WASHINGTON WEEKLY
Keeping the Markets Informed from the Capital
April 4, 2008
Senate Debates Housing Stimulus Package; Contentious Bankruptcy Amendment Tabled
The Senate voted this week 94-1 to move forward on a housing stimulus package. The Foreclosure Prevention Act reforms the Federal Housing Administration (FHA), provides an additional $10 billion in mortgage revenue bonds to be used to refinance certain subprime loans, expands the types of loans subject to early disclosures under the Truth in Lending Act (TILA), and provides a standard property tax deduction for non-itemizers. The Senate voted 58-36 to table an amendment—effectively defeating it—that would allow bankruptcy judges to modify residential mortgage loans in Chapter 13 bankruptcy proceedings.
The Treasury Department released its blueprint of short-, intermediate- and long-term recommendations to improve the regulatory structure of the financial services industry in the United States. Among the short-term recommendations, Treasury proposes modernizing the President’s Working Group on Financial Markets (PWG) and creating a new Federal commission for mortgage origination.
The Senate Judiciary Committee approved along party-lines a bill that would amend the bankruptcy code to allow bankruptcy judges to modify residential mortgage loans during Chapter 13 bankruptcy proceedings.
During a two-day Department of Labor (DOL) hearing on its proposed regulations on the issue of fee disclosures to benefit plan fiduciaries, SIFMA said enhanced disclosure requirements of fees should be addressed under the fiduciary responsibility provisions of ERISA section 404, not the prohibited transaction provisions of ERISA section 408(b)(2).
Appearing before the Joint Economic Committee, Fed Chairman Ben Bernanke said the near-term outlook has weakened relative to earlier projections, but growth could proceed at or above a sustainable pace next year.
The Senate Banking Committee heard from the Federal Reserve, the Treasury Department, the Federal Reserve Bank of New York and the Securities and Exchange Commission (SEC) on their actions to prevent Bear Stearns from filing for bankruptcy.
Senate Debates Housing Stimulus Bill; Bankruptcy Amendment Tabled
The Senate voted this week 94-1 to move forward on a housing stimulus package. Prior to the cloture vote, Senate Majority Leader Harry Reid (D-NV) and Minority Leader Mitch McConnell (R-KY) announced they had reached an agreement that would allow Senate Banking Committee Chairman Chris Dodd (D-CT) and Ranking Member Richard Shelby (R-AL) to create a bipartisan substitute to the underlying bill. The bipartisan agreement, The Foreclosure Prevention Act of 2008, announced the following day by Dodd and Shelby, includes Federal Housing Administration (FHA) modernization language, including an increase in the FHA loan limit from 95 percent to 110 percent of area median home prices or a maximum of 132% of the GSE Conforming loan limit (currently $550,000). Under the agreement, down payments of 3.5 percent will be required for any FHA loan. The Foreclosure Prevention Act would provide an additional $10 billion in the private-activity bond cap for mortgage revenue bonds (MRBs) used to refinance subprime loans. The MRBs would be exempt from the alternative minimum tax (AMT).
The Foreclosure Prevention Act also provides an additional $4 billion in Community Development Block Grant (CDBG) funds; requires lenders wait nine months before initiating foreclosure proceedings against soldiers returning from service; and provides $100 million for housing counseling. The bill also expands the types of home loans subject to early disclosures under the Truth in Lending Act (within three days of application) for all extensions of credit backed by a home, including refinanced loans and would establish a new disclosure that informs consumers about their maximum monthly payments and increases the range of statutory damages for violations. The Foreclosure Prevention Act also provides a standard property tax deduction for non-itemizers of $500 for single filers and $1,000 for joint filers; authorizes a four-year carry back of net operating losses in 2008 and 2009; and creates a $7,000 tax credit for people who buy homes in foreclosure to be claimed over two years.
The Senate voted 58-36 to table an amendment offered by Sen. Richard Durbin (D-IL), which would amend the bankruptcy code to allow bankruptcy judges to modify residential mortgage loans in bankruptcy proceedings. Under the amendment, which Senate Judiciary Committee approved this week as a stand-alone bill (S.2136), bankruptcy judges would be allowed to reduce interest rates on nontraditional and subprime mortgages originated as of the date of enactment of the bill, to the prime interest plus a reasonable premium for risk, and could extend the life of the loan up to 30 years minus the period the loan has been outstanding. The Senate is expected to continue to work on the Foreclosure Prevention Act into next week.
Treasury Releases Regulatory Blueprint
The Treasury Department released its Blueprint for a Modernized Financial Regulatory Structure, which outlines short-, intermediate- and long-term recommendations to improve regulatory oversight of the financial services industry in the United States. Treasury Secretary Henry Paulson said with a few exceptions, the recommendations in the Blueprint should not and will not be implemented until after the current difficulties in the market are corrected. He said the Blueprint addresses complex, long-term issues, which require thoughtful discussions and should not be decided during stressful situations.
Short-Term Recommendations: intended to improve regulatory coordination and oversight immediately
- Modernization of the President’s Working Group on Financial Markets: Treasury recommends modernizing the current PWG Executive Order to broaden the PWG focus to include the entire financial sector, rather than just the financial markets; and expand the PWG to include the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC).
- Creation of a New Federal Commission for Mortgage Origination: Treasury recommends creating the Mortgage Origination Commission (MOC) to evaluate, rate and report on the adequacy of each state’s system for licensing and regulation participants in the mortgage origination process. Federal legislation should establish (or provide the MOC authority to develop) uniform minimal qualifications for state mortgage market participant licensing systems.
- Clarification of Liquidity Positioning by the Federal Reserve: The current temporary liquidity provisioning process during market instability should be enhanced to ensure the process is calibrated and transparent; and appropriate conditions are attached to lending and information flows to the Federal Reserve through on-site examinations or other adequate means. The PWG should consider broader regulator issues associated with providing discount window access to non-depository institutions.
Intermediate Recommendations: focused on eliminating duplication and modernizing the regulatory structure for certain financial services sectors within the current framework
- Transition the Thrift Charter: Treasury recommends transitioning the federal thrift charter to a national bank charter and merging the OCC and the OTS over a two-year period.
- Federal Supervision of State-Chartered Banks: Treasury recommends the rationalization of direct federal supervision of state-chartered banks. One approach would place all bank examination responsibilities for state-chartered banks with the Federal Reserve. Another approach would give bank examination responsibility to the FDIC. Treasury recommends a study to make a definitive proposal regarding the appropriate federal supervisor.
- Creation of a Federal Charter for Certain Payment Systems: Treasury recommends a federal charter for systemically-important payment and settlement systems and granting the Federal Reserve primary oversight responsibilities for such systems.
- Creation of an Optional Federal Charter for Insurance: Treasury recommends the creation of an Optional Federal Charter overseen by an Office of National Insurance within Treasury. As an intermediate step, Congress should establish a federal Office of Insurance Oversight within the Treasury to establish a federal presence in insurance for international regulatory issues.
- Unification of the Oversight of the Futures and Securities Markets: Treasury recommends merging the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). In preparation, the SEC should undertake a number of actions to modernize its regulatory approach, such as: 1) adopting core principles for exchanges and clearing agencies; 2) expediting the SRO rule approval process; 3) creating a general exemption under the Investment Company Act for already actively trading exempted products, such as exchange traded funds, to improve the new product approval process and 4) enacting legislation to expand the Investment Company Act to permit a new global investment company.
- Harmonization of Regulation of Broker-Dealers and Investment Advisors: Treasury recommends statutory changes to harmonize the regulation and oversight of broker-dealers and investment advisers offering similar services to retail investors. Treasury also recommends investment advisors be subject to a self-regulatory regime similar to that of broker-dealers.
Long-term Recommendations: Treasury recommends an objective-based regulatory approach focusing on three key goals: market stability regulation to address overall conditions of financial market stability, prudential financial regulation to address issues of limited market discipline caused by government guarantees and business conduct regulation to address standards for business practices.
- Market Stability Regulator: The Federal Reserve would have responsibility and authority to gather appropriate information, disclose information, collaborate with other regulators on rule writing and take corrective actions when necessary to ensure overall financial market stability. The Fed would have authority to join in examinations with the prudential and business conduct regulators to achieve its mission. The Federal Reserve would also have the authority to develop information reporting requirements for federal financial services providers and holding companies with federally chartered financial institutions affiliates.
- Prudential Regulator: The prudential regulator would focus on the safety and soundness of firms with federal guarantees, similar to the OCC, but with the authority to regulate affiliate relationship issues. Prudential regulation would be applied to individual firms and would include capital adequacy requirements, investment limits, activity limits and direct on-site risk management supervision. The focus of the prudential regulator is on protecting the assets of the insured depository institution. Treasury recommends giving some consideration to including the government-sponsored enterprises within the prudential regulatory framework.
- Business Conduct Regulator: The business conduct regulator would monitor business conduct regulation across all types of financial firms, including rule writing for disclosures, business practices and chartering/licensing of certain types of financial firms. The business conduct regulator would be responsible for chartering and licensing of a wide range of financial firms, including broker-dealers, hedge funds, private-equity funds, venture capital funds and mutual funds. The business conduct regulator would be responsible for setting national standards applicable to all types of financial services firms, whether federally or state-chartered.
Senate Judiciary Committee Approves Bankruptcy Bill along Party Lines
The Senate Judiciary Committee approved the Helping Families Save Their Homes in Bankruptcy Act of 2007 (S.2136) along a party-line vote 10-9. The bill, introduced by Sen. Richard Durbin (D-IL), would amend the bankruptcy code to allow bankruptcy judges to modify residential mortgage loans in Chapter 13 bankruptcy proceedings. Homeowners would be required to pass a means test to verify their inability to pay off the current mortgage. Under the bill, bankruptcy judges would be allowed to reduce interest rates on nontraditional and subprime mortgages originated as of the date of enactment of the bill, to the prime interest plus a reasonable premium for risk, and could extend the life of the loan up to 30 years minus the period the loan has been outstanding. Also, under the bill, if a borrower sells their home within five years of the mortgage modification, the lender would receive any increase in market value up to the original loan amount.
The Committee rejected a substitute amendment offered by Sen. Arlen Specter (R-PA) also along party lines 10-9. The amendment, which Specter introduced as a stand-alone bill (S.2133) in October, would authorize bankruptcy judges to reduce the amount of outstanding principal on a mortgage if both the lender and the borrower agree. The bankruptcy judge would be authorized to change the interest rate on a primary residence if the debtor meets certain income-level thresholds. The amendment would sunset seven years from enactment.
SIFMA Testifies Before DOL on Fee Disclosures
In testimony before the Department of Labor (DOL) two-day public hearing on the issue of fee disclosures to benefit plan fiduciaries, William Ryan, executive director, Legal & Compliance Division, Morgan Stanley, testifying on behalf of SIFMA, said SIFMA strongly supports the goal of ensuring that plan fiduciaries have the information they need to ensure compensation received by service providers is reasonable. However, the Department’s goal of enhanced disclosure requirement of fees should be addressed by the issuance of guidance under the fiduciary responsibility provisions of ERISA section 404, not the prohibited transaction provisions of ERISA section 408(b)(2). SIFMA urged the DOL to recognize that “one size does not fit all” and not mandate specific disclosure of what is required of every service provider regardless of the types of service providers involved. SIFMA also expressed concern that the Department inadvertently over-extended its reach through the use of ERISA section 408(b)(2) as the vehicle for the changes. Finally SIFMA believes the effective date of the final rule needs to, at a minimum, coordinate with the effective date of Form 5500 reporting (July 2010). Assistant Labor Secretary Bradford Campbell said the regulations under consideration will be completed by the end of the year and a separate set of regulations on disclosures to plan participants is forthcoming.
Bernanke Says Recession Possible, Growth Possible Next Year
Appearing before the Joint Economic Committee (JEC) this week, Federal Reserve Chairman Ben Bernanke said developments in the financial markets—including pressures in short-term bank funding markets, limits on available credit, strains on municipal bonds and student loans, troubles in the nonconforming segment of the mortgage market, slowdowns in issued high-yield debt and strains in commercial paper—which reflect in part greater concerns about housing and the economic outlook more generally have weighed on real economic activity. He said the near-term outlook has weakened relative to earlier projections, but with stimulative monetary and fiscal policies benefitting the economy in the second half of the year, growth should proceed at or above its sustainable pace next year. He said, however, in light of the recent situation in the financial markets, the uncertainty in the forecast is high. Chairman Bernanke said the Treasury’s Blueprint for a Modernized Financial Regulatory Structure was an interesting first step, but serious consideration, discussion and analysis would be needed before any changes were made. He said if the recommended role for the Fed were to be realized, the Fed would require adequate powers, authorities and expertise. JEC Chairman Charles Schumer (D-NY) said Treasury’s Blueprint was a good foundation, but does nothing to address the current crisis. He said six principles would best guide the U.S. toward a stronger financial system 1) controlling systemic risk, 2) unifying and simplifying the regulatory structure, 3) regulating the unregulated, 4) incorporating global solutions to maintain competitive, 5) providing greater transparency and 6) moving away from the philosophy that no regulation is a good thing.
Bernanke said the Fed’s actions to prevent Bear Stearns from filing for bankruptcy, was not a bailout and was taken to protect the viability and integrity of the U.S. economy. He said the Fed’s decision to provide financing helped all market participants by maintaining a healthy and functioning financial system. Bernanke said the Fed reviewed the situation and decided it was important to act because of 1) Bear Stearns' interconnectiveness and importance in the financial markets and the subsequent shock to the system if it were to file for bankruptcy and 2) the current fragility of the market. Bernanke said the circumstances were extremely unique and he hopes will never be repeated. Bernanke said the goal of the Primary Dealer Credit Facility and the Term Securities Lending Facility is to ensure liquidity in the markets. He explained the loans are fully collateralized and are not a subsidy. The Federal Reserve retains the right to exchange collateral and has never lost money through its loan systems. JEC Chairman Schumer expressed concern there was a lack of transparency in the derivatives and credit default swaps markets. Bernanke said the derivatives listed on exchanges were regulated and over-the-counter derivatives are typically made up of more than one party and are also regulated.
Senate Banking Committee Examines Recent Fed Actions
Federal Reserve Chairman Ben Bernanke said recent market conditions caused the Fed to reconsider its position on temporarily opening the discount window to primary dealers. Bernanke said the Fed does not need additional statutory authority to review the safety and soundness of broker-dealer firms who are using the discount window. He said the Fed has been working effectively with the SEC and with the investment banks. If Congress chooses to create a standard facility for broker-dealers, Bernanke suggested careful consideration of the new facility’s merits and parameters. Senate Banking Chairman Chris Dodd (D-CT) said he supports the actions of the Federal Reserve, the Federal Reserve Bank of New York and the Treasury Department in the Bear Stearns situation. Treasury Under Secretary for Domestic Policy Robert Steel said Treasury was active throughout the four days the deal was crafted and its goal was to place Bear Stearns with a firm which could secure Bear Stearns’ funds, investments and obligations. Steel said during the negotiations, JP Morgan, Bear Stearns and the NY Fed determined the Federal Reserve’s involvement was necessary. Timothy Geithner, President, Federal Reserve Bank of New York, said the goals of the NY Fed were to avert a Bear Stearns default and to minimize any inherent moral hazard. Geithner said the Bear Stearns scenario was rare because of the speed and magnitude in which the market confidence and liquidity decreased. Bernanke said the Fed’s role was to facilitate the acquisition and insure the firm’s liabilities.
Ranking Member Richard Shelby questioned the Securities and Exchange Commission’s (SEC) oversight of Bear Stearns as a consolidated supervisor entity. SEC Chairman Christopher Cox said the SEC had Bear Stearns on a watch list since the summer of 2007 after the failure of two of their hedge funds. He said the SEC saw no effects of the hedge fund failures on Bear Stearns, but the SEC continued to monitor daily its capital and liquidity levels. Cox reported Bear Stearns had capital and liquidity levels above regulatory thresholds until the week of March 10. When confidence in Bear Stearns evaporated, the firm experienced a liquidity decrease from $12.4 billion to $2 billion in one day. Cox said during the week of March 10, the SEC and the NY Fed were in close contact sharing information and met on March 13 to begin the emergency talks. Steel told Shelby the Fed actions and Treasury’s increased vigilance are improving the market situation and lessening the potential of another investment bank failure.
Bills Introduced This Week
Senate Health, Education, Labor and Pensions (HELP) Committee Chairman Edward Kennedy (D-MA) introduced the Strengthening Student Aid for All Act of 2008 (S.2815), which increases Pell Grant aid for the lowest income students to $4,731, increases the amount students can borrow under the federal loan program by $1,000 and enables parents to defer payments on PLUS loans while students are in college. The bill also requires the Secretary of Education designate guaranty agencies as “lenders of last resort” on an institutional basis (rather than the current student-by-student basis) and clarifies the Secretary of Education’s authority to provide these lenders with capital to make the loans. S.2815 would allow the Department of Education to serve as a “secondary market of last resort” that would buy Federal Family Education Loan Program (FFELP) loans from lenders in need of new capital to make additional loans.
Senate Special Committee on Aging Chairman Herb Kohl (D-WI) introduced the Senior Investor Protection Act of 2008 (S.2794) this week. The bill would create a new grant program to encourage state regulators to adopt a uniform standard for the accreditation of senior financial advisors. The bill encourages states to adopt provisions outlined in the North American Securities Administrators Association’s (NASAA) new model rule on the use of senior designations. States would be permitted to use the funds for a number of senior investor protection efforts, including hiring additional staff to investigate and prosecute cases, funding new technology and providing educational materials to increase awareness and understanding of designations.
The Foreclosure Prevention and Sound Mortgage Servicing Act (H.R.5679), introduced by Rep. Maxine Waters (D-CA), requires that a mortgage servicer engage in reasonable loss mitigation strategies before foreclosing on a principal residence. Possible loss mitigation strategies include repayment plans, loan modifications, short sales and deed-in-lieu of foreclosure. Under the bill, all servicers are required to provide a toll-free or collect-call phone number to help borrowers, servicers engaged in loss mitigation are prohibited from conditioning a loan modification on a waiver of legal rights and servicers are required to notify borrowers with Adjustable Rate Mortgages (ARMs) of the date of any impending increase in the interest rate and the projected mortgage payment at the anticipated rate. H.R.5679 gives borrowers the right to sue if lenders and servicers begin a foreclosure process without attempting loss mitigation.
Rep. Waters also introduced the Neighborhood Rescue and Stabilization Act (H.R.5678), which would provide an additional $10 billion in funding for community development block grants (CDBG). H.R.5678 requires the Department of Housing and Urban Development create a formula to distribute the funding among states based on the adjusted share of total foreclosures during the most recent six month period for which data is available.
The Homebuyers Tax Credit Act (H.R.5670), introduced by Rep. Vito Fossella (R-NY) and Rep. Bill Pascrell (D-NJ), would provide a temporary $10,000 homebuyers tax credit. The tax credit would only apply to principal residence purchases and to houses valued at or below the conforming loan limits (or 125% of median home price, not to exceed $729,750). The tax credit would expire one year from enactment of the bill.
Sen. George Voinovich (R-OH) introduced the Protecting American Homeowners Act of 2008 (S.2791), which would extend the tax penalty exclusion for mortgage debt cancellation for one year, through 2010; impose a two-year moratorium on prepayment penalties; simplify mortgage documents; and provide $200 million in appropriations for financial counseling programs. S.2791 would also provide $1 billion in Community Development Block Grant (CDBG) funding. Under the bill, the government sponsored enterprises would be required to register with the Securities and Exchange Commission (SEC) and put SEC fees into a permanent financial counseling and foreclosure prevention fund.
Sen. Maria Cantwell (D-WA) and Sen. Jon Ensign (R-NV) introduced the Clean Energy Tax Stimulus Act of 2008 (S.2821), which would extend a number of energy tax incentives, including the renewable energy production tax credit. S.2821 would also provide an additional $400 million in clean renewable energy bonds (CREBs) for public power providers and cooperatives.
The Week Ahead
- On Monday, April 7, the Senate Banking Committee is scheduled to hold a field hearing in Philadelphia on predatory lending and the foreclosure crisis.
- The Senate Finance Committee will hold a hearing on the Iran Counter-Proliferation Act of 2007 (S.970) on Tuesday, April 8.
- On Wednesday, April 9 and Thursday, April 10, the House Financial Services Committee will hold a two-day hearing on the FHA Housing Stabilization & Homeownership Retention Act.
- The Senate Finance Committee will hold a hearing on identity theft on Thursday, April 10.
- Also on Thursday, April 10, the Senate Appropriations Subcommittee on Transportation, Housing and Urban Development, and Related Agencies will hold a hearing titled, “The Federal Housing Administration's Role in Addressing the Housing Crisis.”
- The Senate Banking Committee will hold a hearing to examine proposals to mitigate foreclosures and restore liquidity to the mortgage markets on Thursday, April 10.