bad credit, you cannot get a loan. >> i agree with you. is washington willing to the politicize housing, then what

you're saying is correct. i think what you're saying is absolutely true. >> i am not making any judgment. that is the result. >> i appreciate that. >> the guaranteed subsidizes that the spectrum of the power. it enables the 30-year fixed- rate. this will take us five or 10 years to develop. there would be no liquidity in the credit. it would be fairly priced,

probably not. reassembly government guarantee is cheaper than a fictional market. the rationale, historically, to my understanding is you subsidize the borer with a 30- year fixed-rate, instilling more benefits public policy wise. i do not know the studies and realities of this. this is the methods that have been sacrosanct. for years we subsidize the 30 year mortgage and create more home ownership and better communities, because we have bigger houses and more involvement in the community.

>> the mortgage tba market is like the futures market with some important differences. you can sell a private security, where in the tba market you can sell loans to go into a security not yet created. they could allow physical to a rare flurry of loans. -- tba market most of the originators sell loans to the short division they have created. we found in financial markets that they have government guarantees behind sovereign markets trade with much greater liquidity than non sovereign market.

they hedge their positions. tba market has proven to be the most liquid and effective head. >> those with the low limit will go back to the pre crisis levels, or is currently. we will see if this is something that will work. >> what is the market expecting right now, going back to your allusion to washington? what do they think washington is going to do? >> it is mandated that the loan go down to 625 at this point. i think the market would hope that it continues to drift down in a meaningful way. i do not think we will create a

private-label mortgage market. we cannot compete. >> any activity in the upper levels? >> my belief is no, it will go into private label -- label or mortgage securitized nations. >> my point is that somebody is being asked, what about the consequences, the trade-off to lower the lending limit down? what are the benefits? we do not have any real information to make the decision. no price discovery as to what would willing parties in the private markets traded at risk for and evaluate what that cost would be no guarantee exposure

to our balance sheet and reducing the loan limit down and evaluate it with real measurements. what is the effect and the costs? i am suggesting that we can create private markets and this price information will help the economy allocate capital more effectively and help us make better public policy as part of the process. >> i think all of you.

i was in no way critical we have created a mechanism where those people with big credit pay more for their mortgages and most people with bad credit pay less for their mortgages. the question is, will we ever de politicize and cause the market to work in a normal way for people with bad credit will pay more for their breaks? i appreciate your bringing that out. i think all of you for your testimony. i look forward to seeing you individually in our offices. >> it is excellent and exposes some real policy choices we have. we have collectively for

generations for republicans and democrats have said putting people in homes is key to america and has resonated and as a result, a lot of these programs have begun to do that. we're looking at how to make the transition and to do it in an effective way and how to maintain a market. in this hearing, despite the esoteric title, it is essential to what we are going to do going forward. can the private market step in? let me ask a few other questions. i will join the senator in allowing you to come by the office. it will be a dialogue going forward.

the question is, if my understanding is correct, it is not subject to the security laws. it is exempt because of the participation of the agencies. if we move to a private market where these activities have to be performed, would that induce sec registration requirements and other forms? will it complicate things further? how should we think about things further? >> loans currently delivered in the tv a market -- it allows you to sell them before securities are created. that cannot say planning on securitized next year, please buy the securities in advance.

it delimit possibility for physical delivery into foreign sale. other mechanisms could be developed. they may not be as efficient the sec is going in the other direction right now, more detailed disclosure about lawns. the sacs direction is contrary to what we need to create the market for a non agency. we understand this is not going to happen next year. it is an adaptation going forward. it is to provide investor protections, not in the same way that is done presently by private labels, but work those

features in. >> that is correct. one of the proposals is that we ensure liquidity and market in single issue -- separating the guarantee function from the insurance fund in and the issuance function. comment on that approach of separating the guarantee function from the issuance function. >> are you saying separate the government guaranteeing it or private guaranteeing it? >> do we need to have multiple

issuers. >> the issuance should be a single issuance, so investors are not confused. it is always done by the same issuance. . the world can be determined. if it is a single issuer, it could likely be a government entity -- entity. >> i think they are all saying the same thing. -- it is all accomplishing the same thing, trying to separate guarantee function. at the same time, maintaining it won for a couple of issuers and maintaining that. we are saying this in a different way.

>> do you want to elaborate? >> in the current tv a market there is a perception that fannie mae and freddie mac, an issuer name is a significant as far as liquidity. that was basically we get into too many issuers and it will affect the level of liquidity. a single lane issuer is what i was advocating. it will cost as in liquidity if we have multiple issuers. >> in just thinking back, it is the way we walked into the

gse's. if you are going to give a monopoly, it has to be somewhat qualified governmental at these. this approach would imply that the insurer would be some type of entity, closely regulated by the government, or the guarantees would be subject to market pricing and activity. >> exactly. we are not going to get the credit market established quickly. the current into structure, the 30-year guaranteeing is not going to go away tomorrow. it will take time for that to develop it. .

>> one idea is to avoid this monopoly situation, so that you cannot allow that to exist only as a cooperative. . there is monopoly profits, so it has to go back into the chain where it is competitive. . having one or two issuers is good, getting as many participants to take the credit risk is good. 20 different mortgage originators would go through this one guarantor. 20 different loan documents. 20 different loan market. it is a careful balancing act between spreading the risk and standardizing. >> let me ask this final

question. i will begin with you mr. davidson. i think it implicates bigger issue, which is recognizing that we should take steps now to begin a transition that legislative text -- steps and it is not likely going to happen likely today. i think everyone has suggested that there are things today that should be considered to begin this process, that could save us the trouble of trying them in the future on a larger scale or adopting them as an exclusive remedy. if you can comment on your

approach and how it may work. and then what are the steps that you would suggest outside of legislative per view over the agency's today and the legal framework. >> i believe it is something are exploring currently to add capital. they probably need approval of at hcfa. i think they can move in that direction. i like the subordinated bond approach. i think they should use more

private mortgage insurance. the key fact is sending the message to f.h.p. at eighth that experimentation is good -- fhfa that experimentation is good. finding the right solution has value. move the dialogue away from eliminating the tse's tomorrow, because they were bad before our their pieces that we want to preserve of the gse's over time? i think it is doable. >> i propose one idea. there is no single monolithic solution. all of these markets are

complex and the price risk differently. the subordinated bonds solution may be the best solution we may have to go back and executed to see what the cause of the credit is. the cd of markets are one avenue of exploratory thought. i do not have a particular singular solution. you have to prices, find out what the costs are and what the banks -- best execution is for the government's balance sheet. >> there are a portfolio of things we need to work on in the interim, given the legislation in the near term. the fha can play a large part in this. we can lower them further on a gradual basis.

it would enable the private market to open up. you could limit the amount of borrowing that banks can do from the system. he could encourage bonn the legislation to open up and be in other funding vehicle. i think there is a portfolio of approaches. they will attack the u.s. housing system and be the solution for mortgage finance. there are several things we can do it in the next few months without legislation. they are a few things that we should work towards and we can rise to the top quickly. >> thanks very much. this has been very helpful to the subcommittee. as the senator suggested. do not be surprised if you're called again to give reviews and advice. this has been extraordinarily helpful. some of my colleagues may have additional questions.

we ask that those questions be submitted before the end of the week. it is wednesday. by friday, i think that is fair. we will get them to you and return them as promptly as possible. again, thank you very much. the hearing is adjourned. [captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2010] --2011. [unintelligible] >> next, live your calls and

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