Housing Finance Reform: Access to the Secondary Market for Small Financial Institutions

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Chairman Johnson and Ranking Member Shelby, thank you for the opportunity to testify today.

This hearing is a timely one. For many years community financial institutions have been denied fair and equal access to the secondary market.

Earlier this year Jay Brinkmann , chief economist for the Mortgage Bankers Association, summed up the impact this had on competition:

"...[t]he pricing strategies that Fannie and Freddie pursued contributed to the concentration of mortgage lending within the largest banks. The GSEs offered reduced 'guarantee fees' for their largest customers, which placed smaller lenders at a competitive 'disadvantage.'" "NY Fed Thinks Megabanks May Be the New GSEs," National Mortgage News, March 16, 2011.

Banks prosper by making prudent loans with an adequate return and maintaining a reasonable cost structure. Community banks have long prospered by establishing and maintaining a relationship with their customers. This traditionally was accomplished with equal parts of small-business, consumer, and commercial real estate lending, plus some fee income on serviced loans. Today 97% of our banks are community banks and they are increasingly finding this business model under siege.

In the mortgage lending arena our nation's community financial institutions face two continuing but related threats to their future. While community financial institutions did not cause the financial crisis, they are being subjected to what will likely amount to ten thousand or more pages of regulations spawned by the Dodd Frank Reform Act. The Qualified Residential Mortgage (QRM) and Qualified Mortgage (QM) statutory provisions totaling just 12 pages have already ballooned to about 800 pages of proposed rules. These regulations disproportionately impact community financial institutions and are a threat to their profitability since they needlessly add costs that act the same as a capital surcharge.

Second, this regulatory overload adds insult to injury. Fannie and Freddie (the "GSEs") had a long history of giving their largest and riskiest customers lower guarantee fees, while charging community lenders much higher fees. This denied community financial institutions fair and equal access to the secondary market, disadvantaged them economically, and in many cases resulted in their handing over their best customers to their large bank competitors. Discounting for volume is a recipe for disaster in the credit guarantee business. Additionally their government guarantee allowed the GSEs to accumulate huge portfolios and distort pricing for all competing mortgage investors. For years this disadvantaged community financial institutions and now the taxpayers have been disadvantaged to the tune of over $160 billion.

As far back as 1995 Fannie's top 25 volume customers, led by Countrywide, benefited from substantially lower guarantee fees than Fannie's 1200 smallest customers. This trend intensified over the course of the next decade. In 2007 Countrywide accounted for one in four loans purchased by the GSEs.

Edward J. Pinto is a resident fellow at AEI.

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