Prepared Testimony of Representative Maxine Waters on the Proposed Acquisition of Countrywide Financial by Bank of America
Thank you for the opportunity to provide testimony on Bank of America's proposed purchase of Countrywide Financial. This transaction stands as one of the most important that the Federal Reserve has reviewed in recent memory. If completed, it will create the nation's largest mortgage lender and mortgage servicer. And it will do so in the midst of a crisis—specifically, a meltdown in the mortgage markets that has led to a foreclosure wave unlike any since the Great Depression, nearly toppled a major investment bank, and resulted in a credit crunch that threatens our entire economy.
Therefore, it is absolutely essential that the Federal Reserve get this right. I would be less than candid, however, if I said that I was filled with confidence that it will do so, in light of the institution's lackluster record during the run-up to this crisis. While there is plenty of blame to go around among the many—perhaps too many- federal regulatory agencies with oversight of financial institutions in the subprime lending and mortgage backed securities markets, the Federal Reserve's role in the years prior to the mortgage-market meltdown was especially distressing.
First, then-Chairman Greenspan repeatedly underplayed or outright denied the possibility that skyrocketing housing prices—the only reason the lax underwriting standards that pervaded the subprime market did not lead to disaster sooner— might be symptomatic of an asset bubble at risk of bursting. As a member of the House Financial Services Committee for over a decade, I certainly don't recall him issuing forceful warnings of this possibility in his bi-annual appearances before us as mandated by the Humphrey-Hawkins Act.
Second, and more troubling, the Federal Reserve declined to take even minimal steps to curb the deceptive practices and outright fraud taking place in the subprime lending market as it grew from virtual non-existence a decade ago to a $625 billion dollar industry accounting for a quarter of all mortgages in 2006. Former Chairman Greenspan never pushed subprime lenders for so much as a voluntary industry code of conduct, despite a direct plea from the Greenlining Institute and the ongoing effort to elicit one –futile as it turned out—by another major federal regulatory stakeholder, now FDIC Chairwoman Bair who was during the early years of this Administration a senior Treasury official.
Most glaringly, the Federal Reserve declined to put into place comprehensive protections for subprime borrowers under the authority conferred upon it under Regulation Z of the federal Truth in Lending Act and the Home Ownership Equity Protection Act of 1994. While it issued a rule in 2001 that required income documentation for some HOEPA-covered loans, additional rulemaking under its broad authority to regulate unfair, deceptive, and abusive lending practices was not forthcoming over the next seven years-- even as so-called "no doc" loans, exotic mortgage products like "2-28" ARMs, and fraudulent sales practices permeated the subprime lending industry. Not until January of this year did the Federal Reserve propose anything near the sort of comprehensive protections of borrowers in both the home purchase and refinancing contexts that were clearly needed years ago.
So troubling a history compels me to be very direct in stating that the Federal Reserve bears a heavy responsibility to prove its commitment and competence in the review of the Bank of America/Countrywide transaction. This is especially so given the activist crisis management role the Fed has assumed in recent months under Chairman Bernanke, as well as the prominence Treasury Secretary Paulson gives the institution in the Administration's proposed new scheme for regulating the financial markets. Simply put, if the Federal Reserve continues to act as the primary watchdog over financial crises in the contemporary economy, then we must be assured that it will not resume a stance of detachment and negligence when the stakes for American consumers are high. We have now learned the hard way that failure to vigilantly protect consumers inevitably leads to harm to the safety and soundness of financial institutions and the economy as a whole—the traditional realms of the Fed. Hiding its head in the sand is no longer an option.
What does this mean for the Federal Reserve's review of this particular transaction? Taking a page from Secretary Paulson's approach of moving American financial regulation in the direction of so-called "principles-based" oversight of the financial markets, I suggest that two principles anchor the Federal Reserve's assessment of this acquisition. These principles can be articulated in the form of questions:
First, is this transaction safe for the financial markets and the American economy? And, second, does the acquisition put in place a clear plan to ensure the best possible outcome for the millions of distressed Countrywide borrowers who face possible foreclosure?
If the answer to either of these questions is no, then the acquisition must be stopped in its tracks. With respect to the stability of the financial markets, I would simply observe that the entire course of this crisis has followed a single troubling pattern. Things look bad…then they turn out to be worse than we thought. This has particularly been the case with regard to the exposure of large banks, hedge funds, and other investors to losses from mortgage-backed securities, and other instruments that have suffered plummeting values as the credit crunch spreads—including leverage loans and collateralized debt obligations or "CDOs." While it exited the direct subprime lending market a number of years ago, Bank of America recently reported mortgage-backed securities and related trading losses in the first quarter of over $1.3 billion dollars, and an 80 percent drop in profit compared to the same period last year. It has now had to reserve $6 billion to cover potential credit losses—and sits on nearly $35 billion in mortgage-backed securities, leveraged loans to private equity firms, and CDOs. Clearly, the Federal Reserve must do a careful analysis to ensure that swallowing Countrywide will not make Bank of America so sick that it soon needs the emergency life support Bear Stearns received a short while ago. The economy simply cannot withstand many such events too close together, especially given the enormous size of the post-acquisition Bank of America-- an entity that will have a piece of well over one-third of the mortgages in the United States.
I caution the Federal Reserve also to examine very carefully the exposure that Bank of America has to civil and even criminal liability resulting from the recent behavior of Countrywide executives. Countrywide CEO Angelo Mozillo sold in excess of $450 million in stock in the months prior to the subprime implosion, even as he continued to tout Countrywide's subprime loan products to consumers and the markets. He is now leaving the company with a golden parachute of $120 million even after a voluntary reduction of $37.5 million. In my view, any reasonable analysis of this transaction must focus on the potential liability that Bank of America faces, as Countrywide shareholder law suits and civil and criminal inquiries that are already or may be launched by the SEC, Department of Justice, and other federal or state regulators come to fruition.
However, even if a consummated acquisition results in a Bank of America that appears financially healthy, the transaction should not be permitted to go forward in the absence of a concrete, transparent strategy for ensuring that as many distressed Countrywide borrowers as possible will be able to stay in their homes, with mortgage payments they can afford for the long-term. Without this, the Countrywide name will be buried forever but the damage inflicted by its employees, and the mortgage brokers it allowed to operate with little or no oversight in communities across this state, will continue to be felt far into the future.
In terms of evaluating the plan that Bank of America will, I understand, expand upon in its testimony today, I would again suggest that the Federal Reserve follow two principles. With respect to the process for executing loan workouts and other loss mitigation activities, the operative question should be: "Does this plan make it as easy for distressed borrower to get help from Bank of America resolving problems with their loans as it was to get the loan from Countrywide in the first place?"
To date, the answer to this question has clearly been "no." As a threshold matter, I want to point out that Countrywide is currently the largest servicer of mortgages in the country, and its purchase by Bank of America will create by far the largest institution of this kind. I have been focused on mortgage servicers since the beginning of this debacle, and it is now clear that within a generally opaque and under-regulated mortgage market, mortgage servicers represent by far the least understood and overseen segment of the industry. With no duty to report on their activities to federal regulators or Congress, and no fiduciary obligation whatsoever to the borrowers for whom they are the first and only point of contact, mortgage servicers have acted in response to this crisis only as much as they voluntarily wish to, and told policymakers and the public only as much about their activities as they feel like. This must change.
The first step is improved outreach. While the industry touts as comprehensive and effective strategies for reaching delinquent and at-risk borrowers its direct mailings, toll free HOPE NOW Alliance phone number, and participation in local homeownership preservation workshops, a different story is being told by witnesses at this and prior public hearings as well as by investigative journalists and broader gauge analyses like the one recently conducted by the California Reinvestment Coalition. It is striking to me that, while Countrywide, Bank of America, and other lenders – who are also major mortgage servicers—have run major television campaigns during recent sporting events such as the Super Bowl and NCAA college basketball tournament, encouraging prospective homebuyers and existing homeowners to take out new loans or to refinance, no campaign of equal magnitude has targeted to borrowers seeking help with workouts for their existing subprime and other troubled loans. The Federal Reserve must ensure that Bank of America's proposed post-acquisition outreach strategies significantly exceed the standard of "more of the same."
This holds true as well for the accessibility and authority of loss mitigation personnel at Bank of America after the transaction takes place. In two hearings before my Subcommittee on Housing and Community Opportunity, I heard of the difficulties borrowers and even their trained advocates confronted in getting to an actual human to address their problem, much less one authorized to execute a long-term, sustainable solution such as a loan modification. Phone calls go unanswered; borrower inquiries are not responded to for months; no real loss mitigation offer is made until the borrower is on the verge of foreclosure, if at all, and then only if the borrower forfeits legal rights.
While Countrywide does not appear to be the worst among servicers—again, it is difficult to know since none of them are providing data subject to outside audits—it is certainly not doing a stellar job, as witnesses at prior public hearings on this transaction have testified. Notably, like other servicers, even as it has been forced by the magnitude of the crisis to expand its servicing operations, Countrywide has tried to cut costs by outsourcing these functions to India and Costa Rica, which seems unlikely to enhance outcomes for borrowers. Meanwhile, no such belt-tightening seems to have taken place in providing rewards to the mortgage brokers who originate their loans—beneficiaries this year of an all-expenses-paid trip to Aspen, Colorado. This strike me as, at best, a misalignment of priorities and resources that cannot be permitted to survive this transaction.
Finally, and most important, the Federal Reserve must hold Bank of America accountable for loss mitigation outcomes for the Countrywide borrowers it inherits. Here, the critical questions are "Will Bank of America prioritize loss mitigation outcomes that keep distressed borrowers in their homes whenever feasible, and when a loan workout is executed that achieves this goal, does the resulting repayment plan, loan modification, or other strategy put in place a monthly payment plan that is affordable and sustainable for the borrower?"
I have introduced legislation—The Foreclosure Prevention and Sound Mortgage Servicing Act—that would codify this reasonable standard, and require servicers to report data demonstrating that they are meeting it going forward. I was compelled to do so because policymakers have no access to data to assess definitively whether voluntary industry efforts like the HOPE NOW Alliance are adhering to it, while the limited data disclosed by the industry coupled with the anecdotal reports of counselors, consumer attorneys, and borrowers themselves strongly suggest they are not. To provide but two examples—at my Subcommittee's hearing on April 16th, HOPE NOW revealed that fewer than 4% of total loan workouts resulted in rate modifications of five years or longer. Similarly, at the same hearing, Countrywide reported an increased pace of loan workout and modifications in comparison to its testimony at a November 2007 Subcommittee hearing. Nevertheless, as little as 15% of total loan workouts in the six months ending March 31 consisted of rate reduction modifications of 5 years or longer. I say "as little as" because, again, the data provided to me was imprecise.
Step one in analyzing the proposed outcomes of any strategy Bank of America furnishes to the Federal Reserve, then, is to insist upon comprehensive, audited data on both Countrywide's and Bank of America's loss mitigation activities to date. This minimum standard is something that even Secretary Paulson—no fan of compelling industry behavior so far during this crisis—apparently took the major servicers to task for failing to meet in a closed-door meeting last week.
The most fundamental issue, however, extends beyond the question of forbearance versus repayment plans versus loan modifications versus other loan workout outcomes: It is the standard of affordability that Bank of America will apply to any workout. The bottom line criterion for evaluating a workout is whether the payment plan that results is affordable to the borrower over the long-term. And neither HOPE NOW, nor Countrywide, nor Bank of America are willing to be clear about the affordability standards that are being applied to most of the distressed loans they are servicing.
This cannot be allowed within the plan that Bank of America submits to the Federal Reserve. One of the most striking findings of my Subcommittee's hearings on mortgage servicing was that large servicers like Countrywide and Bank of America service mortgages originated subject to guarantees by the VA, FHA, and the GSEs – Fannie Mae and Freddie Mac—as well as large Alt A and subprime portfolios, which are where many of the problems lie.
The significant portion of their portfolios subject to these governmental or quasi-governmental guarantees are must adhere to strict loss mitigation guidance issued by the guarantors, which mandate that loss mitigation offers meet certain affordability standards. These standards typically require that the borrower be left with a ratio of debt-to-income that is not too high to be sustained for the long-term. They also require that after monthly expenses including debt service on the mortgage and all other secured and unsecured debt—such as credit cards and auto loans—are deducted from a borrower's monthly income, enough money is left over that the borrower will be able to meet unexpected expenses. For example, Fannie Mae requires that $200 in residual income be available after making the monthly mortgage payment under a proposed loan workout, while Freddie Mac generally adheres to a residual income standard of 20% of borrower's monthly income.
In plain English, Countrywide, Bank of America, and most other large servicers are adhering to time-tested affordability standards for a significant portion of their portfolios – which tend to be the safer products they service due to strict VA, FHA, and GSE underwriting guidelines—while utterly failing to report to the public or policymakers on the affordability standards they are utilizing in servicing the Alt A, subprime, and other riskier portions of their portfolios, much less committing to employing a uniform, proven affordability standard when servicing those loans. In my view, the Federal Reserve's assessment of this proposed acquisition must be considered negligent on its face if Bank of America is permitted to implement a loss mitigation plan for the borrowers it currently services, and those it inherits from Countrywide, that perpetuates this lack of transparency and uniformity with respect to the affordability standard that applies to loans its services falling outside the purview of the VA, FHA, and the GSEs.
I conclude by stating that the American people desperately need for the Federal Reserve's assessment of this massive mortgage market-related transaction to represent a triumph of hope over experience – a new chapter in which the Fed ensures that major mergers and acquisitions yield positive outcomes for consumers and communities, as well as the institutions involved. Thank you.