My Planned Oral Remarks

But how is that going to help me get re-elected?

Bravo!

To all of those cynics of the legislative system on the blogosphere (and particularly this website) -- I just spent the past week in DC myself in a Congressional Operations Seminar.

The testimony is READ by the congresspersons and the staff LONG before the hearing -

“Congress in session is Congress on public exhibition, whilst Congress in its committee-rooms is Congress at work” -- Woodrow T. Wilson

Yes, they will not pay attention to you directly during the hearing. This is because they have already received your testimony and, quite possibly your pre-scripted responses to their pre-scripted questions.
The function of these hearings (aside from certain "investigative" hearings) is not to educate CONGRESS, but the PUBLIC.

I think it's amazing that you've been tapped; what happened to the "Geeks vs. Suits" explanation that seems masked in your writing?

You say blaming CRA is wrong and blaming deregulation is wrong.

You then continue "By requiring Freddie Mac and Fannie Mae to hold less capital than banks ...", which sounds like regulation to me -- not deregulation. And that's partisan regulation that was promoted by CRA. The partisan narratives you describe have all the elements of the answer -- but they point to one party, and you seem to not want to acknowledge that.

In lessons learned #3 you state "I recommend that Congress not try to create cheap mortgages and instead use other means to encourage home ownership." Did you really want to say "encourage"? It really shouldn't be any of the governments business whether or not free people want to or should want to own homes. It's really just another form of slavery, and I can't imagine why I would want my government to give a whit -- even though I understand why they do.

Instead of bailing out existing banks, why not use the bailout funds to create new banks, capitalized from the $700b? Let the failed banks fail, then solve the liquidity crisis by creating new banks free from the shackles of toxic assets. Then privatize the banks immediately afterwards to get the government out of the picture.

See:

http://www.youtube.com/watch?v=BdmI14oSe4g

...for an elaboration. Comments?

Just for the *sake of argument*:

1. Capital requirements matter.

Not as much as sound underwriting standards.

2. Securitization is not necessary for mortgage lending.

What about the large number of studies that show how much it has expanded access to investor capital and brought down lending spreads?

What about the benefits of geographical diversification, which may best be achieved by pooling?

3. Subsidized mortgage credit is an inefficient tool for promoting home ownership.

True or false: Liquidity is an efficiency, not a subsidy.

4. Recent financial innovations, particularly credit default swaps, have changed our financial system in ways that current policymakers fail to recognize.

As far as securitization, it looks more like it was CDO technology, not CDS technology, that was systematically abused, to the extent that one can split hairs.

CDS technology appears to have been abused in a very serious way by a AIG and the monolines, yes?

Amicus, Arnold briefly addressed your point 2 in his fantasy testimony:

However, with a level regulatory playing field, depository institutions could obtain all of the advantages of Method B [securitization] with none of the disadvantages. A multi-state bank holding company could have a portfolio of mortgage loans that is geographically diversified. A well-known bank holding company could issue debt instruments that could be held by any investor who now holds mortgage securities.

you were totally right about mortgage restructuring for 8 million homes. the idea is totally insane. stanton and that other dude were anoying. you were also right that congress will probably fall for the restructuring scheme. zombie time.

"What about the benefits of geographical diversification, which may best be achieved by pooling?"

I do agree with you that there are benefits in securitization, but I'd think carefully about how we do it. As we have things now, banks can entirely divorce themselves from the risk of a loan they originated, own, and collect for. It would seem to be more sensible to disallow that; it would make sense to make the people who own a loan responsible for collecting on it, which in turn implies that there would be regulations on precisely what sort of institution can buy a loan.

If a bank wants more capital, it can get it by selling bonds or perhaps preferred stock, which are claims on the revenue stream of the bank independent of the risk of any specific mortgage -- in other words, they don't remove the risk from the bank.

A well-known bank holding company could issue debt instruments that could be held by any investor who now holds mortgage securities.
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Yes, but then they would have an illiquid bank note, quite possibly. What's more, the bank would have more than just mortgage risk, but all the risks associated with a nationally chartered bank.

it would make sense to make the people who own a loan responsible for collecting on it
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Here is a thesis to test: the "securitization model" works during ordinary times.

What we've been through is the creation of a too-good-to be true product, called a AAA security backed by skimpy, sub-prime, alt-A and recycled CDO collateral. This is not "ordinary".

If you introduce a "product" with a high-return and low-risk into a very efficient capital market, you'll see capital flock to it. You might even see a mania develop.

It's understandable that the "securitization" model broke down. But, then again, every time we had the same kind of mania in the past, the prevailing "system" broke down too.

All's to say that dumping securitization wholesale is probably too facile.

Arnold,

You have done the improbable: abbreviated brilliance with artful efficiency. Good form.

I frequently disagree with you, but I respect your ability to marshall your ideas in ways that can allow people to better value from their own insights; the mark of a good teacher.

I'll catch you on CSPAN later.

Arnold,

Where are the soundbites? Presumably you're one among many "boring" academic types who are going to talk at these politicians. Give them something memorable that they can spit at the press.

Give us a meme!

Arnold,

Your planned testimony is well articulated, but I agree with SheetWise. We are suffering from the worship, by the public and our federal government, of a “false god,” home ownership. Because home ownership is seen by many as a key to family and neighborhood stability and prosperity, the government rewards home buyers, owners, and sellers through tax-deductible points, home-mortgage interest payments, and capital gains. We have even re-defined home owners to include those with zero equity in their homes. The rewarding of borrowing has effectively led to a destruction of equity since the unwinding of excessive debt has dramatically lowered the market value of all homes. And, Fannie Mae and Freddie Mac have served as our mortgage landfills.

The policy of subsidizing borrowing hurts young people in two ways: first, artificially high prices made it (and continue to make it) nearly impossible for some to buy their first home; and second, low-income families are hurt by higher mortgage-interest rates – the benefit of home-mortgage tax deductibility flows to high-income home owners who pay almost all of the income taxes in the country at present. Although housing prices are now falling and credit markets are tight, debt subsidies will maintain the demand for debt and postpone the day when new buyers can afford to buy a home and new construction can begin again. Ironically, some politicians want to “stabilize” home prices in order to get the housing industry moving again. They propose to do this through still more debt rather than clearing the way for home prices to fall to the point that first time buyers can afford to enter the market.

Deductibility of home-mortgage interest keeps the federal government from collecting taxes appropriate to the subsidized buyer’s tax bracket. This is a case of economic inefficiency, higher home costs and lower government revenues, rather than a moral issue. Homeowners are smart enough to realize that, for them, this is a subsidy on all debt. Tax deductibility of home-mortgage interest is a special case of a more general economic distortion; tax deductions are subsidies from one group, taxpayers in general, to home owners to promote taking on debt.

I would recommend ending deductibility of home-mortgage-interest payments and dissolving Fannie Mae and Freddie Mac, the latter to encourage banks and financial institutions to offer mortgages which they intend to keep.

Good Job Arnold!

The part I like best is the call for a stern sheriff. I see the need for strong effective leadership. A call to sit down and wait or pay a stiff penalty while this gets sorted out is a sound practice that ought to have been used.

I hope Congress listened to you!

It seems to me as though the problem was not a structural failure of the securitization model but rather of the agency ratings system, and by extension, the over-dependence of buyers of debt on these ratings.

1. Securitization takes a stream of relatively homogenous debt and turns it into pools of good stuff and bad stuff not unlike a refinery turns crude oil into gasoline and tar. The suits were happy to keep on making and selling the gasoline while piling up rusty barrels of sludge in the back room until one day it caught fire and turned the buiding into a Superfund site. This is not a failure of securitization but of management.

2. The ratings agencies continued to assign investment-grade ratings to debt instruments on the basis of historical trends, when the underlying debts were being consummated well beyond all historical norms. The models should have included more pessimistic default scenarios. The banks gave them barrels of tar, but the agencies kept on stamping "Gasoline" on the side.

I'd recommended saying this in fewer words -- and using a good deal more verbal pictures something closer to baby language.

You're talking to members of Congress, remember.

Congressmen understand catchy phrases and metaphorical pictures. I don't see many of these in your comments here. If you want to be understood -- and have some impact -- paint a picture for them. Otherwise, what you have to say I'm afraid will be lost on most.

Of course, I sure hope they actually let you say what you are planning to say.

Usually these guys are more interested in hearing themselves talk, rather than actually listening to anyone else speak.

Let us know where we can watch this, if it's broadcast.

My earlier comments were before seeing the testimony. While owner occupied housing was mentioned, I was stunned that there was nothing mentioned about owner occupied homes that had been refinanced. If the owner has already taken their equity from the home -- what should the governments position be? If a responsible borrower watched their home value rise and then fall -- how should we resolve that that borrower with the one who watched their value rise, took the equity in cash, then saw it fall, and is now in foreclosure?

Could we honestly conclude that my neighbor, who foolishly refinanced his home at the height of the market -- and used that money to buy a boat and an RV -- should now have his mortgage recalculated to the same terms as mine? Do they get to keep the boat and RV? What if they used the money to tour the world? These type of questions might provide some insight as to why gun sales are up.

Re: Home ownership, thank you Maniel. The governments interest in home ownership was well understood by Adam Smith. Capital is very mobile, labor much less mobile, and land immobile. There has always been a balancing act in tax policy related to these three factors of production based on those properties. For the government to keep all of their taxing opportunities viable, they need the somewhat mobile working capital to be invested in immobile capital.

Consequently, home ownership is public policy.

Good on ya, mate! Give'm hell, AK!!

oops! I was sick the last few days and didn't read the rest of the log! Good job at any rate!