[Senate Hearing 110-928]
[From the U.S. Government Publishing Office]
S. Hrg. 110-928
NOMINATIONS OF: RANDALL S. KROSZNER,
ELIZABETH A. DUKE, AND LARRY A. KLANE
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
ON
nominations of:
Randall S. Kroszner, of New Jersey, to be a Member of the Board of
Governors, Federal Reserve System
__________
Elizabeth A. Duke, of Virginia, to be a Member of the Board of
Governors, Federal Reserve System
__________
Larry A. Klane, of the District of Columbia, to be a Member of the
Board of Governors, Federal Reserve System
__________
THURSDAY, AUGUST 2, 2007
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania ELIZABETH DOLE, North Carolina
JON TESTER, Montana MEL MARTINEZ, Florida
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Aaron D. Klein, Economist
Dean V. Shahinian, Counsel
Lynsey Graham Rea, Counsel
Joseph L. Hepp, Professional Staff Member
Peggy R. Kuhn, Republican Senior Financial Economist
Andrew Olmem, Republican Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
Jim Crowell, Editor
C O N T E N T S
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THURSDAY, AUGUST 2, 2007
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 3
Senator Bunning.............................................. 5
Senator Allard............................................... 5
Senator Casey................................................ 25
WITNESSES
Randall S. Kroszner, of New Jersey, to be a Member of the Board
of Governors, Federal Reserve System........................... 7
Prepared statement........................................... 50
Biographical sketch of nominee............................... 53
Response to written questions of:
Senator Dodd............................................. 88
Senator Casey............................................ 104
Senator Schumer.......................................... 109
Senator Menendez......................................... 112
Senator Akaka............................................ 118
Elizabeth A. Duke, of Virginia, to be a Member of the Board of
Governors, Federal Reserve System.............................. 8
Prepared statement........................................... 67
Biographical sketch of nominee............................... 69
Response to written questions of:
Senator Dodd............................................. 121
Senator Casey............................................ 130
Senator Menendez......................................... 134
Senator Akaka............................................ 136
Larry A. Klane, of the District of Columbia, to be a Member of
the Board of Governors, Federal Reserve System................. 9
Prepared statement........................................... 79
Biographical sketch of nominee............................... 81
Response to written questions of:
Senator Dodd............................................. 137
Senator Casey............................................ 144
Senator Schumer.......................................... 146
Senator Menendez......................................... 148
Senator Akaka............................................ 151
NOMINATIONS OF:
RANDALL S. KROSZNER, OF NEW JERSEY,
TO BE A MEMBER OF THE BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM;
ELIZABETH A. DUKE, OF VIRGINIA,
TO BE A MEMBER OF THE BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM;
LARRY A. KLANE, OF THE DISTRICT OF COLUMBIA,
TO BE A MEMBER OF THE BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM
----------
THURSDAY, AUGUST 2, 2007
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:45 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order. My
apologies to all of you this morning for--they are doing an
experiment, I guess, or test on constitutionality this morning.
Not a good excuse but, nonetheless, that is reason I am a few
minutes late, and I apologize to my colleagues and to the
witnesses and to your families.
Let me make an opening statement, if I can, and then I will
be turning to my colleague from Alabama, the Ranking Member,
and any other Members who wish to make some opening statements
here. We will then swear in the witnesses and hear your
testimony, and then we will raise some questions with you.
First of all, I am pleased to welcome all of you here this
morning. Today the Committee will meet in open session to hear
from Dr. Randall Kroszner, Ms. Elizabeth Duke, and Mr. Larry
Klane, who have been nominated to the Federal Reserve Board of
Governors.
One of the most important and influential nominations that
we consider in this Committee is that of a Governor of the
Federal Reserve Board. The seven Federal Governors are the only
individuals appointed by the President of the United States and
confirmed by the U.S. Senate who have a voice in our Nation's
monetary policy. The Governors are responsible for upholding
the Fed's dual mandate: to promote employment and achieve price
stability. Fulfilling this mandate creates the conditions
necessary for our economy to grow and for every American to
have an opportunity to participate in the shared prosperity of
our Nation.
The role of the Fed is critical not just in setting
monetary policy; it also serves as a regulator of the safety
and soundness of our largest lending institutions and, very
significantly, as a regulator and enforcer of the laws passed
by the U.S. Congress and signed by the President to protect
consumers and ensure that they have an opportunity to
participate and succeed in the American economy.
The duties of the Fed are no less important than the Fed's
monetary policy responsibilities. In fact, given the depth of
experience that the Fed's current Governors have in monetary
policy, issues of consumer protection and bank supervision are
of particular importance with respect to the nominees that we
have before us today.
It is for all of these reasons that the Fed Governors
should be of the highest caliber and quality to serve our
Nation. The position of Governor also requires substantial
political independence. In establishing the Federal Reserve,
the Congress created a system in which each Fed Governor's seat
has a fixed 14-year term. I know some of my colleagues wish
that the Founders had thought of us in that way. Governors at
the Fed enjoy the third longest term given to any appointee in
the Federal Government, beyond only the lifetime appointment
awarded to Federal judges and the 15-year term given to the
Comptroller General.
Of the nominees, Dr. Kroszner has been nominated to fill a
full 14-year term. The others have been nominated to partial
terms of years. All of the nominees have indicated in their
questionnaires that, if confirmed, they intend to serve their
full terms. Given the length of these terms, a nominee to the
Federal Reserve Board of Governors requires careful
deliberation and very thoughtful consideration.
In closing, I want to return to the importance of the Fed's
role as an agency charged by the Congress with many important
consumer protection functions, particularly with respect to
subprime lending and credit cards. I have not been shy about
expressing my view that the Fed's actions have been
unsatisfactory in my view over the past several years in that
regard, and I look forward to exploring this area, among
others, with our witnesses today.
Before I turn to my colleague, the Ranking Member, I will
briefly introduce the nominees.
Dr. Randall Kroszner assumed the role of Governor of the
Federal Reserve Board on March 1, 2006. His current term
expires on January 31, 2008, and he has been nominated to serve
a new 14-year term expiring February 1, 2022.
I got to tell you, Doctor, when I was thinking about that
number, I have a 5-year-old daughter, and she will be a junior
in college when that is over with. It gives a dimension to this
that I cannot imagine her being in that position, but that is
how long a time we are talking about here with your nomination
and the consideration of the Senate.
Dr. Kroszner previously served on President Bush's Council
of Economic Advisers from 2001 to 2003 and has a distinguished
background. I would note he was educated at Brown University,
where my brother-in-law--in fact, a good part of my sister's
family are there. They have strong connections to Brown
University as well.
Elizabeth Duke has been nominated to fill a term--let me
ask you, first of all, Doctor, your family members are here. I
know you have some, I think, with you here today. Would you
care to introduce them? We would like to welcome them to the
Committee.
Mr. Kroszner. Yes, please. I have my mother, Helen
Kroszner, and my niece, Kimberly Kroszner, with us here.
Chairman Dodd. Well, thank you for joining us here this
morning. Nice to have you with us.
Elizabeth Duke has been nominated to fill a term which
expires January 31, 2012. Ms. Duke is Senior Executive Vice
President and Chief Operating Officer for Towne Bank in
Virginia. Ms. Duke also served as the Chair of the American
Bankers Association--I believe the first woman to do so, if I
am correct--from September 2004 through September 2005 and in
doing so was the first woman to chair the ABA. And I wonder if
you have any family members here, Ms. Duke, you would like to
introduce.
Ms. Duke. Yes, I do. My two sisters and my two nieces.
Chairman Dodd. Where are they here? Right there. Thank you.
You got the front row seats here. Good. Nice to have you with
us this morning.
Mr. Larry Klane has been nominated to fill a term ending
January 31, 2010. Mr. Klane is currently the President of
Capital One Global Financial Services. Again, do you have any
family here, Mr. Klane?
Mr. Klane. I do. Behind me is my wife, Polly, who is
carrying a child that we expect in roughly 2 months.
Chairman Dodd. Congratulations.
Mr. Klane. Thank you. With her are her folks, Alecne and
Jack.
Chairman Dodd. Great.
Mr. Klane. I also have my father, and if you do not mind, I
would just like to mention someone who is not here, and that is
my mother, who passed away 3 weeks ago and for whom we are
having a memorial service tomorrow. She is with us in spirit.
Chairman Dodd. You bet she is. She may have some questions
for you, in fact.
Mr. Klane. She asked many during her life.
Chairman Dodd. I am sure she did.
[Laughter.]
In fact, I think you can hear her right now. Anyway, let me
recognize my colleague from Alabama, Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman, for scheduling
this hearing.
This panel of nominees will have very important
responsibilities, as Chairman Dodd has mentioned. The Federal
Reserve must implement sound monetary policy, ensure the
vitality and viability of our Nation's financial institutions
and payment system, and maintain financial stability.
During Chairman Bernanke's appearance before this Committee
in July, we had a full discussion of the Nation's economic
performance and risk factors on the horizon. Although we have
seen the stock market waver in the past few days, the economy
is performing well with strong GDP growth.
We also continue to enjoy a low unemployment rate, both
historically and relative to other industrialized nations. The
risk of inflation, not slow growth, remains the predominant
concern as we continue to see a rise in energy and food prices.
During Chairman Bernanke's appearance last month, we also
had an extended discussion of the Federal Reserve's recent
activities that Senator Dodd brought up relating to subprime
mortgage lending because you are not only the central bank, you
are a bank regulator, as you well know. I remain concerned that
the weaknesses in the subprime market may have broader systemic
consequences. We have been told that the problem is largely
isolated and contained, but I am concerned that it may not be.
I will be particularly interested in hearing your views on the
scope of the problem today and how the Federal Reserve will
monitor and manage the situation going forward.
The Federal Reserve Board also faces the challenge of
implementing significant new capital requirements for our
banking system. Chairman Dodd and I are pleased that the
banking regulators, all of them, were able to reach a consensus
on final regulations to implement Basel II. On this Committee
we will continue to monitor this process as the new standards
go into effect.
The three nominees, Mr. Chairman, before this Committee
this morning all bring specific expertise and insights to the
Board, a lot of balance. Governor Kroszner has already done so
for the past year and a half. Elizabeth Duke and Larry Klane
will bring valuable insights to the Board given their broad
experience in the banking and financial services industry.
These talents will be particularly helpful as the Federal
Reserve works to address the issues that I cited earlier.
I am pleased that the President has sent forward this panel
of nominees, and I look forward, Mr. Chairman, to working with
you and other Members of this Committee to get these
nominations to the floor and get them confirmed so they can go
to work.
I do want to say one thing about Governor Kroszner. This is
your third appearance, third nomination hearing before this
Committee. In February of 2006, the Committee confirmed you to
the position that you currently hold, member of the Board of
Governors of the Federal Reserve. In November of 2001, the
Committee here, the Banking Committee, considered your
nomination as a member of the Council of Economic Advisers
favorably. The Senate confirmed you for this position, and you
served the Council through July of 2003, when you went back to
the Fed. So the 14-year term is a long time, but that is why we
set it up for you to be independent. I wish we had 14-year
terms.
Thank you, Mr. Chairman.
Chairman Dodd. Before I turn to Senator Bunning, I just
want to underscore the point that Senator Shelby has raised. I
could not help but notice this morning, Richard, two headlines:
``U.S. Crisis Sends World Markets Tumbling,'' and then in the
Financial Times, ``German Subprime Lender Is Bailed Out Here.''
So for those who think this problem has been contained, again,
just watching what is happening--all of us would hope it had
been contained, but clearly it is not at this point here.
And so this is a matter the Fed has got to take very, very
seriously, and let me turn to Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. I am glad we are
holding this hearing, and I hope that we can soon hold a markup
on these nominees.
When the current vacancies came up last year, I made it
clear to the Fed that I thought those seats should be filled
with people with real-world experience in banking. In fact, I
wish more seats were filled with folks with real-world
experience and less from academia. Naturally, I am pleased that
the President sent us two nominees with extensive experience in
the marketplace. I have been critical of the Fed in the past
for going too far in interest rates actions. Part of the reason
the Fed went too far was because the room was filled with
academics, not considering the impact their actions would have
on industry and individuals. I am confident that the
perspective these nominees will bring to the Fed will only
improve Fed policy and decisionmaking.
Mr. Chairman, you and I have been critical of the Fed's
handling of the housing boom and bust. Many Members of this
Committee agree that the Fed was asleep at the switch as
lenders got more and more irresponsible. Only after we
pressured the Fed to act did they rein in the worst of the
nontraditional and subprime lending practices.
The Fed has started taking action, and it was clear from
our hearing with Chairman Bernanke 2 weeks ago that the Fed
would take further steps. It is especially important for people
with industry experience to be on the Board while new
regulations are under consideration.
As I tell all nominees to the Fed, I told these three when
they visited me that it was important for them to speak up and
speak their minds in the meetings. Too often in the past, the
Fed has been dominated by a single voice. Chairman Bernanke has
been much better than his predecessor, and I expect that will
continue. I believe these nominees will make sure that they are
heard when they need to be.
Again, Mr. Chairman, I hope that we can quickly move these
nominees through the Committee and through to the floor. I look
forward to hearing from our nominees and their testimony.
Chairman Dodd. Thank you, Senator.
Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, thank you for holding today's
hearing. As always, I appreciate the opportunity to hear from
nominees, and I welcome them to the Banking Committee, along
with you.
Today we will be considering the nominations of three
highly qualified individuals to be Members of the Board of
Governors of the Federal Reserve System. I have had the
opportunity to sit down and meet with all three and believe
that they will bring a great deal of real-world experience to
the Board of Governors.
First, I would like to welcome and comment on the
nomination of Larry Klane. Besides from being born in my State
of Colorado, Mr. Klane will bring an expertise of consumer and
small business credit to the Fed. As an executive of Capital
One, Mr. Klane will be a valuable asset to the Fed as it
considers how to better ensure that consumers understand their
credit card bills and the terms of their credit card agreements
and mortgage loans.
Next, I would like to turn to the nomination of Elizabeth
Duke. Ms. Duke is a former Chairman of the American Bankers
Association and now the chief operating officer of Towne Bank
in Hampton Roads, Virginia. Along with Mr. Klane, Ms. Duke will
bring her 20-plus years of banking experience to the Federal
Reserve Board of Governors, which is dominated by academia.
Finally, I would like to welcome Dr. Randall Kroszner back
before the Committee. As we are all aware, Dr. Kroszner is
already a Governor who was appointed to fill an unexpired term.
I look forward to continuing to work with him and the Fed in
the future.
In closing, I would encourage all the nominees to become
familiar with the Government Performance and Results Act, which
has been named PART Assessment by the administration. The
Results Act is a key tool in giving agencies the focus and
vision to carry out effective and efficient programs. I would
exhort the nominees to become familiar with the appropriate
strategic plans, annual performance plans, annual
accountability reports, and financial statements. If properly
utilized, they can help you achieve success in meeting your
mission. I would also point out to you that you can look at how
your agencies are performing if you look under Expectmore.gov.
Or it might be .com, but it will get you there.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
I am going to ask the witnesses to stand and raise their
right hands and be sworn. Do you swear or affirm that the
testimony you are about to give is the truth, the whole truth,
and nothing but the truth, so help you God?
Mr. Kroszner. I do.
Ms. Duke. I do.
Mr. Klane. I do.
Chairman Dodd. And do you agree to appear and testify
before any duly constituted Committee of the U.S. Senate?
Mr. Kroszner. I do.
Ms. Duke. I do.
Mr. Klane. I do.
Chairman Dodd. I thank you very much.
Dr. Kroszner, we will begin with you and your opening
statement, and I would just say to you and to all of the
witnesses and our colleagues here, any corroborating or
supporting evidence you want to add will all be included in the
record.
STATEMENT OF RANDALL S. KROSZNER, MEMBER-DESIGNATE, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Kroszner. Thank you very much. Chairman Dodd, Senator
Shelby, and Members of the Committee, I am very pleased to have
the opportunity to appear before you today as a nominee to
serve a new term on the Board of Governors of the Federal
Reserve System. I am honored that President Bush has nominated
me to serve another term on the Board. If confirmed by the
Senate, I will work to the best of my abilities to fulfill the
significant responsibilities of this office.
During the last quarter century, the Federal Reserve has
achieved much success in reducing and stabilizing inflation and
inflation expectations. This success has helped to contribute
to a tendency for the fluctuations in employment and output to
be lower than in the past and a reduction in the frequency and
severity of recessions. If confirmed, I would continue to work
with Chairman Bernanke and the other members of the Federal
Open Market Committee--the FOMC--to continue to underscore the
role of long-term price stability in achieving prosperity and
maximum employment.
The Federal Reserve also has a fundamental responsibility
to consumers and users of the banking and financial system.
Discriminatory or abusive lending practices should not be
tolerated, and the privacy of individuals and their financial
data must be protected. Since I joined the Federal Reserve, we
have undertaken a number of initiatives to better protect and
to better inform consumers. These include: issuing guidance on
nontraditional mortgage products and on subprime mortgages and
improving our collaboration with the State banking supervisors;
launching a pilot project in collaboration with other Federal
agencies and State regulators to examine non-depository lenders
for compliance with consumer regulations; improving disclosures
for privacy notices and credit cards; improving the handbook on
adjustable rate mortgages that creditors are required to give
to all adjustable rate mortgage applicants, and committing to
propose new rules before the end of the year to require that
lenders provide other mortgage disclosures more quickly and to
improve mortgage loan advertisements; undertaking a series of
hearings, including one that I chaired in June, to assess the
impact of specific practices in the mortgage market; and
committing to propose new rules exercising our authority to ban
unfair or deceptive practices under the Home Ownership and
Equity Protection Act. If confirmed, I will continue to place
the highest priority on protecting consumers while ensuring
that creditors continue to provide credit responsibly.
An important part of my research as an economics professor
at the University of Chicago, and my practical policy work as a
member of the Council of Economic Advisers, was devoted to
banking and financial regulation as well as banking and
financial crises. The safety and soundness of the U.S. banking
system and U.S. payments system is critical to achieving
economic growth, maximum employment, and general economic
stability, and the Federal Reserve works closely with other
Federal regulators and international regulators to achieve this
goal. The Federal Reserve also has an important role to play in
responding to and mitigating the impact of financial crises and
shocks. If confirmed, I would continue to work vigorously to
protect and promote the safety and soundness of the system.
Thank you once again for holding this hearing, and I look
forward to your questions.
Chairman Dodd. Thank you very much.
Ms. Duke.
STATEMENT OF ELIZABETH A. DUKE, MEMBER-DESIGNATE, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Ms. Duke. Thank you, Chairman Dodd, Senator Shelby, Members
of the Committee. It is an honor to come before you today as a
nominee for the Federal Reserve Board of Governors. I am
grateful to President Bush for nominating me and to you for
holding this hearing to consider my nomination.
For most of my 32 years in banking, I worked for State
member community banks. Our primary Federal regulator was the
Federal Reserve. We cleared our checks, initiated our wires,
and safe-kept our securities with the Federal Reserve Bank of
Richmond. And I served as a director of the Richmond Fed. So I
come to you with a full appreciation of the responsibility
entrusted to a Federal Reserve Governor. If I am confirmed, I
promise to bring everything that is in me, every day, to
fulfill the trust you will be putting in me.
My experience with monetary policy comes from being
impacted by it. I learned my first painful lesson about
inflation and monetary policy when the national prime rate went
from 8 percent to 21 percent. Our small business customers
couldn't have survived, so we actually created our own lower
prime and learned to live with it. Later, I worked through
recessions and expansions with those same customers. With these
experiences in mind, I strongly support the dual mandate
Congress has given the Federal Reserve of pursuing both stable
prices and maximum employment.
In addition to monetary policy, the Federal Reserve is
charged with the safety and soundness of the financial system.
I weathered the banking and thrift crisis and wrote my checks
to the FDIC to restore the fund. In more than 25 years of
teaching, I have taught probably more than 3,000 bankers and
bank examiners the basics of sound banking practices. The
importance of safety and soundness in our banking system is a
part of my DNA, and I think it is the most important experience
that I could bring to the Federal Reserve.
The Fed has sole responsibility for consumer protection
regulations governing regulated and non-regulated financial
service providers. I look forward to reviewing the comments,
research, and work already underway with respect to subprime
lending regulations and guidance.
And I believe I can bring some relevant experience to the
process. I worked with the Virginia banking commission when
they were first given responsibility for supervision of nonbank
mortgage lenders after the collapse of one of the most
predatory lenders I have ever seen.
As Chairman of the American Bankers Association, I worked
with bankers and regulators in all States on numerous
regulatory matters. I don't believe we can solve the subprime
issue without cooperation and coordination across the full
spectrum of regulation, supervision, and enforcement of all
mortgage loan participants. I would welcome the opportunity to
lead such an effort.
The role of the Federal Reserve in our Nation's payment
system doesn't have the headline cachet of monetary policy or
consumer regulation, yet I believe it has every bit as much of
an impact on the everyday lives of the American consumer. We
are in the midst of a payment revolution with evolving
technology and the passage of Check 21. I would hope to be
actively involved with the payment infrastructure as well as
modernization of the rules and regulations governing payments.
Finally, service on the Federal Reserve Board would feed my
passion for financial education. I have been in the classroom,
raised money to teach the teachers, conducted awareness media
tours, and lobbied for curriculum changes. All of our work on
consumer disclosure will be in vain if we don't raise a
generation of consumers who can use those disclosures to make
good financial choices.
Thank you for allowing me this time. I look forward to your
questions.
Chairman Dodd. Thank you, Ms. Duke.
Mr. Klane.
STATEMENT OF LARRY A. KLANE, MEMBER-DESIGNATE, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Klane. Chairman Dodd, Senator Shelby, and Members of
the Committee, I am honored to appear before you today as a
nominee to serve as a member of the Board of Governors of the
Federal Reserve and would like to thank you for scheduling this
hearing. I also want to thank the President for his confidence
in nominating me for the position. If confirmed by the Senate,
I look forward to working with the other Board members to
fulfill the full range of objectives that Congress has
established for the Federal Reserve. It has been a lifelong
personal goal for me to enter public service, and I can think
of no better place to contribute than the Board of Governors.
I have spent 25 years working in business, finance, and
banking. For the past 14 years, I have devoted my career to
financial services, including 7 years in wholesale financial
services and the capital markets at The Bankers Trust Company
and its acquirer, Deutsche Bank. I have spent the past 7 years
in consumer and small business lending, principally in the
United States, but also in Canada and Europe.
As President of Capital One's Global Financial Services
Division, I currently serve roughly 10 million consumers and
small businesses, and I have been the President of our Federal
Savings Bank and am currently the Chairman of our bank in the
United Kingdom.
Let me turn briefly to a couple of specific areas of
responsibility at the Federal Reserve Board. In Chairman
Bernanke's recent testimony on monetary policy, he devoted
substantial attention to consumer protection matters, and I
would like to underscore the importance of this element of the
Board's responsibilities by beginning there. As a banking
practitioner, I have gained firsthand knowledge of consumers
and their financial needs and, if confirmed, I would bring my
energy, focus, and experience to vigorously fulfilling the
Fed's consumer protection responsibilities.
In addition to protecting consumers through guidance,
rulemaking, and supervisory focus, I would also strongly
support the Federal Reserve's longstanding commitment to
financial literacy. In connection with my service on the Board
of America's Promise--a nonprofit organization dedicated to
improving the lives of America's children--I have seen the
power of education, including financial education. The Federal
Reserve also has responsibility for the stability of America's
financial system as well as for the direct supervision of many
financial institutions and all bank holding companies. My
experience with a broad array of banking regulators in the
United States and abroad has shown me firsthand the importance
of good supervision--not only for maintaining sound financial
institutions, but also for protecting consumers.
The Federal Reserve also oversees the smooth functioning of
the payments system. In recently reading the testimony of Fed
nominees who came before this Committee following the tragedy
of 9/11, one particularly appreciates this aspect of the
Federal Reserve's duties. With technology, business, and other
developments impacting the U.S. payments system, this is an
area of continued importance.
Of course, a central--if not the central--responsibility of
the Federal Reserve is the pursuit of sound monetary policy.
Congress has given the Fed a ``dual mandate'' of maximum
employment and price stability and, if confirmed, I would
approach monetary policy firmly within this framework.
In conclusion, Mr. Chairman and Members of the Committee,
if confirmed to the Board of Governors, my objective would be
to use my experience in banking and business to help the
Federal Reserve execute the broad responsibilities that
Congress has set before it. I thank you for your consideration
and look forward to your questions.
Chairman Dodd. Well, thank you, the three of you. I
appreciate your statements, and what I am going to do is have a
clock on for--there are four of us here, so I will put 10
minutes up. I will not hold anybody to it rigidly, but that way
we each get an idea, and it should be an adequate time to at
least start the questioning. And if more Members show up, we
may reduce that in the second round to a little less than that
to make sure we get some opportunity to respond.
Let me begin. I was taken with all of your opening
statements. They are, very smartly, brief, which is always good
advice, I suppose, at moments like this. But I noted in all
three testimonies, all three statements, the reference to the
importance of the responsibility to consumers and the users of
the banking and financial systems, and how, Doctor, you talked
about discriminatory and abusive lending practices should not
be tolerated, the privacy of the individual and their financial
data must be protected. Ms. Duke, I think you--or, Mr. Klane,
rather, you talked about Chairman Bernanke's statement to
underscore the importance of the element of the Board's
responsibilities in consumer protection matters, and, Ms. Duke,
you talked about the Fed has the sole responsibility for
consumer protection regulations governing regulated and non-
regulated financial service providers.
I thank all three of you for highlighting that particular
importance, and I would like to at least begin my questioning
with you regarding these matters, because it has been a matter
of concern. As you have heard from Senator Bunning and others,
with the passage of the HOEPA bill back in 1994, a long time
went on before the Fed assumed its responsibility under that
legislation, which was not a voluntary request on the part of
the U.S. Congress for the Fed to assume a major responsibility
in protecting consumers from the very practices that you have
identified in your opening statements here. In fact, it was not
until, of course, this problem began to emerge in a public way
that the Fed has begun to respond with guidance and more
recently with the hearings on the rulemaking function and
authority. And let me just say I am pleased that, in fact,
Chairman Bernanke's testimony here just a few days ago talked
about the speed with which they hope to promulgate these rules,
a comment period so that we can have some response. That is
little solace to those who are going through this today in a
sense, who have lost their homes or find themselves in
financial ruin here because there was not a better cop on the
beat to make a difference in their lives. And certainly I
accept the notion that there is a certain amount of speculation
involved in this matter here. I do not know exactly to what
extent, but certainly I recognize that is part of it, but I
think also all of us recognize that an awful lot of it here was
rather underhanded activity, in a way, on the part of some
people here that it caused this situation to emerge.
So I am going to begin asking you about these questions
here because they are extremely important to me. I know they
are important to Senator Shelby and Senator Bunning. All of us
on this Committee care very much about what is happening.
I would, first of all, ask you whether or not--just as a
general proposition here, I showed you the headline in the
Financial Times and the story here. What is your view on this?
Do you believe this problem has been contained? I mean, there
has been some suggestion in informal conversation out of the
Fed that the problem has been contained. And yet all the
evidence we are seeing is to the contrary. Where do you stand
on that question, Doctor? Has this problem been contained or
not contained, in your view?
Mr. Kroszner. Well, certainly you are exactly right that
there are a lot of challenges in this market. There are a lot
of families and households that are feeling pain--who face the
prospect of losing their homes--and that is something that can
be a real tragedy. The Fed needs to respond to that, and I
think we have been responding to that.
Chairman Dodd. I have a suggestion. Three and a half years
ago, the Fed staff had information that this was a problem that
was emerging. Three and a half years ago. And yet, you know,
here is the bill sitting there and not much happening here at
all.
Mr. Kroszner. The Fed actually did, with the other
regulators, issue guidance in 1999 and an expanded guidance in
2001 concerning subprime mortgages, and then we also went ahead
in 2005 and 2006 with the nontraditional mortgage guidance, as
well as more recently the subprime guidance. And so we are
trying to reduce the pain, to keep people in their homes,
because it makes sense both from the point of view of the
individuals, from the point of view of the community, as well
as from the point of view of the lenders and servicers in
almost all circumstances.
With respect to the broader implications, we are monitoring
this very closely ourselves and in conjunction with our
colleagues at the Securities and Exchange Commission, the other
banking regulators, as well as banking regulators around the
world, to look for signs of where the market is going.
I think that at this stage the economic fundamentals are
really unchanged from where Chairman Bernanke talked about them
in this Committee about 2 weeks ago, and so we have not seen an
effect on the broader real economy. But we are looking very,
very carefully at that.
With respect to individuals, they are going to continue to
face challenges. I think this is going to be with us for some
time, and that is why Chairman Bernanke announced that we
really are going to be doing some important regulatory changes
or at least proposing those by the end of the year.
Chairman Dodd. Should I conclude from your answer that it
is not contained, in your view?
Mr. Kroszner. Well, with respect to the macro economy, the
real economy does not yet seem to be affected by this. With
respect to individuals and their families, I think we are going
to be seeing more delinquencies and we are going to be seeing
more foreclosures.
Chairman Dodd. So it is not contained.
Mr. Kroszner. With respect to the individuals, yes.
Chairman Dodd. Ms. Duke.
Ms. Duke. I think the problems in the credit market,
unfortunately I do have some experience with trouble debt, and
that specific issue will probably get a lot worse before it
gets better. What worries me now, having been through a trouble
debt situation before, is that with these loans now having been
sliced and diced and ending up in various different places,
they are being serviced by various entities who may themselves
be experiencing some stress. And so I am not sure really what
is going to happen to the collection processes of these loans.
A lot has been made of the foreclosure rates. As a lender,
foreclosure is the last step, and at that point, from the
standpoint of the lender, you have actually lost the battle
there. Where we really need to step in is earlier than that.
So while I agree, I do not think that the subprime issues
have impacted the overall economy, the day-to-day functioning
of the economy, what worries me is the very specific situation
of a borrower who, for whatever reason, is in a loan that they
cannot pay and not sure what to do, where to do it. I think
some of the things that we will need to take a look at are
finding a trusted third-party intermediary. It has been my
experience that a borrower in trouble, the last person they
want to talk to is the lender They need someone to bring
information to bear as to what the options might be to get
through this, and also in some cases some liquidity to provide
as a bridge to get from one piece of financing to another.
Chairman Dodd. Well, I appreciate your answer on that, and
I will turn to you in a second, Mr. Klane, on this. You know,
looking here at nominees to this very important Board here, in
a sense a dose of good reality here, I mean, the slowdown in
growth of real GDP has clearly been affected by this matter.
The idea somehow these are segregated issues here that do not
affect the larger economic picture of the country is troubling.
And I want you to be very straightforward. I know you have all
been coached to be careful about what you say here, but we are
looking for some important guidance from the people who are
going to be sitting here making very important decisions. And
the suggestion that somehow what is happening in the housing
market is not affecting real growth in GDP I find rather
breathtaking.
Mr. Klane, let me ask you if you have an opinion on this.
Mr. Klane. Frankly, Senator Dodd, I share your----
Chairman Dodd. You have got to bring your mike closer to
you. Is it on? There you go.
Mr. Klane. Is that good?
Chairman Dodd. Yes.
Mr. Klane. Chairman Dodd, I share your concern across the
subprime mortgage issues that you have outlined in a number of
dimensions: first is the question of how we got to where we
are; second is the difficulty for human beings and their
families who are caught in the situation as well as their
communities, which suffer during these times; and then, third,
what it means for the economy as a whole--whether it is Bear
Stearns' hedge funds that can no longer support themselves
because of investments in CDOs that find their roots in
subprime mortgages, or the headlines which you shared with us.
Going forward, if confirmed, I would put my full energy
against the commitments that the Federal Reserve has made in
order to take all of the arrows in the regulatory quiver to
protect consumers with respect to, for example, rulemaking
under the Home Equity Protection Act. I would jump into these
issues vigorously, with all of my energy.
I applaud, by the way, this Committee and you for bringing
together significant home mortgage originators and servicers to
create a series of principles in order to help families, as
best they can, work through the foreclosure process. I
undoubtedly think that we will see some more worsening before
it gets better. I also applaud the compassion that underlies
that effort and the compassion that underlies the work of the
Federal Reserve and the Reserve banks as they engage
communities around the country, as Ms. Duke commented, to
encourage people in trouble to feel more free to reach out to
the lenders before it is too late, and hopefully to work things
out. I know the Federal Reserve and the SEC have clarified some
accounting rules that would otherwise get in the way of
servicers helping people work out of troubled loans that were
part of securitizations. I applaud these efforts and, if
confirmed, would continue to work to help households with
troubled loans and their communities.
I would also join the Board with a concern around whether
the subprime mortgage issues have broader impact on the economy
and financial markets. I would be as vigilant as possible and
take, together with the rest of the Board, whatever actions
would be deemed necessary, depending on how things unfold.
Chairman Dodd. Let me ask you, Senator Menendez in a March
22nd hearing we had on this subject matter here--Roger Cole,
who is the Director of the Division of Banking Supervision and
Regulation, was testifying. Senator Menendez asked him the
following question--he said as to why the Federal Reserve Board
seems to have done so little as the subprime crisis was
building, Mr. Cole said, ``I will say''--and I am quoting him
here. ``I will say that given what we know now, yes, we could
have done more.''
What I want to know from all of you very quickly, if you
can here, is: One, do you agree with Mr. Cole that the Fed and
other regulators could have done more, in your view today as
you stand before us here, sit before us? And, second, to point
out that for years the Fed had begun to act, there were people
drawing attention to the problem, and do you believe the Fed
acted in a timely fashion? On both those questions, Doctor, do
you want to----
Mr. Kroszner. Well, I think it is very difficult to make
policy with 20/20 hindsight. As I mentioned before, the banking
agencies together issued subprime mortgage guidance in 1999,
expanded in 2001, in 2005, and 2006 the non-traditional
mortgage guidance; and this year the new subprime guidance has
come out.
I think we have undertaken a lot of actions with respect to
the individual banks and institutions that we do regulate.
Something that I think is very important to recall is that our
regulatory ambit is relatively contained. The enforcement
powers and supervisory powers we have are only over depository
institutions. Many of the problems that have come up have been
outside our direct enforcement and supervisory ambit. So it is
very difficult to have gotten information from, or supervised
or taken any actions against those who are outside what we
regulate and supervise.
Chairman Dodd. So your answer would be that you could not
have done more and the Fed acted in a timely fashion? Is that
how I read your answer?
Mr. Kroszner. Well, as I had said, it is very difficult to
make policy with 20/20 hindsight, but I think we were taking
actions on these issues back in 1999, 2001----
Chairman Dodd. I am not asking you to make policy. I am
just asking you the question of whether or not you think the
Fed acted in a timely fashion and could have done more, looking
back.
Mr. Kroszner. Looking back, I think we did undertake a lot
of actions, and unfortunately a lot of the greatest challenges
occurred outside what we could have done, outside where we
could have had enforcement or supervision.
Chairman Dodd. Ms. Duke, the same question.
Ms. Duke. I think if you look at it in hindsight, clearly
something different could have been done and had a different
outcome. And I think this may be a good opportunity to look at
the whole mortgage origination and delivery process across all
originators.
Chairman Dodd. Well, I agree with that. That is why we are
here.
Mr. Klane.
Mr. Klane. I just want to start by noting the sources of
the subprime problems are complex and go well beyond regulatory
action or inaction. I would look forward to working with the
Committee on all elements, including the complexity of so many
different types of mortgage originators, the multiplicity of
supervisory agencies, and the role of the securitization
market. The model of mortgage origination is more complex than
in the past.
All that being said, sitting here with hindsight, I think
we can say very clearly that if the Fed had acted somewhat
earlier, we might have had to some extent a better outcome.
Chairman Dodd. Thank you very much.
Senator Shelby.
Senator Shelby. I want to pick up on the same subject,
subprime, because it is my understanding that a lot of the
subprime loans, a lot of them in the future will be reset at a
higher rate of interest. Now, if you have thousands and
thousands--and we do--or billions and billions of dollars'
worth of subprime loans where they pay nothing down to speak of
and pay basically interest only for the first 2 years, and then
they are going to reset those upward in 2 years; I see problems
down the road, and most people that I have been in contact with
have.
Ms. Duke, you have been a president of a bank. You have
been an executive of a bank. You went through the--you referred
to it earlier, a lot of us did--21-percent prime. You remember
that, obviously. A lot of us are concerned about the rating
agencies here. I hope Senator Dodd will hold a hearing on this.
We asked the SEC Chairman right here in this Committee the
other day--because I introduced legislation to bring--and it
had broad support--to bring competition to our rating agencies.
We are concerned about conflicts of interest and things like
that.
How can you take--you know, the basic question: How can you
take a bunch of questionable loans, bundle them together, and
then sell them as securities and rate them investment grade,
AAA at times, because you put a few things with them? Some of
those, as we have seen some of our most reputable investment
banks saying that some of those funds are basically worthless
now.
Does that trouble you as a former banker, having to work
out problems on businesses and mortgage loans? You have had the
experience.
Ms. Duke. I have had the experience of working out troubled
debt. I have had the experience of having that debt mount up a
lot faster than anybody ever expected. But all of that
experience was in the case of a lender face to face with the
borrower. We still held those loans and----
Senator Shelby. And these were sold, most of them were
securitized.
Ms. Duke [continuing]. That is the part that really
concerns me, is identifying where those loans are right----
Senator Shelby. Well, somebody is holding the risk there,
are they not?
Ms. Duke. Somebody is.
Senator Shelby. I mean, you spread the risk. You pass it
on. But somebody is holding that risk, and, gosh, I would hate
to be the one holding some of that risk knowing that a lot of
that stuff is going to be reset.
Mr. Klane, you come out of the banking industry. You
understand that well, and you understand risk. Somebody is
going to eat those loans, aren't they?
Mr. Klane. Well, I think we can see some of the
implications of that in some of the hedge funds holding CDOs
and CLOs already. You point out one of the areas of complexity
that has caused some of these problems--and it is really not
directly related to, by the way, consumer protection issues.
You certainly raise a number of important points, and I think
it also underscores the importance going forward of having
underwriting criteria that take into account rate reset.
Senator Shelby. I want to get into Basel II with you, and I
will start with Dr. Kroszner. We are all concerned about
capital standards here. We raised that many times, Senator
Dodd, his predecessor Senator Sarbanes, everybody on this
Banking Committee, Democrat and Republican. We had a good
banking system.
Several of us--Senator Dodd and I--have served on this
Committee a long time, and we went through the thrift crisis
right here. We do not want to go through that again in any way.
Capital brings a cushion, and some of us are concerned where we
are going with Basel II. Some of those models might work, and
some of them might not work. I know that some of the big banks
have told me personally that what is driving that is freeing up
capital, you know, lowering capital.
You will be a bank regulator. You will not be the only one,
and we brought this up with the FDIC and Sheila Bair, the
Chairman, and others. There is widespread concern. I hope it
works. I know where you are today. We were glad to see what you
did, you know, with the other banking regulators. But some of
us have--we hope Basel II works. But we would hate to see
problems come before this Committee for the taxpayer like we
went through with the thrifts because we lowered capital
standards.
Do you want to comment on that?
Mr. Kroszner. Certainly. First, I would like to thank
Senator Dodd, Senator Shelby, and other Members of the
Committee who were very helpful in making sure that we got to a
good outcome, at least in principle, among the regulators to
move ahead with modernization of the capital standards, the so-
called Basel II. I think it is very important from a safety and
soundness point of view that we do move ahead with them because
we must encourage modern risk management techniques.
The traditional Basel I system was fine 25 years ago, but
it is not appropriate today for our large institutions. And if
regulation does not keep up, we will not be maintaining our
duty to maintain the safety and soundness of the system.
Basel II has very large numbers of belts and suspenders in
it to ensure that capital will not fall inappropriately. The
key----
Senator Shelby. What do you mean by inappropriately?
Mr. Kroszner. Relative to risk.
Senator Shelby. Okay.
Mr. Kroszner. And so Basel II was very helpful in giving
incentives for banks and other financial institutions to reduce
risk. Unfortunately, in the current system, Basel I, there are
some perverse incentives that could lead banks to take on
excess risk because the capital charges are not sensitive to
risk. But moving to a more modern framework, we are giving the
institutions the right incentive to try to reduce risk. I
believe that there would be sufficient capital in the system to
adjust for any of those risks.
I would never, ever want to subject the financial system,
the U.S. economy, or the taxpayer to the problems that happened
in the savings and loan crisis. This is something that I have
done a lot of research on and have, I think, a very strong
paper trail on--that we need strong capital in order to have a
safe and sound banking system. And I believe Basel II will be
consistent with that, but it will also help us reduce risks in
that system.
Senator Shelby. How will this affect the small and medium-
size banks?
Mr. Kroszner. Well, this is a very important consideration
that has led us to agree to propose a so-called standardized
approach for the smaller and medium-size banks, which is
something that they had requested, and I think will improve the
risk sensitivity, but also maintain sound capital for those
institutions and maintain a level, competitive playing field.
Senator Shelby. Ms. Duke, you come out of the small banks,
but you also have come out of one of the big holding companies,
too. If you were a CEO of a small bank in Portsmouth, Virginia,
now, would you be concerned from Basel II or would you be
concerned about capital standards? Would you be concerned that
some of the big banks might have a competitive advantage over,
say, a community bank?
Ms. Duke. I think there are a lot of banks of all sizes who
are wrestling with exactly those issues. Frankly, I think we
wrestled with them when Basel I was being proposed, and I think
we are going to have to get some experience with them. The
concern of the smaller banks is that larger banks will be able
to hold less capital and that that would make them more
competitive.
I suspect that the benefit of the risk management and risk
measurement practices that are pioneered by the large banks
with larger resources; will actually ultimately accrue also to
the smaller banks.
Senator Shelby. Mr. Klane.
Mr. Klane. Well, I would like to say I am not expert on the
technical aspects of the evolving Basel II Accord.
Senator Shelby. But you have had a lot of experience in the
banking industry.
Mr. Klane. Yes, indeed, and I think that having a well-
capialized banking system lies at the very core of the creation
of the Federal Reserve system. As a banker, I have seen the
power of being well-capitalized, as opposed to the opposite.
Senator Shelby. And there are days you are glad you had
that capital.
Mr. Klane. Capital is a very handy tool, and I appreciate
your focus on it.
Senator Shelby. Put it up there.
[Laughter.]
Mr. Klane. I would say that, per our earlier conversation,
Senator Shelby, the financial system has taken on increasingly
complex risks, such as the CDOs which have caused such concern.
We need to ensure that banks and financial institutions
understand the assets on their balance sheets and that they
hold capital that is consistent with the risks of those
assets----
Senator Shelby. Let me stop you a minute. Who understands
those complex rules--I mean, this bundling and what they mean
and all this, the derivatives that come through it today? It is
very important, Doctor, for the Fed to understand as a bank
regulator, it is very important for the FDIC to do it, the
Comptroller of the Currency, the other bank regulators. Am I
right?
Mr. Klane. It is absolutely important for them to
understand it. It is certainly important for financial
institutions who hold them to understand it. And it is
important for the regulators to ensure that those financial
institutions have appropriate risk management frameworks so
that they can manage the risk that they are taking on daily.
Senator Shelby. One thing that you and Ms. Duke you bring
to the Federal Reserve Board of Governors is experience in the
financial markets. Dr. Kroszner and others are academics. It is
very important to have them, too, and a little balance. I
commend the President for nominating you two.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you.
Before turning to Senator Bunning, all of our guests here
this morning in the Committee, of course, are distinguished,
but I wanted to recognize Wade Henderson, who is CEO and
President of the National Leadership Conference on Civil
Rights, and we thank him for being here this morning and
submitting some questions.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Each of you were in my office, and we had meetings, and I
stressed the importance of you being an independent voice and
speaking up when you had something to say in one of the Fed
meetings. It is especially important for you if you dissent to
speak up. I mean if you have a reason to dissent. Obviously,
dissent for the sake of dissenting is not what I am talking
about. I am talking about if you disagree with the policy that
is being discussed.
Can I count on you? You know, it is easy to say before you
are confirmed, but can I count on you? When I read the minutes
of the Fed and I see no dissent and I see no disagreement, I am
saying they have got a bunch of people over there that think
the same all the time. And that is impossible because I know
you have disagreements on policy. If you do not, there is
something the matter.
Can I count on you before I cast my vote on you to leave
this Committee and go to the floor and then when I get to the
floor, before I vote on your nomination? I want to be able to
count on you to speak out, all of you.
Mr. Kroszner. Definitely. I think if you were to poll the
other members of the FOMC, they would certainly say that I have
not been a shrinking violet either at the formal meetings or in
informal discussions. That is a part of my background, is to
speak up, to speak my mind, and if I disagree, to put those
ideas forward. So you can count on me.
Senator Bunning. Ms. Duke.
Ms. Duke. Yes, sir. I think I have a history of speaking my
mind, and----
Senator Bunning. Yes, I would imagine you did.
[Laughter.]
Mr. Klane. Likewise, Senator, I would absolutely commit to
bringing all of my points of view forward, and if I dissented,
not of course just for the sake of dissenting, I would do so
clearly and would move forward with what I thought was right.
Senator Bunning. I am going to follow up on the Chairman
and the Ranking Member on the subprime thing, because this is
under my skin and under my craw, because this was on a prior
Chairman's watch. The prior Chairman was kind of looked at as
God Himself, and no one is God Himself. We all make mistakes.
Believe me, I know from being here for 21 years how many
mistakes I have made.
The Fed has got to see in regulating banks what kind of
securities and what kind of loans they are making to their
customers, because by the time the Fed gets to look at the
banking sheets and when they are regulating them, almost all of
those loans have been bundled and sold off, and Standard &
Poor's and Moody's and all the rating systems are rating that
paper as AAA. And that is what has caused what we have in the
subprime lending institutions right now. We have paper that is
useless or worthless because the Fed did not look beyond the
sheet.
Now, I asked this question of Chairman Bernanke, and he
said, ``We did not have any power to do that.'' And I said,
``Well, you better have power to do it. You better look
beyond,'' because all of a sudden now we have a crisis, or darn
close to a crisis. I think it is a crisis. And I lived up here
through the thrift mess, and we had numerous opportunities
prior to the mess to clean it up. In fact, President Reagan
offered a bill prior to the bailout of the thrifts, the year
before, that was killed by certain Members of the House of
Representatives because it was going to affect their States
more dramatically.
I am going to hold you responsible if you do not look
beyond the balance sheets and look at what is going on in the
banking system as far as loans. You, Ms. Duke, as a banker know
exactly what kind of loans you have made to your customers on
mortgages. And to accommodate someone for a $400,000 home with
a mortgage that is not responsible--and that is all I can say,
it is not responsible. You know, if you loan somebody money or
if a mortgage company loans somebody money, that they know 5
years from now that the interest rates may not be the same and
it has been an interest-only mortgage and now they have got to
adjust it, we are looking for trouble. So I am asking you to
look beyond.
Now, you are going to have to convince Chairman Bernanke
because he does not think he has the power to look beyond. But
you as three new members, or one being reappointed and two new
members, you are going to have to look beyond the balance
sheets of the banks you regulate to find out what kind of
mortgages they are dealing with on a daily basis. And we have
got to stop it because to get it better, we have to stop what
is happening.
I know that you have given guidelines and made rules and
regulations, and hindsight is 20/20 always. But looking into
the future, we have got to correct the problem.
Can I count on you to do that? That is another thing, all
three.
Mr. Kroszner. Certainly, Senator. As I mentioned before,
our supervisory and enforcement powers are limited to certain
depository institutions, but we are now working much more
closely with the States and with the Federal Trade Commission
to deal with these problems, to share information, to share
expertise.
One of the initiatives that Chairman Bernanke mentioned in
his testimony before you just a couple of weeks ago was an
initiative we have spearheaded to work with the State
supervisors, the Federal Trade Commission, and the other
Federal banking regulators to do consumer compliance exams in
non-depository institutions, to be able to reach mortgage
brokers and finance companies, and to reach others that
traditionally we had not been able to reach. I think that is
one very important step. We are trying to get at exactly what
you are talking about.
More broadly, we have been working very closely with the
States--and since I have been at the Fed, I think our
relationship with the States is as close as it has ever been--
to get them to adopt guidance that we put out. We have had a
lot of success in working with them to get that. So we are
trying to expand the scope to be able to make sure that
wherever the problems are in the system, we can reach out to
them. And also, as the Chairman had mentioned in his testimony
2 weeks ago, we expect to be proposing rules that, although not
enforced by the Fed----
Senator Bunning. Thank you. I have got a couple more
questions I want to get in before my time runs out. Thank you
very much.
Ms. Duke, when you were Chairman of the American Bankers
Association, you advocated for many policy positions that could
come before you at the Fed. Will you be able to view those
issues in an unbiased manner? And are there any policy
decisions at the Fed that you think that you should not
participate in?
Ms. Duke. Yes, Senator, as Chairman of the American Bankers
Association for at least 1 year, and for a couple years prior
to that I was the primary spokesperson and the key listener for
the association, and you will find that there are a number of
statements that I have made on the record regarding various
banking issues.
The positions taken by the association were the result of a
lot of discussion and a lot of investigation into various
regulatory matters, and I think that experience would serve me
well. But in making any decision as a Governor of the Federal
Reserve, my only viewpoint would be that of public policy and
the public interest.
Senator Bunning. Thank you.
Mr. Klane, I have got to ask you this one because it is
very important to the foreign policy of this country. On
Tuesday, Deutsche Bank announced that it had ended all
contracts with clients in Iran. Given your experience in the
management of the Deutsche Bank's Global Division, do you think
the timing was appropriate? Should the bank have terminated
their ties with Iran at an earlier date?
Mr. Klane. Senator Bunning, let me say that when I was at
Deutsche Bank and in the business that I ran, we had nothing to
do with Iran. I am not really in a position to comment on the
rules and regulations and the timing of Deutsche Bank's
decisions. But I would say that with respect to my being on the
Board of Governors, if confirmed, I would certainly do whatever
was necessary to ensure that the institutions which the Federal
Reserve supervises fully comply with U.S. laws and regulations.
Senator Bunning. Do you think the Fed has a direct
involvement in seeing what banks are dealing and not dealing in
that manner?
Mr. Klane. Most certainly for the institutions which it
regulates.
Senator Bunning. OK. Thank you very much, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Allard.
Senator Allard. Thank you, Mr. Chairman.
I am going to change the subject. I have got a few things
that other Members have not asked, and I will give you a chance
to respond to those.
Both former Chairman Greenspan and the current Chairman of
the Fed Bernanke have expressed concerns about industrial loan
corporations because they are exempt from the bank holding
company and, therefore, not subject to the consolidated
supervisory requirements that other banks and both bank holding
companies are.
Do you think corporate owners of ILCs should be brought
under consolidated supervisory requirements to ensure safety
and soundness? I will let each one of you respond to that, if
you would like, please.
Mr. Kroszner. I do think it is important to maintain the
safety and soundness of the system that we have consolidated
supervision of organizations that would be very heavily
involved in the banking and payment system.
Senator Allard. Do you want to answer my question more
directly, as it applies to ILCs, industrial loan companies?
Mr. Kroszner. I would say it would be the same for an ILC.
Senator Allard. OK. Ms. Duke.
Ms. Duke. I think the owners of any banking institution,
including ILCs, whether it be a corporation or whatever, should
have Federal supervision on a consolidated basis.
Senator Allard. Mr. Klane.
Mr. Klane. I completely agree.
Senator Allard. OK. Now, the U.S. continues to have a low
national savings rate, which contributes to our growing current
account deficit. Again, Chairman Bernanke testified, ``To
reduce its dependence on foreign capital, the U.S. should take
action to increase its national savings rate.''
What suggestions do you have for promoting savings and
investment among Americans? Does anybody want to comment on
that? Let me start with Mr. Klane, and then we will go back.
Governor Kroszner, you always had to start things out, so we
will give you the last word.
Mr. Klane. Well, to underscore the importance of your
point, I think long-term excessive deficits are not a good
thing, and that increasing the U.S. savings rate over time
would be good for us now and for future generations.
Essentially we are borrowing today and will need to re-pay
later. There is a private component to that, and there is a
Government component to that. I would hope that we could make
progress against both aspects of that.
There are many public policy ideas that come before you and
your colleagues in the House in order to orient Americans
toward savings, and I am not here to advocate a particular one,
but I think the general proposition is important. And I would
also add that this is an area where general education and
financial literacy can have a positive impact, not only for an
individual's ability to look at disclosures, but also for
broadly understanding their own level of savings and what it
means for their retirement. This could have a very beneficial
macroeconomic implication.
Senator Allard. Ms. Duke.
Ms. Duke. I am not sure I have an answer for how to improve
the savings rate. I do think it is important. I do worry
particularly on an individual basis with the level of savings,
particularly for those of my generation, the baby boomers, the
level of savings that will be available to fund retirement and
that sort of thing.
As a banker, I have on occasion promoted ideas that would
encourage savings in banks, but I do not have an answer for
that right at the moment.
Senator Allard. Mr. Kroszner.
Mr. Kroszner. It is certainly a very complicated issue to
try to understand exactly how to get people to save more. I do
not have any particular proposal to put forward today, but I do
think it is important to think about the incentives in the tax
system, because many analyses that have been done comparing the
U.S. tax system with other countries suggests that there is
more of a bias against savings with respect to the tax system
in the U.S. than there is elsewhere. So I think looking at that
and whether there are lessons to be learned from other
countries for tax reform here could potentially be valuable.
Senator Allard. I want to follow up with some questions on
the subprime area. Most of the questions, as I have understood
them, have focused on securitization and how those securities
get rated and whatnot. But I am wondering if maybe the problem
is more fundamental about that and that is our exotic loans
that we kick out there.
Do we need to do something to prevent exotic loans from
happening? At one time in our banking system we did not have
those, at least that I am aware of. And so do we need to do
something about those exotic loans, or do we--maybe on a
security we need to have some analysis made as to what
percentage of the security is exotic loans. I would like to
have you comment. Ms. Duke, you can go first this time.
Ms. Duke. The securitization process has really given us a
lot of benefits, and I worry that sometimes it sounds like we
are opposed to securitization.
Senator Allard. I agree, and I support that.
Ms. Duke. It has given us a ton of benefits, and I think
now we are seeing probably some of the difficulties in working
through that.
Senator Allard. So the question is----
Ms. Duke. The exotic mortgages?
Senator Allard. Yes, do we need to--somehow or other, on
the analysis that maybe that information is already available,
what percentage of the security is exotic.
Ms. Duke. I don't know whether that--what percentage is
available. I don't know whether they are actually packaged
separately. Some of what are today considered to be exotic
mortgages in the old world, the nontraditional mortgages, those
were mortgages that were not made at all, with the exception
in--directly in the banks, where there was the ability to look
at the full set of circumstances surrounding the borrowing. And
so I think there are occasions there are uses for particularly
the low documentation loans, that sort of thing.
Senator Allard. But, you know, you have to evaluate the use
of it versus the benefits, and right now the benefits seem to
be less than what anybody anticipated. And so I guess it serves
us----
Ms. Duke. Well, I think you are right. Any lender is going
to have to evaluate what the likely losses are on the loan
before they make the loan or invest in the mortgage.
Senator Allard. But if we look at today's problem, lenders
have not done a very good job in doing that.
Ms. Duke. No, they have not.
Senator Allard. So what do we do? If they do not do a very
good job and really perform overall--when you look at it, maybe
we do not allow for some of these exotic loans.
Ms. Duke. I think the process is new enough that we have a
lot to learn about that, and I suspect that there are very few
of those loans being made right today.
Senator Allard. Mr. Klane?
Mr. Klane. Senator Allard, I think you raise related and
important issues. The first issue concerns innovations. I think
innovation in lending is a good thing for consumers. It is
important, though, that these products not become so complex
that a human being cannot understand them. This is a consumer
protection and disclosure-related challenge. In addition,
leading products should be underwritten appropriately and
delivered to individuals that can afford them.
These are very important issues, but in dealing with them,
I would not want to squash innovation. Innovation has greatly
benefitted many Americans in pursuing their dreams of, in this
case, homeownership.
The second part of your question concerns securities which
commingle loans, some of which may be poorly underwritten and
others well underwritten; they may contain ``exotic'' products,
or they may be plain vanilla. I am not an SEC attorney, but I
believe that is publically traded securitizations, there are
certainly important disclosure obligations so that investors
who buy them know what they are getting. These objections
should be fully and vigorously enforced.
I think it would be on the whole a bad outcome if all
innovation in lending were somehow ceased. I think that would
be a detriment to consumers.
Senator Allard. Mr. Kroszner.
Mr. Kroszner. I very much would underscore both what my
colleagues have said about the importance and value of the
securitization market for homeownership and having good, solid
underwriting standards. As you know, we put out guidance last
year on nontraditional mortgages--I think that is the same as
you are talking about for some of the more exotic products--
because we wanted to make sure that if they were being used,
the underwriting standards were appropriate for the person that
was using them.
So I think taking an approach of guidance this way and
also, exactly as Ms. Duke had mentioned, the markets have also
responded, are ways to deal with some of the challenges in this
area.
Senator Allard. A final question. My time is running out
here. You are all familiar with the strategic plans, annual
performance plans, annual accountability report, and financial
statements of the Federal Reserve. Have you had a chance to
look at those? Are you familiar with those?
Ms. Duke. I have not.
Senator Allard. OK. Let's put that aside. What do you
consider to be the most important priorities and challenges
facing the Fed as it strives to meet the needs of the American
people? Mr. Klane.
Mr. Klane. I think, as in my opening statement, there are
at least four areas that I highlighted. It is hard to trade
them all off, but obviously the sound pursuit of monetary
policy, particularly in the current environment, is critical.
I began my remarks with consumer protection, I think
illustrating the importance and the urgency, really, at this
point in time, of that element. The safety and stability of the
payment system and continued sound supervision is important.
And I would not at all dismiss the importance of maintaining a
safe payment system in the context of changing technology and
whether it is terrorism or money-laundering activities that
affect it. We need to get all of these right, and I think these
are all legitimately critical for the Federal Reserve Board.
Senator Allard. Ms. Duke.
Ms. Duke. I think I would agree on those and add to that
the understanding and perhaps changes in the way we view this
whole securitization process where there are entities that are
now facing banking risks that are not indeed bankers.
Senator Allard. Mr. Kroszner.
Mr. Kroszner. Certainly maintaining the appropriate balance
in the dual mandate, to make sure that we have maximum
employment growth consistent with low and stable inflation, and
ensuring that inflation expectations remain contained; second,
as I had said in my opening statement, a fundamental
responsibility to prevent discriminatory and abusive practices
in lending; and, third, to ensure the broader stability of the
banking and financial system.
Senator Allard. I am one that pushes hard for a lot of
accountability in our agencies. I do that by reviewing the PART
program, which has been put out by the President, where they
set goals and objectives that are measurable. And when you show
up before any Committee that I might be on, you can usually
count on the question relating to your agency because I want to
know how it is performing. I am an appropriator and I serve on
the Budget Committee. And I think it is important as Members of
the Congress to focus on accountability and ways of measuring
it. It helps us better justify to the taxpayer the need for the
program or the need to eliminate the program because it is--
although I do not think they ever eliminate anything around
here. But I do think that that is part of our responsibility,
and you are liable to get some questions from me on that.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
We have been joined by Senator Casey. Senator, thank you
for being here.
STATEMENT OF SENATOR ROBERT P. CASEY
Senator Casey. Mr. Chairman, thank you very much, and I
appreciate the work that has gone into this hearing and for the
witnesses who are here and for your service. We appreciate
that.
I am one of the sponsors, along with Senator Schumer and
Senator Brown, of the Borrowers Protection Act, a lot of
provisions in that legislation. One of them that I wanted to
ask you about is lender liability. What we are trying to do
with that act is to respond aggressively and in a timely way to
the subprime crisis in America for a lot of families who were
in many cases devastated by policies and practices which,
frankly, should have been cracked down on a long time ago and
by the failure of our system to allow people to have the kind
of information that they need in a very clear and
understandable way before they sign on the dotted line, so to
speak.
So one of the issues that we have focused on is lender
liability, and I am very concerned about and disturbed by not
only what has happened in the past up until now in terms of the
inability of our regulatory apparatus to deal with this, but I
am also concerned about the kind of dismissive or casual
reference to the crisis right now, people saying it is
contained, it is getting better, we are moving in the right
direction. I do not have that sense at all, and for the
families devastated, they cannot--you know, alleged containment
or alleged better policy is not going to help them. And I am
concerned about the families who are caught already in those
mortgages that will be reset, but I am also concerned about
families down the road who will be adversely impacted if we do
not get this right.
One of the issues, of course, is what happens with regard
to lender liability, and I wanted to throw it out to any one of
the three of you or all of you to comment on strategies to
protect borrowers and, in particular, the aspect of lender
liability. Maybe, Mr. Klane, if you could start, and we will go
right to left.
Mr. Klane. Well, Senator, I share your concern about the
subprime mortgages situation from a number of the dimensions
that you highlight, including just the sheer human cost for
people who have, unfortunately, found themselves in a bad
place.
I think the question of protecting borrowers is important.
I look forward to reviewing the bill, which I have not yet had
a chance to. There are many ideas that have been put forth,
including ideas by the Federal Reserve. I know the Federal
Reserve is considering these ideas as they think about rule
writing under HOEPA. I would look forward, if confirmed, to
throwing my energy behind moving expeditiously in this area.
With specific respect to lender liability, there are
important--I am not a lawyer--but there are important
liabilities that lenders currently have. I think part of what
you are grappling with is how to extend that liability perhaps
deeper into the securitization chain.
It is an extremely complicated question. I have not devoted
my career to focusing in on that particular one. Extending
liability could well play a role in solving the situation. But,
if so, it would have to be done in a way that did not eliminate
the offering of credit or the vibrancy of the securitization
markets. And I would look forward to helping find that right
balance when learning more about the issue.
Senator Casey. Thank you.
Ms. Duke.
Ms. Duke. Senator, I would share your concern, and there
are a number of factors involved here. One is for the
originators of mortgages, the original lenders of mortgages,
and the questions would be, you know: What are the requirements
for entry into that business? What sort of penalties can we
enforce against that particular originator? And then the second
piece is: If that loan is sold into the secondary market, what
liability would attach to the assignee?
The difficulty in assignee liability is that, first of all,
it has to be absolutely evident from the file, anything that
was a matter of judgment, subject to a matter of judgment after
the fact would create additional risk and uncertainty and
probably reduce the availability of credit in that marketplace.
I think it might be helpful to look to the experience of
some of the States because I know a number of States have
grappled with this. Some States I think are very happy with
their law. I know in Georgia they had strict assignee
liability, and it actually reduced the availability of credit.
I do not have the details of what the law was, but I think that
would be a good place to look to see what issues caused that.
Senator Casey. Thank you.
Mr. Kroszner. I would very much agree that it is extremely
valuable to use the States as a laboratory to see what can be
effective and what is not, because we want to protect
consumers, but we also want to make sure that responsible
borrowers can still get credit to people who can use it
responsibly.
I think it is very clear that the challenges that many of
America's families and households are facing now with respect
to keeping their homes is one that is going to be with us and
is probably going to continue to grow for some time. And so I
sympathize with the view that it is very important to try to
keep people in their homes, to deal with this issue, which is a
very important issue.
One of the things that we have done at the Federal Reserve
is, with the other agencies, put out a very clear statement
that lenders and servicers should work with borrowers to try to
keep people in their homes, to try to restructure the loans to
keep people there. It is for the benefit of the family, for the
community, and in almost all cases for the benefit of the
servicer.
Senator Casey. Thank you, and even at the risk of
redundancy, I know that Chairman Dodd and Ranking Member Shelby
have been very concerned about this issue and have brought this
issue to the fore in this Committee. And I appreciate the work
they have done on this issue already.
But just so we fully amplify this issue, I would ask each
of you to submit for the record I guess two sets of testimony,
really: one on the act, the Borrowers Protection Act, your own
view on that and your analysis of it; and, second, maybe a more
broader ranging written testimony regarding the subprime crisis
and how to deal with it. I think that would help us in our
deliberations.
Response from Governor Randall Kroszner
Let me begin by updating you on several recent actions by the
Federal Reserve in response to financial market developments.
As Chairman Bernanke recently noted, the Federal Reserve, in
cooperation with other federal agencies, is closely monitoring
these developments and has taken steps to increase liquidity in
the markets. In particular, changes to our discount window
program are designed to assure depository institutions of the
availability of a backstop source of liquidity so that concerns
about funding do not constrain them from extending credit and
making markets. Also, the Federal Open Market Committee has
stated that it is monitoring the situation and is prepared to
act as needed to mitigate the adverse effects on the economy
arising from the disruptions in financial markets.
It is crucial to protect consumers from abusive practices while
continuing the flow of credit by responsible lenders into the
subprime mortgage market, and the Federal Reserve has been
active in addressing issues in the mortgage markets. Starting
in 1999, the Federal Reserve along with the other federal
supervisory agencies issued guidance related to subprime
mortgage lending practices and expanded guidance in 2001. In
December 2005, we and the other federal supervisory agencies
issued proposed Interagency Guidance on Nontraditional Mortgage
Product Risks, which was finalized in September 2006. The
guidance addresses the need for an institution to have
appropriate risk management practices and underwriting
standards, including an assessment of a borrower's ability to
repay the loan at the fully indexed rate, assuming a fully
amortizing repayment schedule, including any balances added
through negative amortization. The guidance details recommended
practices for lenders' consumer disclosures so that a borrower
receives clear, balanced and timely information. In May of this
year, the Federal Reserve and the other federal supervisory
agencies have also issued similar guidance for subprime
mortgages, stressing the same fundamental principles of prudent
underwriting and consumer protection.
Various outreach and research efforts have deepened our
understanding of the issues and revealed that many of the most-
worrisome practices are found in credit extensions by
nondepository lenders and brokers, many of which are outside
the supervisory scope of the federal banking agencies. To that
end, the Board and the other agencies coordinated with the
Conference of State Bank Supervisors (CSBS) on the two most
recent guidance documents to promote and encourage their rapid
adoption beyond federally supervised institutions. The CSBS
published nearly identical guidances and has urged the States
to implement them in order to ensure a more level playing field
in the mortgage market and provide consistent protection of
consumers.
In addition, the Federal Reserve has launched a cooperative
pilot project with the CSBS, the Office of Thrift Supervision,
the Federal Trade Commission, and the American Association of
Residential Mortgage Regulators aimed at expanding consumer
protection compliance reviews at selected nondepository lenders
with significant subprime mortgage operations. As part of this
effort, the Board will examine nonbank subsidiaries of bank
holding companies for compliance with federal consumer
protection laws, including the Home Ownership and Equity
Protection Act (HOEPA). The other partners in the project will
conduct similar reviews of nondepository subsidiaries of thrift
holding companies, independent mortgage lending companies, and
mortgage brokers doing business with these entities. The
partner agencies intend to share information about the
examinations, review the lessons learned, and seek additional
ways to cooperate to ensure effective and consistent
supervision of these entities. At the conclusion of the
reviews, the agencies will analyze the results and determine
whether the project is to be continued and, if so, what the
focus of future reviews will be.
In April of this year, the Board and other federal financial
institutions regulatory agencies issued a statement to
encourage supervised institutions to work constructively with
residential borrowers who are financially unable to make their
contractual payment obligations on their home loans. Last week,
the Board, the other federal financial regulatory agencies, and
the CSBS issued a statement encouraging federally regulated
financial institutions and state-supervised entities that
service securitized residential mortgages to review the
governing documents for securitization trusts to determine the
full extent of their authority to identify borrowers at risk of
default and pursue appropriate loss mitigation strategies
designed to preserve homeownership.
I share your concerns about the subprime mortgage market and
the need to consider actions to stop abuses while preserving
access to credit for all borrowers. Your proposed legislation
(the Borrower's Protection Act, S. 1299) addresses some of the
issues the Board has focused on that may require regulation
under the Home Ownership and Equity Protection Act (HOEPA).
Those issues include:
Prepayment penalties,
Failure to require escrows for taxes and insurance,
Stated income and low-documentation lending, and
Failure to give adequate consideration to a
borrower's ability to repay a loan.
In June of this year, I chaired a public hearing at the Board
to gather information about how we might use our HOEPA
rulemaking authority to address concerns about these loan terms
and features. In addition to testimony, the Board received
approximately 100 comment letters from the public in response
to the topics discussed at the hearing. Board staff are
analyzing these letters and the testimony to formulate
recommendations for action to the Board. In addition, the Board
continues to seek input from consumer and industry groups, the
Federal Reserve's Consumer Advisory Council, our fellow
regulators, and others who may have useful insights about
mortgage lending practices. The Board plans to issue proposed
rules under its HOEPA authority before the end of the year.
I am also pleased to serve as the Federal Reserve's
representative on the board of directors of NeighborWorks
America, which has a program to encourage borrowers facing
mortgage payment difficulties to seek help by making early
contact with their lenders, servicers, or trusted counselors.
NeighborWorks' Center for Foreclosure Prevention recently
launched a national advertising campaign to raise awareness
about its 24-hour national hotline that connects struggling
borrowers with homeownership counselors. Since the launch of
the campaign this past June, the daily call volume has
increased almost two-fold from 1,000 to almost 2,000 calls a
day.
------
Response from Larry A. Klane
Reflections on S. 1299
The proposed Borrower's Protection Act of 2007 addresses many
elements of the mortgage market that may have contributed to
the current problems, particularly in the subprime mortgage
area. In particular, by addressing the duties of brokers and
the standards of care and underwriting of originators, the bill
centers on two critical issues. Without undertaking an
exhaustive analysis of the bill--which is outside my area of
expertise--I would, however, make the following points:
Clarifying the role and responsibility of brokers--in this bill
as ``fiduciaries''--is something that could help consumers
understand their relationship with these entities. Clarifying
and increasing the level of loyalty and duty that the broker
provides to the borrower should put borrowers in a better
position to obtain appropriate mortgages.
As the root of the subprime problem is that too many loans were
made to borrowers who could not ultimately afford them,
improved underwriting standards are clearly necessary. The
combination of legislation, good regulation, and market forces
needs to come together to ensure that loans are made on the
reasonable basis that a borrower can repay the loan. I would
also note that strengthening the duties of the broker, as the
bill does, may preserve a broader array of consumer choice than
by pre-defining ``affordability.''
While clear disclosures enable a fiduciary to fulfill its duty,
the bill does not explicitly raise the issue of disclosures to
borrowers. I want to emphasize the importance of disclosures
and clear documentation so that borrowers can understand and
evaluate the products being considered.
``How to deal with the Subprime Crisis''
The problems in the subprime mortgage market have many far-
reaching implications for individual households and
communities. The central problem is that too many subprime
loans were made to borrowers who could not ultimately afford
them. Any solution to this problem will need to address at
least two issues: first, helping existing subprime borrowers
and communities cope as well as possible with today's
situation, and second, creating structural elements to help
avoid this problem in the future.
With regard to the first issue, existing lenders and servicers
need, and should be encouraged, to help troubled borrowers to
the fullest extent they can. This requires adequate human
resources to assist troubled borrowers, and it requires
troubled borrowers to communicate with their lenders long
before foreclosure is imminent. I support all of the efforts to
encourage both of these actions. In this regard, the Federal
Reserve Banks, community groups, and financial institutions
each have an important role to play in assisting troubled
borrowers. I also support the SEC's recent efforts to clarify
that where these mortgages are part of a securitization,
servicers can make best efforts to modify loans without
jeopardizing the treatment of the securitization.
Creating a more permanent structural solution to avoid a
recurrence of problems going forward is a multifaceted
challenge. While there are many components, here are a number
of issues that I believe are important to address in the
subprime mortgage market:
The fragmented nature of the mortgage broker
industry creates challenges both in regulatory oversight and in
enforcing standards. Many consumers do not understand that the
broker has no fiduciary duty toward them.
Loans must be reasonably affordable to the
borrower. Unaffordable loans should not be made.
Financially educated consumers are essential to a
well-functioning market. Too many current borrowers were not
adequately prepared to understand the complexity and
appropriateness of their loans' terms.
Consumer disclosures on mortgage loans should be
strengthened and clarified so mortgage brokers can make wise
and informed choices.
While subprime borrowers must be adequately protected, overall
success includes reputable lenders willing to extend credit and
who have the required expertise in the full credit spectrum.
Any solution must be careful to create an environment where
reputable institutions are willing to participate in the market
and to innovate in order to create products that offer choice
to consumers.
______
Response from Elizabeth Duke
I share your concern about sub-prime loans and about current
conditions in the mortgage market. The discussions held in this
nomination hearing have only intensified my desire to delve
more deeply into the issues and use my experience as a small
business lender to help formulate changes that will have long
term benefit for homeownership and the mortgage market in this
country.
I would like to start with some observations about sub-prime
lending generally and then comment on your bill.
First, I would like to emphasize that the growth of the
secondary market--with non-traditional lenders making non-
traditional loans--has resulted in higher levels of home
ownership and an opportunity for building wealth in segments of
the population that were closed out of traditional mortgage
lending. So our challenge here is to reduce the cost in terms
of financial difficulty and foreclosure while preserving
flexibility and opportunity with mortgage products in the
future.
Chairman Bernanke has discussed with this committee the Federal
Reserve's intention to propose rulemaking under HOEPA later
this year. New regulations are a good first step, but we must
also look to the enforcement of those regulations. We should
encourage the joint state and federal regulatory discussions
and pilot programs already underway to achieve this end.
Although banks are participants in the mortgage market, the
market has expanded well beyond insured financial institutions.
I think it is time to review the entire mortgage marketplace
including prime, jumbo, alt-A as well as non-traditional
mortgages. It is important that we consider all the players and
all the regulators in the marketplace to ensure uniformity
across the full spectrum of originators, loan servicers, rating
agencies and investors.
As the mortgage market expanded rapidly in recent years,
competition led to breakdowns in risk assessment and risk
pricing. Now, concerns about credit risk have caused liquidity
to dry up. Consequently, very few loans with high risk features
are being made today. Innovation in mortgage lending over the
last few years has created loan structures and terms with which
there was little experience when the loans were made. In
designing the mortgage products of the future, statistical
studies of the contribution of various risk features to actual
credit loss will be quite helpful to all in assessing and
pricing risk. Use of the Federal Reserve research capability to
dissect the decisions and conditions that led us to this state
could identify changes that can prevent a recurrence.
Stemming the tide of foreclosures may be the most pressing and
the most difficult problem of the day. Foreclosure is the
highest cost loan resolution option for the borrower, the
lender, and the community. Successful loan work-outs require
good communication between the borrower and the lender, and we
should do everything possible to facilitate this, including
support of trusted third party intermediaries. Workouts also
require flexibility to match modifications to individual
borrower circumstances. To this end, we should continue to
investigate any legal, accounting or structural impediments to
loan modifications. And we should be supportive of flexibility
and creativity in providing responsible lending to fund
restructured loans. We should recognize, however, some
foreclosures will need to take place. In cases where there is
no possibility of workout, the lender should be able to take
responsibility for the property, including taxes and
maintenance. The lender will also have the greatest incentive
to re-sell the property so it can be reoccupied and the
recovered funds can be invested in new loans.
Your legislation recognizes the immediacy of the current
foreclosure problems and indicates the willingness of Congress
to provide assistance to state, local and community based
groups. Just as all real estate markets are local, so are real
estate problems. It will take the commitment of many on the
front lines supported by state and federal governments to
resolve each loan individually. One way to make more private
funds available might be to designate the circumstances under
which refinance assistance could qualify for CRA credit.
Legislation governing mortgage standards and practices must be
evaluated in light of the balance between consumer protection
and credit availability. As lenders are increasingly separated
from originators and borrowers, they will be unwilling to
assume risks they can neither assess nor control. In evaluating
the balance, I would look to the experience of the states that
have already enacted similar legislation. And I would hope we
would undertake the study of the full mortgage market that I
proposed above and use the information from such a study to
guide our regulatory changes impacting this important part of
our economy.
I wanted to move to another issue, the question of referral
of cases to the Department of Justice under the Equal Credit
Opportunity Act Amendments of 1976. Here is the record just
since 2001 in this administration. Since 2001, the Fed has made
the following referrals: in 2001, the Fed made one referral; in
2002, six referrals; in 2003, zero referrals; in 2004, three
referrals; in 2005, two referrals; in 2006, five. So literally
in those years, in those 6 years, just a handful of referrals.
And I would ask you to comment on that because one of the
problems that we often encounter in Government--and I saw this
in State government, and I have seen a little bit of it in my
short time in Washington--is it is great to have a law, it is
great to have a statute or a law and regulations in an agency
and a budget and all the trappings of what Government can do to
regulate and to enforce the law. But sometimes when you look
back at enforcement statistics or, in this case, referral data,
it tells you a lot about--sometimes it does not really matter
if the agency or the administration or the public official who
is running that agency, if that person or that administration,
so to speak, is not fully committed to the detail in the
statute to make such referrals, it does not matter whether or
not you have the power to refer.
I would ask you to comment on that because you are asking
for confirmation and you are asking for power, and that is the
privilege that we all have to exercise that power. I want to
know how you are going to exercise the power to refer matters
to the Department of Justice and how you make that
determination.
Mr. Klane. Senator Casey, I first of all want to say that
supporting and enforcing our country's fair lending laws is an
absolute, critical centerpiece of both the Fed's
responsibilities and good supervision. I would take this
responsibility, if confirmed, with the utmost of seriousness.
I cannot comment on, of course, the Fed's historic record
or their judgment on individual cases. I can say as a
practitioning banker two things: one is that in the business
areas that I am responsible for, I take fair lending laws very
seriously. Second, I would also say as one supervised by the
Federal Reserve, I have felt a rather vigorous energy against
this area. And while I cannot comment on the overall pattern of
referrals, I can give you at least some assurance that I have
seen them very actively involved. And I would not hesitate as a
board member for one moment if, based on fact and good
analysis, an institution showed a pattern of discrimination, to
do whatever the law required us to do, including referring it
to the Department of Justice.
Senator Casey. Thank you.
Ms. Duke.
Ms. Duke. I am not sure I have much to add to that. I have
been supervised by both the Federal Reserve and the FDIC, and I
can also attest to their energy in pursuing fair lending and
examining specific files looking for evidence, patterns of any
sort of discrimination. And I think that is entirely
appropriate, and I think that is something that would be our
responsibility to oversee the supervisory process, to review
the reporting, and to review the reports of the exams.
Senator Casey. Do those numbers seem low? I know I am out
of time. I mean, these are national numbers. This is not one
community or one State. These are--what is your sense of that?
Chairman Dodd. You are not out of time. You can continue.
Ms. Duke. I am not sure that I can comment as far as
whether or not they seem low. I would say, you know, perhaps
they might in terms of a big statistical number, but, frankly,
all of the banks that I am familiar with are putting a lot of
time and energy into themselves policing what is going on on
the front lines of the banks. And so I would be surprised if
there is widespread violation among those banks, because I know
the amount of resources that are going on inside the banks in
order to prevent any problems from occurring.
Senator Casey. Thank you.
Doctor.
Mr. Kroszner. I think following on what Ms. Duke has said,
we have tried in our regulatory, supervisory, and compliance
processes to be proactive, to ask whether something may not be
appropriate, and to take remediary action before something
becomes a systematic pattern or practice. That is why I would
not overemphasize the particular number of actual referrals
because a lot of compliance activity does not actually get to
the referral level.
But with respect to referrals, as Sandy Braunstein, the
head of our Consumer and Community Affairs Division, had
testified before Congress recently just in the first 6 months
of 2007, we have already made five referrals. So we are active
in this area, but I would not want to put too much emphasis
just on the particular numbers because there is a lot of
remediation that goes on in advance, not only by the Federal
Reserve, but by the other regulators also.
Senator Casey. Thank you. It may be lead to more questions
later, but being a first-year Senator, when you get 2 minutes
and 47 seconds extra, that is pretty good stuff. Thank you, Mr.
Chairman.
[Laughter.]
Senator Shelby. That is what you call a ``kind Chairman.''
Chairman Dodd. It will cost you at some point.
[Laughter.]
No. In fact, I wanted you to know, Senator, we set that
time, but before you arrived, I had said this is a loose number
here. There are not that many of us here.
And I should point out, by the way, that I want the
witnesses to know that the fact that there are not as many
members here is not an indication of their lack of interest.
But with so many other commitments, wrapping up here in the
last few days here before the August break, there are
Committees meeting trying to get legislation out, as well as
matters on the floor. And I am going to leave the record open
for several days because I am sure they will have questions
from both the minority and the majority here. And I would urge
you to respond to those in an appropriate fashion and time so
we can have the benefit of your answers to those questions.
Let me turn to Senator Shelby. I have an additional line of
questioning I want to follow. We do not really need the clock
on at this point. Why don't we just conduct this a little more
informally.
Senator Shelby. Thank you, Mr. Chairman. I just have an
observation.
Dr. Kroszner, you are a member of the Board of Governors.
You have written extensively. We were very impressed with your
published articles dealing with finance and monetary policy and
the economy and so forth.
It would be my understanding that as Members of the Fed--
and since you are on the Fed--that your top responsibility
should be price stability, you know, a goal of trying to keep
our currency strong, trying to make sure that inflation does
not erode the foundation of our monetary system and destroy our
economy.
So I know that Chairman Greenspan and Chairman Bernanke
have indicated that here, and before that, Senator Dodd and I
go back a while to Dr. Volcker. You know, so important.
How important to you as a member of the Fed now and a
future member of the Fed is price stability, as far as your
responsibility at the Fed?
Mr. Kroszner. I think it is crucial to fulfilling our dual
mandate, because I think the best way to achieve maximum
employment growth is through low and stable inflation.
Senator Shelby. That is right.
Mr. Kroszner. So if we can keep inflation expectations
contained, if we can keep actual inflation contained, that is a
very good environment for business people and individuals to be
making decisions that will maximize prosperity and their
welfare.
Senator Shelby. And at times, as a member of the Board of
Governors of the Federal Reserve, all three of you will have to
make some tough decisions. I referred to Dr. Volcker, and Ms.
Duke alluded to that earlier. We were here when interest
rates--prime went to 21 percent. Is that correct?
Ms. Duke. Yes, sir.
Senator Shelby. And there was a crisis in this country, but
the inflation was rampant. The Fed had to choke it off the best
they can, and it is not easily done. The best thing is to not
let inflation get away from you. Is that correct, Dr. Kroszner?
Mr. Kroszner. Definitely, and this is why we take a very,
very serious look at inflation, where it is now and also where
it is going. Because we want to make sure that the path of
inflation is one that is well contained, the path of inflation
expectations of what people think is going to happen to
inflation is contained, because it affects individual's
business behavior. And we know from research and data from
around the world that a low and stable environment is the best
way to maximize prosperity.
Senator Shelby. You know, you have been nominated to a 14-
year term, the maximum term on the Fed. I think that is one
reason when we created the Federal Reserve, to make the Fed
independent so you, all three of you, can make the tough
decision without regard to the political whims of the moment.
And I believe you will make them. I think you have to make
them.
I wish you well, and I look forward to supporting your
nominations. I hope Senator Dodd will schedule a markup as soon
as possible, and we will get you to the Fed and get you to work
there.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, as well.
Let me, if I can, we received some--and we will continue to
receive correspondence regarding the nominations. I mentioned
the presence of Wade Henderson, who is here in the room. We
received a letter from the Leadership Conference on Civil
Rights, which says that even though it has been aware of the
prevalence of unfair and deceptive loans for several years, the
Fed has inexcusably failed to invoke its HOEPA authority in a
way that would have protected homeowners. And just that point
that I raised in the first line of questioning is a matter of
deep concern to me regarding the fact this legislation was
passed in 1994, and almost nothing happened with it. And so I
appreciate it.
There is a line of questioning I want to follow up here
that relates again to the subprime, and then I have some
questions as well. This is not the only subject matter, but
this is a looming economic issue. And, Doctor, you are on the
Fed today, and obviously with the two nominees before us and
given the length of service and the importance of this question
and how the Fed is going to respond to this is a matter of deep
concern to people all across this country. I cannot go anywhere
without this issue being raised, as you might expect, anywhere
in the country, the concerns about it and what has happened.
I spoke yesterday with a number of mortgage bankers around
the country just to solicit their opinions as to what they
thought was happening and what solutions might lay out there
for us to try and deal with what has--the seizing up of credit
that is really getting rather dramatic here and could have
very, very serious implications. That was their opinion, by the
way, and many of them almost virtually universally in talking
to people in various parts around the country, from the Far
West to the Midwest and East that I spoke with.
We held hearings in this Committee on the problems of the
subprime market, and they raised some serious concerns about
the incentive structures. I want to talk about the incentive
structures in here because they worry me and trouble me because
they seem to be having a dual set of standards regarding parts
of our population. I am very worried about that being the case.
For example, mortgage brokers originate about 75 percent of
subprime mortgages. They make their money on fees called
``yield spread premiums,'' which I am sure all three of you are
very familiar with here. The higher the interest rate they get
a borrower to take, the higher their fees--a direct correlation
between the two. Moreover, the more loan volume they generate,
the more fees they generate as well here.
The problem is that these yield spreads lead to higher
interest rates for borrowers, higher interest rates lead to
prepayment penalties, which are included in the subprime area,
and as lenders are forced to lock in their higher yield. This
is a widespread problem. While almost no prime loans have
prepayment penalties, nearly all subprime loans include them as
part of their packages.
I wanted to ask all three of you here, beginning with you,
Dr. Kroszner, I want to hear how you would address this. I
think there ought to be a standard here that applies with some
universality here because it seems to have built into it almost
designed burdens here that make it clearly the subprime
market--which, by the way, maybe I should have said this
earlier, and I am pretty confident I am speaking for almost
everybody here--I think that is true. Certainly I feel very
strongly that this is a very, very important element, the
subprime market in our country. The idea of homeownership and
the value of the wealth creation associated with that, the
improvements of neighborhoods and communities, I directly
correlate to the ability of people to have an equity interest
in their own home. Nothing does a better job, in my view, to
stabilize communities and neighborhoods than homeownership. And
it has been a goal going back to the Truman administration and
talking about the importance of this. It has been embraced, by
and large, on a bipartisan basis over the years.
We also know that if you have one foreclosure in a fragile
neighborhood, one foreclosure out of an entire one-eighth of a
mile, which is roughly what a city block is here, the value of
every other home--every other home in that neighborhood--
declines by $3,000 to $5,000, with one foreclosure. So the
ripple effects of this are profound and serious, in my view.
I want to know why we should not here, if we are going to
have a subprime market, recognize we are going to be extending
credit to people who are fragile--at least that is the idea in
terms of their ability economically to address all of these.
Why are we making it more burdensome for them? And why are we
allowing brokers out there, in effect, to charge fees in a
sense or collect fees based on the interest rates they are able
to sell to people who are less well informed in terms of these
matters and then have prepayment penalties, of course, which
even increase the burden financially, thus increasing the
likelihood of foreclosure, thus increasing the likelihood of
the very problems we are trying to address? And why shouldn't
the Fed, I ask the question, take the position here of banning
prepayment penalties here and have a different system by which
brokers earn their fees?
Mr. Kroszner. Well, Senator, I couldn't agree with you more
about the importance of this problem. There are hundreds of
thousands of families and households who are facing the
potential loss of their home, and as I mentioned in my response
to Senator Casey, that number is probably going to be
increasing over time. So this is a very, very important problem
that I know the Chairman and every member of the Federal
Reserve Board takes extremely seriously.
I am also very glad that you focused on the issue of
incentives because, as an economist, I really think of things
in terms of incentives. I think that is exactly the right way
to think about things. What were the incentives in the market?
How can we improve incentives to make sure that responsible
lenders can continue to provide credit to responsible borrowers
in this market without having a seizing of credit, without
choking that credit off?
As you know, in the subprime mortgage guidance that we just
put out, we have proposed a 60-day grace period so that there
would be a minimum of 60 days, a minimum of 2 months, before a
reset in an adjustable rate mortgage comes. That person would
not have to pay prepayment penalties and would be able to
arrange for alternative financing.
One of the things that we looked at in great detail in the
HOEPA hearing that I held on June 14th was exactly this issue
of prepayment penalties. Different States have different
regulation of them. As I had mentioned before, I think looking
at the data that have come from the States to understand the
implications of various restrictions on prepayment penalties
are important, and this is one of the areas that we are looking
very seriously at under our HOEPA authority.
And so I agree that what we can do with the HOEPA
authority, that we do expect to propose rules by the end of the
year, to be able to set standards that will apply to all
brokers to make sure that there are appropriate underwriting
standards, to think about practices such as prepayment
penalties, whether they are appropriate or not, and in what
cases they are not appropriate.
Chairman Dodd. Let me just share some data with you here,
and this is from the Home Mortgage Disclosure Act data. The
Home Mortgage Disclosure Act and the data collection under that
act found some very serious disparities--alarming disparities,
in my view--in the incidence of higher-priced subprime lending
for African Americans and Hispanics in this country. The 2005
data shows that 54.7 percent of African American borrowers and
46.1 percent of Hispanic borrowers got high-priced loans when
buying a home compared to 17.2 percent of non-Hispanic and non-
African American.
In the Fed's analysis of the data, significant racial and
ethnic differences remained unexplained even after accounting
for other information. Reported in the Home Mortgage Disclosure
Act's data, the Fed found that borrower-related factors
accounted for only about one-fifth of the disparity.
Now, in my view, this reveals some very significant
problems in our mortgage system, a problem that is almost
certainly reflected in other parts of the financial services
sector.
I wonder if you are as alarmed as I am about this data,
which shows here the disparity in higher-priced mortgages here
within that community. And I want to know specifically as a
member of the Board, would you support the elimination of
prepayment penalties for people in that area? And what ideas
specifically do you have to change the relationship on how
brokers collect fees? If they are going to get them based on
getting higher rates from people, it seems to me that ought not
to be the consideration in determining whether or not or what
fee a borrower pays here. Too many of them hold themselves out
as mentors, as you and I know. You have seen their website,
which I talked about at earlier hearings, where one of the
first questions you are asked is tell that borrower you are his
mentor or her mentor, in a sense. The idea they are mentors, of
course, is ridiculous. They are not the mentor. They are not
the advisor. They are out there trying to get those loans here.
So I want to know with some specificity here, this is very,
very important to me, to have some assurance and some sense of
security that if a person is going to be on that Board for 14
years, how are we going to deal with this issue and whether or
not you embrace the same view I do here that these ideas are
just wrong, and they are dangerous, in my view, what it means
for our country.
Mr. Kroszner. I very much agree that it is extremely
important to protect people in these markets, and we have to
protect them against abusive practices. And exactly as you said
before, there are incentives in the market that I do not think
many borrowers are aware of because I do not think that we have
sufficient disclosure to the borrowers about some of these
practices.
I think many borrowers think exactly as you describe, that
the particular broker may be acting in their interest, but that
is not in many cases the case. They are acting in the interest
of maximizing their profits, which, as you said, may be related
to charging the borrower more, not getting the best deal for
the borrower.
So I think one important thing that we need to do is make
the consumers more aware of who is the broker working for and
the incentives that the broker----
Chairman Dodd. Doesn't it need to go beyond disclosure,
though, in your view? I know you advocate disclosure. I do not
disagree. Disclosure is very important. I do not minimize your
point on that. I agree with you totally. But it seems to me
that more than disclosure is required. Shouldn't the broker
have to declare either I am the agent for the lender or I am
the agent for the borrower here, it seems me.
Mr. Kroszner. Well, I do not want to get into the details
of exactly what to----
Chairman Dodd. Well, I do. I do.
Mr. Kroszner [continuing]. Disclose.
Chairman Dodd. I am interested in details on this.
Mr. Kroszner. Certainly, these are exactly the kinds of
things that we are looking at in developing our HOEPA rules,
and we are still reviewing those. That is why I do not want to
commit to particular details. But obviously thinking about
exactly these kinds of issues, about disclosing who is the
person working for and what those incentives are. And I
completely agree with you about thinking about the role of
prepayment penalties. This is exactly what we were discussing
at the HOEPA hearing. What kind of incentives do they create?
Are they something, as some people have argued, that can help
to reduce costs to borrowers, or are they something that really
are abusive or abusively used against borrowers?
So that is why we are looking at the data from the
individual States which have different regulations, talking
with consumer groups, talking with a number of others to try to
understand how best to respond to this problem. Because as you
said, we do not want credit to seize up. We want to make sure
that the American dream can still be reached by many, many
people who may not have the same length of credit histories or
may have more fragile credit histories. So we want to make sure
that responsible lending continues there, but we want to
prevent abusive practices.
Chairman Dodd. Let me come back to that.
Ms. Duke, I will not repeat the questions. You have got a
flavor of where I come out on this thing here. It is very
important to me here. These are long terms here on the Federal
Reserve. This is going to be a major issue, and I want to get
some sense of where you are on these issues.
Ms. Duke. Senator, I agree with you about the concern, and
it is something that I am a little frustrated about, in that
right now I only can answer this question in the light of my
own experience.
Chairman Dodd. I agree.
Ms. Duke. I am anxious to get to the point--would be
anxious to have available to me the research capability of the
Federal Reserve. I think also the reserve bank structure, which
goes into all parts of our country, is another great asset of
the Fed in order to really examine the entire process.
Chairman Dodd. Do these numbers I cited to you here
regarding people who are getting high-priced loans, the
disparity, does that concern you?
Ms. Duke. It concerns me, and it concerned me when those
numbers first came out. And, again, I would very much like to
delve into the research and information on all of the various
reasons why those numbers would be different, whether they are
in the origination structure, whether they are in the incentive
structure, whether they are in the way that companies market
mortgage loans. I would really like to have the chance to take
a look at all of those----
Chairman Dodd. How about prepayment penalties? How do you
feel about that?
Ms. Duke. On prepayment penalties, I agree with the
guidance that a borrower should have a period of time before a
rate changes in order to make a decision to do something
different. My familiarity with prepayment penalties in the past
has historically been when the lender had made a rate
commitment to the borrower and wanted to make sure that that
money stayed invested for a given period of time.
Chairman Dodd. Why is there a distinction----
Ms. Duke. But in a situation where the price is changing--
--
Chairman Dodd. For a prime loan, you do not have prepayment
penalties.
Ms. Duke. Right.
Chairman Dodd. A subprime you do. Why the distinction?
Ms. Duke. I do not know.
Chairman Dodd. Well, you have been in this--you chaired the
ABA. You must have some idea.
Ms. Duke. I do not know why the prepayment penalties have--
--
Chairman Dodd. Dr. Kroszner, why would you have a
distinction between a prime and a subprime loan and requiring a
prepayment penalty for the subprime and not for the prime?
Mr. Kroszner. My understanding is--and I certainly do not
speak with certainty on this--is because of concerns about
rapid prepayment of some of these types of instruments, to be
able to get what some people have argued, to get lower interest
rates, to be able to securitize them, the prepayment penalties
were helpful to be able to get them into the securities, to be
able to get them out to the market. But I have not evaluated
that.
Chairman Dodd. Doesn't it seem inherently contradictory? A
subprime borrower is a borrower who does not qualify for a
prime loan, so obviously their financial situation is more
fragile. So we are going to have a prepayment penalty on them
here, thus increasing the more difficult problem of meeting
their obligations. It seems to me just to be counterintuitive
unless you have some other purpose in mind here that you would
have that distinction between a prime loan and a subprime loan.
Mr. Kroszner. What some people have argued--and, again, I
have not evaluated this--is that there may be more frequency of
prepayments, more frequency of moving from one home to another,
and so this provides some form of protection for the people who
are buying the securitized mortgages, and so that allows a
lower initial interest rate to be provided.
I have not evaluated that argument, so I do not know how
important or extensive that is.
Chairman Dodd. Let me ask Mr. Klane. I have been focusing
here, but you have heard my line of questioning here. Why don't
you respond to what I have been raising?
Mr. Klane. Chairman Dodd, let me build on two important
things that you said, if I may. The first has to do with the
importance of the issue. I want to provide some perspective on
the issue, from where I sit, that is not often introduced, but
underscores this Committee's concern.
Sometimes we think of the subprime population as a marginal
element of the United States, and I did a little research on
the topic. There is no bright-line definition of a ``subprime
borrower.'' And a subprime borrower is different from a
subprime loan. Within financial institutions and regulators, a
good starting point is to define a subprime borrower as someone
who has a FICO score, Fair Isaac--it is a credit score--of 660
and below. That is just a starting point, and there is lots of
grayness. And I asked the question: What percent of people in
America have 660 FICO scores and below? The answer to that
question is 30 percent.
In the housing market, sometimes loans with FICO scores of
620 and below are considered subprime. Again, these are gray
areas. There is 20 percent of Americans with FICO scores of 620
and below.
But if you think of either number, 20 or 30 percent of our
population that is affected and captured in the scope of, the
spirit of the conversation, I think it underscores why it
affects so many of the constituencies and communities that all
of you serve and that we as bankers serve. And I just want to
say, as part of my record, how significant I think that is,
just as a sheer piece of the American public.
The second topic concerns the fragmentation of the mortgage
banking system, which makes actually fixing it very difficult.
There is no one regulator, no one bullet, I believe, that will
fix it. But it is fragmentation--75 percent of volume generated
by brokers, virtually none of whom would be supervised directly
by an institution like the Fed--that gives particularly
important weight to the rule-writing capabilities under HOEPA,
which do have an advantage of affecting all participants in the
mortgage market, whether or not the Federal Reserve directly
supervises them.
So I think the focus that you have encouraged and that the
Fed is now showing by its commitment to rule writing under
HOEPA is important to create a national standard. Of course,
because it affects everyone, it needs to be done with care. You
do not want to create more harm than good. But I think a
national standard against a very fragmented, problematic area
is a good start.
I have looked at the letter from the Leadership Conference
on Civil Rights, and I think there are very many important
elements of concern that are raised there. I think there are
legitimate concerns with the use of prepayment penalties, for
that matter. That being said, I would also want to throw
myself, if confirmed, into this debate. I would want to benefit
from a much broader conversation that I could have as an
individual consumer or from my own personal banking experience,
to work with the Committee and the other Governors to come up
with a good, strong, appropriate set of rules which would cover
and include prepayment penalties as appropriate.
Chairman Dodd. There are two areas here--and Senator Shelby
has talked about one of them in particular, and I agree with
him on it, and that is the credit rating agency and the broker
side. If I had to pick two areas, it seems to me, that the
Committee ought to be looking at potentially and legislatively,
as well as really examining what more--and we just, of course,
dealt with the credit rating agencies about a year ago here--
thanks to Senator Shelby, by the way, who pursued that
aggressively. Looking back at it, maybe now that we know more,
maybe we should have done more in a sense, and I don't know
whether he agrees with that at all or not, but it is something
I want to look at.
Senator Shelby. Competition.
Chairman Dodd. Well, something out there. The fees driven
again, anecdotally, I am told--and I would not want to suggest
this is based on any empirical data, but anecdotally, when you
get--someone suggested to me the other day that as much as 60
percent of the fees collected by the credit rating agencies
have come specifically from the secondary mortgage market. And
if that is true lately here, then you wonder how these AAA
ratings occurred here. The obvious question arises, whether or
not the fees were driving the conclusions on rates.
Now, again, it is anecdotal. I am not suggesting that is
some data we collected here on the Committee that I would
require, but there is enough people out there talking about it
that it raises some very legitimate concerns.
Before I turn to Senator Shelby, and then I have some
additional questions here, let me ask you, because in my
conversations with a lot of these mortgage bankers around the
country, soliciting their sort of opinions on various things,
several have suggested--and I probably ought to address this to
you, Doctor, although the rest of you can comment on it as
well. Several have suggested that the seizing up here warrants
allowing the--that Fannie and Freddie should play a helpful
role at this particular juncture in restoring the flow of
credit to the sector. Obviously, there are consumer issues that
need to be addressed, and we are dealing with GSEs, and we have
got to deal with that legislation. But the idea that Fannie and
Freddie would be able to have some credit flow into this market
might do something right now to deal with what you have
described and I have described as seizing up, and they
described yesterday.
Now, again, this was their conclusions here. I just want to
share with you in my conversations yesterday what several of
them said to me they thought might be a valuable move to be
made at this particular point. What is your reaction to that?
Mr. Kroszner. Well, obviously that is a very important
issue that is part of the GSE debate as to what is the
particular role of the GSEs and how can they be focused on
providing affordable housing. So I think that is certainly
something to seriously consider, what sort of role they could
play.
Chairman Dodd. I know that. I am talking about right now
whether or not, you know, encouraging, having the
administration encouraging--I realize we have got some
legislation to deal overall with GSEs, but right now, given the
role that Freddie and Fannie can play here about having them
have extend some additional credit here to lighten up or to at
least release some of the seizure.
Mr. Kroszner. Well, there may be some issues with respect
to the particular rules and regulations that they are operating
under, and so I want to say only with respect to that that they
have to be consistent with the regulations that are there. But
if they could be helpful in this area, I think it would be very
valuable----
Chairman Dodd. Do you think they could be?
Mr. Kroszner [continuing]. To focus them on this mission.
There has been some debate about what the legal requirements
and restrictions are on their portfolio.
Chairman Dodd. I just want to know what do you think.
Mr. Kroszner. I think it could be helpful to have them
focus on affordable housing more than they have been.
Chairman Dodd. Do any of you have any opinion on this? Ms.
Duke or Mr. Klane? No? OK.
Senator Shelby.
Senator Shelby. I want to get back to subprime because I
think subprime loans in the markets are very important. Very
important. It has always been my understanding--I used to do
some of this--that you price risk. You price risk. You have
prime loans. You have investment grade this and bonds. You are
pricing risk, are you not, in a sense?
Mr. Kroszner. Definitely.
Senator Shelby. And you cannot take risk out of a market.
There is always going to be risk.
I think that you, as the Fed, as a regulator, ought to do
everything you can, and the other agencies, to make sure that
fraud and sharp dealings and all this kind of stuff, taking
advantage of people, is eliminated as much as we can. Senator
Dodd and I are very much interested in that. But I do not think
you can take risk out of the marketplace, and when people
borrow money, that is a risk for all of us, whether we have a
high credit rating and a lot of income or marginal. We have
promoted homeownership, and we think that is very important in
this country. In some areas, maybe we have overpromoted it. I
do not know that. It is a question that some of your academic
friends will be studying because that is important, too, and
where we come down on that or not.
As far as prepayment penalties, Senator Dodd, I know myself
personally and I knew professionally that in a lot of
commercial loans where they sell these--they securitize, that
they have prepayment penalties because they are selling those
bonds based on that this will be a certain payout.
Am I correct on that, Ms. Duke?
Ms. Duke. Yes.
Senator Shelby. So the subprime market is not the only area
where you have prepayment penalties. I have seen a lot of very
high-priced loans--I mean, not risky loans with a good interest
rate that have prepayment penalties. Haven't you?
Ms. Duke. Yes.
Senator Shelby. OK. But I think there ought to be fairness
out there in the market. I agree with Senator Dodd on that, and
you as a regulator too ought to look at that because we need to
cut that out. We do not need a marketplace where people are
taken advantage of or the risks are not fully explained and the
people that are doing that maybe have incentives the wrong way.
Incentives make the market work, and without incentives,
the market will never work. But I guess there are incentives
and then there are incentives. And how do we get there?
Senator Dodd, that is all I have.
Chairman Dodd. Well, thank you, Senator Shelby, and I
appreciate that point on the prepayment penalties. My point was
we do not have them in prime and we do in subprime, and that is
my concern here. I understand the----
Senator Shelby. Excuse me a minute. We do have prepayment
penalties in prime loans--I mean, in very quality blue-chip
loans. I know we do.
Ms. Duke. On the commercial side.
Chairman Dodd. Commercial side.
Senator Shelby. That is right.
Chairman Dodd. But not in the mortgage area. That is my
point here.
Senator Shelby. OK.
Chairman Dodd. It is the very constituency that is,
arguably, more fragile, or they would not be in the subprime.
Yes, that is my point here. Again, we are dealing with a
constituency here that the fact they are subprime lender, we
automatically--that is a recognition that they are in a more
delicate position financially than others. And so my concern is
here that we are adding--well, I have made the point. It is
adding to their financial burden at a time we are trying to
keep them in--it is one thing to get a person in a house. If
you cannot keep them in there, then, of course, the ripple
effects are what concern me here, which becomes very, very
valuable.
Let me, if I can, raise just a few other questions, if I
can. Ms. Duke, as Chairwoman of the American Bankers
Association, you wrote a regular column for the ABA journal,
and you wrote a column entitled ``Singing the Regulatory
Blues,'' in which you discuss Sarbanes-Oxley, the FACT Act, the
PATRIOT Act, the Gramm-Leach-Bliley Act, and you stated, and I
quote, ``The goal, as Jane Byrne, the Center's Director, put
it, is to roll back regulation.'' But what specific regulations
do you think ought to be rolled back?
Ms. Duke. Senator, there is not any one particular
regulation that causes the burden in banking. It is the
combination of all of the regulation. I would really talk about
two examples. One would be the BSA regulations, which there the
issue with the banks is as much the uncertainty of some of the
requirements as it is the specifics of the requirements.
The other area I would highlight would be in the payments
area. The payment system has changed over the years, and as
each new form of payment came through, whether it was ATMs or
debit cards, now Check 21, each one carries with it its own set
of regulations and its own process for collection, its own
process for return. And when you put all of those together, it
is very difficult from the banking side to really predict what
the impact of that regulation is going to be on any given
payment, much less from the consumer side, and in some cases
they do not even know where the payment--what path that payment
has taken.
And so when we talk about regulatory burden, it is the sum
total of that burden more than it is any specific regulation.
Chairman Dodd. I appreciate that. I am not going to argue
with you, obviously, but this is something we ought to look at
all the time here to determine whether or not things we have
done are doing the job we want them do. I just get concerned
when you--we sweep with the broad brush in here without some
specificity.
So it might be helpful to the Committee that you give us
maybe some additional ideas in response to the written
questions in this area. I would be interested in knowing. I am
not trying to pin you down here, in this kind of a setting
here, to those specifics. But in the next few weeks if you
would let us know specifically what you have in mind, I would
be appreciative.
Ms. Duke. Senator, if I could, none of that would preclude
me, as a regulator, from proposing and enforcing a new
regulation whenever it was warranted.
I would first like to recognize the ongoing efforts of many to
reduce and streamline our existing regulatory framework. The
regulatory agencies have been engaged individually and
collaboratively in reviewing existing regulations. This
committee put much thought and effort into the regulatory
relief bill that passed last year. The SEC and PCAOB have been
engaged in an ongoing effort to reduce the burden of Sarbanes-
Oxley Section 404 while retaining investor protection. I doubt
that a year passes without at least one hearing in this
committee related to regulatory burden.
And I would like to reiterate my earlier pledge that if I am
confirmed, nothing would preclude me from proposing, enforcing
or voting in favor of any regulation.
The cost of regulatory compliance has concerned bankers for as
long as I have been in banking. It would be an easy fix if we
could all point to one especially burdensome regulation as the
source of the problem. Unfortunately, it is the sum of many
different regulations that create the overall burden. When I
was a community banker, I thought small banks had the true
burden because we had such limited resources. When FDICA
passed, the number of implementing regulations exceeded the
number of employees in my bank by 2. When I was with larger
banks, I realized that the compliance task was equally
difficult, primarily due to operational complexity and long
lines of communication.
Numerous studies have attempted to quantify regulatory
compliance costs. However, in recent years, the discussion has
turned from purely cost to regulatory risk and uncertainty.
I'll offer a few examples.
Smaller banks, in particular, struggled with Sarbanes-Oxley
Section 404 compliance. And many who were not required to
comply under the law felt examiner pressure to comply anyway.
The expanded anti-money laundering responsibilities created by
the Patriot Act have elevated regulatory risk. All banks are
committed to detecting and reporting suspicious activity, but
few banks are certain they know how to do so adequately. One
area where banks are particularly uncertain is in the servicing
of money service businesses. As business types are identified
as high risk, banks that feel unable to monitor the risk at a
reasonable cost are stopping service to those businesses.
Finally, I mentioned payment system regulation in my testimony.
Electronic payments are coming of age, surpassing paper
payments in the last few years as the payment of choice. Check
21 and ACH conversion promise to accelerate this change. As
each payment method has evolved, so has its body of regulation.
The result is a complicated tangle of forward collection and
return rules and timetables. If they are confusing to bankers,
they must be even more confusing to consumers. The Federal
Reserve System is at the heart of the payment system in this
country. If confirmed, I would like to devote time to studying
the regulations and procedures surrounding payments with the
goal of proposing changes that would make the payment system
more efficient, understandable and predictable.
Chairman Dodd. I appreciate you saying that, as well. That
is not a bad comment to make at this point.
Mr. Klane, you were just talking here about the FICO
standards here in terms of people's creditworthiness. I note
here, and let me ask you the question and have you respond to
it.
Capital One has come under some scrutiny and received some
criticism for refusing to report consumers' credit limits on
their credit cards, which can artificially depress, some argue,
customer's FICO scores. This issue rose during the Committee's
consideration of the Fair Credit Reporting Act reauthorization.
Critics allege that Capital One was gaming the system by
deliberately depressing the consumers' credit scores to gain
competitive advantage by making its own customers appear to be
greater credit risks and therefore less likely to receive
marketing offers with more favorable terms from competitors.
In June of this year the U.S. District Court for South
Carolina allowed a lawsuit which alleged that the credit
bureau's violation of the Fair Credit Reporting Act for failing
to obtain that information to proceed.
As I understand it last month the company announced that it
would be reversing its policies in this regard. Critics raise
concern about this practice in light of the cross-marketing
practices, arguing that the company benefited from marketing
products such as its home equity lines of credit to its
customers who scores the company had depressed.
I wonder if you might share with us any involvement you had
in establishing? Why did Capital One decide to change its
credit limit reporting? Do you believe that critics who suggest
that a failure to report credit limits do depress consumers'
credit scoring? Are they wrong in doing so? And what do you
believe its effect on consumers for failing to report their
credit limits? And should the Board consider prohibiting this
practice?
There is a lot of questions there and we will repeat them
if you want.
Mr. Klane. No thank you.
First of all, let me say that I do not run Capital One's
domestic credit card business. So in that regard, it is very
difficult for me to comment on practices in a very particular
area, let alone a singular practice.
And of course, I am not here to represent Capital One. I
am, of course, here as a private citizen looking to perform
public service in the context of the responsibilities that
Congress has laid out to the Federal Reserve Board. I would be
very honored to do so.
As you rightly note, Capital One as an institution, I also
learned, has changed its policy with respect to this. The
rationale for having done this practice, as I understand it--
again I am not responsible for the policy--had less to do with
the items listed in the accusation than a belief that the
credit line is a sensitive piece of information and the
interplay between credit risk and credit line assignment is a
legitimate competitive issue to be kept proprietary. The value
of that I am not here to establish.
In any case, taking all of these points into account, the
institution decided, as you note, to change its policy. And
therefore, it is no longer a current issue. But I do not have
responsibility for that unit, Senator.
Chairman Dodd. Should the Board, in your view, would you
recommend as a member of the Board supporting prohibiting this
kind of a practice from occurring?
Mr. Klane. I would approach all of the questions that come
to the Board with absolute integrity and objectivity and in
order to fulfill the mandate set before it, always keeping in
mind the point of view of the public interest.
There are many practices, we have discussed many today, in
mortgage which are not good practices. I would look forward to
the opportunity, if confirmed to the Board, to take stock of
the particular practice that you have highlighted, which I am
not an expert on, as well as others and determine what
regulatory perspective--whether rule writing, guidance, or
supervisory influence--would be appropriate. I would take that
as a very important element of being on the Board.
Frankly, I think that my experience in banking, knowledge
of consumers in a practical way, complements the existing Board
expertise. I can assure you the consciousness with which I
bring consumer interest with the roughly 10 million small
businesses and consumers that I serve is very, very important.
And I think it would be helpful to the Board's overall
deliberation. In any case, my energy would very much be against
these type of issues.
Chairman Dodd. I am informed by my staff here that--and
they raise the issue here and I will raise it with you--that as
I understood it, you did run the home-equity loan shop at
Capital One.
Mr. Klane. I run Capital One Home Loans but that is not----
Chairman Dodd. Their point is that--which did the cross-
marketing and therefore benefitted from the withholding of the
information. How do you respond to that?
Mr. Klane. Capital One Home Loans markets to Capital One
customers. Capital One Home Loans also markets to the general
public through advertising and other ways. All consumers who
wish to apply for a loan have access to it.
Chairman Dodd. But if, in fact, their credit rating under
FICO were such that competitors would be less interested in
them as customers is that not--aren't you advantaged to some
degree as a result?
Mr. Klane. I do not see why that would be the case,
Senator.
Chairman Dodd. Let me raise the issue quickly with you, as
well, about Regulation Z, and again to you, Doctor, as well. I
have been impressed that over the last number of months, as a
result of the work of Senator Shelby and myself and others
here, and having hearings on the credit card industry and some
of their practices that some have changed, clearly. The
universal default, double cycle billing, a number of other
matters here have--major companies have changed, anyway.
Obviously, I have a concern that these things can move back
and forth, depending on where people are and a position to have
some influence on these practices. My concern is that once
those who care about these elements are no longer in a position
to do much about it, the practices can return unless there are
some clear rules.
I am told that there are some $20 billion in fees that have
increased in the last 20 years in the credit card industry as a
result of additional provisions that have been added to this.
Again, I am a great advocate of credit cards. Do not
misunderstand me. I think they are a wonderful and very helpful
to a lot of people.
But I have been very concerned about again capturing and
holding people. There was a story the other day, I do not know
if you saw this thing, Dick, where some guy had 2,000 credit
cards shipped to him. Obviously a rare case but nonetheless
some indication of the consumer frustration with this issue and
what happens.
So I would be interested if you have any comments or ideas
on the credit card, the Regulation Z area, and the decision by
the Board to take up this matter? And specifically what
suggestions you would make to the Board to prohibit certain
activities, which again I point out are being stopped by major
companies, the ones who allow for minimum monthly payments,
obviously.
Mr. Klane. If I may, while I do not run Capitol One's U.S.
credit card division, I am very aware of the broader set of
issues.
I would also like to start out by saying that I share, as a
consumer and as a broad industry participant, the very
legitimate concerns that this Committee and others have had
with respect to practices throughout lending but including
credit cards. I see a number of practices there that I would
regard as bad practices.
I would say there is some important progress being made and
I point to two things, both of which you have referred to,
Senator. One is this Committee itself, just by bringing focus
on the issue, has given some incentive--we have spoken about
incentive structures--to a number of issuers to change
practices I think for the better of the consumer. I would
applaud the work of you and the Committee in that regard.
With respect to Reg Z and truth in lending, this is the
first revision since, I believe, 1981. The world has changed
tremendously since that point in time. I have been rather
impressed with the ambition, and to some extent of the length,
of the change in the disclosure regime. Of course, it is in a
comment period now. I am very encouraged by the Federal
Reserve's work there.
I also want to emphasize one element that I think is quite
right-minded. And that is they have adopted a consumer
perspective. I have worked in consumer finance for many years.
And it is quite extraordinary, on the altar of doing something
clearer for the consumer, how much gets done that is unclear or
burdensome in its structure or length. Of course, Senator
Schumer, came forward years ago with the concept of a ``Schumer
box.''
The Federal Reserve has done consumer research to actually
see how consumers absorb information and what is the most
important information. That spirit is reflected in Reg Z. I
think that is a great direction.
If confirmed to the Board, I would be very eager to apply
my experience to absorbing the comments that are being received
and putting out final guidance, final rules. Also, I would note
this is just one of three parts of the Truth-in-Lending
revision. This is the revolving open-ended credit part. We
still have fixed term loans that is installment loans to see. I
believe they will also be approaching mortgage lending.
I agree that disclosure is an enormously important element.
Well disclosed practices can help lead to a free and vibrant
market, which can yield great outcomes for consumers. But it
may not be enough and certain practices in and of themselves
might be just bad and legitimately banned. That goes far beyond
disclosure, something that has to be taken with great care
because you can, to my earlier comment, potentially do more
harm than good.
But I would like to say to you and Senator Shelby and the
rest of the Committee that if confirmed to the Board I do not
walk in with some religious belief that disclosure is the end
of what needs to be done in all lending, let alone credit
cards. If certain practices should or ought to be banned, upon
reflection, receiving comments, that would yield good and
better outcomes, I would certainly, as a Board member, be open
to that Senator.
Chairman Dodd. Let me, because we have only about 10
minutes left on a vote here and I have had you sitting here for
a long time already this morning. You said something that
provokes a question that I will ask you and then have you
submit an answer to us here.
I mentioned two practices. You suggested, at least I heard
you suggest, there may be additional practices than the ones I
have mentioned, the universal default and double cycle billing,
that run that, in your mind, as ones that are offensive or
wrong and should probably be banned or treated differently than
they presently are.
I would be very interested in having you expand on that
answer, if you think there are additional areas that would
certainly warrant our attention, whether it is disclosure or
some further action necessary. I would be interested in that.
Mr. Klane. I would be delighted to.
I would like to highlight two specific practices and two more
general areas in credit card lending where I have concerns.
On the specific practices, as we discussed in the hearing, I
share the Committee's concern with ``universal default'' and
double-cycle billing. It is encouraging that a number of
issuers who engaged in these practices have recently changed
their approach, but to the extent some industry participants
continue these practices, I remain concerned.
In addition, I believe that current credit card disclosures are
not adequate. This is the first of the two more general areas I
want to address. The complexity of current disclosures, along
with the difficulty in using them to focus on the most
consumer-relevant terms and conditions, leave consumers
inadequately equipped to make informed choices among products
and issuers. Disclosures must be made clearer and more
consumer-relevant. In this regard, I am highly encouraged by
the on-going work of the Federal Reserve in its efforts to
revise Regulation Z. The use of consumer focus groups and the
explicit effort to create simpler and more comprehensible
disclosures is a strong step in the right direction. These
proposed regulations are out for public comment, and I look
forward to the Federal Reserve's finalizing them. Once they are
final, we will be able to judge, after some experience, whether
further adjustments, amendments, or expansions need to be made.
My second general area of my concern is penalty repricing of
accounts, which occurs when a customer breaks one or more of
the rules embodied in the credit card contract's terms and
conditions. While it is legitimate in general for an issuer to
be able to change the price of credit on open-ended lines to
customers who demonstrate higher levels of riskiness through
such rule breaks, I am concerned about:
insufficient disclosures and/or notices to
consumers on repricing actions (e.g., initially when receiving
the card, at the moment of rule break, and at the moment of
repricing);
the inclusion of multiple repricing rules that can
be triggered by a single infraction; and
the options available to consumers who have
experienced repricing (e.g., the ability to return to the prior
rate based on good performance over time or the ability to pay
off the existing balance at the prior rate over some time
frame).
The Federal Reserve's proposed revisions to Regulation Z,
including the 45-day notice provision, address some aspects of
the concerns I have outlined. However, the general area of
repricing deserves continued attention to ensure that consumers
are adequately protected and able to make good decisions on
their use of credit cards.
The weight of what is on my mind is the disclosures that--
--
Chairman Dodd. One of the things that concerns me here is
the amount of consumer debt in the country. We are talking
about, I think if my members are right here, someone mentioned
the other day, I think I saw this, something $9,300 is the
average revolving debt of a household in the United States. And
that is mostly credit card debt, I presume here.
And of course, a savings rate that is negative in the
country, at a time when we ought to be incentivizing savings,
it seems to me, and trying to do what we can to reduce the
level of consumer debt.
Much of it is, of course--and today, with the bankruptcy
laws having been changed, the ability for people to find some
relief and move on here is obviously making life much more
difficult for people.
Quickly, Dr. Kroszner, do you have any--I want to know what
your reaction to this is?
Mr. Kroszner. I think very much along the lines of what my
colleague, Mr. Klane, has said--one of the things that we have
really tried to do is make disclosure effective. This is a
basic principle I have been teaching in business school for 16
years to do some basic consumer testing.
We have a great responsibility that you have given us to
regulate disclosure. I do not think we had used that as
effectively as we could have in the past because we had not
asked consumers what is useful to them, what do they need to
know, what is helpful to them.
So we have really tried to get at that. And I think the new
proposal that we have out there which much more clearly
explains penalty rates, much more clearly explains what
potential things could happen as they have different credit
events.
And in addition and importantly, give them 45 days to be
able to search for an alternative credit card or alternative
source of credit, if they are going to be facing some sort of
penalty rate, is something that will be very helpful in making
it much less likely for some of these practices to come back.
Chairman Dodd. Very good. Any further questions?
Senator Shelby. No.
Chairman Dodd. I have kept you a long time here. Again, I
appreciate your willingness to serve. Let me say I think that
is very, very important and I congratulate you on being
nominated. It is a high honor, obviously.
As I pointed out earlier, these are terms of office that
are only exceeded by Federal judges and the Comptroller
General--not that the both of you are necessarily having the
length of term that Dr. Kroszner is being offered here with a
14-year term. But obviously, tremendously important.
The Federal Reserve Board's influence on the ability of our
economy to grow and to expand and to create opportunity for
people is just so very important. Obviously these issues we
have talked about here, there are many other issues to talk
about when discussing the role of the Fed. But the ones that
are so important to many Americans today, the issue of subprime
lending and what happens with credit cards and the like has
obviously provoked a lot of questions here today because of the
importance of those issues.
And so I thank you for your willingness to serve. I commend
you for that. That is admirable in my view and we do not
celebrate public service enough, in my view, in this country.
And so I thank you for doing that.
Senator Shelby. Senator Dodd, since they are all here, we
know that tomorrow we will be getting out of here and we will
be back the day after Labor Day, I guess. But do you have any
idea when you might hold a markup on these nominations?
Chairman Dodd. No, not yet.
Committee adjourned. Thank you.
[Whereupon, at 12:02 p.m., the hearing was adjourned.]
[Prepared statements, biographical sketches of the
nominees, and responses to written questions supplied for the
record follows:]
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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM RANDALL S.
KROSZNER
Q.1. Dr. Kroszner, at your confirmation hearing on August 2nd I
asked you about the possibility of a spillover from the
problems in the subprime market into the market in general and
the broader economy. You responded: ``I think that at this
stage the economic fundamentals are really unchanged from where
Chairman Bernanke talked about them here in this Committee
about 2 weeks ago, and so we have not seen an effect on the
broader real economy.'' Five days later you voted at the FOMC
meeting to keep interest rates constant and voted for a
statement that did not directly mention the house market and
reiterated that the Fed's primary concern was inflation, not
slow economic growth.
Two days later the market began a serious decline which
caused the Fed's Federal Open Market Committee, on which you
serve, to issue the following statement: ``Financial market
conditions have deteriorated, and tighter credit conditions and
increased uncertainty have the potential to restrain economic
growth going forward. . . . To promote the restoration of
orderly conditions in financial markets, the Federal Reserve
Board approved temporary changes to its primary credit discount
window facility.'' The FOMC also acted to reduce interest rates
at the discount window by 50 basis points. You voted in favor
of the action and statements. Dr. Kroszner can you explain your
testimony on August 2nd with your votes on August 17th? What
changed between your testimony and the Federal Reserve's
statements?
A.1. Financial market conditions have been volatile since early
summer and at times markets have been under significant strain.
Those strains eventually became sufficiently intense that the
Federal Reserve concluded that they posed a significant risk to
economic growth.
Let me provide additional background. The statement
released after the August 7, 2007, FOMC meeting noted that
``Financial markets have been volatile in recent weeks, credit
conditions have become tighter for some households and
businesses, and the housing correction is ongoing.'' The
statement went on to note that, partly as a result of these
developments, ``. . . the downside risks to growth have
increased somewhat.'' However, the minutes of that meeting
indicated that, while the downside risks to growth had
increased, ``. . . Committee members again agreed that
maintaining the existing stance of policy at this meeting was
likely to be consistent with the overall economy expanding at a
moderate pace over coming quarters and inflation pressures
moderating over time.'' In the days following the August 7
meeting, conditions in financial markets deteriorated swiftly
and sharply. Conditions in various money markets both in the
United States and abroad became impaired, with overnight and
term interest rates moving up sharply. Conditions in secondary
mortgage markets also worsened, with adverse implications for
mortgage credit availability, and various other financial
markets also deteriorated. In light of these developments, the
FOMC issued the statement referenced in the question. In
addition, the Federal Reserve took a number of additional
actions in mid-August to increase the availability of
liquidity. More recently, the Federal Reserve reduced the
target federal funds rate and the primary credit discount rate
by \1/2\ percentage point each on September 18, 2007. As noted
in the associated statement, those actions were ``intended to
help forestall some of the adverse effects on the broader
economy that might otherwise arise from the disruptions in
financial markets and to promote moderate growth over time.''
Most recently, the FOMC reduced both the funds rate and the
primary credit rate a further \1/4\ percentage point to ``help
forestall some of the adverse effects on the broader economy
that might otherwise arise from the disruptions in financial
markets. . . .''
Q.2. Do you still believe that we have not seen an effect on
the broader economy from the problems in subprime mortgages? If
so, how do you explain the market problems that led to the
Fed's action? If not, how could your statement before this
Committee at your nomination hearing be proven incorrect so
quickly?
A.2. Since the time of my appearance before the Committee in
early August, we have received a great deal of additional
economic data about macroeconomic activity, and the impact of
the problems in subprime mortgages is still uncertain; for
example, real economic growth in the third quarter was
estimated to be 3.9 percent and the economy added 166,000 jobs
in October. Stresses continue in parts of the mortgage and
financial markets, however, and we will continue to assess the
potential effects on broader economic prospects.
Still, around the second week in August--about a week
following my testimony before your Committee--conditions in
financial markets deteriorated sharply further. That
deterioration caused the Federal Reserve to reappraise the
macroeconomic situation and led the Federal Open Market
Committee to issue a statement on August 17 with the assessment
that the downside risks to growth had increased appreciably. At
its meeting on September 18, the Committee judged that
macroeconomic developments warranted a half-percentage-point
reduction in the federal funds rate, consistent with the
pursuit of the price stability and maximum sustainable
employment. In his remarks at the Federal Reserve Bank of
Kansas City's Economic Symposium on August 31, Chairman
Bernanke described the developments that had taken place in
financial markets in the immediately preceding weeks. A notable
aspect of those developments has been the speed with which they
have occurred. In response, the Federal Reserve has acted
promptly and forcefully.
Q.3. Dr. Kroszner, can you share with the Committee your views
on the separation between banking and commerce? Specifically,
what are your views on Industrial Loan Companies?
A.3. Congress has, for a variety of reasons, sought to maintain
a separation between banking and commerce in the United States.
And there is no doubt that our financial system remains the
envy of the world--competitive, innovative, and resilient.
Nevertheless, the question of whether continuing the nation's
policy on the mixing of banking and commerce might help or
hinder the U.S. financial system and economy as we move further
into the 21st century seems worthy of consideration.
A large body of economic research discusses and attempts to
quantify the costs and benefits associated with mixing banking
and commerce. Most of this research deals with bank ownership
of commercial firms rather than commercial ownership of banks.
In addition, much of the existing empirical research is based
upon the experiences of other countries, whose financial
markets, legal institutions and corporate cultures, which have
developed over the course of centuries, are often quite
different from those in the United States. As a result, this
research has limited value in terms of predicting the likely
effects of permitting greater mixing of banking and commerce in
the United States. Furthermore, the existing literature does
not provide a clear consensus as to whether the overall
benefits associated with greater mixing of banking and commerce
outweigh the costs.
While the literature on this issue is mixed, it is clear
that permitting broad mixing of banking and commerce would be a
significant shift in policy and one that could have significant
structural implications for the financial markets and the
economy. That is why I believe it is important for Congress to
fully consider both the benefits and costs of mixing of banking
and commerce before making any major changes in this area. It
is also one of the reasons why I and my fellow Board members
have urged Congress to review the exemption in current law that
permits any type of firm, including a commercial firm, to
acquire an FDIC-insured industrial loan company (ILC). The
continued growth in both the number and size of ILCs controlled
by commercial firms under this special exception threatens to
remove from Congress the important decision on whether broad
mixing of banking and commerce should, or should not, be
permitted. The special exception for ILCs in current law also
has the potential to undermine other important policy
objectives established by Congress, such as the proper
supervisory and regulatory framework for organizations that
control an insured bank in the United States and for foreign
banks that seek to enter the banking business in the United
States.
Q.4. Dr. Kroszner, in response to a question at your
confirmation hearing on your conduct at FOMC meetings you said:
``I think if you were to poll the other members of the FOMC, I
think they would certainly say that I have not been a shrinking
violet either at the formal meetings or in informal
discussions.'' However, you have never cast a vote in dissent
of an FOMC action during your time on as a Fed Governor. Can
you give the Committee several examples of times that you were
not a `shrinking violet'? Specifically, on what occasions do
you think your opinion moved the consensus of the Board to a
different outcome?
A.4. At the University of Chicago, where I have been a
professor for many years, it becomes second-nature to state
one's views clearly, forcefully, and to the extent possible
supported with empirical evidence. I have fully brought this
approach to my activity at the Board and the FOMC. I am active
in the discussions with the Chairman and with other members of
the Board and FOMC both prior to the meetings and during the
FOMC meetings themselves. Although it would not be appropriate
to describe the specifics from such discussions, since they are
intended to be confidential, I believe that such interactions
have helped to shape policy decisions and the manner in which
those decisions have been communicated. In particular, given my
role as chair of the oversight committee on banking supervision
and regulation, I provide assessments of the banking and
financial services industries that I believe other members of
the FOMC find valuable in reaching their decisions. While it's
not possible to know whether any member's comments have changed
a consensus opinion, I have no doubt that my comments have been
helpful to my fellow committee members and helped inform the
consensus eventually reached.
Q.5. Dr. Kroszner, in response to a question at your
confirmation hearing on tax policy you stated, ``I do think it
is important to think about the incentives in the tax system,
because many analyses that have been done comparing the U.S.
tax system with other countries suggests that there is more of
a bias against savings with respect to the tax system in the
U.S. than there is elsewhere. So I think looking at that and
looking at if there are lessons from other countries that can
be learned for tax reform here could potentially be valuable.''
Can you please elaborate on this point and inform the Committee
which tax policies you think the U.S. should consider adopting
from other nations? In your analysis can you please include a
rough estimate of the net fiscal impact of these tax changes on
gross federal revenue?
A.5. Recent reports by the Department of the Treasury (Business
Taxation and Global Competitiveness, 2007) and by the
Congressional Budget Office (Corporate Income Tax Rates:
International Comparisons, 2005) have shown that the United
States has the second highest statutory corporate tax rate
among both the G7 and the OECD countries. If the international
comparison is performed using ``effective'' corporate tax rates
(for equity-financed investment) the United States ranks as the
fourth highest among both the G7 and the OECD countries.
(``Effective'' corporate tax rates take account of additional
features of corporate tax structures--particularly depreciation
allowances--along with statutory corporate tax rates.) Even
though the ranking of the United States is less unfavorable on
an ``effective'' tax basis, many economists have suggested that
the U.S. corporate tax structure be improved to encourage
investment and raise the after-tax return to saving.
Overall (that is, taking account of both corporate and
individual taxes), the United States relies more heavily on
income taxes and less on consumption-based taxes than do most
OECD countries (OECD, Fundamental Tax Reform: An International
Perspective, 2005). Some studies suggest that shifting the mix
of taxes toward consumption-based taxes could increase national
saving (see, for example, JCT, Tax Modeling Project and 1997
Tax Symposium Papers). Other studies point to ways in which
even an income-based (as opposed to a consumption-based) system
could be made to be more encouraging of saving (see, for
example, Treasury, A Summary of the Dynamic Analysis of the Tax
Reform Options Prepared for the President's Advisory Panel on
Federal Tax Reform, 2006).
Ultimately, the effect of changes in the structure of the
tax system on revenue collections would depend on the details
of the policy change. Generally speaking, any framework could
be designed to raise revenues relative to the status quo, to be
revenue-neutral, or to reduce revenues, depending on the
setting of key parameters such as tax rates and what is
included in the tax base.
Q.6. Dr. Kroszner you served on the President's Council of
Economic Advisors from 2001 through 2003. During your service
you were involved in advising the President on many economic
policies, including those that lead to the basis for many of
the Bush tax cuts. Do you favor making the Bush tax cuts
permanent? Do you believe that the estate tax should be
permanently repealed? Do you think that the Bush tax cuts of
2003 increased or decreased total federal revenue?
A.6. As a member of the Federal Reserve Board, I have avoided
taking a position on specific questions of fiscal policy and
have instead attempted to articulate the principles that I
think most economists would agree are important for the long-
term health of the economy and for helping fiscal policy to
contribute as much as possible to that health. With regard to
taxes, I subscribe entirely to the following principles laid
out by Chairman Bernanke earlier this year in testimony before
the House Budget Committee (February 28, 2007):
In the end, the fundamental decision that the Congress, the
Administration, and the American people must confront is how
large a share of the nation's economic resources to devote to
federal government programs, including transfer programs such
as Social Security, Medicare, and Medicaid. Crucially, whatever
size of government is chosen, tax rates must ultimately be set
at a level sufficient to achieve an appropriate balance of
spending and revenues in the long run. Thus, members of the
Congress who put special emphasis on keeping tax rates low must
accept that low tax rates can be sustained only if outlays,
including those on entitlements, are kept low as well.
Likewise, members who favor a more expansive role of the
government, including relatively more-generous benefits
payments, must recognize the burden imposed by the additional
taxes needed to pay for the higher spending, a burden that
includes not only the resources transferred from the private
sector but also any adverse economic incentives associated with
higher tax rates.
The consensus view among economists is that tax cuts reduce
revenue, on net. These effects are smaller than simple,
``static'' calculations would indicate because tax reductions
stimulate additional economic activity. However, even though
some of the revenue that would be shown as lost under a static
calculation is recouped, not all of it is.
Q.7. Dr. Kroszner, in your appearance before the Committee, you
stated that you are a strong believer in the Fed's dual mandate
for maximum employment and price stability. Are there
approximate figures for the nation's unemployment rate and
inflation rate that match what you believe to be maximum
employment and price stability? If so, can you share what those
are?
A.7. I have avoided giving an estimate of the sustainable level
of the unemployment rate. There are two main reasons for my
reluctance to take that step. First, economic theory strongly
suggests--and empirical evidence corroborates--that the
sustainable level of the unemployment rate is not constant over
time, but is influenced by a variety of forces at work in the
economy. For example, during the late 1990s, when the
underlying or structural rate of productivity growth was
picking up, the evidence suggests that a lower level of
unemployment could be sustained, for a time, consistent with
stable inflation. Because the sustainable unemployment rate is
influenced by other factors, the Federal Reserve must always be
alert to changes in such factors and must communicate to the
public that it does not regard the sustainable rate of
unemployment as a constant but as something that must be
inferred, that likely changes over time, and that can be
estimated at any given moment only with considerable
imprecision. Articulating a specific estimate would risk
suggesting that the sustainable rate of unemployment is a
constant and is precisely knowable, neither of which is true.
The second reason not to give an estimate of this variable is
that such an estimate might be misconstrued as a commitment to
achieving that specific rate of unemployment. In fact, one of
the most important lessons of the past thirty years or so is
that while central banks can and should work hard to smooth the
fluctuations in real activity and to achieve high levels of
employment, they should not pre-commit to delivering on
specified levels of the unemployment rate. Central banks must
accept whatever sustainable unemployment rate the economy
generates, and must optimize the conduct of their policy given
that circumstance; no matter how much they might like to do so,
they cannot deliver a lower unemployment rate over the
intermediate-to-long run without causing the economy to
overheat and, thus, inflation pressures to build. An inflation
objective is, in principle, quite different, because it can be
chosen and deliberately pursued, and the central bank can be
held accountable for failure to achieve it on average, over
time. There are serious arguments on both sides of whether the
Federal Reserve should articulate a specific numerical
inflation objective. Because, as you know, those arguments are
currently under discussion by the Federal Open Market
Committee, I think it best for me not to express a view on the
issue.
Q.8. Dr. Kroszner can you inform the Committee of any periods
in American history where you believe that maximum employment
was not being reached or that price stability was not achieved?
During those periods, what actions do you believe the Fed
should have undertaken to achieve its mandate?
A.8. For a long period of time beginning around the mid-1960s
and ending earlier this decade, price stability was not
achieved. The consensus view of macroeconomists is that prior
to 1979, the Federal Reserve ran a monetary policy that was too
expansionary and that allowed the inflation rate to rise to
very damaging levels. Beginning under Chairman Volcker, the Fed
then had to engage in a long-term effort to bring inflation
down to levels consistent with a functional definition of price
stability. Similarly, during periods of recession and the
immediate aftermath thereof, maximum employment has not been
achieved. At all times, under the dual mandate given to the
Federal Reserve by the Congress, the Fed must strike a balance
between the two legs of its dual mandate. Empirical evidence
consistently shows that since the early-to-mid-1980s, the Fed
has systematically reacted to economic weakness by running a
more expansionary policy than would otherwise be appropriate,
and has reacted to high inflation by running a more restrictive
policy than would otherwise be appropriate. This systematic
behavior has been an important underlying component of the much
more successful conduct of policy since 1979 than during the
period before then.
Q.9. Dr. Kroszner at your confirmation hearing, you discussed
the State's role in consumer protection, stating: ``I would
very much agree that it is extremely valuable to use the States
as a laboratory to see what can be effective and what is not
effective, because we want to protect consumers, but we also
want to make sure that responsible borrowers can still get
credit to people who can use it responsibly.'' Given this
position, do you agree or disagree with the policy of
preemption that the OCC has undertaken?
A.9. The principle of preemption is a judicial doctrine that is
grounded in the Supremacy Clause of the U.S. Constitution.
Ultimately, whether a state law is preempted by a federal law
turns on whether Congress, in enacting the federal law,
intended the federal law to supersede and preempt the state
law. The Supreme Court has developed several standards for
assisting the courts in determining whether Congress expressly
or implicitly intended a federal law to preempt a state law.
Recently, the Supreme Court reviewed certain aspects of the
preemption rules issued by the Office of the Comptroller of the
Currency and found that these rules were consistent with
Congress' intent in enacting the National Bank Act. Because
preemption ultimately involves questions of Congressional
intent and application of the legal principles established by
the Supreme Court under the Supremacy Clause, I believe the
issue of whether a federal law or a federal agency's rules
preempt state law is one that is best addressed by the Congress
and the courts.
Q.10. Dr. Kroszner, when asked about the low number of referral
of cases by the Fed to the Department of Justice under the
Equal Credit Opportunity Act Amendments of 1976, during the
height of the subprime mortgage market problems over the past
few years, you stated: ``Just in 2007, just in the first 6
months, we have already had five referrals. So we are active in
this area.'' Do you believe that in the first half of 2007
there were only 5 cases in America that merited referral to the
Justice Department? Do you believe the same to be true in 2006
when the Fed only referred five cases for the entire year? If
not, can you please explain to the Committee why the Fed has
referred such few cases?
During your time as Governor, you have taken a lead role in
the areas of consumer protection and the mortgage market. What
has been the resource allocation within the Fed to consumer
protection and specifically to referring cases under the Equal
Credit Opportunity Act Amendments of 1976? What has been the
change in the resources allocated to this issue over the last
five years (please provide this information on an annual
basis).
A.10. The Federal Reserve has a long-standing commitment to
ensuring that every bank it supervises complies fully with the
federal fair lending laws, namely the Equal Credit Opportunity
Act (ECOA) and the Fair Housing Act. Fair lending is an
integral part of every consumer compliance examination we
conduct. When conducting fair lending examinations, our
consumer compliance examiners perform two distinct functions.
First, examiners evaluate the bank's overall fair lending
compliance program. In essence, examiners make sure that
management is committed to fair lending and has put in place
the appropriate systems, policies, and staff to prevent
violations. If an institution's staff or systems fall short,
examiners direct the institution to take corrective action.
Second, examiners determine if the bank has violated the fair
lending laws. To that end, they review lending policies and
practices to make sure they are not discriminatory. Examiners
also test the institution's actual lending record for specific
types of discrimination, such as underwriting discrimination in
consumer loans, or pricing discrimination in mortgage or
automobile lending.
Because the Federal Reserve requires the state-member banks
it supervises to devote significant resources to fair lending
and because we examine them routinely for fair lending
compliance, we expect fair lending violations--especially those
involving a pattern or practice of discrimination--to be rare
among the banks we supervise. Our experience has been that such
violations are indeed rare, but when they occur, we do not
hesitate to take strong action. If we have reason to believe
that there is a pattern or practice of discrimination under
ECOA, the Board has a statutory responsibility under that Act
to refer the matter to Department of Justice (DOJ), which
reviews the referral and decides if further investigation is
warranted. A DOJ investigation may result in a public civil
enforcement action or settlement. As I mentioned in my
testimony, in the first six months of this year alone, we
referred five institutions after concluding that we had reason
to believe that they had engaged in a pattern or practice of
discrimination. Last year, we referred four institutions. If a
fair lending violation does not constitute a pattern or
practice, the Federal Reserve makes sure that the bank remedies
it. From 2004 through 2006, we cited approximately sixty banks
for such violations involving discrimination on a prohibited
basis under ECOA. Our fair lending findings and referrals only
pertain to the banks that we supervise, which are a subset of
the overall market. Thus, our findings of fair lending
violations are not a measure of the number of fair lending
violations in the entire market.
You also ask about the resources dedicated to consumer
protection over the past five years. As of June 30, 2007, the
Federal Reserve Banks employed 287 professional personnel
dedicated to consumer compliance supervision. The number of
staff dedicated to consumer compliance supervision varies over
time in response to changes in the number and complexity of
state member banks that we supervise. Note that since 2002, the
number of state member banks, including large complex banks,
has generally declined. In 2002, there were 950 state member
banks and of those 18 had over $1 billion in assets. In June
2006, there were 888 state member banks and of those 8 had over
$1 billion in assets.
The following is a table showing the number of professional
personnel, including examiners, dedicated to consumer
compliance supervision at the Reserve Banks since 2002.
Consumer compliance examiners assess compliance with fair
lending, as well as other consumer protection statutes. Thus,
it is not possible to separately measure staffing dedicated to
the referral of matters under the Equal Credit Opportunity Act.
RESERVE BANK STAFFING DEDICATED TO CONSUMER COMPLIANCE
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December 2002 December 2003 December 2004 December 2005 December 2006 June 2007
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Staff............................................. 300 292 279 269 274 287
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In addition to Reserve Bank staffing, the Board has a Fair
Lending Enforcement Section, which brings additional expertise
to the examination process and ensures that fair lending laws
are enforced consistently and rigorously throughout the Federal
Reserve System. Many other Board staff members, such as
oversight analysts and attorneys, also regularly work on fair
lending matters.
Q.11. Dr. Kroszner, at your confirmation hearing you stated:
``I think the best way to achieve maximum employment growth is
through low and stable inflation.'' Do you believe that the Fed
should implement an explicit target (or target range) for
inflation to best achieve this goal?
A.11. As I noted earlier, there are serious arguments on both
sides of this question. Because, as you know, those arguments
are currently under discussion by the Federal Open Market
Committee, I think it best for me not to express a view on the
issue.
Q.12. Dr. Kroszner, at your confirmation hearing you discussed
the value of low inflation, concluding: ``we know from research
and data from around the world that a low and stable
environment is the best way to maximize prosperity.'' Over the
last five years the American economy has enjoyed a period or
remarkably low and stable inflation. Do you believe that the
economy has maximized prosperity over the last five years?
A.12. I believe that, by pursuing the dual mandate of price
stability and maximum sustainable employment, the Federal
Reserve did indeed maximize its contribution to general
prosperity during the past five years. Indeed, over the last
five years, the growth of real GDP in the United States
averaged 2.9 percent at an annual rate. More generally, the
U.S. economy demonstrated remarkable resilience in the past
several years in the face of very substantial shocks including
the tragic attacks on 9/11, corporate governance scandals,
financial crises in Latin America, and huge swings in the price
of imported crude oil. I have no doubt that the Fed's policy of
maintaining low and stable inflation helped support this
resilience.
Q.13. Dr. Kroszner, at your confirmation hearing I was very
pleased that you agreed with me in a question about practices
in the subprime mortgage market when you stated: ``it is
extremely important to protect people in these markets, and we
have to protect them against abusive practices.'' What specific
abusive practices do you think the Fed has failed to protect
individuals against?
A.13. When the Board saw problems in the parts of the market we
supervise and examine, we took strong action by issuing
guidance with other regulators. We first issued guidance on
subprime lending in 1999 and again in 2001. When problems
surfaced concerning nontraditional mortgages, we issued
guidance on those. The guidance addressed both underwriting and
consumer protection principles, including marketing practices.
Then we immediately turned our attention to the subprime
markets, especially the hybrid arms, developing substantially
similar guidance for those markets. The guidance addressed
several issues, including underwriting standards used to
qualify borrowers for subprime hybrid ARMs.
We share the concerns of Congress that certain lending
practices may have led to the problems we are seeing in the
subprime market today. We plan to propose rules under our HOEPA
authority by the end of this year that would apply to subprime
loans offered by all mortgage lenders. We are looking closely
at practices such as prepayment penalties, failure to offer
escrow accounts for taxes and insurance, stated-income and low-
documentation lending, and the failure to give adequate
consideration to a borrower's ability to repay. I chaired a
full day hearing in June on these practices that yielded
valuable insight from both industry and consumer groups. The
Board also solicited written comments from the public on the
practices discussed at the hearing. The Board received nearly
100 comment letters, and staff is closely examining the issues
raised and discussing possible remedies.
Q.14. Dr. Kroszner, at your confirmation hearing, we discussed
the question of why there are pre-payment penalties for
subprime residential mortgages but not for prime residential
mortgages. At the hearing, you stated: ``What some people have
argued--and, again, I have not evaluates this--is that there
may be more frequency of prepayments, more frequency of moving
from one home to another, and so this provides some form of
protection for the people who are buying the securitized
mortgages, and so that allows a lower initial interest rate to
be provided. I have not evaluated that argument, so I do not
know how important or extensive that is.'' Why have you not
evaluated the prepayment issue given your service as the HOEPA
point person for the Fed over the past 18 months?
Can you please provide the Committee with your evaluation
of this argument? Do you believe that pre-payment penalties are
appropriate for subprime mortgages and not for prime mortgages?
Do they constitute one of the abusive practices that you
mentioned at the hearing or do they not?
A.14. We are still evaluating the hearing testimony and comment
letters on prepayment penalties in order to determine the
appropriate regulatory response. In addition, we have had
meetings with a number of participants involved in mortgage
lending to assess the potential utility of prepayment penalties
and the costs they impose on consumers. These are very
difficult issues to resolve; however, I anticipate that we will
propose rules to address abuses in the subprime market by the
end of this year.
Q.15. Dr. Kroszner, how do you explain the Federal Reserve's
findings from the HMDA data that in 2005, 54.7% of African-
American borrowers and 46.1% of Hispanic borrowers got high-
priced loans when buying a home compared to 17.2% of non-
Hispanic whites?
A.15. The 2005 HMDA data show substantial differences across
racial and ethnic groups in the incidence of higher-priced
lending. Accounting for a variety of individual
characteristics, however, can substantially reduce the
differences. Nonetheless, these disparities raise important
questions, and I share the concern they may result in part from
illegal discrimination. It is not possible to determine whether
a lender has violated fair lending laws from HMDA data alone,
however, because the data do not include many factors that
lenders routinely use to set loan prices, such as credit scores
and loan-to-value ratios. Thus, when the Federal Reserve
conducts an examination of a lender's pricing, examiners obtain
additional information to determine whether any pricing
disparity by race or ethnicity is fully attributable to
legitimate factors, or whether any portion of the pricing
disparity may be the result of illegal discrimination.
Q.16. In the Fed's analysis of the data, significant racial and
ethnic differences remained unexplained even after accounting
for other information reported in the HMDA data. The Fed found
that borrower-related factors accounted for only about one-
fifth of the disparity. Do you believe that there is racial
discrimination in the mortgage market? If so, how do we root it
out of the system? What specific additional steps should the
Fed undertake to do so? If you do not believe that there is
racial discrimination, how do you explain these racial
disparities?
A.16. I believe aggressive enforcement of fair lending laws can
help root out illegal discrimination. To that end, the Federal
Reserve is committed to rigorously enforcing the fair lending
laws, and we recently referred two nationwide mortgage lenders
to the DOJ because we found evidence that Hispanic and African-
American borrowers paid more for their loans than did
comparable white borrowers.
These referrals resulted from a process of targeted reviews
of institutions for pricing discrimination that the Federal
Reserve initiated when the HMDA pricing data first became
available in 2005. We developed, and continue to refine, a HMDA
data analysis program that identifies institutions with
statistically significant pricing disparities by race or
ethnicity. Because HMDA data lack many factors that lenders
routinely use to make credit decisions and set loan prices,
such as information about the borrower's creditworthiness and
loan-to-value ratios, HMDA disparities alone cannot be used to
determine whether a lender discriminates. Thus, we analyze HMDA
data in conjunction with other supervisory information to
evaluate a lender's risk for discrimination.
For the 2005 HMDA pricing data, Federal Reserve examiners
performed a pricing discrimination risk assessment for each
institution that we identified through our HMDA data analysis.
These risk assessments incorporated not just the institution's
HMDA data, but also the strength of the institution's fair
lending compliance program, our past supervisory experience
with the institution, consumer complaints against the
institution, and the presence of fair lending risk factors such
as discretionary pricing. Based on these comprehensive
assessments, we determined which institutions would receive a
targeted pricing review. Depending on the examination schedule,
the targeted pricing review could occur as part of the
institution's next examination, or outside the usual
supervisory cycle. We have already initiated this same review
process based on our analysis for the 2006 HMDA data.
Q.17. Dr. Kroszner, we discussed the role that the GSE's play
in the housing market at your confirmation hearing. I
specifically asked about the role that Freddie and Fannie ``can
play here about having them have extend some additional credit
here to lighten up or to at least release some of the
seizure.'' You responded that: ``I think it could be helpful to
have them focus on affordable housing more than they have
been.'' Does that response mean that you believe that OFHEO
should allow the GSEs to, consistent with safety and soundness
and proper consumer protection practices expand their portfolio
holdings in subprime mortgages during this period of market
turmoil?
A.17. We encourage the GSEs (Fannie Mae and Freddie Mac) to
help refinance subprime mortgages and securitize these
mortgages to the fullest extent allowed by their charters.
However, the GSEs do not need to expand their portfolios to do
so. Fannie Mae and Freddie Mac currently hold hundreds of
billions of dollars of their own mortgage securities in their
portfolios; these could be readily sold to provide the
financial wherewithal to fund new mortgages directly if they
wish to do so. Moreover, the substantial repayment of mortgages
currently held in their portfolios also gives them considerable
room for holding additional subprime mortgage assets without
expanding the size of their portfolios. Finally, the GSEs'
ability to securitize mortgages is not constrained by the size
of their portfolios, and they should be encouraged to actively
securitize subprime mortgages to the extent allowed by their
charters. In the longer run, I believe that we should focus the
GSEs' portfolios on affordable housing in the manner suggested
by Chairman Bernanke in his speech in March 2007. In this way,
the GSEs' portfolios would have a clear and focused public
purpose, and the systemic risks associated with these
portfolios would be more limited.
Q.18. Dr. Kroszner, during your time as a member of the Board
of Governors you have dealt extensively with the negotiations
regarding the updating of the BASEL bank capital standards. It
was my understanding that the agencies had a commitment to act
on the Basel II and Basel IA approaches in tandem. Now that the
standardized option will take the place of Basel IA, can you
assure us that that the proposed rule for the standardized
approach will be issued at the same time that the final rule on
the advanced approach is issued to preserve the commitment to
keep the new capital rules for large banks and all the other
banks moving forward in tandem?
A.18. As indicated in the interagency press release on July 20,
2007, the agencies have agreed to proceed promptly to issue a
proposed rule that would provide all non-core banks with the
option to adopt a standardized approach. As you noted, this new
proposal will replace the earlier issued Basel IA proposal. The
press release stated the agencies' intention that the proposed
standardized option would be finalized before core banks begin
the first transition period year--the first opportunity for
which is early 2009. It is important that banks intending to
adopt the Basel II advanced approaches at the first opportunity
have sufficient lead time to develop appropriate internal
systems and carry out an effective parallel run. It also is
important for agency examination staffs to have time to assess
bank systems before early 2009. The agencies have just issued
the final rule related to the advanced approach and substantial
progress has been made on drafting the standardized proposal.
The agencies have a firm commitment to move expeditiously to
issue the standardized proposal, and I very much support that
commitment. Thus, I anticipate that the two rules--Basel II
advanced and standardized--would go into effect at the same
time in early 2009.
Q.19. During the current credit crunch in the mortgage markets,
there have been a number of reports of problems in the market
for MBS issued by Freddie Mac and Fannie Mae, in addition to
the subprime and jumbo markets. For example, Dow Jones
Newswires reported on August 16, 2007, that prices on ``some of
the highest-quality mortgage bonds are plummeting . . . largely
because they're available to trade.'' It appears that investors
may be selling these GSE MBS in large numbers in order to raise
funds to cover collateral calls for subprime securities.
Ironically, it is the fact that the GSE MBS have retained their
credit quality that makes it possible to sell them in these
difficult times when liquidity for other mortgage assets has
largely evaporated. Nonetheless, the fact that so much of this
paper is reportedly being sold may be resulting in some
problems in this market, including increased spreads that may
result in higher costs for homeowners. Are these reports
accurate? Has the Federal Reserve seen increased selling of
GSE-issued MBS? If so, what has been the impact in the
marketplace?
A.19. Relative to other forms of mortgage securities, the
market for GSE-issued MBS has generally remained stable
throughout the recent mortgage market difficulties. While
spreads have widened somewhat, they have remained well below
their recent historical highs. Moreover, this market has
generally functioned smoothly. Mortgages that have been
securitized by GSEs are well-accepted in the secondary market
because they come with GSE-provided guarantees of financial
performance, which in turn are unquestioned largely because
market participants appear convinced that GSE commitments are
backed by the full faith and credit of the U.S. government--the
letter of the law and the protestations of government officials
notwithstanding. Presumably, market participants believe that,
in the event of a GSE failure, the government would have no
practical alternative but to come to the rescue.
Q.20. If Fannie Mae and Freddie Mac were allowed to purchase
their MBS, would that help maintain prices for those
securities? if so, would that, in turn, make it easier for
other entities to raise money by selling their GSE MBS?
A.20. Generally, Fannie Mae and Freddie Mac's securities trade
in a world-wide market of highly rated securities, and the
prices of these securities are unaffected by the GSEs'
portfolio actions. Moreover, entities holding GSE MBS have had
little problem selling their holdings if they wish. During the
recent mortgage market difficulties, the prices of the GSE
securities have been largely unaffected when compared to the
price movements of other securities, even though the GSEs were
constrained in their purchases of their own MBS by the
portfolio caps. Thus, allowing Fannie Mae and Freddie Mac to
purchase their own MBS has the effect of enhancing their
profitability, but does not seem to have substantial effect on
the market prices for MBS issued by the GSEs. GSE
securitization efforts provide ample liquidity for the GSE-
guaranteed MBS market and there is little need to expand the
GSEs' portfolio purchases of their own MBS.
Q.21. The Federal Reserve has never exercised its authority
under the FTC Act to promulgate a regulation on unfair or
deceptive acts and practices. You have said that you think it
is more appropriate to address these problems on a case-by-case
basis. Please explain your views in this area?
A.21. Because the Board and the other banking agencies can
enforce the FTC Act in particular cases and issue supervisory
guidance, the need for rules was not clear. A determination of
unfairness or deception depends heavily on the facts of an
individual case. Therefore, we believe that using our
enforcement authority and issuing guidance are effective tools
in dealing with unfair or deceptive practices. The Federal
Reserve and the other banking agencies have used their broad
authority to enforce the FTC Act against the institutions they
supervise to prevent unfair or deceptive acts or practices.
Also, the Board and the FDIC have jointly issued guidance and
``best practices'' for the institutions they supervise. The OCC
has also issued guidance concerning potentially unfair or
deceptive practices. Nonetheless, the Board will continue to
assess whether there are unfair or deceptive practices that are
appropriately addressed by adopting rules of general
applicability under the FTC Act or other consumer protection
laws.
Q.22. A recent American Banker article (``The Fed's Record on
Abusive Loans,'' August, 29, 2007), points out that the ``Fed
has never taken an enforcement action related to unfair and
deceptive practices,'' whereas other banking regulators have
taken action 29 times in the past seven years. Please explain
the lack of action in this area on the part of the Federal
Reserve?
A.22. In conducting examinations and addressing consumer
complaints, the Federal Reserve considers whether the practices
of the institutions we supervise are potentially unfair or
deceptive. Examiners generally are able to address any
potential violations they find through the supervisory process,
which is not public. We have generally found this approach to
be effective in preventing unfair or deceptive practices.
Q.23. As you know, only the Federal Reserve, the Office of
Thrift Supervision, and the National Credit Union
Administration currently have the authority to promulgate a
rule dealing with unfair or deceptive acts or practices. In
your view, should the other agencies be given the same
authority? Please explain your reasoning.
A.23. As we have noted, the practical difficulty in writing
rules of broad applicability is that a practice may be unfair
in some circumstances but not in others. Finding that a
practice is unfair or deceptive is heavily dependent on the
facts and circumstances. That is why the FTC has also preferred
the same case-by-case enforcement approach that the Board, the
OTS and the NCUA have followed. If other agencies have
rulewriting authority under the FTC Act, they will face the
same challenge.
In addition, the FTC Act authorizes the Board to write
rules for all banks, which ensures consistency. If Congress
were to authorize the OCC and FDIC to write rules, we would
recommend that there be a mechanism for ensuring that all
banks, as well as thrifts and credit unions, are subject to the
same standards. We would also encourage the FTC and NCUA to
adopt similar rules for nonbank lenders and federal credit
unions, respectively.
Q.24. The Committee recently passed legislation to improve the
regulation and transparency of the private educational loan
market--the fastest growing segment in the $85 billion student
loan market. Among the growing trends in the private student
loan market is the practice of some lenders using non-
individual data--like a school's default and graduation rate--
in the underwriting used to establish the rate a student
borrower is offered. It's a practice that is eerily reminiscent
of mortgage ``redlining'', when mortgage rates and products
were denied to people based on where they lived rather than
their individual credit-worthiness. One of the ways Congress
addressed mortgage redlining was through enactment of tough
anti-discrimination laws and improving transparency of market
practices in the form of HMDA (the Home Mortgage Disclosure
Act), which the Federal Reserve oversees.
Do you think HMDA has been an important tool to promote
transparency? Do you think a disclosure, transparency regime
for private student loans similar to HMDA is a more useful
approach to addressing concerns about potential ``redlining''
in the private student loan market or do you believe we should
prohibit the practice of underwriting based on factors such as
the school one chooses to attend?
A.24. I believe that HMDA data have been an effective tool to
increase transparency in the mortgage market. Determining
whether a similar approach--or other legislation that would
prohibit certain underwriting factors--would be appropriate in
the student loan market would require a careful analysis of
that market and a balancing of the potential benefits, risks,
and costs of each approach.
Q.25. Dr. Kroszner in one of your academic articles you discuss
in great details the pros and cons of the Investment Company
Act of 1940. Barbara Roper of Consumer Federation of America
has said ``The 1940 Act may be the most pro-investment piece of
legislation ever enacted. It has made it possible for average
Americans to participate in and profit from our markets. And
that has supplied our equity markets with tremendous amounts of
capital.'' I observe that investors hold more than $11 trillion
of assets in the nation's mutual funds, indicating broad
support.
In your article, you conclude, and I quote--``the Act thus
imposes costs on investors--and on modern corporate
governance--without countervailing benefits to investors or to
the functioning of the market generally'' Can you share with
the Committee your thoughts on why the Investment Company Act
of 1940 is bad policy?
A.25. The development of mutual funds for individual investors
fostered by the Investment Company Act of 1940 has been of
tremendous value to individuals. I definitely concur with
Barbara Roper that mutual funds have helped to make ``it
possible for average Americans to participate in and profit
from our markets. And that has supplied our equity markets with
tremendous amounts of capital.'' In my article, I was
commenting on only one specific aspect of the 1940 Act, namely,
whether the restrictions on ownership embodied in the Act can
constrain ``the ability of institutions to discipline corporate
management on behalf of households and other investors''
(quoting p. 48 of my article). The other aspects of the 1940
Act that have helped to establish a vibrant and competitive
mutual fund industry are to be applauded.
Q.26. Dr. Kroszner, you were a member of the Shadow Financial
Regulatory Committee in 2005 when they made the following
statement: ``The Committee believes that the PCAOB's basic
functions ultimately should be transferred to the SEC.'' Why do
you believe that the PCAOB's accounting oversight duties should
be transferred back to the SEC, in light of the problems raised
through the accounting crises that caused Congress to create
the PCAOB only 5 years ago?
A.26. The credibility and accuracy of financial reports are
crucial to the proper functioning of capital markets. It is
thus important for Congress to have focused attention on these
issues in light of the corporate governance scandals in 2001
and 2002. I believe it is valuable to continue to emphasize the
necessity of high standards in auditing. The PCAOB is designed
for, and making, constructive contributions towards that
important purpose. With Mark Olson, my former colleague from
the Federal Reserve Board, as the chair of the PCAOB, I know
that it is in good hands. Over the long run, Congress can
consider whether ultimately the PCAOB functions are most
effectively and efficiently undertaken through a separate
entity or within the SEC.
Q.27. Dr. Kroszner, you testified on behalf of the United
States as an expert witness in a case before the United States
Court of Federal Claims involving Citizens Federal Bank. The
D.C. Circuit issued an opinion captioned Citizens Federal Bank
v. United States which included comments critical of your
expert testimony and indicated in multiple instances that you
lacked some basic information regarding matters on which you
rendered opinions. For example, the Court wrote: ``Professor
Kroszner's opinion on the regulators' attitude toward parent
company debt is, in the Court's view, entitled to very little
weight in light of limited understanding of the regulatory
structure and atmosphere to which Citizens [a thrift] was
subject.''
What was your reaction to the Court's opinion? Do you think
your testimony in this case, and the judge's finding that your
viewpoint carried `little weight in light of [your] limited
understanding of the regulatory structure' has any bearing to
your ability to be a Fed Governor, particularly given your
portfolio at the Fed of bank supervision and regulation?
A.27. I have been undertaking research, teaching, and
consulting related to banking and financial supervision and
regulation for more than fifteen years and have published
numerous articles on these topics in both academic and
practicioner journals. In this opinion, I believe the Court is
referring to specific facts and circumstances of a particular
institution involved in the case. In another case also before
the United States Court of Federal Claims, American Capital
Corporation v. United States, I also testified as an expert
witness on behalf of the United States, and the Court's two
opinions in that case suggest that the Court did put much
weight on the testimony I provided. I believe my breadth of
both practical and academic experience related to banking
supervision and regulation has been very valuable to my
portfolio at the Fed, which includes chairing the Board
committee that oversees our division of banking supervision and
regulation.
Q.28. Dr. Kroszner in your academic work you focused on issues
of bank regulation in developing countries, you made the
following conclusion: ``An explicit central bank may not be
needed, but rather mechanisms to provide added liquidity,
perhaps through the clearing system, in times of trouble.'' Can
you explain this finding and what implications it has for
developing countries that are considering establishing a
central bank? Under what circumstances would you recommend
against a nation establishing a central bank?
A.28. As you noted, I made that statement in the context of
academic research on monetary and financial structure and
regulation, and consequently I was focusing only on particular
aspects of the relevant issues. The questions of whether a
nation should establish a central bank, and if so what form the
central bank should take, are quite complicated. The answers
depend on a wide variety of factors, such as the size of the
economy and the financial system; the openness of the economy;
the degree of integration it has achieved with a larger
economy--perhaps a neighbor or close trading partner; and
whether it has adequate political, legal, and social
institutions to support the establishment and ongoing operation
of an independent national central bank. Appropriate bank
supervision, with strong tools, is needed for economies even
where the decision has been made not to have a national
currency and, hence, a national central bank.
------ --
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR CASEY FROM RANDALL S.
KROSZNER
Q.1. Earlier this year Chairman Dodd sent a letter to the
Federal Reserve Chairman, Mr. Bernanke, asking him to act on
the Fed's authority and duty under HOEPA (The Home Ownership
and Equity Protection Act) of 1994 to address predatory loans.
We asked him to do three things:
Require all mortgage originators to evaluate a
borrower's ability to repay prior to making a mortgage loan and
that the Fed create a presumption that a loan that requires a
borrower to pay more than 50 percent of his or her income to
cover the cost of principal, interest, taxes, and insurance is
not a sustainable loan and fails to meet this test;
Designate the failure to escrow taxes and
insurance as an unfair and deceptive practice;
Restrict the use of low- and no-documentation
loans.
Do you support the Fed taking each of these three actions?
A.1. I chaired a Federal Reserve hearing in June 2007 to gather
information on these and other practices and concerns in the
subprime mortgage market from both industry and consumer
groups. Specifically, in that hearing, we examined the failure
to give adequate consideration to a borrower's ability to
repay, the failure to offer escrow accounts for taxes and
insurance, stated-income and low-documentation lending, as well
as prepayment penalties. The Board also solicited written
comments from the public on the practices discussed at the
hearing. The Board received nearly 100 comment letters, and
staff is closely examining the issues raised and discussing
possible remedies. For example, failure to escrow for taxes and
insurance can lead to a situation akin to payment shock for
borrowers if the borrower did not understand or fully
anticipate the cost of taxes and insurance that the borrower
must pay. It is a common practice for these payments to be
escrowed in the prime markets, and I see no reason that escrows
should not be standard practice in the subprime markets too.
We are reviewing the testimony from the hearing and the
public comment letters received in connection with the hearing.
Chairman Bernanke has said that he expects we will issue
proposed rules by the end of the year. It would be premature
for me to comment on the precise content of the proposed rules
or to express a view in support of any particular action at
this juncture
Q.2. A central goal of HOEPA is equity protection. Given the
decline in homeownership rates among African-Americans over the
past few years, and given the equity stripping that we have
seen in the subprime mortgage market: Has the Federal Reserve
done everything in its power to protect the home ownership and
equity of these consumers? What, if anything, can be done
differently?
A.2. We have taken action on several fronts to address concerns
about abusive subprime lending. Regarding equity loss among
African-American communities, the Federal Reserve has a long-
standing commitment to ensuring that every bank it supervises
complies fully with the federal fair lending laws, namely the
Equal Credit Opportunity Act (ECOA) and the Fair Housing Act.
Fair lending is an integral part of every consumer compliance
examination we conduct. We recently referred two nationwide
mortgage lenders to the Department of Justice because we found
evidence that Hispanic and African-American borrowers paid more
for their loans than comparable white borrowers. And for these
and all consumers, we are planning to propose rules under HOEPA
later this year, to address concerns about abuses in the
subprime mortgage market.
Q.3. Congress is considering a number of measures to address
some of the abuses in mortgage lending, including the
Borrower's Protection Act. That bill would establish lender
liability for the actions of associate appraisers and brokers.
Do you support establishing that liability?
A.3. Whether it is appropriate to hold a lender liable for the
acts of brokers and appraisers--who are essentially independent
contractors--raises many issues, including whether lenders are
in a position to perform due diligence to guard against undue
risk of liability.
Other actions can be taken to address broker abuses. Many
states are strengthening their licensing requirements and
oversight of brokers in response to the problems in the
subprime market. The Conference of State Bank Supervisors
(CSBS) will be looking at the activities of brokers as part of
a pilot program with the Federal Reserve and other agencies to
look at the actions of non-bank subsidiaries of bank holding
companies with significant subprime mortgage lending
operations. The CSBS also has developed a nationwide
registration and licensing system for all mortgage brokers and
loan originators not affiliated with depository institutions,
to help limit the ability of bad actors to move to a new state,
and to continue engaging in irresponsible practices there,
after having run afoul of regulators in their old states.
Independence in the appraisal process is essential to
ensuring that pressure is not placed on an appraiser to render
a particular collateral value to enable a loan to be made. With
respect to appraisers, the reform measures adopted pursuant to
the Financial Institutions Reform, Recovery and Enforcement Act
of 1989 led to an improvement in the quality of appraisals. The
states all have in place programs for the licensing and
certification of appraisers, based on national standards. The
Federal Reserve and the other federal banking agencies have
appraisal regulations and guidelines that cover the real estate
lending activity of federally regulated institutions. Through
recent guidance, the Federal Reserve and the other agencies
have stressed the importance of quality appraisals and, in
particular, independence in the appraisal process from the
individual who originates the mortgage.
Q.4. There is a great deal of data on mortgage lending from the
Home Mortgage Disclosure Act. That data show unexplained racial
disparities in mortgage lending, including interest rates and
costs. Would you support using these data to identify banks and
lenders with unexplained disparities, racial or otherwise, as a
reason at the very least to open an investigation of those
lenders?
A.4. Because HMDA data lack many factors that lenders routinely
use to make credit decisions and set loan prices, such as
information about the borrower's creditworthiness and loan-to-
value ratio, we analyze HMDA data in conjunction with other
supervisory information to evaluate a lender's risk for
discrimination. The Federal Reserve developed, and continues to
refine, a HMDA data analysis program that identifies
institutions with statistically significant pricing disparities
by race or ethnicity. Each institution identified by our HMDA
analysis program is carefully assessed for pricing
discrimination risk, based on its HMDA data, as well as the
strength of its fair lending compliance program, our past
supervisory experience with the institution, consumer
complaints against the institution, and the presence of fair
lending risk factors such as discretionary pricing. Based on
these comprehensive assessments, we determined which
institutions should receive a targeted pricing review. During a
targeted pricing review, the Federal Reserve collects
additional information, including potential pricing factors
that are not available in the HMDA data, to determine whether
any pricing disparity by race or ethnicity is fully
attributable to legitimate factors, or whether any portion of
the pricing disparity may be attributable to illegal
discrimination.
Q.5. Two of you have worked for banks and governor Kroszner has
been on the Federal Reserve Board for the past year. In your
opinion, is it possible for banks or lenders to provide people
with too much credit, so much that their financial situation is
actually harmed?
A.5. While this is a possibility, a lender that continuously
provides credit at levels that result in financial harm to
borrowers, such as the loss of a borrower's home, will not
remain a viable entity in the long term. The recent closure of
numerous subprime lenders illustrate the fact that imprudent
underwriting and unwarranted layering of risk can lead to
excessive delinquencies, losses, erosion of capital and,
ultimately, business failure. Therefore, the lender's
assessment of a borrower's ability to repay, as the recent
interagency mortgage guidance emphasizes, is a fundamental
ingredient in prudent underwriting standards.
Q.6. Have banks in the recent past been extending too much
credit to consumers and if so, what should regulators do about
that?
A.6. Perspective gained from the passage of time will be
beneficial in making the final determination of recent market
events. Regulators have to strike the right balance between
exercising their supervisory authority and encouraging banks to
extend credit. Ultimately, regulators are responsible for
promoting a healthy banking system in which banks have
appropriate risk-management practices and consumers have access
to credit.
Supervisors have been very active in responding to recent
changes in the lending environment. Due to concerns about the
quality of underwriting, the agencies issued guidance with
respect to nontraditional mortgage loans more than a year ago,
and there has been guidance regarding subprime lending programs
since 1999. These statements all discuss the importance of the
assessment of the borrower's ability to repay.
In addition, the CSBS has urged the states to adopt both
the nontraditional mortgage guidance and the recent subprime
mortgage lending guidance. To date, thirty-eight states have
adopted the nontraditional mortgage guidance and thirty-one
states have adopted the subprime guidance. Finally, the Board
and the other agencies issued statements in April and September
that encourage lenders and servicers to work constructively
with borrowers who are in default or whose default is
reasonably foreseeable.
Q.7. And should regulators look for ways to ensure that too
much credit is not provided?
A.7. As discussed above, lenders have strong incentives to
ensure that their underwriting remains prudent and does not
result in unwarranted risk-taking. Additionally, excessive
regulation can result in the unintended consequence of
curtailing credit to otherwise creditworthy borrowers.
Nevertheless, good banking supervision is vital to the health
of banks. The Federal Reserve and the other agencies have a
number of tools to address unsafe and unsound lending
practices. Among them are the ability to issue guidance and
regulation, when appropriate, and the bank examination process,
which provides direct and timely feedback to supervised
institutions regarding their credit policies and underwriting
practices.
Q.8. Do you believe that yield spread premiums, which
financially reward mortgage brokers for steering borrowers to
higher rate loans than they might otherwise qualify for and
prepayment penalties which trap borrowers in unfair loans, can
distort competition?
A.8. Compensation for mortgage brokers that depend on yield
spread premiums can give mortgage brokers incentives to guide
borrowers to higher rate loans than would compensation not
based on the loan rate. More effective disclosure of costs
would allow borrowers to better evaluate competing mortgage
products and improve their awareness of whether the broker has
the incentives to act in the best interest of the borrower. In
some circumstances, a borrower might benefit from a yield
spread premium if, in return for a higher rate, the broker pays
some or all of the closing costs. A yield spread premium raises
the rate a consumer pays on his loan, although it may, as
noted, be used in whole or part to help cover closing costs.
When market interest rates decline, individuals with relatively
high loan rates have a greater incentive to refinance.
Prepayment penalties can reduce the benefit of refinancing if
the length of time set for the expiration of the prepayment
penalty is relatively long.
Q.9. Last Thursday the Leadership Council on Civil Rights
called upon the FRB to intervene in the subprime crisis,
specifically noting that it is ``glad that the nominees showed
strong interest in getting rid of prepayment penalties and
other abusive terms in subprime loans.'' What are you planning
to do to combat the abusive practice of steering of borrowers
(and specifically minorities) into loans that are more
expensive than loans for which the borrowers could qualify?
A.9. Federal Reserve consumer compliance examiners use the
Interagency Fair Lending Examination Procedures to detect
disparate treatment, such as steering minority borrowers into
more expensive loans. If an institution makes both prime and
subprime loans for the same purpose, such as for home
purchases, differences in the percentages of minority and non-
minority borrowers in various loan product categories are
evaluated to determine whether they are significant and merit
further review. If an institution has subprime mortgage
subsidiaries or affiliates, examiners evaluate the various loan
products offered, grouped by minority and non-minority
borrowers, to determine if there are differences in the
percentage of applications received by applicants in different
groups at the institution compared to any of its subsidiaries
or affiliates. Examiners also consider whether the institution
has clear, objective standards for referring applicants to
subsidiaries or affiliates, classifying applicants as ``prime''
or ``subprime,'' or deciding what kinds of alternative loan
products should be offered or recommended to applicants. When
conducting fair lending examinations, examiners may rely upon
statistical analysis, report and loan file reviews, information
learned from interviews conducted with bank staff and, when
appropriate, third parties, as well as additional information
obtained from the institution.
I also note that the Federal Reserve, the Office of Thrift
Supervision, the Federal Trade Commission, and state agencies
represented by the CSBS and the American Association of
Residential Mortgage Regulators, are cooperating in an
innovative pilot project to conduct targeted consumer-
protection compliance reviews of selected non-depository
lenders with significant subprime mortgage operations. The
agencies plan to evaluate the risk-management practices used
for ensuring compliance with state and federal consumer
protection regulations and laws, including the Equal Credit
Opportunity Act and the Federal Trade Commission Act. The
collaborative state/federal pilot is scheduled to begin in the
fourth quarter of this year and will focus on non-depository
subsidiaries of bank and thrift holding companies, as well as
mortgage brokers doing business with, or working for, these
entities. Additionally, the states will conduct coordinated
examinations of independent state-licensed subprime lenders and
their associated mortgage brokers. The agencies will select a
sample of entities under their respective supervisory or other
authorities for review or investigation. Any violations
identified, such as illegal steering, would be addressed by
appropriate corrective or enforcement action.
Q.10. What are you planning to do, as LCCR requests, to ensure
that the FRB ``uses [the keys to resolving the ongoing
foreclosure crisis] as quickly as possible?''
A.10. We and the other federal financial regulators have issued
guidance to financial institutions in April 2007 and to loan
servicers in September 2007, urging them to work with borrowers
to avoid foreclosure when possible. We have worked with other
regulators to clarify accounting and tax issues that had the
potential to hinder the workout process. We also are working
closely with the CSBS to make similar efforts with respect to
state-regulated institutions and servicers.
Q.11. What will you do to get rid of abusive terms and
practices in the subprime market so that borrowers can remain
in their homes and good, responsible lenders are not placed at
a competitive disadvantage?
A.11. We plan to propose rules under HOEPA addressing unfair or
deceptive practices in mortgage lending before the end of the
year. The four practices discussed at our recent hearing--
prepayment penalties, failure to require escrows for taxes and
insurance, stated income lending, and failure to consider
repayment ability--are currently under review, and we have
received about 100 public comments on those practices which are
also under review. In addition, we expect to propose rules
aimed at abuses in mortgage advertising. The proposed rules
will also be aimed at ensuring the consumers get their mortgage
disclosures at a time when the information is likely to be most
useful to them.
------ 50
3 5 4 1.86
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM RANDALL
S. KROSZNER
Q.1. The subprime mortgage market is collapsing, and I am
concerned about what is happening to the real people that are
at the human end of this crisis, many of whom were deceived by
unscrupulous mortgage brokers into taking out a mortgage that
they could never afford. In his testimony before this
committee, Chairman Bernanke agreed with me that additional
regulation of the mortgage broker industry is warranted in
light of this crisis. The positions you have taken in the past
on the regulatory role of the Federal Reserve suggest that you
may not agree with Chairman Bernanke's views on the regulation
of brokers.
I have been fighting, along with Senators Brown and Casey,
to pass federal legislation that would strengthen federal
regulation of all mortgage brokers. We believe that inaction is
too costly, for both consumers and the markets. Our bill would
establish a fiduciary duty and good faith standards for
mortgage brokers and other non-bank mortgage originators,
require originators to underwrite loans at the fully indexed
rate, and prohibit steering, among other things.
While I recognize that you cannot take a position on a
specific piece of legislation, do you agree with the principle
that increased federal regulation and oversight of the mortgage
broker industry is appropriate? What types of regulations would
you support to advance the goals of the Federal Reserve?
A.1. Greater oversight and regulation of mortgage originators,
including mortgage brokers, is an approach that has merit. A
nationwide registration and licensing system for all mortgage
loan originators would help limit the ability of bad actors to
move to a new state after having run afoul of regulators in
other states. The Conference of State Bank Supervisors and
American Association of Residential Mortgage Regulators have a
promising initiative to establish a national registry. It would
be appropriate for any new legislation to ensure that all
individual originators are included in the same nationwide
registry.
Promoting access to credit and to homeownership are
important objectives, and the Board believes that responsible
subprime mortgage lending can help advance both goals.
Therefore, the Board believes it is extremely important to
strike the right balance by seeking to protect consumers from
predatory lending practices without restricting credit from
responsible lenders to borrowers with shorter or lower-rated
credit histories. For example, the Board is looking at whether
it should issue a rule under HOEPA requiring a lender to
evaluate the borrower's ability to repay a loan. It seems self-
evident that adequate consideration of repayment ability is
necessary. However, our experience in crafting the recent
interagency guidance on mortgage lending taught us that this
principle is far easier to articulate in general terms than in
detailed and objective rules stating which underwriting
practices constitute ``adequate'' consideration. This is
especially true for mortgage credit underwriting, which can
depend on several pertinent consumer-specific factors. We are
continuing to work on this and other issues, keeping in mind
that any new rules must be specific enough so that creditors
can determine whether their practices are in compliance because
legal uncertainty could have the unintended effect of reducing
credit options for creditworthy subprime borrowers. At the same
time, rules must be flexible enough to allow creditors to
consider the pertinent factors and individual circumstances of
particular consumers and to innovate prudently and fairly.
Q.2.a. You recently chaired a hearing at the Federal Reserve
examining the Board's authority to regulate the subprime
lending industry under HOEPA. As you know, the Fed was heavily
criticized for its failures to exercise its authority under
HOEPA to regulate the industry. And I understand that you were
responsible for HOEPA during your time at the Fed.
What is your current view of the Fed's authority under
HOEPA? Given the recent problems in the subprime mortgage
industry, what steps do you personally plan to take in your
role as Governor, should you be confirmed for the full term, to
prevent these abuses from happening again in the future?
A.2.a. The Federal Reserve has responsibility under HOEPA to
prohibit acts or practices in connection with mortgage loans
that it finds unfair or deceptive, or designed to evade HOEPA.
In June 2007, I chaired a hearing on how we should use this
authority to address abuses in the mortgage market, including
the subprime sector. The hearing yielded valuable insight from
both industry and consumer groups. The Board also solicited
written comments from the public on the practices discussed at
the hearing. The Board received nearly 100 comment letters, and
staff is closely examining the issues raised and discussing
possible remedies. In addition, we expect to propose rules
aimed at abuses in mortgage advertising. The proposed rules
will also be aimed at ensuring the consumers get their mortgage
disclosures at a time when the information is more likely to be
most useful to them.
Q.2.b. Do you agree that the current problems in the subprime
mortgage market are a result of a market failure? Do you
believe that this market will be able to correct itself without
additional regulation from the Fed and other regulators?
A.2.b. As you know, the market for subprime mortgages has
adjusted sharply in recent months. Originators are employing
tighter standards and some large lenders are pulling back from
using independent brokers. Still, we must consider what we can
learn from this episode to help prevent problems from
recurring. Loan delinquencies have been boosted by loose
underwriting standards in late 2005 and 2006 together with
broader economic factors such as the deceleration in house
prices. We are evaluating how improved disclosures, more
effective enforcement of underwriting standards at lenders, and
new rules could help prevent this situation from arising in the
future. In deciding which actions to take, we will do what we
can to prevent abuses without curtailing responsible subprime
lending.
Q.3. You have written that you believe that TRIA, the Terrorism
Risk Insurance Act of 2002, should not be extended. In a 2004
editorial in the American Banker arguing against the original
extension of TRIA, you wrote, ``Any federal intervention into
terrorism insurance markets after 2005 should be limited to
workers' compensation insurance and possible preemption of
state mandates that property insurance policies include
coverage for fire losses caused by terrorist attacks.'' Please
explain why you believe that private insurance and reinsurance
markets are sufficient to bear the risks of large-scale
terrorist attacks. What do you propose as a solution if the
private market cannot provide sufficient insurance to ensure
continued construction and economic growth?
A.3. It is important to clearly define what constitutes
``large-scale terrorist attacks.'' Unfortunately, the
possibility exists of a catastrophic event so large that
private markets and the private insurance industry would not be
able to bear the associated losses. For events of that scale
and beyond, government has a role to play. However, I believe
that the private sector is capable of handling losses
associated with smaller-scale events, and that for those risks,
private markets and private institutions should be allowed
maximal scope to operate and innovate. Indeed, it should be
noted that under current law, the Terrorism Risk Insurance
Extension Act, private insurers actually now bear a large
amount of risk for terrorism attacks via their deductibles
under the program, copayments beyond those deductibles, as well
as the aggregate industry retention level, which is now close
to $30 billion. Moreover, the study conducted last year by the
President's Working Group on Financial Markets found that
conditions in the terrorism insurance market have improved
since 9/11, with take-up rates rising and premium rates
declining, even as the industry's exposure to terrorism risk
has increased over time under TRIA.
In designing a strategy to manage terrorism risk, I believe
that policymakers should explore options that facilitate the
transfer of risk to private insurance markets and capital
markets. For example, as I suggested in my 2004 editorial,
modifications to the corporate tax code that reduce insurers'
costs of holding the capital required to underwrite terrorism
risk could be considered.
------ --
----
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM RANDALL
S. KROSZNER
Subprime Market
As I have stated before, and expressed recently when
Chairman Bernanke was before this Committee, I do not think the
Fed's response to the subprime market has matched the severity
of crisis at hand. I remain unconvinced that the Fed took every
action possible when it could have. Had it used its authority,
earlier, with more veracity, perhaps the subprime market would
not be in the same place it is today.
Q.1. Do you think the response the Federal Reserve has taken
has been an appropriate and sufficient response thus far to
mitigate the decline of the subprime market?
A.1. The Federal Reserve is responding to the decline in the
subprime market. We are working to help those borrowers who are
in distress and reviewing all of our options to help prevent
problems from recurring. To help the borrowers who may be
facing foreclosure, the Federal Reserve, along with other
federal supervisory agencies, has issued two statements in 2007
to encourage lenders and loan servicers to identify and contact
borrowers who, with counseling and possible loan modifications,
may be able to avoid delinquency or foreclosure. The community
affairs offices of the twelve Reserve Banks have also provided
significant leadership and assistance to foreclosure-prevention
efforts.
Prospectively, we are reviewing all of our options under
the law to prevent these problems from recurring, while still
preserving responsible subprime lending. In doing so, we
recognize that some market adjustments are already underway as
originators and investors have tightened lending standards. We
issued principles-based guidance on underwriting and consumer
protection standards for nontraditional mortgages in 2006 and
for subprime mortgages in 2007. The guidances had a positive
effect on the market, particularly with respect to
nontraditional mortgage loans. Many institutions took steps to
conform their policies and practices to the guidances even
before they were finalized.
We currently are reviewing Truth in Lending rules to
improve disclosures. Improving disclosures, however, requires
extensive consumer testing and trials, and it may take some
time to do it right. In addition, we are committed to using our
rulemaking authority under the Home Ownership and Equity
Protection Act to propose additional consumer protections later
this year. We held a public hearing in June and solicited
comments from the industry and consumer groups. We are taking
great care to address the abuses without unduly constraining
responsible credit.
Q.2. You have had an integral role in overseeing the Federal
Reserve's authority under HOEPA. Can you describe the extent of
your involvement in developing the Federal Reserve's response
to the subprime crisis?
A.2. I have been a member of the committee of the Board that
oversees the Division of Consumer and Community Affairs (DCCA)
since the summer of 2006 and have chaired the committee since
March 2007. I also have been a member of the committee of the
Board that oversees the Division of Banking Supervision &
Regulation since I arrived at the Board in March 2006 and have
chaired this committee since March 2007. When I arrived at the
Board, the inter-agency proposal on guidance for non-
traditional mortgages had already been published (late December
2005) and, as a committee member, I was engaged in responding
to comments and shaping the final guidance. I then assumed the
primary responsibility in early 2007 to work with the other
federal banking agencies, in coordination with the CSBS, to
develop the subprime guidance that the agencies put out for
comment in early March 2007 and finalized in late June 2007. I
participate in our triennial meetings of the Consumer Advisory
Counsel where we have valuable dialogue and debates among
industry participants and consumer representatives on a variety
of consumer issues, including subprime mortgages. In June, I
chaired a day-long HOEPA hearing involving a wide spectrum of
participants to gather information about potentially unfair and
deceptive practices in the subprime mortgages. In particular,
we focused on four areas: prepayment penalties, low- and no-
documentation mortgages, failure to escrow for taxes and
insurance, and the ability to repay. The information we
obtained at that hearing and from the approximately 100 written
comments that we subsequently received have been very helpful
as the Board formulates additional rulemaking. I have been
working very closely with the staff to develop these proposals,
which we expect to issue in December.
Q.3. Do you think that, given the benefit of hindsight, the
Federal Reserve could have done more to stem the fallout of the
subprime market? Didn't we have a sense of how bad the subprime
turmoil could be?
A.3. The Federal Reserve and other federal supervisory agencies
have been providing principles-based guidance and supervisory
oversight to the lenders that we supervise for many years. We
first issued guidance on subprime lending in 1999 and again in
2001. When problems surfaced concerning non-traditional
mortgages in 2004, we issued guidance on those. We then
developed guidance for subprime mortgages, especially for
adjustable-rate products. We also created disclosures that
lenders were required to provide to borrowers to help them
better understand mortgage products. Still, many subprime
adjustable-rate mortgages made in late 2005 and 2006 were
originated with very high cumulative loan-to-value ratios and
less documentation of borrower income, as loan performance
stayed strong amid continued house price appreciation. The
sharp deceleration of house prices since 2005 has left many of
the more-recent borrowers with little or no home equity and has
led to higher delinquencies. In this situation, some borrowers
found that refinancing--the typical way for many subprime
borrowers to avoid large scheduled interest rate resets--has
been difficult or impossible and some borrowers (particularly
owner-investors) may have found that walking away from their
properties was the best option.
Q.4. You chaired a hearing on June 14th of this year that was
the last of five hearings examining possible actions under
HOEPA. What has the impact of those hearings been thus far?
What results from those hearings can we expect?
As we heard from Chairman Bernanke recently, he expects the
Fed to propose additional rules under HOEPA later this year.
Are you involved in developing additional action under HOEPA
that the Fed may take or recommend? Can you describe what you
expect those efforts to result in?
A.4. As oversight Governor for the Division of Consumer and
Community Affairs at the Federal Reserve, I am very involved in
the HOEPA rulemaking. As you noted, I chaired the hearing on
June 14, 2007, on issues related to subprime mortgages. The
hearing gathered information on how the Board might use its
rulemaking authority under HOEPA. We heard from representatives
of consumer and community groups, state officials, lenders and
mortgage brokers, as well as secondary market participants.
These witnesses provided valuable information about certain
practices prevalent in subprime lending, including stated
income lending, prepayment penalties, failure to escrow for
taxes and insurance, and making loans without assessing the
borrower's ability to repay. I anticipate that the proposed
rules we will issue in December are likely to address these
issues.
Earlier hearings held in 2006 have also provided valuable
information which we have used in a number of ways. For
example, the 2006 hearings indicated that consumers need better
information about the risks of nontraditional mortgages such as
interest only and payment option ARMs. The Board is committed
to reviewing mortgage disclosures using consumer testing to
make disclosures more useful to consumers; however, because
testing takes time, in the short run the Board and OTS have
updated the Consumer Handbook on Adjustable Rate Mortgages to
include information about nontraditional mortgage products.
Q.5. Are other areas of the subprime crisis that the Fed has
not yet addressed?
A.5. In addition to our HOEPA rulemaking, we are engaged in a
rigorous review of the mortgage-related rules under Regulation
Z, which implements the Truth in Lending Act (TILA). We intend
to issue proposals before the end of the year to ban several
deceptive advertising practices and require important consumer
disclosures earlier in the mortgage process to better enable
consumers to compare and shop among loan products.
Q.6. The majority of subprime loans are originated by mortgage
brokers, yet the Federal Reserve has not yet cracked down on
these abuses. Do you think this is an area the Federal Reserve
should look at? Should the Federal Reserve do more to hold
lenders responsible for abuses by the brokers who originate
their loans?
A.6. The states are the primary regulators of the mortgage
brokers they license, and they have promising initiatives
underway to address concerns about mortgage brokers'
activities. Many states are strengthening their licensing
requirements and oversight of brokers in response to the
problems in the subprime market. The Federal Reserve is working
with the states where appropriate. For example, the Conference
of State Bank Supervisors (CSBS) will be looking at the
activities of brokers in our pilot program to look at the
actions of non-bank subsidiaries of bank holding companies. The
CSBS also has developed a nationwide registration and licensing
system for mortgage brokers and mortgage originators not
affiliated with depository institutions. Such a system should
limit the ability of bad actors to move to a new state and to
continue engaging in irresponsible practices there, after
having run afoul of regulators in their old states.
We and the other federal supervisory agencies do expect our
institutions to have systems and controls in place for
establishing and maintaining relationships with brokers and
other third parties, including procedures for due diligence.
Institutions are expected to have adequate oversight over third
parties to monitor quality of originations and compliance with
the institution's underwriting standards and applicable laws
and regulations.
Whether it is appropriate as a general matter to hold a
lender liable for the acts of brokers--who are essentially
independent contractors--raises many issues, including whether
lenders are in a position to perform due diligence to guard
against undue risk of liability.
TRIA
In 2004, you wrote an article in which you said, ``If
Congress does decide to extend the Terrorism Risk Insurance
Act, the program's scope should not be expanded, and the amount
of losses that the private sector must bear before federal
assistance kicks in should increase annually over the duration
of any extension.'' Obviously, Congress did decide to extend
TRIA, and as you know, we are currently grappling with the next
steps for this legislation.
Q.7. Can you explain your current views on TRIA? Do you support
further extensions of TRIA?
A.7. On the whole, my views on TRIA have not changed markedly
since I wrote that article in 2004. In particular, I continue
to oppose expansion of the role of the federal government in
the terrorism insurance market, particularly for attacks using
conventional materials. Indeed, last fall, the study conducted
by the President's Working Group on Financial Markets reported
that market conditions have improved since the terrorist
attacks of 9/11, with take-up rates rising as premium rates
have fallen. These improvements have occurred against the
backdrop of the TRIA (and TRIEA), which has raised the private
sector's level of exposure to terrorism losses over time;
however, the continued federal involvement may have hindered
the development of private market solutions during this time as
well. In short, I would be more inclined to support temporary
extensions of TRIA that reduce, rather than expand, the role of
the federal government in the terrorism risk insurance market.
Q.8. How much of the burden do you think the private sector
should bear for providing terrorism insurance? Do you think
terrorism risk insurance is possible without government
involvement?
A.8. Unfortunately, the possibility exists of a catastrophic
event so large that private markets and the private insurance
industry would not be able to bear the associated losses. For
events of that scale and beyond, government has a role to play.
However, I believe that the private sector is capable of
handling losses associated with smaller-scale events, and that
for those risks, private markets and private institutions
should be allowed maximal scope to operate and innovate.
Q.9. Wouldn't you agree that short term authorizations lead to
uncertainty and instability within the insurance market? What
about the ripple effects, for example on real estate, housing,
construction, mortgage-backed securities, etc?
A.9. Although short-term authorizations may lead to some
uncertainty for commercial insurers and policyholders, I am not
aware of evidence that they have significantly affected
economic activity or the stability of financial markets.
Access to Capital
Over the last few years, the Federal Reserve, the Small
Business Administration and others have conducted studies that
reveal minorities have unequal access to credit for small
business development, even when factors such as credit history
and net worth are comparable to non-minorities.
Q.10. In your opinion, in addition to promoting financial
education, how can we improve ``access to capital'' for
minority-owned businesses?
A.10. Minority-owned businesses play an important role in the
growth and expansion of our economy. Many of the Federal
Reserve Banks have targeted programs in support of minority and
small business development. As one example, the Federal Reserve
Bank of Boston in 2007 developed a program to address the need
for small loans by small businesses. The Massachusetts Banking
Partners Small Business Loan Program is a state-wide initiative
in partnership with local banks to bring loans and technical
assistance to small businesses that generally have twenty or
fewer employees, are located in low- or moderate-income census
tracts, or require small loans. To promote participation in the
program by banks and businesses, the Community Affairs program
at the Federal Reserve Bank of Boston hosted a series of forums
across the state, published an article featuring the loan
program and provided technical assistance to lenders.
The Federal Reserve Bank of St. Louis also sponsored an
initiative to foster entrepreneurship. Beginning with a survey
of the local climate for entrepreneurial development, which was
conducted in a number of cities including Arkadelphia, Tupelo
and Memphis, the Bank has held forums and workshops to help
entrepreneurs move their businesses to the next stage of
development. The Bank also developed a resource guide and
highlighted opportunities for entrepreneurs to access technical
assistance and expertise.
The Federal Reserve is also committed to supporting the
growth and expansion of minority-owned depository institutions.
Of the approximately 200 such institutions nationwide, 20 are
supervised by the Federal Reserve. In August, I spoke at the
Interagency Minority Depository Institutions National
Conference which was hosted in Miami. At that time, I announced
a new training and technical assistance program the Federal
Reserve is launching to address the needs of minority
institutions. The program will include workshops, self-directed
educational programs, and a web-based resource and information
center. The Board is partnering with the Federal Reserve Bank
of Philadelphia in the development of this program, which will
be launched on a pilot basis this fall. The full program will
be launched in early 2008.
Q.11. What role can the Federal Reserve play to encourage
institutions to engage in expanding access to capital, both for
individuals and businesses?
A.11. The Federal Reserve Board and the twelve Federal Reserve
Banks each have established Community Affairs Offices. The
function of these offices is to promote community development
and access to credit. Each of the Reserve Banks develops an
understanding of the needs of the communities within their
District, by conducting research and outreach. The data
developed and information gathered are then published in
various media and academic journals and magazine articles, as
well as presented in workshops and forums which can help meet
the informational needs of the financial institutions in the
respective Districts. The data which is developed provides a
framework for developing programs and services. Those
informational products are designed to foster depository
institutions' provision of credit and banking services to
traditionally underserved markets, increase consumers'
awareness of the benefits and risks of financial products and
encourage development of new products, and promote among policy
makers, community leaders and the private sector a better
understanding of the practices, processes and resources that
result in successful community development programs.
For issues which cut across several Districts, the Reserve
Banks may offer programs collaboratively. For example, in 2006
the Reserve Banks developed a series of programs on the
challenges of asset-building in low- and moderate-income
communities. The Reserve Bank System also co-sponsored a
research forum to feature academic research on issues related
to asset building such as financial literacy, manufactured
housing, public policy and savings products. This year, all
twelve Reserve Banks are undertaking a project with the
Brookings Institution, in which each Bank is conducting a case
study of a targeted neighborhood with a high concentration of
poverty. Those case studies will provide comparative data to
help the Federal Reserve System understand better the provision
of financial services in extremely low-income communities.
Q.12. What actions would you recommend the Federal Reserve take
in this area?
A.12. See answer to 11 above.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA FROM RANDALL S.
KROSZNER
Q.1. Our modern, complex economy depends on the ability of
consumers to make informed financial decisions. Without a
sufficient understanding of economics and personal finance,
individuals will not be able to appropriately manage their
finances, evaluate credit opportunities, and successfully
invest for long-term financial goals in an increasingly complex
marketplace. What must be done to ensure that Americans have
the knowledge and skills necessary to make informed financial
decisions?
A.1. Consumers need to be well-informed in order to make
decisions about the products and services that best suit their
needs, particularly given the highly sophisticated and
competitive financial services marketplace in the U.S. Informed
consumers are essential to efficient market operations.
Accordingly, the Federal Reserve has a long-standing commitment
to promoting consumers' understanding of financial products and
services. In addition to writing consumer protection rules and
disclosure requirements to ensure consistency in the
information that consumers receive when they obtain a loan or
other banking service, we also publish numerous consumer
information brochures that provide information about specific
products that are available at no charge to the public by
request or through our website at www.federalreserve.gov/
consumerinfo/default.htm.
The Federal Reserve System also actively participates in
various national, regional, and local initiatives to support
financial education efforts. For example, Board staff advise
the federal Financial Literacy and Education Commission,
NeighborWorks America', and the JumpStart Coalition,
while staff in the Community Affairs and Public Affairs Offices
of the Federal Reserve Banks work with coalitions that include
community organizations, youth education coalitions, and
financial institutions to help further financial education. A
listing of many of the Federal Reserve's offerings and recent
activities in financial education can be found at
www.federalreserveeducation.org, as well as in Chairman
Bernanke's testimony on the topic in May 2006 at
www.federalreserve.gov/newsevents/testimony/
bernanke20060523a.htm.
Additionally, the Federal Reserve recognizes the value of
expanding the body of research to increase the understanding of
the effectiveness of financial education in general, as well as
the efficacy of the various approaches to program design and
delivery. Federal Reserve Board researchers have published
studies on various aspects of financial education, several of
which can be found at www.federalreserve.gov/research/staff/
hogarthjeannem.htm. In addition, the biennial Federal Reserve
System Community Affairs Research Conference has highlighted
research on the effectiveness and role financial literacy
programs play. Further, the Federal Reserve has sought to
create a clearinghouse of such research to ensure easy access
to literature on the topic. These studies can be found under
the Financial Education Center section of the Federal Reserve
Bank of Chicago's Consumer and Economic Development Research &
Information Center website at www.chicagofed.orgckedric/
cedric_index.cfm.
Q.2. Approximately 10 million households in the United States
do not have accounts at mainstream financial institutions.
Unfortunately, too many of these households depend on high-cost
fringe financial services. They miss out on opportunities for
saving, borrowing, and lower cost remittances found at credit
unions and banks. What must be done to bring these households
into mainstream financial institutions?
A.2. Many benefits can accrue to consumers by establishing a
relationship with a depository institution, including potential
cost savings and access to savings vehicles that non-bank
financial service providers cannot provide. In addition,
unbanked or underbanked populations may represent new market
opportunities to depository institutions. The Federal Reserve
has dedicated resources to engage in outreach, education, and
technical assistance to help increase awareness of the
challenges and opportunities in reaching the unbanked.
The Federal Reserve System has undertaken initiatives to
gain a better understanding of the unbanked and to highlight
opportunities for depository institutions to reach out to this
market through the financial education activities and programs
offered by the Federal Reserve's Community Affairs Offices
throughout the country. For example, the Federal Reserve Banks
of Philadelphia and St. Louis are convening conferences in the
coming months to discuss innovative strategies for reaching the
unbanked and developing products that are responsive to their
needs. Several Federal Reserve Banks have examined the
challenges immigrant communities confront in accessing
financial services through their publications, conferences, and
research, including the Federal Reserve Banks of Boston,
Chicago, and San Francisco. The Federal Reserve System engages
in partnerships to help increase awareness of the issues and
how they may differ in various markets. For example, the Board
and several of the Federal Reserve Banks have recently worked
with the Financial Literacy and Education Commission to develop
a series of four regional workshops in Chicago; Edinburg,
Texas; Seattle, and New York to address the challenges and
opportunities in reaching the unbanked, as well as a forum on
reaching and serving Asian communities. Given the importance of
this issue, the Federal Reserve will continue to engage in
efforts to bring unbanked consumers into mainstream financial
institutions.
Q.3. I am deeply concerned that too many working families are
taken advantage of by unscrupulous lenders through payday
loans. What must be done to restrict payday loans and expand
access to affordable, small loans?
A.3. As a member of the Federal Reserve Board, I support
efforts to ensure that consumers, including working families,
are not taken advantage of by unscrupulous lenders. None of the
state member banks supervised by the Federal Reserve System
engage in payday lending. Nonetheless, we have participated
with the other federal supervisory agencies in issuing
interagency guidelines that address matters related to payday
lending. In addition, Board staff consulted extensively with
the Department of Defense (DoD) when it developed a rule
implementing the consumer protection provisions of section 670
of the John Warner National Defense Authorization Act for
Fiscal Year 2007, also known as the Talent Amendment, which was
effective October 1, 2007. The final DoD rule contains
limitations and requirements for payday loans, motor vehicle
title loans, and tax refund anticipation loans extended to
active duty service members or their dependents by any creditor
engaged in the business of extending such credit and their
assignees.
The Federal Reserve works to expand access to affordable
small loans in many ways. We encourage banks to expand access
to affordable small loans through our supervision of banks
pursuant to the Community Reinvestment Act (CRA). Guidance
issued by the Federal Reserve Board and other supervisory
agencies provides that making affordable small unsecured loans
with reasonable terms will receive favorable consideration
under the CRA. Further, the Federal Reserve System's Community
Affairs staff continues to be involved in programs to help low-
and moderate-income consumers make better financial choices.
Several of the Reserve Bank community affairs programs host
roundtables, help convene or provide advisory services to
groups educating consumers about the problems inherent in
payday lending, and in some cases, promote alternatives.
Q.4. Too many working families have their Earned Income Tax
Credit benefits needlessly reduced by high cost-refund
anticipation loans (RALs). What must be done to restrict these
predatory loans and encourage alternatives to RALs?
A.4. The Federal Reserve is actively involved in efforts to
provide financial education and programs to help low- and
moderate-income consumers make better choices, as explained in
the previous answer. The Federal Reserve also engages in
research that explores issues relating to consumers' use of
financial services, including subprime loans and consumer
literacy. Research providing information about the impact of
credit products, policies and programs can be used in
formulating future policies.
With respect to the cost of credit, the Federal Reserve
does not have the authority to set loan fees or interest rates,
but we do develop and enforce the disclosure requirements
relating to terms and cost associated with loans subject to
Regulation Z, which implements the Truth in Lending Act. As
noted, the Talent Amendment does include restrictions on tax
refund anticipation loans, payday loans and motor vehicle title
loans, as defined by DoD, extended to active duty service
members or their dependents. The rule, which was issued by DoD
after consultation with Federal Reserve Board and other
agencies' staff, limits the amount that the creditor can charge
in interest and fees, including charges imposed for single
premium credit insurance and other ancillary products sold in
connection with covered transactions.
Q.5. I am concerned that consumers are not provided with enough
information about the long-term consequences of making only the
minimum credit card payments. What must be done to ensure that
consumers are adequately informed of the true cost of making
only the minimum payment?
A.5. The Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005 (the ``Bankruptcy Act'') requires that creditors
put on the periodic statement a toll-free telephone number to
obtain an estimate of the time to repay if the consumer makes
only minimum payments. The Act permits, but does not require,
creditors to provide a more precise estimate based on the
customer's actual account terms. In May 2007, the Board issued
a proposed rule implementing the Bankruptcy Act. In the
proposal, the Board recognized that the Act does not require an
estimate based on actual account terms or placing the estimate
on the periodic statement. Nonetheless, the Board strongly
encouraged creditors to provide the actual repayment disclosure
on periodic statements by creating incentives in the form of
relief from other requirements. The Board also solicited
comment on whether the Board should take other steps to provide
incentives to creditors to use this approach. A recent study
conducted by the GAO on minimum payments suggests that certain
cardholders would find the actual repayment disclosure more
helpful than the generic disclosures required by the Bankruptcy
Act.
------
RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM ELIZABETH
A. DUKE
Q.1. Ms. Duke, in your appearance before the Committee, you
stated that you are a strong believer in the Fed's dual mandate
for maximum employment and price stability. Are there
approximate figures for the nation's unemployment rate and
inflation rate that match what you believe to be maximum
employment and price stability? If so, can you share what those
are?
A.1. I do not have any specific unemployment rate in mind. I am
not sure there is one specific number that would hold true
under all conditions. When I was in school, I was taught that
6% constituted full employment. Yet, we have seen employment
rates substantially below 6% that did not seem to contribute to
higher inflation. Many economists now believe the productivity
growth rate impacts the rate of employment that can be
sustained without leading to higher inflation. So the
unemployment rate would need to be evaluated in the context of
productivity growth and the overall strength of the economy.
With respect to inflation, I would think the Fed's
currently stated comfort range of 1-2% would be a proxy for
price stability. I don't believe that zero inflation makes a
reasonable objective as overshooting it could lead to
deflation. And this range appears to have been successful in
lowering long term inflation expectations in the marketplace.
In my personal and business financial planning, I have used an
expected long term inflation rate of 2-3% to make decisions. I
believe my expectations are consistent with the market
expectations that can be inferred from the pricing of TIPS
securities.
Q.2. Ms. Duke, can you inform the Committee of any periods in
American history where you believe that maximum employment was
not being reached or that price stability was not achieved?
During those periods, what actions do you believe the Fed
should have undertaken to achieve its mandate?
A.2. Clearly, price stability was not achieved in the 1970s and
early 1980s. Ultimately, the Fed did act to reduce the money
supply, drive up interest rates and finally bring inflation
down to the levels we enjoy today. However, it was an extremely
painful process for consumers, businesses and the financial
system. And, I suspect, it was a difficult time for the Fed as
well.
Q.3. Ms. Duke, how do you explain the Federal Reserve's
findings from the HMDA data that in 2005, 54.7% of African-
American borrowers and 46.1% of Hispanic borrowers got high-
priced loans when buying a home compared to 17.2% of non-
Hispanic whites?
A.3. I do not have a full explanation, but some of the
differences may relate to information not included in the HMDA
data. That said, I would fully support use of the Fed's
analytical resources to try to uncover and quantify the reasons
for the disparity. It is important to understand the causes in
order to be able to change the outcome.
Q.4. In the Fed's analysis of the data, significant racial and
ethnic differences remained unexplained even after accounting
for other information reported in the HMDA data. The Fed found
that borrower-related factors accounted for only about one-
fifth of the disparity. Do you believe that there is racial
discrimination in the mortgage market? If so, how do we root it
out of the system? What specific additional steps should the
Fed undertake to do so? If you do not believe that there is
racial discrimination, how do you explain these racial
disparities?
A.4. Within the banks with which I have been associated, I have
observed a high level of management attention, time, effort,
money and resources invested in identifying and avoiding or
eliminating potential racial discrimination. Underwriting and
pricing decisions are increasingly based on statistical models
that should be racially neutral. Regulators regularly conduct
reviews and recommend improvements to bank processes and
scoring systems. Most banks conduct internal reviews of their
own HMDA data with particular emphasis on variations from
norms. And regulators have been able to use the data to
schedule targeted reviews of lending practices.
It is deeply troubling that despite all this effort and
attention, disparities in lending still exist. We need to
continue to be vigilant in our efforts to eliminate all bias in
lending. But I think we also need to investigate all other
possible explanations for disparity. Because we cannot solve a
problem unless we can accurately identify its cause.
Some other factors that I have seen suggested as
contributors would be:
Differences in financial literacy and
sophistication;
Differences in creditworthiness not reflected in
HMDA data;
Differences in marketing methods and
receptiveness to certain marketing practices; and
Distrust of traditional banks.
I am sure there are other possible factors. And I realize
that some of these may prove ultimately to have no impact. But
I think the issue is important enough that we should pursue all
possible explanations in an all out effort to finally change
the results.
The Fed's role should be first as a vigilant regulator. The
Fed should continue to actively monitor activities of banks
under its supervision. It should continue to work with banks to
further improve their own efforts. And, when the Fed finds
evidence of illegal activity, it should promptly refer such
cases to the Justice Department. Additionally, the Fed should
use its research and data analysis capability to continue to
work on diagnosing the possible contributing factors and
potential solutions to this serious problem.
Q.5. Ms. Duke, do you think that the 2001 Bush tax cuts have
resulted in an increase or decrease in real federal revenue?
A.5. I have neither the expertise nor the information to be
able to answer this question.
Q.6 As you know, only the Federal Reserve, the Office of Thrift
Supervision, and the National Credit Union Administration
currently have the authority to promulgate a rule dealing with
unfair or deceptive acts or practices. In your view, should the
other agencies be given the same authority? Please explain your
reasoning.
A.6. Your question appears to refer to rule-writing authorities
under the Federal Trade Commission Act. I do not believe giving
additional agencies rule-writing authority under this act will
necessarily speed up the process of issuing sensible
regulations or improve the effectiveness of the ultimate
regulations.
Under the FTC Act, four agencies--the Fed, OTS, NCUA, and
the FTC--currently have authority to write rules that apply to
a portion of the financial industry. Ideally, all lenders
should be subject to the same regulations. The more entities
there are writing rules separately, the greater the opportunity
for entities engaged in a specific practice to ``charter shop''
those practices and undermine the regulation. If, on the other
hand, other rule-writers were introduced, and all were required
to issue the same rules, it could be harder, not easier, to
achieve sensible rules of general applicability and these rules
could be slower in coming.
I believe it is preferable for the Federal Reserve to use
other authorities it has, under the Home Ownership and Equity
Protection Act, to write rules related to unfair or deceptive
mortgage lending activities. Rules written under these
authorities would apply to all mortgage lenders. As you know,
Chairman Bernanke has pledged to issue proposed rules under
these authorities for public comment later this year. I support
that process.
With respect to mortgage lending, I believe there is a much
larger need to address the regulatory environment outside
insured depository institutions than there is to redistribute
the regulatory responsibilities within the regulatory structure
governing insured depository institutions. More sub-prime loans
have been originated outside the federal supervisory structure
than inside it. Any regulation governing sub-prime lending will
need to be accompanied by an effective supervision and
enforcement regime.
Q.7. Ms. Duke, as you know the FOMC voted unanimously in its
August meeting to keep Interest rates constant and in the
accompanying statement that their ``predominant policy concern
remains the risk that inflation will fail to moderate as
expected.'' Over the next ten days, there were significant
disruption in the equity and bond markets that caused the Fed
to reverse course, cut the rate at the discount window by 50
basis points and issue the following statement ten days after
their August meeting: ``Financial market conditions have
deteriorated, and tighter credit conditions and increased
uncertainty have the potential to restrain economic growth
going forward. In these circumstances, although recent data
suggest that the economy has continued to expand at a moderate
pace, the Federal Open Market Committee judges that the
downside risks to growth have increased appreciably. The
Committee is monitoring the situation and is prepared to act as
needed to mitigate the adverse effects on the economy arising
from the disruptions in financial markets.''
Do you believe that the FOMC made a mistake at their
original August meeting? Do you believe that the predominant
policy concern remains the inflation in light of the events
since the August meeting of the FOMC? If you had been a Fed
Governor, what actions, if any, would you have taken that were
different from those taken by the Fed Governors?
A.7. I don't believe anyone could have predicted the speed or
the pervasiveness with which the credit markets dried up. I
certainly don't believe anyone could have predicted the timing.
And I don't believe anyone knows yet what the ultimate impact
will be on the overall economy.
The discount window is the most appropriate tool available
for use in a credit/liquidity crunch. It was, in fact, designed
to be used in the case of a run on a bank. In this case, the
``run'' took place much more outside than inside the banking
system. I don't think we know yet how effective the Fed tools
will be outside the banking system. The lowering of the
discount rate combined with relaxation of the terms, expansion
of collateral eligibility, and generally welcoming banks to use
the discount window all combined to bring some confidence back
into the market.
My primary concern, if I had been a Fed Governor during the
last month, would be the gathering of as much information as
possible on what impact turmoil in the financial markets was
having on real economic activity.
Based on my observations and understanding of the
situation, I do think the Fed has acted appropriately in recent
weeks:
Q.8. Ms. Duke, at your confirmation hearing you expressed
concern over the state of some subprime borrowers, saying:
``what worries me is the very specific situation of a borrower
who, for whatever reason, is in a loan that they cannot pay and
not sure what to do, where to do it. I think some of the things
that we will need to take a look at are finding a trusted
third-party intermediary.'' Can you please explain in more
detail what policies about to be enacted address your concerns?
Please include what role you think the Fed can and should play
in those policies.
A.8. The keys to successful work-outs are early identification
of the problem, accurate information and communication. Many
borrowers, especially those in trouble, do not want to talk to
the lender. They might not trust the lender or they might not
understand the options available for work-out. And in today's
web of investors and servicers, they might not even be able to
find the right person. There are a number of state, local and
community-based organizations devoted to financial counseling
and, specifically, to the housing markets. They would be in a
position to help these borrowers, but I am sure they find
themselves even more under-funded and under-staffed than usual
in today's environment. So any resources provided to these
groups would be helpful.
Any policies that would help borrowers identify these
groups and encourage them to seek assistance would also be
helpful. I have been horrified, however, to read of the scams
perpetrated by criminals posing as debt assistance groups.
Justice should be swift and penalties severe for that crime. We
would need policies in place to ensure that the places we send
borrowers for help have both expertise and the intent to
actually help.
Servicers, as the intermediaries between borrowers and
investors, are going to play a key role in the resolution of
current loan problems. Servicers will need the legal, financial
and human resource capacity to resolve troubled debt
restructures. The banking regulators have recently issued
guidance encouraging bank servicers to anticipate and work
toward successful loan restructures. But not all servicers are
financial institutions or subject to the recent guidance. Some
servicers may actually be in a better position to accept
reduced principal payouts in satisfaction of loans than they
are to modify the terms of the loans. Lenders willing to
finance reduced payouts would speed the resolution of such
cases. CRA and FHA programs could be used to entice lenders to
make loans available. Care must be taken, however, to limit
such assistance to cases where there is documented income
sufficient to make the payments on a fixed rate loan, the
borrower has a past history of responsible payments, and the
property is a primary residence. I would also favor relief from
taxes on debt forgiven on a primary residence.
We have seen recently the warning signs that financially
troubled servicers could actually increase the number of loans
that result in adverse action against borrowers. We must ensure
that payments made to servicers are recorded and forwarded
promptly to lenders, insurers and taxing authorities. It will
be time-consuming and, in some cases, impossible to reverse
consequences to borrowers whose payments were not properly
credited. It will be especially difficult to defend the
requirement for escrow of taxes and insurance if those payments
are not forwarded in a timely manner.
The role of the Fed in this process would probably be
limited to identification of barriers to loan work-outs such as
servicer agreements and encouragement of banks to participate
in workout lending, as in recent guidances issued by the Fed
and others. Also, the Reserve Banks already maintain close ties
to the local markets within their districts. Their knowledge of
local market conditions, understanding of the loan workout
process and existing community development activities could be
very helpful across the country.
Q.9. Ms. Duke, you have been a very strong supporter of
allowing banks to engage in real estate. You were quoted in a
newspaper story that ``Buying a house is probably the largest
financial transaction most people engage in. It makes sense
that financial institutions be able to own the agencies that
produce that transaction.'' Can you share some more detail as
to why you hold this opinion?
A.9. The purchase of a home is the largest and most important
financial transaction entered into by most individuals. Equity
buildup in that home is the greatest contributor to the
accumulated wealth of most individuals. The purchase and
financing of a home are increasingly linked, both in the
marketplace and in the consumer's mind. And brokerage is an
intermediary activity. However, I have never advocated that
banks be allowed to engage in the ownership or development of
real estate.
Q.10. As a Fed Governor you would have the ability and
responsibility to increase competition in many industries,
provided they were to the benefit of consumers and would not
risk the safety and soundness of the financial system. You were
also quoted saying that allowing banks to enter into real
estate would mean, and I quote--``more competitors, which means
a better deal for the consumer.'' Is it your intention to
advocate this position and others that you believe will benefit
consumers, if you are appointed to the Fed Board of Governors?
A.10. I advocated that position as a banker and as Chairman of
the American Bankers Association. If I am confirmed, I would
not advocate this or any other position. If this decision came
before me in my role as a Governor, I would decide it on the
basis of the law. In this case, I believe Gramm-Leach-Bliley
established a mechanism and criteria for such decisions. In any
actions I took as a Governor, I would be guided by the
responsibilities and authorities given to the Fed by Congress
and by my best judgment of the public policy outcome, based on
all of the evidence and public comments before me at the time.
Q.11. Ms. Duke, as Chairwoman of the American Bankers
Association you wrote a regular column in the ABA Journal. You
wrote a column entitled, ``Singing the Regulatory Blues'' in
which you discussed Sarbanes-Oxley, the FACT Act, the Patriot
Act and the GLB Act and stated, and I quote--``The goal, as
John Byrne, the center's director, put it, is `to roll back
regulation.''' Ms. Duke, what specific regulations do you think
ought to be rolled back?
A.11. I would first like to recognize the ongoing efforts of
many to reduce and streamline our existing regulatory
framework. The regulatory agencies have been engaged
individually and collaboratively in reviewing existing
regulations. This committee put much thought and effort into
the regulatory relief bill that passed last year. The SEC and
PCAOB have been engaged in an ongoing effort to reduce the
burden of Sarbanes-Oxley Section 404 while retaining investor
protection. I doubt that a year passes without at least one
hearing in this committee related to regulatory burden.
And I would like to reiterate my earlier pledge that if I
am confirmed, nothing would preclude me from proposing,
enforcing or voting in favor of any regulation.
The cost of regulatory compliance has concerned bankers for
as long as I have been in banking. It would be an easy fix if
we could all point to one especially burdensome regulation as
the source of the problem. Unfortunately, it is the sum of many
different regulations that create the overall burden. When I
was a community banker, I thought small banks had the true
burden because we had such limited resources. When FDICA
passed, the number of implementing regulations exceeded the
number of employees in my bank by 2. When I was with larger
banks, I realized that the compliance task was equally
difficult, primarily due to operational complexity and long
lines of communication.
Numerous studies have attempted to quantify regulatory
compliance costs. However, in recent years, the discussion has
turned from purely cost to regulatory risk and uncertainty.
I'll offer a few examples.
Smaller banks, in particular, struggled with Sarbanes-Oxley
Section 404 compliance. And many who were not required to
comply under the law felt examiner pressure to comply anyway.
The expanded anti-money laundering responsibilities created
by the Patriot Act have elevated regulatory risk. All banks are
committed to detecting and reporting suspicious activity, but
few banks are certain they know how to do so adequately. One
area where banks are particularly uncertain is in the servicing
of money service businesses. As business types are identified
as high risk, banks that feel unable to monitor the risk at a
reasonable cost are stopping service to those businesses.
Finally, I mentioned payment system regulation in my
testimony. Electronic payments are coming of age, surpassing
paper payments in the last few years as the payment of choice.
Check 21 and ACH conversion promise to accelerate this change.
As each payment method has evolved, so has its body of
regulation. The result is a complicated tangle of forward
collection and return rules and timetables. If they are
confusing to bankers, they must be even more confusing to
consumers. The Federal Reserve System is at the heart of the
payment system in this country. If confirmed, I would like to
devote time to studying the regulations and procedures
surrounding payments with the goal of proposing changes that
would make the payment system more efficient, understandable
and predictable.
Q.12. Ms. Duke, I understand that you were President of a
thrift when the OTS decided to increase its exemption to $1
billion for streamlined CRA compliance. Do you agree with the
OTS's decision? Do you think the Fed should consider something
similar?
A.12. I was not President of a thrift. When I was President of
a community bank, I did ask the Fed on numerous occasions to
consider increasing the bank size for streamlined CRA exams. I
did so out of concern for the resources required to meet the
documentation requirements of the large bank exam. (As it
turned out, soon after the community bank where I was President
passed the $250 million threshold, it was purchased by a $50
billion bank.)
Q.13. Hedge funds perform an important role in the capital
markets. Yet some have raised concerns about their potential
impacts to pension funds and retirees. On February 22, 2007,
the President's Working Group on Financial Markets, of which
the Fed is a member, released a set of principles and
guidelines ``to guide U.S. financial regulators as they address
public policy issues associated with the rapid growth of
private pools of capital, including hedge funds.'' The
agreement concentrates on investor protection and systemic risk
concerns. The PWG determined that additional regulation was not
needed. A recent column in The Chicago Tribune stated: ``When
the hedge fund Amaranth Advisors LLC flamed out last year after
disastrous bets on energy prices, San Diego County's retirement
fund was among those burned. Losses to its portfolio were
estimated at $100 million . . . [This] has, however, raised
concerns about the safety of retirement money and stirred
debate on whether more oversight is needed.''
Last October, the then Chief Economist of the IMF observed
that ``a number of state pension funds were invested in a risky
hedge fund like Amaranth. Diversification into such alternative
investments can be a valuable component of an overall
investment strategy, if it is carefully thought out. The
problem is that all too often, it takes place as a form of
herding and late in the game . . . when the good hedge- or
commodity funds are closed to investment . . . new unseasoned
hedge or commodity funds are started precisely to exploit the
distorted incentives of the pension or insurance fund managers
who queue like lemmings to dutifully place the public's money.
Thus far losses from isolated failures have been washed away in
diversified portfolios and the public has not noticed. Will
this always continue?''
How would you respond to these concerns? Do you agree with
the PWG position that further regulation is not needed? Would
you closely monitor the implementation of this guidance,
working with the other PWG members, to preclude systemic
problems from being caused by hedge funds?
A.13. I think the PWG brings together the right expertise and
the right authority to monitor and make recommendations about
the regulation of hedge funds and private equity. I do believe
this market will continue to require close monitoring.
I share the concern that the ``sophisticated investors''
may not turn out to be sophisticated enough. I actually sat on
a university foundation investment committee when the question
of investment in private equity was before us. We were being
encouraged by the example of other foundations that were using
private equity investments. My opinion was then, and is now,
that the foundation shouldn't invest in anything it couldn't
adequately monitor. I expect that conversation has been
mirrored in foundation and pension board rooms around the
country for years. While losses suffered by pension funds or
foundations might not rise to the level of systemic risk, the
losses might indeed require public policy action.
Q.14. The Committee recently passed legislation to improve the
regulation and transparency of the private educational loan
market--the fastest growing segment in the $85 billion student
loan market. Among the growing trends in the private student
loan market is the practice of some lenders using non-
individual data--like a school's default and graduation rate--
in the underwriting used to establish the rate a student
borrower is offered. It's a practice that is eerily reminiscent
of mortgage ``redlining'', when mortgage rates and products
were denied to people based on where they lived rather than
their individual creditworthiness. One of the ways Congress
addressed mortgage redlining was through enactment of tough
anti-discrimination laws and improving transparency of market
practices in the form of HMDA (the Home Mortgage Disclosure
Act), which the Federal Reserve oversees.
Do you think HMDA has been an important tool to promote
transparency?
Do you think a disclosure, transparency regime for private
student loans similar to HMDA is a more useful approach to
addressing concerns about potential ``redlining'' in the
private student loan market or do you believe we should
prohibit the practice of underwriting based on factors such as
the school one chooses to attend?
A.14. Most banks engage in real estate lending to some degree.
HMDA data has made it possible to compare lending data across a
wide spectrum of lenders. Also, the CRA assessment and
examination process focuses on the geographic distribution of
credit. The two have combined to eliminate geographic
``redlining.''
Student lending is a specialty business engaged in by a
smaller number of institutions. It is difficult to comment on
the potential effectiveness of HMDA-type reporting without
knowing the data that would be collected and reported and the
intended use of the data. If the purpose is to eliminate a
specific practice, prohibiting the practice and enforcing the
prohibition may be more effective than reporting.
Q.15. Ms. Duke you served as a Director at the Federal Reserve
Bank of Richmond. During that time, you worked closely with
Richmond Bank President Broaddus. Mr. Broaddus was known as one
of the Fed's biggest inflation hawks. Do you share Mr.
Broaddus's views and concerns about inflation? Are there any
examples in which your thoughts on monetary policy differ and
if so, can you please inform the Committee of the specifics of
those instances?
A.15. I learned more from my three years on the Richmond Board
than from any other experience in my professional life. I
learned about economics, monetary policy, corporate governance
and management. I learned from Mr. Broaddus, from my fellow
Directors, and from the Richmond bank staff.
At every meeting, the staff gave us a book of economic
charts and an analysis of current economic conditions. Each
Director gave a short presentation on observations from his or
her industry or part of the district. Then we would discuss and
vote on our recommendation for the discount rate. Mr. Broaddus
would give us his opinions and his reasons for them, but I
don't remember any specific comments. I only remember that we
had lively discussions and that our votes were seldom
unanimous.
What I took away from it was not a particular bias. I
learned that my job was to pay attention to the information I
had, seek any information I needed, formulate and express my
own opinion and vote my best judgment. That was my observation
of the way Mr. Broaddus approached his lifetime of service to
the Fed. And that is the expectation I would have of myself if
confirmed as a Fed Governor.
------ --
----
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CASEY FROM ELIZABETH
A. DUKE
Q.1. Earlier this year, Chairman Dodd sent a letter to the
Federal Reserve Chairman, Mr. Bernanke, asking him to act on
the Fed's authority and duty under HOEPA (the Home Ownership
and Equity Protection Act) of 1994 to address predatory loans.
We asked him to do three things:
Require all mortgage originators to evaluate a
borrower's ability to repay prior to making a mortgage loan and
that the Fed create a presumption that a loan that requires a
borrower to pay more than 50 percent of his or her income to
cover the cost of principal, interest, taxes, and insurance is
not a sustainable loan and fails to meet this test;
Designate the failure to escrow taxes and
insurance as an unfair and deceptive practice;
Restrict the use of low- and no-documentation
loans.
Do you support the Fed taking each of these three actions?
A.1. First, I would add to this list negative amortization
loans. Negative amortization is dangerous to consumers and
frequently misunderstood by them.
That being said, as I reviewed this list of loan practices,
I was able to identify at least one specific real borrower who,
in my experience, had a loan request that legitimately needed
the feature that would be prohibited. But the legitimate need
and acceptable risk would only have been apparent with full
knowledge of the borrower circumstances. In the past these
borrowers would not have had access to traditional mortgage
loans. They would have required tailored bank lending.
What I don't know is whether the wholesale offering of
loans with these features without detailed credit analysis is
more often harmful than helpful to consumers. If, on balance,
they are more harmful, the Fed should restrict them knowing
that some borrowers will be unable to obtain credit.
Q.2. A central goal of HOEPA is equity protection. Given the
decline in homeownership rates among African-Americans over the
past few years, and given the equity stripping that we have
seen in the subprime mortgage market: Has the Federal Reserve
done everything in its power to protect the home ownership and
equity of these consumers? What, if anything, can be done
differently?
A.2. A number of equity stripping practices are currently
prohibited. Any practice that has the effect of taking equity
without providing any commensurate benefit to the consumer
should be prohibited.
Q.3. Congress is considering a number of measures to address
some of the abuses in mortgage lending, including the
Borrower's Protection Act. That bill would establish lender
liability for the actions of associate appraisers and brokers.
Do you support establishing that liability?
A.3. Any provision that increases the lender liability will
increase the lender risk, which raises the cost and reduces the
availability of credit. Lender and assignee liability
legislation must be carefully crafted to be sure the enhanced
consumer protection is balanced with the cost and availability
of credit. A review of actual experience in states where lender
liability provisions have been enacted could help predict the
outcome of such provisions.
Q.4. There is a great deal of data on mortgage lending from the
Home Mortgage Disclosure Act. That data shows unexplained
racial disparities in mortgage lending, including interest
rates and costs. Would you support using this data to identify
banks and lenders with unexplained disparities, racial or
otherwise, as a reason at the very least to open an
investigation of those lenders?
A.4. I would support such investigation. I believe the banking
regulators do use HMDA data as a ``screen'' to target banks
with significant disparities for enhanced fair lending exams.
Many banks also perform internal investigations using their own
data.
Q.5. Two of you have worked for banks and Governor Krozner has
been on the Federal Reserve Board for the past year. In your
opinion, is it possible for banks or lenders to provide people
with too much credit, so much that their financial situation is
actually harmed? Have banks in the recent past been extending
too much credit to consumers and if so, what should regulators
do about that? And should regulators look for ways to ensure
that too much credit is not provided?
A.5. Bankruptcy statistics would certainly indicate that some
individuals have been provided with too much credit. But this
would be a very difficult area to regulate. It is hard to
determine accurately in advance how much credit is too much for
any individual. And consumers do not obtain all credit from a
single source. In the past, banks have been criticized more
often for not lending enough than for lending too much.
Q.6. Do you believe that yield spread premiums, which
financially reward mortgage brokers for steering borrowers to
higher rate loans than they might otherwise qualify for and
prepayment penalties which trap borrowers in unfair loans, can
distort competition?
A.6. Borrowers deserve to understand the terms and conditions
of any loan being offered to them. If they are being placed
into loans with terms worse than those they would qualify for
in the competitive market, we should take the necessary actions
to correct such a situation. In addition to specific practices
such as yield spread premiums and prepayment penalties, I would
look at advertising, promotion and the timing and adequacy of
pricing disclosures.
Q.7. Last Thursday the Leadership Council on Civil Rights
called upon the FRB to intervene in the subprime crisis,
specifically noting that it is ``glad that the nominees showed
strong interest in getting rid of prepayment penalties and
other abusive terms in subprime loans.''
What are you planning to do to combat the abusive practice
of steering of borrowers (and specifically minorities) into
loans that are more expensive than loans for which the
borrowers could qualify?
What are you planning to do, as LCCR requests, to ensure
that the FRB ``uses [the keys to resolving the ongoing
foreclosure crisis] as quickly as possible''?
What will you do to get rid of abusive terms and practices
in the subprime market so that borrowers can remain in their
homes and good, responsible lenders are not placed at a
competitive disadvantage?
A.7. I share your concern about sub-prime loans and about
current conditions in the mortgage market. The discussions held
in this nomination hearing have only intensified my desire to
delve more deeply into the issues and use my experience as a
small business lender to help formulate changes that will have
long term benefit for homeownership and the mortgage market in
this country.
I would like to start with some observations about sub-
prime lending generally and then comment on your bill.
First, I would like to emphasize that the growth of the
secondary market--with non-traditional lenders making non-
traditional loans--has resulted in higher levels of home
ownership and an opportunity for building wealth in segments of
the population that were closed out of traditional mortgage
lending. So our challenge here is to reduce the cost in terms
of financial difficulty and foreclosure while preserving
flexibility and opportunity with mortgage products in the
future.
Chairman Bernanke has discussed with this committee the
Federal Reserve's intention to propose rulemaking under HOEPA
later this year. New regulations are a good first step, but we
must also look to the enforcement of those regulations. We
should encourage the joint state and federal regulatory
discussions and pilot programs already underway to achieve this
end.
Although banks are participants in the mortgage market, the
market has expanded well beyond insured financial institutions.
I think it is time to review the entire mortgage marketplace
including prime, jumbo, alt-A as well as non-traditional
mortgages. It is important that we consider all the players and
all the regulators in the marketplace to ensure uniformity
across the full spectrum of originators, loan servicers, rating
agencies and investors.
As the mortgage market expanded rapidly in recent years,
competition led to breakdowns in risk assessment and risk
pricing. Now, concerns about credit risk have caused liquidity
to dry up. Consequently, very few loans with high risk features
are being made today. Innovation in mortgage lending over the
last few years has created loan structures and terms with which
there was little experience when the loans were made. In
designing the mortgage products of the future, statistical
studies of the contribution of various risk features to actual
credit loss will be quite helpful to all in assessing and
pricing risk. Use of the Federal Reserve research capability to
dissect the decisions and conditions that led us to this state
could identify changes that can prevent a recurrence.
Stemming the tide of foreclosures may be the most pressing
and the most difficult problem of the day. Foreclosure is the
highest cost loan resolution option for the borrower, the
lender, and the community. Successful loan work-outs require
good communication between the borrower and the lender, and we
should do everything possible to facilitate this, including
support of trusted third party intermediaries. Workouts also
require flexibility to match modifications to individual
borrower circumstances. To this end, we should continue to
investigate any legal, accounting or structural impediments to
loan modifications. And we should be supportive of flexibility
and creativity in providing responsible lending to fund
restructured loans. We should recognize, however, some
foreclosures will need to take place. In cases where there is
no possibility of workout, the lender should be able to take
responsibility for the property, including taxes and
maintenance. The lender will also have the greatest incentive
to re-sell the property so it can be reoccupied and the
recovered funds can be invested in new loans.
Your legislation recognizes the immediacy of the current
foreclosure problems and indicates the willingness of Congress
to provide assistance to state, local and community based
groups. Just as all real estate markets are local, so are real
estate problems. It will take the commitment of many on the
front lines supported by state and federal governments to
resolve each loan individually. One way to make more private
funds available might be to designate the circumstances under
which refinance assistance could qualify for CRA credit.
Legislation governing mortgage standards and practices must
be evaluated in light of the balance between consumer
protection and credit availability. As lenders are increasingly
separated from originators and borrowers, they will be
unwilling to assume risks they can neither assess nor control.
In evaluating the balance, I would look to the experience of
the states that have already enacted similar legislation. And I
would hope we would undertake the study of the full mortgage
market that I proposed above and use the information from such
a study to guide our regulatory changes impacting this
important part of our economy.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM
ELIZABETH A. DUKE
Subprime
Q.1. How would you characterize the Federal Reserve's actions
in response to the subprime crisis? Do you think the Federal
Reserve has taken adequate action?
A.1. I am responding to these questions assuming you are
referring to the recent credit contraction started by concerns
over sub-prime. I do think the Fed's actions so far have been
appropriate.
If you are referring to the Fed's actions regarding
consumer protection, I think more action is needed and will be
forthcoming.
Q.2. What do you think the role of the Federal Reserve should
be for addressing crises in loan markets such as the subprime
crash?
A.2. The Fed must stay focused on the dual mandate of full
employment and stable prices. To the extent a credit
contraction threatens the macroeconomy and real economic
growth, the Fed might need to provide liquidity. In determining
the amount of liquidity to provide, the Fed must weigh the
relative risks to growth and inflation.
Q.3. Would you say the meltdown of the subprime market is
contained at this point?
A.3. I don't think the participants in the sub-prime market
have yet identified the magnitude of potential losses or where
those losses are currently held. We do not yet know the extent
to which problems in the housing market will spread to the
economy as a whole.
Q.4. What would you recommend the Fed do moving forward to
ensure that subprime market stabilizes?
A.4. I think the Fed is going to need to actively monitor all
segments of the credit markets. Ultimately a reassessment and a
repricing of risk is overdue. Institutions' losses resulting
from reckless lending will go a long way toward ensuring such
behavior and practices aren't repeated. And the part of the
sub-prime market that ultimately emerges will likely be a much
healthier market.
Q.5. Are other areas of the subprime crisis that the Fed has
not yet addressed?
A.5. The Fed is monitoring events closely. As events unfold,
additional action may be needed. I believe the Fed will act as
necessary.
Credit Cards
Q.6. Do you think unscrupulous practices by credit card issuers
is prevalent enough to generate concern or that necessitate
taking a closer look?
A.6. I think practices such as double cycle billing and
universal default are unfair and deserve attention.
Q.7. How would you characterize the prevalence of certain
practices by credit card issuers that appear to either be
misleading or unfair? Is it a problem only among a few issuers,
or a more widespread problem throughout the industry?
A.7. While some smaller institutions have small credit card
portfolios, the business is scale intensive. The majority of
the credit card market is concentrated in a small number of
issuers. I would expect billing and pricing practices to be
similarly concentrated.
Q.8. Do you have a position on legislation that would further
regulate or limit some of these practices?
A.8. I do not have a position on any specific legislation.
Q.9. How do you view the role of the Federal Reserve in this
area? Do you think the Federal Reserve is doing enough to
improve disclosure and strengthen enforcement under TILA? Is
there more to be done?
A.9. I think the work done by the Fed recently on credit card
disclosures should serve as a model of disclosure review. I was
particularly pleased to see the Fed use consumer testing to
determine the effectiveness of disclosures. I look forward to
the continuation of this review of disclosures in closed-end
lending and mortgage lending. In light of the current mortgage
market, review of mortgage disclosures is probably more
pressing than that of other closed-end credit.
Access to Capital
Q.10. Over the last few years, the Federal Reserve, the Small
Business Administration and others have conducted studies that
reveal minorities have unequal access to credit for small
business development, even when factors such as credit history
and net worth are comparable to non-minorities. In your
opinion, in addition to promoting financial education, how can
we improve ``access to capital'' for minority-owned businesses?
A.10. Many years ago, I participated in a study of credit
access conducted by the Virginia Legislature. We found then
that the greatest need was for venture capital and equity
capital. Start-up and small businesses that did not qualify for
traditional bank lending were primarily funded with personal
credit (often credit cards) and support from friends and
family. At the time, there were some experimental state and SBA
programs aimed at the credit needs of micro businesses, but I
don't know what the final results of those programs were.
In the last several years, many banks have tried to improve
the overall efficiency of lending to small businesses using
lessons from the consumer lending process. However, businesses
are much less uniform than consumers in their characteristics,
need for and use of credit. And small business lending blends
the experience of consumer lending with the experience of
commercial lending. I think the level of success with such
programs has been quite uneven.
I haven't seen the studies you reference, but I think we
are still evolving in our understanding of the best way to meet
small business needs, including minority-owned businesses. I
would be quite interested in any of the recommendations or
conclusions from those studies.
Q.11. What role can the Federal Reserve play to encourage
institutions to engage in expanding access to capital, both for
individuals and businesses?
A.11. I think all the banking regulators should encourage
efficient, responsible, unbiased lending to all segments of the
market.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA FROM ELIZABETH
A. DUKE
Q.1. Our modern, complex economy depends on the ability of
consumers to make informed financial decisions. Without a
sufficient understanding of economics and personal finance,
individuals will not be able to appropriately manage their
finances, evaluate credit opportunities, and successfully
invest for long-term financial goals in an increasingly complex
marketplace. What must be done to ensure that Americans have
the knowledge and skills necessary to make informed financial
decisions?
A.1. We must teach these skills in K-12 education. We need to
be sure we have adequately prepared the teachers to teach these
subjects, and the requirements must be deeply imbedded in core
curricula. And we must test for these skills in our proficiency
exams. Many groups are anxious to provide materials and
resources, but we will need to build the infrastructure to use
the tools effectively.
One of my favorite parts of my current job is serving as
the executive sponsor for our management development program.
In a few weeks, our young management associates will go into
local high schools to participate in the ABA ``Get Smart About
Credit'' program. They are extremely excited about the
opportunity to talk about ``what they wished they had known
before.'' We need to find and use every opportunity like this.
Q.2. Approximately 10 million households in the United States
do not have accounts at mainstream financial institutions.
Unfortunately, too many of these households depend on high-cost
fringe financial services. They miss out on opportunities for
saving, borrowing, and lower cost remittances found at credit
unions and banks.
What must be done to bring these households into mainstream
financial institutions?
A.2. We need to tackle the reasons why these households do not
use mainstream financial institutions. I believe some of those
reasons would include:
Inability to manage a bank account resulting in
overdrafts and overdraft fees;
Inability or reluctance to produce documentation
needed to open an account; and
Distrust of mainstream financial institutions.
Q.3. I am deeply concerned that too many working families are
taken advantage of by unscrupulous lenders through payday
loans. What must be done to restrict payday loans and expand
access to affordable, small loans?
A.3. Numerous state and federal regulations, including the new
Talent amendment regulations on military loans, restrict payday
lending. Several banks are working with the FDIC on a pilot
small loan program. Again, financial education would help
consumers understand the expense of payday loans.
Q.4. Too many working families have their Earned Income Tax
Credit benefits needlessly reduced by high cost-refund
anticipation loans (RALs). What must be done to restrict these
predatory loans and encourage alternatives to RALs?
A.4. We can restrict or eliminate the lending by restricting or
eliminating the ability to use the refunds as collateral or by
sending payments only to the taxpayer. It is difficult to
restrict the allure of getting the money today rather than
later.
Q.5. I am concerned that consumers are not provided with enough
information about the long-term consequences of making only the
minimum credit card payments.
What must be done to ensure that consumers are adequately
informed of the true cost of making only the minimum payment?
A.5. The proposed new TILA credit card disclosures contain some
new disclosures related to the consequences of only making
minimum credit card payments. We could require additional
disclosures, but disclosure alone is a poor substitute for
financial understanding. This is another area where financial
education could significantly improve financial health.
------ --
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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM LARRY A.
KLANE
Q.1. Mr. Klane, at your confirmation hearing, you agreed to
submit, in writing, a list of all credit card practices that
you found abusive, in addition to universal default and double
cycle billing. Please submit this list, and include what
practices you think are clearly wrong, which merit further
attention and whether it is disclosure, regulation or
legislation that you believe is best suited to address the
problem.
A.1. I would like to highlight two specific practices and two
more general areas in credit card lending where I have
concerns.
On the specific practices, as we discussed in the hearing,
I share the Committee's concern with ``universal default'' and
double-cycle billing. It is encouraging that a number of
issuers who engaged in these practices have recently changed
their approach, but to the extent some industry participants
continue these practices, I remain concerned.
In addition, I believe that current credit card disclosures
are not adequate. This is the first of the two more general
areas I want to address. The complexity of current disclosures,
along with the difficulty in using them to focus on the most
consumer-relevant terms and conditions, leave consumers
inadequately equipped to make informed choices among products
and issuers. Disclosures must be made clearer and more
consumer-relevant. In this regard, I am highly encouraged by
the on-going work of the Federal Reserve in its efforts to
revise Regulation Z. The use of consumer focus groups and the
explicit effort to create simpler and more comprehensible
disclosures is a strong step in the right direction. These
proposed regulations are out for public comment, and I look
forward to the Federal Reserve's finalizing them. Once they are
final, we will be able to judge, after some experience, whether
further adjustments, amendments, or expansions need to be made.
My second general area of my concern is penalty repricing
of accounts, which occurs when a customer breaks one or more of
the rules embodied in the credit card contract's terms and
conditions. While it is legitimate in general for an issuer to
be able to change the price of credit on open-ended lines to
customers who demonstrate higher levels of riskiness through
such rule breaks, I am concerned about:
Insufficient disclosures and/or notices to
consumers on repricing actions (e.g., initially when receiving
the card, at the moment of rule break, and at the moment of
repricing);
the inclusion of multiple repricing rules that
can be triggered by a single infraction; and
the options available to consumers who have
experienced repricing (e.g., the ability to return to the prior
rate based on good performance over time or the ability to pay
off the existing balance at the prior rate over some time
frame).
The Federal Reserve's proposed revisions to Regulation Z,
including the 45-day notice provision, address some aspects of
the concerns I have outlined. However, the general area of
repricing deserves continued attention to ensure that consumers
are adequately protected and able to make good decisions on
their use of credit cards.
Q.2. Mr. Klane, at your confirmation hearing I raised some
questions associated with Capital One's practice of not
reporting customers' credit limits to the credit reporting
bureau. Specifically, I raised the question as to what the
ramifications to consumers would be if that had the effect of
lowering their FICO score. I asked you, ``But if, in fact,
their credit rating under FICO were such that competitors would
be less interested in them as customers is that not--aren't you
advantaged to some degree as a result?'' You responded: ``I do
not see why that would be the case, Senator.'' Can you please
explain how a lower FICO score would not damage a consumer's
ability to obtain a better interest rate? Can you also please
explain how, if Capital One had proprietary information that
allowed them to selectively market to consumers whose FICO
scores appeared artificially lower to other lenders, how this
would not be an advantage to Capital One? Finally, can you
explain how that would not be a disadvantage to the consumer?
A.2. As mentioned at the confirmation hearing, I appear before
the committee as a private citizen seeking to perform public
service, not to represent Capital One. As I mentioned at the
hearing, I was not engaged in Capital One's decisions
concerning credit bureau reporting as I do not run the U.S.
Credit Card business.
That said, I would like to provide as much perspective on
the question as possible. As you are aware, Capital One has
recently begun to report credit lines for all of its customers.
While the company continues to believe that this information
has strategic risk management value of a proprietary nature, it
recognized that the negative attention this practice has drawn
from various external constituencies outweighed any benefits
from keeping credit lines proprietary. Nevertheless, I would
like to stress that the company's decision to withhold credit
lines was driven by a desire to keep credit line information
proprietary, not to deflate artificially individual customers'
credit scores. Capital One has not sought, nor is it able, to
unilaterally impact customers' credit scores negatively in this
manner, nor is it able to selectively target individuals for
non-competitive offers in the manner suggested. No legitimate
business purpose would be served by that outcome, and there
have been no marketing strategies or approaches I am aware of
that tried to do so.
FICO's methodology is proprietary, and thus no institution
knows what, if any, impact its line reporting policy may have
on their scoring models. Nevertheless, Capital One is not aware
of any statistically valid or conclusive evidence supporting
the contention that a single issuer's policy has, or could
have, any such effect.
Lower FICO scores impede all lenders' abilities to market
to consumers, including Capital One's ability to increase
customer's credit lines, offer them more competitive terms, or
cross-sell mortgage, auto and other loan products to customers.
Q.3. Mr. Klane, can you share with the Committee your views on
the separation between banking and commerce? Specifically, what
are your views on Industrial Loan Companies?
A.3. There has long been a concern among legislators and
regulators on the implications of mixing banking and commerce.
Given the importance of a stable banking system and the
existence of government deposit guarantees, special weight
should be given to ensure that depositories remain safe and
sound. Historically, there has been the view that this safety
and soundness is easier to achieve by maintaining the
separation between banking and commerce. If legislators were to
allow a lesser degree of separation, then it would require a
revised regulatory framework to ensure the safety and soundness
of the depository institutions. This is true for Industrial
Loan Companies as well as other charters that might in the
future allow for a more ``mixed'' model. A clear and workable
supervisory framework is a key element as Congress reassesses
the appropriate degree of separation between banking and
commerce.
Q.4. Mr. Klane, at your confirmation hearing I asked you and
the other nominees: ``whether or not you think the Fed acted in
a timely fashion and could have done more, looking back.'' You
responded: ``All that being said, I think sitting here, with
hindsight, I think we can say very clearly that if the Fed had
acted somewhat earlier, we might have had to some extent a
better outcome.'' Can you please elaborate on what actions the
Fed should have taken that would have provided a better
outcome? Can you please include in your answer when you believe
those actions should have taken place?
A.4. Because I have not been on the Board, I have not been
privy to the information and analysis that was available at the
time. Policy needs to be made at the line of scrimmage, with
only the available data at the time--so hindsight has important
limitations. That said, I was pleased to hear Chairman Bernanke
pledge to exercise the Federal Reserve's authority under HOEPA
to strengthen rules protecting customers from unfair and
deceptive mortgage practices. If such rules were in place
earlier, they might have provided a somewhat better outcome. If
confirmed to the Board, I would look forward to working in this
very important area.
Q.5. Mr. Klane, at your confirmation hearing, in response to a
question from Senator Shelby about concerns about the credit
quality of subprime mortgage that ``it also underscores the
importance going forward of having underwriting criteria that
take into account rate reset.'' When you were in charge of
Capital One's home mortgage division did your company take into
account rate resets in the mortgages that it issued?
A.5. Given the recent events in the subprime mortgage market,
all reflective participants involved in the mortgage industry
have learned the importance of taking into account rate resets.
The vast majority of mortgages issued by Capital One Home Loans
were fixed rate and fully documented. All loans were rigorously
underwritten to the investor's guidelines. Those guidelines,
for the few adjustable rate mortgages issued, were consistent
with industry norms at the time which focused principally on
the initial rate.
Q.6. Mr. Klane, do you think that the 2001 Bush tax cuts have
resulted in an increase or decrease in real federal revenue?
A.6. I do not have available in my current position all of the
data and information required to undertake a full analysis of
the real versus nominal impact on federal revenue of the 2001
changes to the tax code.
Q.7. Mr. Klane, in your appearance before the Committee, you
stated that you are a strong believer in the Fed's dual mandate
for maximum employment and price stability. Are there
approximate figures for the nation's unemployment rate and
inflation rate that match what you believe to be maximum
employment and price stability? If so, can you share what those
are?
A.7. Given the dynamic nature of the U.S. economy, underlying
changes to productivity, and the impact of the global economy
on our country, I do not believe there is a fixed relationship
between the nation's unemployment and inflation rates in order
to match maximum employment and price stability. My assessment
of the relationship between these rates and the twin objectives
would be informed by the specific environment at the time,
along with all of the available information and analysis.
I would like to reiterate my strong support for the dual
mandate. If confirmed, I would ensure that pursuit of both
maximum sustained employment and price stability informed my
thinking on monetary policy.
Q.8. Mr. Klane can you inform the Committee of any periods in
American history where you believe that maximum employment was
not being reached or that price stability was not achieved?
During those periods, what actions do you believe the Fed
should have undertaken to achieve its mandate?
A.8. Having recently read Timothy Egan's moving book, The Worst
Hard Time: The Untold Story of Those Who Survived the Great
American Dust Bowl, I would offer the Great Depression as a
time when America clearly did not achieve maximum employment or
price stability. Many economists have written about this time
period, and I think it is clear that the Federal Reserve, among
other things, should have injected more liquidity into the
banking system and should have stood more firmly as a lender of
last resort for otherwise solvent institutions.
Q.9. Mr. Klane, how do you explain the Federal Reserve's
findings from the HMDA data that in 2005, 54.7% of African-
American borrowers and 46.1% of Hispanic borrowers got high-
priced loans when buying a home compared to 17.2% of non-
Hispanic whites?
A.9. On their face, these differences are worrisome and I agree
that no borrower should suffer discrimination. All regulators,
including the Federal Reserve, should vigorously monitor
compliance and enforce fair lending laws to ensure there is no
discrimination in lending.
Pricing outcomes on loans are driven by an array of
considerations, some of them not included in HMDA data (e.g.,
FICO scores, debt-to-income ratios, etc.). Many factors, other
than discrimination, could contribute to the differences sited.
It is not possible to use HMDA data alone to draw firm
conclusions on precisely what is driving pricing differentials.
However, those data can and should be used, along with all the
other data available to examiners concerning an institution's
lending practices, to try to reach such conclusions in order to
root out discrimination.
Q.10. In the Fed's analysis of the data, significant racial and
ethnic differences remained unexplained even after accounting
for other information reported in the HMDA data. The Fed found
that borrower-related factors accounted for only about one-
fifth of the disparity. Do you believe that there is racial
discrimination in the mortgage market? If so, how do we root it
out of the system? What specific additional steps should the
Fed undertake to do so? If you do not believe that there is
racial discrimination, how do you explain these racial
disparities?
A.10. Discrimination has no place in lending. If confirmed to
the Board, I would enforce fair lending laws vigorously. As
mentioned in a prior answer, it is not possible to draw
definitive conclusions about potential discrimination based on
HMDA data alone because pricing outcomes are driven by an array
of considerations, some of them outside the scope of HMDA data.
However, regulators, in their supervisory capacity, have access
to the full set of data around pricing decisions for regulated
institutions. Regulators need to be vigilant in enforcing fair
lending laws and investigate possible violations. HMDA data can
be a useful starting point.
Q.11. As you know, only the Federal Reserve, the Office of
Thrift Supervision, and the National Credit Union
Administration currently have the authority to promulgate a
rule dealing with unfair or deceptive acts or practices. In
your view, should the other agencies be given the same
authority? Please explain your reasoning.
A.11. Providing this authority is the prerogative of Congress.
I do not feel it is appropriate for me as a nominee to opine on
specific legislation. However, if confirmed to the Board, I
would work to exercise the authority given to the Federal
Reserve to the best of my ability.
Q.12. The Committee recently passed legislation to improve the
regulation and transparency of the private educational loan
market--the fastest growing segment in the $85 billion student
loan market. Among the growing trends in the private student
loan market is the practice of some lenders using non-
individual data--like a school's default and graduation rate in
the underwriting used to establish the rate a student borrower
is offered. It's a practice that is eerily reminiscent of
mortgage ``redlining'', when mortgage rates and products were
denied to people based on where they lived rather than their
individual creditworthiness. One of the ways Congress addressed
mortgage redlining was through enactment of tough anti-
discrimination laws and improving transparency of market
practices in the form of HMDA (the Home Mortgage Disclosure
Act), which the Federal Reserve oversees.
Do you think HMDA has been an important tool to promote
transparency? Do you think a disclosure, transparency regime
for private student loans similar to HMDA is a more useful
approach to addressing concerns about potential ``redlining''
in the private student loan market or do you believe we should
prohibit the practice of underwriting based on factors such as
the school one chooses to attend?
A.12. The private student loan market is growing rapidly and,
given demographics and other trends, looks like it will
continue to grow for some time. The emergence of a private
market should provide a positive additional choice for
consumers needing to borrow to finance education. It is
important in this market, as elsewhere in lending, to have
clear and comprehensible disclosures. If confirmed to the
Board, I would look forward to engaging--as appropriate--in the
issue of the private student loan market. With the tools and
perspectives available to a Board member, I would then be in a
position to gather the full range of input on the topics of
disclosures and whether additional measures should also be
considered.
Q.13. Mr. Klane, as you know the FOMC voted unanimously in its
August meeting to keep interest rates constant and in the
accompanying statement that their ``predominant policy concern
remains the risk that inflation will fail to moderate as
expected.'' Over the next ten days there were significant
disruption in the equity and bond markets that caused the Fed
to reverse course, cut the rate at the discount window by 50
basis points and issue the following statement ten days after
their August meeting: ``Financial market conditions have
deteriorated, and tighter credit conditions and increased
uncertainty have the potential to restrain economic growth
going forward. In these circumstances, although recent data
suggest that the economy has continued to expand at a moderate
pace, the Federal Open Market Committee judges that the
downside risks to growth have increased appreciably. The
Committee is monitoring the situation and is prepared to act as
needed to mitigate the adverse effects on the economy arising
from the disruptions in financial markets.''
Do you believe that the FOMC made a mistake at their
original August meeting? Do you believe that the predominant
policy concern remains the inflation in light of the events
since the August meeting of the FOMC? If you had been a Fed
Governor, what actions, if any, would you have taken that were
different from those taken by the Fed Governors?
A.13. After my receiving this question, the FOMC met on
September 18th and decided to lower both the Federal Funds and
Discount Rate by 50 basis points. The FOMC clearly considered
the recent disruptions to the credit markets and other related
events to pose a broader risk to the economy and the goal of
maximum sustainable employment than during the August meeting.
Not sitting on the Board at the time of either of these
meetings, and thus not having access to the information
available at the moment of these policy decisions, I cannot
speculate whether I would have taken a different position had I
been a Fed Governor and member of the FOMC at the time.
Q.14. Hedge funds perform an important role in the capital
markets. Yet some have raised concerns about their potential
impacts to pension funds and retirees. On February 22, 2007,
the President's Working Group on Financial Markets, of which
the Fed is a member, released a set of principles and
guidelines ``to guide U.S. financial regulators as they address
public policy issues associated with the rapid growth of
private pools of capital, including hedge funds.'' The
agreement concentrates on investor protection and systemic risk
concerns. The PWG determined that additional regulation was not
needed. A recent column in The Chicago Tribune stated: ``When
the hedge fund Amaranth Advisors LLC flamed out last year after
disastrous bets on energy prices, San Diego County's retirement
fund was among those burned. Losses to its portfolio were
estimated at $100 million . . . [This] has, however, raised
concerns about the safety of retirement money and stirred
debate on whether more oversight is needed.''
Last October, the then Chief Economist of the IMF observed
that ``a number of state pension funds were invested in a risky
hedge fund like Amaranth. Diversification into such alternative
investments can be a valuable component of an overall
investment strategy, if it is carefully thought out. The
problem is that all too often, it takes place as a form of
herding and late in the game . . . when the good hedge- or
commodity funds are closed to investment . . . new unseasoned
hedge or commodity funds are started precisely to exploit the
distorted incentives of the pension or insurance fund managers
who queue like lemmings to dutifully place the public's money.
Thus far losses from isolated failures have been washed away in
diversified portfolios and the public has not noticed. Will
this always continue?''
How would you respond to these concerns? Do you agree with
the PWG position that further regulation is not needed? Would
you closely monitor the implementation of this guidance,
working with the other PWG members, to preclude systemic
problems from being caused by hedge funds?
A.14. The emergence of hedge funds and other private pools of
capital is a significant development for the financial system.
They can have significant impact on the regulated banking
sector, as well as on working American families via investments
made by retirement funds. While I do not have grounded
information that would cause me to disagree with the PWG on the
current need for more regulation, I feel strongly that close
monitoring of developments is well justified. If confirmed to
the Board, I would work closely with other PWG members to
monitor the situation, and develop appropriate actions as
needed.
------ --
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR CASEY FROM LARRY A.
KLANE
Q.1. Earlier this year Chairman Dodd sent a letter to the
Federal Reserve Chairman, Mr. Bernanke, asking him to act on
the Fed's authority and duty under HOEPA (The Home Ownership
and Equity Protection Act) of 1994 to address predatory loans.
We asked him to do three things:
Require all mortgage originators to evaluate a
borrower's ability to repay prior to making a mortgage loan and
that the Fed create a presumption that a loan that requires a
borrower to pay more than 50 percent of his or her income to
cover the cost of principal, interest, taxes, and insurance is
not a sustainable loan and fails to meet this test;
Designate the failure to escrow taxes and
insurance as an unfair and deceptive practice;
Restrict the use of low- and no-documentation
loans.
Do you support the Fed taking each of these three actions?
A.1. I support the Federal Reserve's acting on its authority
and duty under HOEPA, and was pleased to hear Chairman
Bernanke's intention in this regard. Further, I think each of
the three areas highlighted justify concern. As I have not
benefitted from the wide set of perspectives that current Board
members would have on these particular points, I do not feel I
can take a fully informed and balanced position these specific
proposals. That said, if confirmed to the Board, I would
certainly examine the issues of affordability, escrowing taxes
and insurance (particularly in subprime loans), and the
appropriate role of documentation to determine the best course
of action.
Q.2. A central goal of HOEPA is equity protection. Given the
decline in homeownership rates among African-Americans over the
past few years, and given the equity stripping that we have
seen in the subprime mortgage market: Has the Federal Reserve
done everything in its power to protect the home ownership and
equity of these consumers? What, if anything, can be done
differently?
A.2. Increasing savings generally (one important component of
which can be homeowner equity) is an important public policy
goal. Achieving these increases is a multi-faceted challenge.
On the specific issue of protecting home ownership and equity,
the Federal Reserve has a role to help ensure borrowers are not
prey to unfair and deceptive practices. The Federal Reserve's
recently stated intent to write rules under HOEPA is a positive
step in this regard.
Q.3. Congress is considering a number of measures to address
some of the abuses in mortgage lending, including the
Borrower's Protection Act. That bill would establish lender
liability for the actions of associate appraisers and brokers.
Do you support establishing that liability?
A.3. Please see the previously submitted response on the
Borrower's Protection Act. On the specific issue of
establishing lending liability around actions of appraisers and
brokers, some forms of liability could play a constructive
role. However, any liability needs to be very clearly
delineated and financial damages reasonable in the context. One
objective would be to maintain a vibrant, responsible mortgage
market. Liability rules would need to be structured in such a
way as to ensure that responsible lenders and brokers do not
vacate the market. Otherwise, consumers and consumer choice
would be unduly limited.
Q.4. There is a great deal of data on mortgage lending from the
Home Mortgage Disclosure Act. That data shows unexplained
racial disparities in mortgage lending, including interest
rates and costs. Would you support using this data to identify
banks and lenders with unexplained disparities, racial or
otherwise, as a reason at the very least open an investigation
of those lenders?
A.4. Discrimination has no place in lending. If confirmed to
the Board, I would enforce fair lending laws vigorously. HMDA
data can be a useful starting point for regulators when
examining lending institutions. However, it is not possible to
draw definitive conclusions about potential discrimination
based on HMDA data alone because pricing outcomes are driven by
an array of considerations, some of them outside the scope of
HMDA data. However, regulators, in their supervisory capacity,
have access to the full set of data around pricing decisions
for regulated institutions. Through rigorous statistical
analysis of the full set of data, regulators can determine
whether or not an institution has engaged in actual
discrimination. Regulators need to be vigilant in enforcing
fair lending laws and investigate possible violations. HMDA
data can certainly be a useful starting point.
Q.5. Two of you have worked for banks and governor Krozner has
been on the Federal Reserve Board for the past year.
In your opinion, is it possible for banks or
lenders to provide people with too much credit, so much that
their financial situation is actually harmed?
Have banks in the recent past been extending too
much credit to consumers and if so, what should regulators do
about that?
And should regulators look for ways to ensure
that too much credit is not provided?
A.5. Lending institutions should make loans that are affordable
to borrowers. This is good not only for the consumer, but also
for the lending institution. A bank that systematically
provides credit inappropriately will not be a safe and sound
institution (in addition to burdening the underlying consumer).
Regulators have a supervisory mandate to ensure safe and sound
institutions. Regulators also must ensure that supervised
institutions have appropriate risk management and associated
underwriting processes. These processes will help ensure that
borrowers receive appropriate loans. In addition of course, the
role of financially informed consumers is critical in achieving
overall good outcomes for borrowers. I strongly support the
financial literacy efforts of the Federal Reserve and many
other institutions.
Q.6. Do you believe that yield spread premiums, which
financially reward mortgage brokers for steering borrowers to
higher rate loans than they might otherwise qualify for and
prepayment penalties which trap borrowers in unfair loans, can
distort competition?
A.6. Brokers steering borrowers to bad loans is unacceptable.
To the extent that incentive structures drive behavior that
results in unfair loans, these incentive structures should be
examined. If confirmed to the Board, I would help the Federal
Reserve execute its responsibilities in this area.
Q.7. Last Thursday the Leadership Council on Civil Rights
called upon the FRB to intervene in-the subprime crisis,
specifically noting that it is ``glad that the nominees showed
strong interest in getting rid of prepayment penalties and
other abusive terms in subprime loans.''
What are you planning to do to combat the abusive
practice of steering of borrowers (and specifically minorities)
into loans that are more expensive than loans for which the
borrowers could qualify?
What are you planning to do, as LCCR requests, to
ensure that the FRB ``uses [the keys to resolving the ongoing
foreclosure crisis] as quickly as possible''?
What will you do to get rid of abusive terms and
practices in the subprime market so that borrowers can remain
in their homes and good, responsible lenders are not placed at
a competitive disadvantage?
A.7. If confirmed to the Board, I would work diligently and
urgently on these issues. I would support the effort to write
rules under HOEPA which address unfair and deceptive practices
across the entire mortgage industry--not just institutions
regulated by the Federal Reserve. More generally, I would work
to broaden the lending choices that consumers have through a
blend of good regulations, informed consumers, and a
competitive marketplace populated by responsible institutions.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM LARRY A.
KLANE
Q.1. 1 understand that Capital One, where you are currently a
top executive, did a brisk business in subprime lending,
particularly in the origination of exotic loans, such as 2/28
and 3/27 adjustable rate mortgages. Were you personally
involved with this type of lending at Capital One, and if so,
in what capacity? Do you believe that Capital One's subprime
lending practices were appropriate? Do you think, given the
plethora of problems that have emerged out of the subprime
lending industry, that Capital One should have taken a more
active role in ensuring that responsible lending principles
were part of its subprime origination practice, including in
its relationship with the mortgage broker industry?
A.1. I am responsible for Global Financial Services, a division
at Capital One. This division serves approximately ten million
consumers and small businesses, principally in the United
States but also in Canada and the U.K. One of the businesses in
this division is Capital One Home Loans.
I believe Capital One Home Loans is a highly responsible
lender. It is a direct originator of loans, meaning that it
does not rely on brokers in any way. All marketing is done
directly to consumers, and every customer is handled by Capital
One Home Loans' employees. The business thus avoids all of the
issues and challenges of managing brokers. The entire process,
from sales through underwriting and finally to settlement, is
executed, controlled and monitored by the business itself.
From a product perspective, the vast majority of loans are
fully documented and fixed rate. This is true for both prime
and subprime loans. All loans are rigorously underwritten
against strict guidelines. Subprime loans were only about 20%
of overall originations and subprime adjustable rate
mortgages--the focus of your question--were a tiny fraction (1%
of loans in 2006 and 1/2 of 1% in 2007). As mentioned,
virtually all loans were fully documented, thus avoiding the
issues now evident in stated income loans. Finally, the
business did not originate any option ARMs or other negatively
amortizing products.
These elements--a direct model (i.e., no brokers), fully
documented loans, predominantly fixed rate products, and strong
underwriting--underlie the responsible lending practices of
this business.
Q.2. As you know, many experts have criticized the Federal
Reserve for not taking a more active role in exercising its
authority under HOEPA to regulate the subprime mortgage lending
industry. What is your position on the appropriate role of the
Fed in regulating mortgage lenders? Do you believe that the
mortgage lending industry should be robustly regulated?
A.2. I believe the mortgage industry needs to be regulated.
Today, there is a mixed model. Some important participants in
the industry are well regulated depository institutions (e.g.,
banks and thrifts), but there is a large part of the market
that is either unregulated or lightly regulated. I think there
is a public policy interest in bringing more consistency of
standards across the industry, as well as higher levels of
regulatory oversight to those participants currently outside of
regulated depository institutions.
The Federal Reserve has an important role to play in at
least three ways. First, it directly supervises many
institutions. Second, it has authority under HOEPA to write
regulations that apply to all participants in the mortgage
market, not just those institutions whom it supervises. (Of
course the Federal Reserve would not have the authority to
enforce these rules for institutions it does not supervise.
This means that states and other regulators will need to
enforce these rules.)
The Federal Reserve has stated its intention to exercise
its rule-writing authority under HOEPA. I welcome this step. If
confirmed to the Board, I would seek to be a driving and
constructive force behind finalizing the rule and assuring that
the mortgage market operates fairly and smoothly in the future.
Third, the Federal Reserve has a role to play working with
other regulatory agencies. The recent joint regulatory
guidances on non-traditional and subprime mortgages, in which
the Federal Reserve participated, were appropriate. So too were
the Federal Reserve's and other agencies' efforts to encourage
lenders and services to work with troubled mortgage borrowers.
It is also important for the Federal Reserve to coordinate with
state regulators. The Federal Reserve has actively worked with
state regulators at CSBS to encourage state adoption of the
non-traditional and subprime guidances. Those guidances,
encouraging underwriting of loans to the fully indexed, fully
amortizing rate, have broad support as an important consumer
protection making unaffordable loans less likely in the future.
Finally, the Federal Reserve's pilot consumer compliance
program with the states, the FTC, and the OTS to examine
institutions for compliance with mortgage-related consumer
protections also seems promising and appropriate.
Q.3. What is your opinion of the Fed's course of action to date
in handling the subprime crisis? What other actions do you
think the Fed should be taking?
A.3. During the past few months, and particularly at and
shortly before the September 18th FOMC meeting, the Federal
Reserve has reacted vigorously to the subprime crisis, its
impact on credit markets, and the potential impact to the
broader economy. These actions (including lowering both the
discount and the target federal funds rate) seem appropriate
and adequate at this time. However, the Federal Reserve will
need to continue to monitor further developments closely. If
warranted by future developments, the Federal Reserve should be
willing to take further action.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM LARRY A.
KLANE
Subprime
Q.1. How would you characterize the Federal Reserve's actions
in response to the subprime sis? Do you think the Federal
Reserve has taken adequate action?
A.1. During the past few months, and visibly at the September
18th FOMC meeting, the Federal Reserve has reacted vigorously
to the subprime situation, its impact on the credit markets,
and the potential impact to the broader economy. These actions
seem appropriate and adequate at this stage, but the Federal
Reserve will need to continue to monitor further developments
closely.
Q.2. What do you think the role of the Federal Reserve should
be for addressing crises in loan markets such as the subprime
crash?
A.2. The Federal Reserve has a number of roles to play in
crises in loan markets. These include ensuring liquidity in the
financial system, standing as a lender (if necessary as last
resort) to member banks via the discount window, and monitoring
the implications of the crisis in case it threatens the broader
economy. If the crisis threatens to impact the broader economy,
the Federal Reserve's role is to adjust monetary policy
accordingly.
Q.3. Would you say the meltdown of the subprime market is
contained at this point?
A.3. While the Federal Reserve has taken strong action, we are
not yet at the end of the current turbulence. It would be
premature to say that no further negative developments will
occur, particularly with the large number of mortgages whose
interest rate will reset over the upcoming months.
Q.4. What would you recommend the Fed do moving forward to
ensure that the subprime market stabilizes?
A.4. The Federal Reserve has taken important actions to
stabilize the current market disruptions. Going forward, the
Federal Reserve should monitor the situation closely and take
additional actions as are warranted as new information or
developments materialize. It is important to assess the impact
of the actions already taken prior to initiating additional
actions.
Q.5. Are other areas of the subprime crisis that the Fed has
not yet addressed?
A.5. Given the recent actions of the Federal Reserve and the
rule-writing work they are undertaking under HOEPA, I have no
important additional areas to suggest.
Credit Cards
Q.6. Do you think unscrupulous practices by credit card issuers
are prevalent enough to generate concern or that necessitate
taking a closer look?
How would you characterize the prevalence of certain
practices by credit card issuers that appear to either be
misleading or unfair? Is it a problem only among a few issuers,
or a more widespread problem throughout the industry?
Do you have a position on legislation that would further
regulate or limit some of these practices?
A.6. I would like to highlight two specific practices and two
more general areas in credit card lending where I have
concerns.
On the specific practices, as we discussed in the hearing,
I share the Committee's concern with ``universal default'' and
double-cycle billing. It is encouraging that a number of
issuers who engaged in these practices have recently changed
their approach, but to the extent some industry participants
continue these practices, I remain concerned.
In addition, I believe that current credit card disclosures
are not adequate. This is the first of the two more general
areas I want to address. The complexity of current disclosures,
along with the difficulty in using them to focus on the most
consumer-relevant terms and conditions, leave consumers
inadequately equipped to make informed choices among products
and issuers. Disclosures must be made clearer and more
consumer-relevant. In this regard, I am highly encouraged by
the on-going work of the Federal Reserve in its efforts to
revise Regulation Z. The use of consumer focus groups and the
explicit effort to create simpler and more comprehensible
disclosures is a strong step in the right direction. These
proposed regulations are out for public comment, and I look
forward to the Federal Reserve's finalizing them. Once they are
final, we will be able to judge, after some experience, whether
further adjustments, amendments, or expansions need to be made.
My second general area of my concern is penalty repricing
of accounts, which occurs when a customer breaks one or more of
the rules embodied in the credit card contract's terms and
conditions. While it is legitimate in general for an issuer to
be able to change the price of credit on open-ended lines to
customers who demonstrate higher levels of riskiness through
such rule breaks, I am concerned about:
insufficient disclosures and/or notices to
consumers on repricing actions (e.g., initially when receiving
the card, at the moment of rule break, and at the moment of
repricing);
the inclusion of multiple repricing rules that
can be triggered by a single infraction; and
the options available to consumers who have
experienced repricing (e.g., the ability to return to the prior
rate based on good performance over time or the ability to pay
off the existing balance at the prior rate over some time
frame).
The Federal Reserve's proposed revisions to Regulation Z,
including the 45-day notice provision, address some aspects of
the concerns I have outlined. However, the general area of
repricing deserves continued attention to ensure that consumers
are adequately protected and able to make good decisions on
their use of credit cards.
Q.7. How do you view the role of the Federal Reserve in this
area? Do you think the Federal Reserve is doing enough to
improve disclosure and strengthen enforcement under TILA? Is
there more to be done?
A.7. The Federal Reserve has important responsibilities with
respect to implementing TILA. I have been very encouraged by
the proposed revisions to Reg Z concerning credit cards and
open-ended credit. This revision, the first in over twenty-five
years, is a strong step forward to improve disclosures. In
particular, I applaud the Federal Reserve's use of consumer
focus groups to help ensure disclosures are understandable and
address the key elements consumers need. If confirmed to the
Board, I would look forward to help finalize these rules.
Access to Capital
Q.8. Over the last few years, the Federal Reserve, the Small
Business Administration and others have conducted studies that
reveal minorities have unequal access to credit for small
business development, even when factors such as credit history
and net worth are comparable to non-minorities.
In your opinion, in addition to promoting financial
education, how can we improve ``access to capital'' for
minority-owned businesses?
A.8. In addition to education, I would offer two avenues to
help ensure access to capital for minority-owned business.
First, fair lending laws must be enforced so no minority-owned
business is discriminated against. Second, legislation and
regulation need to ensure that responsible lending institutions
are encouraged to lend across the full credit spectrum.
Minority-owned businesses will be among those hurt if there is
a significant reduction in the willingness of lenders to extend
credit across the full credit spectrum. Thus legislators and
regulators need to ensure they do not inadvertently chill
innovation and full credit spectrum lending that would be of
benefit to these borrowers.
Q.9. What role can the Federal Reserve play to encourage
institutions to engage in expanding access to capital, both for
individuals and businesses?
A.9. The Federal Reserve System has an important role to play
in educating individuals and small business owners on how to
access capital and other financial matters. In addition, in
connection with its supervisory role, the Federal Reserve has
responsibility to enforce fair lending and other relevant laws.
Supervised institutions may also benefit from interaction with
the Federal Reserve which clarifies the positive role that
prudent extension of credit to individuals and businesses can
have on an institution's safety and soundness.
As an experienced banker (serving roughly ten million
consumer and small business customers currently), I would look
forward, if confirmed, to helping the Federal Reserve continue
its important work in this area.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA FROM LARRY A.
KLANE
Q.1. Our modern, complex economy depends on the ability of
consumers to make informed financial decisions. Without a
sufficient understanding of economics and personal finance,
individuals will not be able to appropriately manage their
finances, evaluate credit opportunities, and successfully
invest for long-term financial goals in an increasingly complex
marketplace. What must be done to ensure that Americans have
the knowledge and skills necessary to make informed financial
decisions?
A.1. I fully agree with the critical importance of individuals
having the information and the necessary financial education to
make informed financial decisions. This is particularly
critical to ensure good outcomes (for individuals and for the
economy at large) in today's complex, competitive marketplace.
As a current board member of America's Promise--a not-for-
profit organization dedicated to underprivileged kids--I am
constantly reminded of the tremendously beneficial impact of
financial education. Achieving the goal of broad financial
literacy will take the combined efforts of parents, schools,
financial institutions, relevant government bodies, and not-
for-profit organizations. Financial education must begin before
college.
Q.2. Approximately 10 million households in the United States
do not have accounts at mainstream financial institutions.
Unfortunately, too many of these households depend on high-cost
fringe financial services. They miss out on opportunities for
saving, borrowing, and lower cost remittances found at credit
unions and banks. What must be done to bring these households
into mainstream financial institutions?
A.2. First and foremost, these households must be made aware of
the full range of options available to them. Today, many
responsible financial institutions are developing products and
services designed to meet the needs of the un- or under-banked.
Community-based organizations have a very helpful role to play
in providing education and directing these households to
responsible institutions. Second, regulators have a role in
encouraging the development of these programs in their
supervised institutions. The stronger and more vibrant the
participation of responsible institutions in providing services
to these households, the better the outcome will be for these
households and their communities. It is in the interest of
these families that legislation and regulation do not prohibit
or unduly restrict the responsible provision of banking
services and the extension of credit across the full credit
spectrum.
Q.3. I am deeply concerned that too many working families are
taken advantage of by unscrupulous lenders through payday
loans. What must be done to restrict payday loans and expand
access to affordable, small loans?
A.3. Financial education and an awareness of available options
from responsible lending institutions are two key elements to
address this situation. In addition, it is in the interest of
these families that legislation and regulation do not prohibit
or unduly restrict the responsible extension of credit across
the full credit spectrum.
Q.4. Too many working families have their Earned Income Tax
Credit benefits needlessly reduced by high cost-refund
anticipation loans ( RALs). What must be done to restrict these
predatory loans and encourage alternatives to RALs?
A.4. In my current position, I do not have access to all the
information I would need to have about Refund Anticipation
Loans. If confirmed to the Board, I would do whatever is
required to fulfill the Federal Reserve's responsibilities--
including protecting consumers--that exist in this area.
Q.5. I am concerned that consumers are not provided with enough
information about the long-term consequences of making only the
minimum credit card payments. What must be done to ensure that
consumers are adequately informed of the true cost of making
only the minimum payment?
A.5. I strongly support meaningful disclosure around the
implications of minimum payments. The Federal Reserve's current
proposal for revisions to Regulation Z seeks to implement the
Bankruptcy Reform Act's significant requirements in this
regard. Institutions should inform customers who consistently
pay only the minimum of the consequences of their behavior. For
those customers who pay the minimum for a number of consecutive
months, it would be beneficial for the lending institution to
provide a notice on their statement informing them of the
consequences of doing so. In this statement, the institution
could encourage consumers to pay more than the minimum in order
to pay down their balance more quickly. Going further, an
institution could also provide customers with a web address for
an online calculator, which allows them to enter specific
information, customized to their situation, and receive real-
time information about how long it will take to pay off their
balance.