[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                   COMMERCIAL REAL ESTATE: A CHICAGO
                     PERSPECTIVE ON CURRENT MARKET
                   CHALLENGES AND POSSIBLE RESPONSES

=======================================================================

                             FIELD HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 17, 2010

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-136











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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES WILSON, Ohio                 KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
              Subcommittee on Oversight and Investigations

                     DENNIS MOORE, Kansas, Chairman

STEPHEN F. LYNCH, Massachusetts      JUDY BIGGERT, Illinois
RON KLEIN, Florida                   PATRICK T. McHENRY, North Carolina
JACKIE SPEIER, California            RON PAUL, Texas
GWEN MOORE, Wisconsin                MICHELE BACHMANN, Minnesota
JOHN ADLER, New Jersey               CHRISTOPHER LEE, New York
MARY JO KILROY, Ohio                 ERIK PAULSEN, Minnesota
STEVE DRIEHAUS, Ohio
ALAN GRAYSON, Florida












                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 17, 2010.................................................     1
Appendix:
    May 17, 2010.................................................    55

                               WITNESSES
                          Monday, May 17, 2010

Askew, William E., Senior Policy Advisor, The Financial Services 
  Roundtable.....................................................     9
Born, Kent, Senior Managing Director, PPM America, on behalf of 
  the CRE Finance Council........................................    42
Borzak, Peter, Principal, Pine Tree Commercial Realty, on behalf 
  of the International Council of Shopping Centers...............     7
Cohen, Bruce R., CEO, Wrightwood Capital, on behalf of the Real 
  Estate Roundtable..............................................    44
Cosenza, G. Joseph, Vice Chairman and Director of the Inland Real 
  Estate Group, Inc., and President, Inland Real Estate 
  Acquisitions, Inc., on behalf of the National Association of 
  Realtors and the Illinois Association of Realtors..............     8
Dubberly, Paula, Associate Director, Division of Corporation 
  Finance, U.S. Securities and Exchange Commission...............    39
Hough, Thomas W., CEO and Chairman, Carrollton Bank, on behalf of 
  the Illinois Bankers Association...............................    11
Lemieux, Cathy, Senior Vice President, Federal Reserve Bank of 
  Chicago........................................................    28
Lowe, M. Anthony, Regional Director, Division of Supervision and 
  Consumer Protection, Chicago Regional Office, Federal Deposit 
  Insurance Corporation..........................................    25
McKee, Daniel T., Central Regional Director, Office of Thrift 
  Supervision....................................................    27
Ohlendorf, Greg M., President and CEO, First Community Bank and 
  Trust, on behalf of the Independent Community Bankers of 
  America and the Community Bankers Association of Illinois......    12
Otto, Bert A., Deputy Comptroller, Central District, Office of 
  the Comptroller of the Currency................................    26
Sellers, Leslie, President, Appraisal Institute..................    41
Stoklosa, Kevin, Assistant Technical Director, Financial 
  Accounting Standards Board.....................................    40

                                APPENDIX

Prepared statements:
    Askew, William E.............................................    56
    Born, Kent...................................................    65
    Borzak, Peter................................................    79
    Cohen, Bruce R...............................................    85
    Cosenza, G. Joseph...........................................    97
    Dubberly, Paula..............................................   105
    Hough, Thomas W..............................................   118
    Lemieux, Cathy...............................................   122
    Lowe, M. Anthony.............................................   136
    McKee, Daniel T..............................................   153
    Ohlendorf, Greg M............................................   158
    Otto, Bert A.................................................   172
    Sellers, Leslie..............................................   184
    Stoklosa, Kevin..............................................   193

              Additional Material Submitted for the Record

Moore, Hon. Dennis:
    Written responses to questions submitted to Cathy Lemieux....   197

 
                   COMMERCIAL REAL ESTATE: A CHICAGO
                     PERSPECTIVE ON CURRENT MARKET
                   CHALLENGES AND POSSIBLE RESPONSES

                              ----------                              


                          Monday, May 17, 2010

             U.S. House of Representatives,
                          Subcommittee on Oversight
                                and Investigations,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 1 p.m., in 
room 2525, Dirksen Federal Courthouse, 219 South Dearborn 
Street, Chicago, Illinois, Hon. Dennis Moore [chairman of the 
subcommittee] presiding.
    Members present: Representatives Moore and Biggert.
    Also present: Representatives Bean, Foster, and Gutierrez.
    Chairman Moore of Kansas. Everybody is here so we're going 
to start a little bit early, just a couple of minutes early.
    This field hearing of the Subcommittee on Oversight and 
Investigations of the House Financial Services Committee will 
come to order.
    Our hearing today is entitled, ``Commercial Real Estate: A 
Chicago Perspective on Current Market Challenges and Possible 
Responses.'' This is our 13th O&I hearing this Congress and our 
third field hearing.
    Before we begin with opening statements, I want to take a 
moment of personal privilege to first thank Ranking Member Judy 
Biggert for asking that we come to Chicago to focus on this 
important issue of commercial real estate. Thank you very much, 
Judy.
    Congress can learn more about the particular issues or 
challenges when we get out of Washington and hear directly from 
local business leaders, financial institutions, and regulators 
on the ground as we will today.
    I also want to thank Ranking Member Biggert and Full 
Committee Ranking Member Spencer Bachus' staff, Nicole Austin 
and Jason Goggins, for their good efforts and for working 
closely with my staff, not only on this field hearing, but on 
all of the O&I hearings we have held to date.
    And I want to thank the people of Chicago for welcoming us, 
especially Chief Judge James F. Holderman of the Northern 
District of Illinois for letting us borrow his courtroom this 
afternoon.
    We will begin this hearing with members' opening 
statements, up to 10 minutes per side, and then we will hear 
testimony from our witnesses for each witness panel. Members 
will have up to 5 minutes to question our witnesses. The Chair 
advises our witnesses to please keep your opening statements to 
3 minutes to keep things moving so we can get to members' 
questions. Also, any unanswered questions can always be 
followed up in writing for the record.
    Without objection, all members' opening statements will be 
made a part of the record, and I want to recognize myself for 
an opening statement.
    Commercial real estate continues to be an area of deep 
concern as we work to support a strong economic recovery, not 
only in Chicago, but throughout our country. The Congressional 
Oversight Panel's February report received a lot of attention 
as they wrote, ``between 2010 and 2014, about $1.4 trillion in 
commercial real estate loans will reach the end of their terms. 
Nearly half are at present `underwater.' Commercial property 
values have fallen more than 40 percent since the beginning of 
2007. A significant wave of commercial mortgage defaults would 
trigger economic damage that could touch the lives of nearly 
every American.''
    We must look at this problem from all angles. Lending 
securitization, asset valuation, regulation, and so on, and so 
I look forward to the observations that our witnesses will 
share with us today.
    I now recognize for 5 minutes the ranking member of the 
subcommittee, my colleague representing the 13th District of 
Illinois, Ranking Member Judy Biggert.
    Mrs. Biggert. Chairman Moore, thank you, and welcome to 
Chicago. Last September, I asked Chairman Frank, our Financial 
Services Chairman to hold a hearing on commercial real estate.
    Chairman Moore, thank you for scheduling this important 
hearing and for coming here to Chicago to chair it. And I thank 
my Illinois colleagues--Representatives Gutierrez, Bean, and 
Foster--for joining us. I also want to thank Chief Judge 
Holderman as well as his staff, for kindly allowing us to use 
this courtroom today. And I thank many of our local witnesses 
for sharing their expertise with us.
    I'm very disappointed that the Department of the Treasury 
could not spare even one staff member to testify on such an 
important topic, but we'll move on. And we're here to address 
an increasingly problematic sector over our economy--that is 
the commercial real estate market or CRE market. Chicago is 
home to key leaders in all aspects of commercial real estate, 
including acquisitions, appraisals, mortgage lending, and 
securitization, to name a few.
    In 2009, we lost more jobs here than in any other 
metropolitan region in the country. This March, unemployment in 
Illinois increased to 11.5, percent which is above the national 
average of 9.9 percent in April.
    With businesses downsizing or shutting their doors, and 
workers being laid off, taxes increasing, and regulatory and 
market uncertainty on the rise, we can anticipate additional 
residential foreclosures, followed by commercial building 
vacancies.
    During the first quarter of 2010, CRE mortgage 
delinquencies in Chicago exceeded the national average, rising 
to 6.7 percent. Illinois banks continue to fail; last Friday, 
it was Midwest Bank and Trust Company. Last month, seven banks 
went under, including our own State Treasurer's family bank. 
Excessive concentrations in certain types of risky commercial 
real estate loans and even loans to criminals played a role. 
Where were the regulators?
    We must address the causes of the turmoil in the CRE market 
and remove barriers to market recovery. Will we need an Act of 
Congress? Regulatory action? What about ideas that voluntarily 
can be implemented by market participants? For example, can 
banks simply extend the terms of a loan until market prices 
recover? I think it will take an all-of-the-above approach, but 
our ultimate goal should be to keep out of the equation any 
additional taxpayers' bailouts.
    Taxpayers backed the $700 billion TARP program and the 
bailouts of Fannie Mae and Freddie Mac to the tune of $145 
billion as of last week. And if the FHA or FDIC insurance funds 
are depleted, taxpayers may be asked to front for those as 
well.
    In my view, it's high time that the Federal Government 
permanently exit the ``too-big-to-fail'' bailout business, and 
instead enact effective financial reforms to reestablish market 
discipline and transparency. And instead of shipping new taxes 
from Illinois to Washington for bureaucrats to spend on a new 
agency or programs, we should hold regulators accountable for 
doing their job and allowing small business entrepreneurs to 
retain and invest more of their money in their own businesses.
    We need to break down the barriers to recovery. For 
example, right away, Congress should infuse small businesses 
with capital and give them certainty for short- and long-term 
planning so that businesses can expand and create jobs. 
Congress should extend for more than 1 year the increased 
section 179 expensing limits; for 2010, the 5-year net 
operating loss carry back; and accelerated depreciation.
    In addition, this week, the House should reject any bill 
that more than doubles the tax on carried interest. It would be 
a big mistake and devastating for Chicago if Congress increases 
taxes that would severely curtail investment in real estate. 
With more cash flow instead of tax flow, small businesses can 
and will expand, create jobs, and get our economy back on 
track.
    Regulators could gain a sense of urgency and make a serious 
effort to fix the foundational accounting problems in the 
commercial real estate market before it's too late.
    Since February 2009, I have been asking Federal Reserve 
Chairman Bernanke, as well as other regulators, to address 
issues like this. The response in Washington is that the issues 
are being addressed, but here in Chicago, in Illinois, that's 
not what our constituents are reporting. Regulators have issued 
guidance after guidance after guidance, but it's vague and 
meaningless without clear and consistent execution by the 
examiners on the ground.
    Examiners should not force banks to devalue performing 
loans. That's so counterproductive. Just because, in the run-up 
to the crisis, they underreacted by failing to stem commercial 
real estate loan concentrations in some community banks, that 
should not mean that they now must overreact. Nor should 
examiners instill unfounded fear in our community bankers. This 
is having a ripple effect, worsening the credit crunch and 
forestalling economic recovery.
    Today, it's critically important that we examine the trends 
here in Chicago, explore the causes behind the collapse, and 
find solutions--be they regulatory, statutory, or voluntary 
among industry participation--to restore the flow of credit so 
they can restore productivity to our commercial properties. We 
don't need stall tactics. We need solutions. Some banks will 
fail and some loans and securities will go bad, but I'm 
confident that many will succeed. By recognizing and breaking 
down existing barriers to stability in commercial real estate, 
we can put Chicago firmly back on the road to economic recovery 
and get unemployed Illinoisans back to work.
    I look forward to working with my colleagues on solutions. 
I look forward to hearing from today's witnesses. And again, 
thank you, Chairman Moore, and I yield back.
    Chairman Moore of Kansas. My thanks to the ranking member 
for her statement. The Chair now recognizes for 3 minutes 
Congressman Luis Gutierrez, the chairman of the Financial 
Institutions Subcommittee, who represents the Fourth District 
of Illinois and chairs our Democratic Task Force on Commercial 
Real Estate. You are recognized for 3 minutes.
    Mr. Gutierrez. Thank you so much. First of all, I have to 
say to everybody, you're going to miss Chairman Moore. We came 
together in 1993 to Congress, and I'm unhappy that you're 
leaving, and I'm saddened. Your shoes will be hard to fill; 
they're very large.
    Judy Biggert, thank you so much for your concern and your 
effort and for working so closely with all of your colleagues. 
I would say more nice things about you, but I don't want them 
to be used against you in the coming election, so I'll share 
some things in private with you later on.
    Yes, it's coming. And as Chairman Moore has indicated, they 
have asked me to head up a task force in the Subcommittee on 
Financial Institutions. We're getting ideas. And so the 
testimony today will be used as part of that task force 
information and putting legislative work before the Congress of 
the United States.
    And why do I say it's a tsunami? Because here's what's 
going to happen. You have $3.4 trillion. That's what the 
commercial real estate market is worth, and $1.4 trillion of it 
comes due in the next 5 years. That means somebody has to get a 
new loan, refinance, restructure. If we're having such a hard 
time today getting banks to lend people money, what would make 
us think that in the next 5 years, commercial real estate, 
which is doing so poorly, is simply going to all get 
renegotiated?
    I want to remind everybody how close this is and evidence 
about how real it is and something that maybe most people can 
understand here in Chicago. I had a hearing, and we had the 
owner of Mr. Beef, over on Orleans. If you haven't had one, you 
should. It's a Chicago institution and interesting and ironic, 
Midwest Bank which just closed last Friday, taken over by the 
FDIC, told Mr. Beef they were calling in his loan. Not that Mr. 
Beef isn't profitable, you can go there any day. They did it 
because they said they had to call in his loan because the 
amount of money that was extended to him on the real estate and 
the value of that real estate were not on par. That's just one 
example.
    So the place that you go shop for your clothes, the place 
you go to eat, the place you go to buy books, the local 
business maybe where your kids get tutoring, all of those local 
businesses, even though they're thriving and doing as well as 
Mr. Beef is doing, that doesn't mean the bank isn't going to 
call in the loan and possibly then close down the business. And 
we all know that in Chicago, we have businesses with apartments 
on top of them.
    Lastly, let me just say this just to show you what's going 
to happen. Twenty percent of the loans today in the Chicago 
area, land loans, are not performing, 20 percent today. That's 
stuff that really hasn't even been built or even opened up yet. 
Now take that into consideration when you think of the $1.4 
trillion and you begin to see the scope of this.
    So I thank Chairman Moore for calling this hearing and I 
thank Judy Biggert for encouraging the committee to come here 
to Chicago because I want to make sure that as we develop the 
legislation, and legislation will be developed to counteract 
this, that Chicago is taken into consideration.
    Thank you very much, Mr. Chairman.
    Chairman Moore of Kansas. Thank you, sir. I next recognize 
for 3 minutes Congresswoman Melissa Bean, who represents 
Illinois' 8th District. She's the co-chair of the New 
Democratic Financial Services Task Force and brings 2 decades 
of business experience with her to Congress. Congresswoman 
Bean, please.
    Ms. Bean. Thank you, Mr. Chairman, and I would also like to 
thank Congresswoman Biggert, ranking member on the 
subcommittee, for holding this important hearing. And Mr. 
Chairman, thank you for traveling from Kansas, your District. 
It goes without saying that you're not in Kansas any more. 
You're here in the big city and we appreciate having a local 
hearing so we can get perspective from those who are in the 
industry and can bring a Chicago metropolitan perspective to 
these hearings.
    I have long been concerned with the problems we're facing 
in commercial real estate. If left unaddressed, I fear our 
current economic recovery could be delayed or even reversed. 
While in the Wall Street reforms that we have already passed 
through the House and we're waiting to get back from the 
Senate, we did address mortgage reform on the residential side, 
and there is a risk retention component that applies to 
commercial lending as well, but we didn't really get as beat on 
the commercial side.
    As other members have just stated, according to the 
Congressional Oversight Panel Report on CRE, $1.4 trillion of 
loans will come due in the next 4 years. Half of these are 
currently underwater. In Illinois, the delinquency rate for 
commercial mortgages is 6.8 percent, which is more than 1 
percent higher than the national average.
    Further troubling, the delinquency rate for local 
construction and land loans in the Chicago area is 25.7 
percent. While economic indicators are improving, delinquency 
rates in the commercial real estate space continue to rise.
    The problems in the commercial real estate market don't 
just impact the investors and developers of commercial real 
estate, but many of our community banks who hold these loans. 
As community banks write off losses in their commercial real 
estate portfolio, this limits the amount of new loans that they 
can make. As we have seen recently in Illinois, many community 
banks are overexposed to commercial real estate and have 
already been closed by the FDIC.
    With hundreds of banks around the country on the FDIC's 
watch list, addressing this problem is of critical importance. 
The way I see it, there are several questions we need to 
answer.
    First, how do we deal with the performing but underwater 
commercial real estate loans that are coming due at banks that 
are unable or unwilling refinance?
    Second, how do we strike the proper balance of prudent 
regulation of banks and the risk they have on their balance 
sheets with an appropriate flexibility to address exacerbated 
market conditions?
    Third, how do we restart the securitization market for 
commercial real estate loans and enable smaller institutions to 
take advantage of securitization, to add much needed liquidity 
in the market?
    Finally, how do we make sure banks are able to offer loans 
to creditworthy borrowers who need a commercial real estate 
loan?
    If the answer to these questions requires legislation, I 
believe the committee should seek to do so in a matter that 
effectively addresses the problems in the market while 
minimizing the risk and cost to taxpayers.
    Thank you, and I yield back.
    Chairman Moore of Kansas. Thank you. Finally, the Chair 
will recognize for 3 minutes Congressman Bill Foster, who 
represents Illinois' 14th District, and has brought his 
scientific and business background to great use in the House 
Financial Services Committee.
    Mr. Foster. I would like to thank my colleagues for 
arranging this hearing and to echo thanks to Chief Judge 
Holderman for allowing us to use this wonderful venue.
    It strikes me that the keys to this problem to the extent 
that it can actually be solved are first to let the market 
separate those firms and projects which can actually be saved 
from those that cannot. There has been a certain amount of 
misallocation of capital in the last several years. When I look 
at shopping centers built out in the middle of developments 
which were not built, these will represent stranded investments 
for the next decade, and it is a mistake to struggle to try to 
keep these. They will be dark for the next decade and that's 
just the way it is.
    On the other hand, there's a fraction of businesses that 
are viable, do have a good cash flow and viable business model, 
and these are the ones that we should concentrate on and save. 
We must provide incentives to bring private equity off of the 
sidelines and into the business to save this.
    My office is working specifically on a proposal to 
incentivize mezzanine financing. There are a number of other 
proposals working their way through Congress and through the 
Administration and I will be very interested in seeing the 
reaction of our witnesses to these various proposals.
    I think also where appropriate, we may want to consider 
methods of providing regulatory capital relief to small banks, 
heavily committed, heavily invested in commercial real estate. 
That is a very dangerous game to play and we could be in a 
situation where we're causing trouble downstream, but the 
fraction of their investment in commercial real estate that is 
really not at risk maybe should not be fully counted in the 
normal way that we count investments in commercial real estate 
in their capital requirements.
    I look forward to hearing the reactions of all of our 
witnesses to these various proposals and I yield back the rest 
of my time.
    Chairman Moore of Kansas. Thank you, sir. I am pleased to 
introduce our first witness panel: Mr. Peter Borzak, principal, 
Pine Tree Commercial Realty, testifying on behalf of the 
International Council of Shopping Centers; Mr. Joseph 
``Cosenza,'' is that pronounced correctly, sir?
    Mr. Cosenza. Yes.
    Chairman Moore of Kansas. --vice chairman and director of 
The Inland Real Estate Group, and president, Inland Real Estate 
Acquisitions, testifying on behalf of the National Association 
of Realtors and the Illinois Association of Realtors; Mr. 
William Askew, senior policy advisor, The Financial Services 
Roundtable; Mr. Thomas Hough, CEO and chairman, Carrollton 
Bank, testifying on behalf of the Illinois Bankers Association; 
Mr. Greg Ohlendorf, president and CEO, First Community Bank and 
Trust, testifying on behalf of the Independent Community 
Bankers of America, and the Community Bankers Association of 
Illinois.
    Without objection, your written statements will be made a 
part of the record. You will each have 3 minutes to summarize 
your statements and touch on the key messages you would like to 
share with the panel up here.
    Mr. Borzak, sir, you are recognized for 3 minutes.

  STATEMENT OF PETER BORZAK, PRINCIPAL, PINE TREE COMMERCIAL 
  REALTY, ON BEHALF OF THE INTERNATIONAL COUNCIL OF SHOPPING 
                            CENTERS

    Mr. Borzak. Thank you. I would like to thank you all for 
holding this hearing and considering these issues that are 
facing our industry. My name is Peter Borzak, and I'm 
representing the International Council of Shopping Centers, 
also known as ICSC, which is the dominant trade organization 
for the retail real estate industry. ICSC boats over 55,000 
members in 92 countries worldwide.
    My company, Pinetree Commercial Realty, is based in 
suburban Chicago. We have been in business since 1995 and have 
developed or acquired 56 shopping centers.
    As you know, this cycle was not caused by the commercial 
real estate industry, but was rather caused by residential real 
estate lending and the mislabeling of securitized debt. 
However, the resulting financial market meltdown caused prices 
of commercial real estate to drop on average 30 to 40 percent 
which is now continuing to pose threats to the commercial real 
estate industry, the banking sector, and the economy in 
general.
    Although there is capital coming into the commercial real 
estate industry, that capital right now is targeting only 
premium properties in a handful of the largest markets in the 
metropolitan United States.
    Commercial real estate is a capital-intensive industry and 
there are a couple of things that Congress can do to try to 
keep commercial real estate from posing a greater threat to the 
economy.
    Number one, please do not pass the increased tax on carried 
interest. This tax is not meant to target the commercial real 
estate industry and it is not meant to correct a problem in our 
industry. Rather than a scalpel, Congress is proposing using a 
bazooka to address the carried interest issue in the financial 
sector and it will cause devastating effects for local 
operators who provide jobs and the majority of the real estate 
across this country. Carried interest helps alignment and 
carried interest is subordinate, generally, to returns on cash 
investments. Enacting this legislation will drive commercial 
real estate prices down even further and cause further job 
loss.
    Number two, from my experience, local regulators seem to be 
trying to work with local and regional banks to help them 
through this difficult period. However, Washington seems intent 
on forcing consolidation and putting more banks out of 
business. There seems to be a huge double standard in dealing 
with the money center banks that are considered ``too-big-to-
fail'' and the local banks that are considered too small to 
matter. As these small banks are shuttered, so are the 
thousands of relationships with local real estate operators, 
retailers, and local business people.
    Local and regional banks provide most of the real estate 
and small business loans in our country and losing those 
relationships will cost us in lost jobs, lost businesses, and 
greater consolidation. Both of these issues are truly ``Main 
Street'' issues that will have a direct impact on employment 
and economic recovery. There's obviously a lot more detail that 
can be provided on these issues when time is not a factor.
    Thank you again for holding these hearings and considering 
the needs of the commercial real estate industry.
    [The prepared statement of Mr. Borzak can be found on page 
79 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Borzak.
    Mr. Cosenza, you are recognized for 3 minutes.

 STATEMENT OF G. JOSEPH COSENZA, VICE CHAIRMAN AND DIRECTOR OF 
THE INLAND REAL ESTATE GROUP, INC., AND PRESIDENT, INLAND REAL 
     ESTATE ACQUISITIONS, INC., ON BEHALF OF THE NATIONAL 
    ASSOCIATION OF REALTORS AND THE ILLINOIS ASSOCIATION OF 
                            REALTORS

    Mr. Cosenza. Chairman Moore, Ranking Member Biggert, and 
Representatives Gutierrez, Bean, and Foster, thank you for 
inviting me to testify. My name is Joe Cosenza, and I have been 
a Realtor for 42 years. I am vice chairman and one of the four 
original school teachers who started and own the Inland Real 
Estate Group here in Oak Brook, Illinois, along with my 
partners Dan Goodwin, Bob Baum, and Bob Parks, who are all 
still working today.
    Since 1968, I have directly overseen the purchase for 
Inland of over $32 billion of income-producing properties. We 
have 1,400 employees.
    I am here today to testify on behalf of more than 1.1 
million Realtors who are engaged in all aspects of the real 
estate transaction. Today, I will present six proposals that we 
believe will improve the struggling commercial real estate 
industry which supports 9 million jobs in every sector of our 
economy. While none of these can solve the crisis alone, 
together, they can contribute to the recovery.
    First, we believe the most effective means of improving the 
cash flow on property is to allow new investors to accelerate 
depreciation from 39 years down to 15 years. This is a proposal 
that my company, Inland, would certainly invest in because all 
new money goes to pay down existing debt and to improvements on 
the property.
    Second, we support the increasing the cap on credit union 
business lending from the current 12 percent up to 25 percent 
of total assets. H.R. 3380, introduced by Representatives 
Kanjorski and Royce, would accomplish this goal and we urge the 
passage of this bill. This will put fresh money into the system 
at no cost to the Federal Government.
    Third, we propose developing a short-term mortgage 
insurance program to cover the difference between today's 
current value and the debt until the market recovers. It would 
be limited to performing properties that are viable for the 
long term.
    Fourth, Realtors recommend that the Federal Reserve Board 
provide term extensions for loans on properties that can 
support their current debt. This is a winning situation for 
banks and owners and requires no legislative action.
    Fifth, we propose that Congress and the Federal Reserve 
extend the TALF program through the end of 2010 that addresses 
the massive shortfalls in the market. Requirements must be 
loosened so that more investors will participate.
    Finally, sixth, we need to increase small business lending. 
Applications must be easier to complete. We also recommend the 
waiving of the fees and raising loan limits for both SBA 7A and 
504 loans, and particularly 504 loans to be used for 
refinancing.
    In conclusion, the National Association of Realtors 
believes it is critical for Congress and regulators to act now. 
We thank the subcommittee for this chance to provide input. I 
welcome any questions.
    [The prepared statement of Mr. Cosenza can be found on page 
97 of the appendix.]
    Chairman Moore of Kansas. Thank you, sir.
    Mr. Askew, you are recognized, sir, for 5 minutes.

   STATEMENT OF WILLIAM E. ASKEW, SENIOR POLICY ADVISOR, THE 
                 FINANCIAL SERVICES ROUNDTABLE

    Mr. Askew. Commercial real estate is a $5 trillion 
industry. Banks and commercial mortgage-backed securities are 
the largest sources of credit for CRE.
    Revitalizing the CMBS market is critical; $1.4 trillion in 
U.S. real estate loans are maturing between 2010 and 2014, and 
without a liquid secondary market, these loans will have 
trouble refinancing, putting more pressure on already depressed 
real estate valuations.
    The Roundtable formed a commercial real estate coalition to 
develop ideas to support the CRE industry. The coalition 
includes leading industry practitioners and other trade 
associations, many of them on your witness list.
    The coalition set three goals to guide its deliberations: 
first, to restore confidence in the commercial real estate 
sector; second, to maintain regulatory compliance while 
balancing the need for additional lending; and third, to 
restart the commercial mortgage-backed securities market for 
long-term financing.
    Last month in the Roundtable and Coalition, the Coalition 
published a White Paper entitled, ``Recapitalizing Commercial 
Real Estate: A Roadmap to Recovery.'' We have 51 
recommendations to meet these goals.
    The recommendations represent a holistic approach, as there 
is no one silver bullet to solve the problems facing the 
market. I have submitted the full paper with my written 
testimony and I'll now highly just a couple of the key 
recommendations.
    First, utilize securitization to restart the CMBS market 
for long-term financing. The restart of the securitizations 
will be key to the economic recovery. In the absence of a CMBS 
market or other viable secondary market solutions, there's a 
financing void for commercial mortgage loans. Left unfilled, 
this lack of financing will further exacerbate the downward 
pressure on the commercial real estate values.
    We encourage policymakers to continue to consider the 
unique characteristics of asset classes when adopting risk 
retention proposals and avoid one-size-fits-all legislation 
which may hurt borrowers and investors alike. Additionally, we 
urge policymakers to avoid unintended consequences in creating 
new rules. For example, FAS 166 and 167 rules, combined with a 
risk retention mandate and changes in risk-based capital could 
virtually halt new securitizations.
    Second, extend TALF to inject liquidity and confidence in 
the CMBS market. The CMBS TALF was developed to inject 
liquidity and confidence into the market by encouraging the 
securitization of privately originated loans in important asset 
classes to consumers and businesses. The program is set to 
expire and an extension is vital to the market.
    TALF has been helpful in tightening spreads and encouraging 
certain new CMBS issuance. However, a crucial next step in 
market liquidity is the issuance of a new multi-borrower pooled 
``conduit'' CMBS in order to provide the capacity necessary to 
satisfy the enormous volume of maturing loans and borrower 
demand.
    We recommend that Treasury utilize the TALF program as a 
direct and temporary solution to address the absence of a 
private-sector hedging tool that the banks do not have 
available today.
    Third, eliminate procyclical accounting policies and 
practices. The economic crisis highlighted the impact of 
procyclical accounting standards on financial markets including 
CRE. For example, the application of fair value accounting 
standards, which use near term exit pricing for asset 
valuation, proved to be both challenging and problematic during 
this period.
    The Roundtable recommends that FASB evaluate procyclical 
accounting standards and report to Congress how such standards 
might be modified in the current economy. This would include 
evaluation of fair value accounting, loan loss reserves, non-
performing short-term loans, gain-on-sale, treatment of covered 
bonds, and deferred tax assets.
    Finally, the Roundtable encourages greater coordination 
between accounting policy and other regulatory and statutory 
changes to avoid market dislocation, and to provide markets 
with certainty and confidence.
    Thank you for this opportunity to present the Financial 
Services Roundtable's view.
    [The prepared statement of Mr. Askew can be found on page 
56 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Askew.
    Mr. Hough, you are recognized, sir, for 3 minutes.

  STATEMENT OF THOMAS W. HOUGH, CEO AND CHAIRMAN, CARROLLTON 
      BANK, ON BEHALF OF THE ILLINOIS BANKERS ASSOCIATION

    Mr. Hough. Thank you, Chairman Moore, Ranking Member 
Biggert, and members of the subcommittee. My name is Thomas 
Hough, and I am the chairman and Ceo of Carrollton Bank and 
also chairman of the Illinois Bankers Association.
    While Illinois bankers are working hard to meet the credit 
needs of our communities, we are facing unprecedented pressure 
from our regulators these days and we're very concerned about 
that.
    My time here is brief, so I'll try to make just two points. 
First, we believe that there are major disconnects in 
assurances regulators are making to Congress in Washington, 
D.C., with respect to their impact on community bank lending 
and community bank closings. Our members talk nonstop about the 
stringent regulatory environment today and how the application 
of outdated accounting rules is undermining their ability to 
extend credit. Obviously, we're in turbulent economic times, 
which dictate a high level of caution when lending. But that 
alone does not explain the sometimes overly aggressive 
decisions and forced write-downs that our banks are 
experiencing in their field examinations today.
    For example, commercial loans are being downgraded even 
when they are fully performing. Collateral-dependent loans are 
being classified based on atypically depressed property values, 
even when the collateral is producing expected revenues, there 
is no intent to sell it in this distressed market, and a loan 
is not only current, but has never been past due. And based on 
accounting rules that were written for another era, we are 
being told to write down loans based on the performance of 
completely unrelated loans in our portfolio and even based on 
loans in the portfolios of our competitors down the street, in 
some cases.
    These examination mandates are being repeated every day 
throughout our State and they are needlessly depleting bank 
capital and in turn creating so much competition in capital 
markets that most banks' chances for raising new capital today 
range from slim to none.
    This leaves many banks with few options. Many are shrinking 
their balance sheets, either by selling assets or by curtailing 
lending or not renewing loans. Unfortunately, for some banks 
the only option is no option at all and that's to be drawn into 
receivership.
    Current Federal law provides virtually no discretion to the 
FDIC and the prudential regulators after the point when a 
bank's capital levels fall below certain levels, even when due 
to overly conservative write-downs based on ill-fitting 
accounting rules.
    Since Congress enacted fiducia in 1991, the regulators had 
no choice at that point to trigger so-called prompt corrective 
action when a bank's cap drops below a certain level. And 
that's my second point.
    There's a major disconnect between when our regulators do 
have the discretion in the examination stage at the banks in 
the field to avoid causing the unnecessary depletion of capital 
compared to when do not have that discretion, in the prompt, 
corrective action stage. They are not connecting the dots 
between cause and effect and they should be. There has not been 
enough discussion of these disconnects and there should be.
    Most community banks will survive if given the time and 
leeway to work through this one-in-a-lifetime recession and 
more of them will lend more in their communities if they are 
not encumbered with unnecessary write-downs, needless cap 
recalls, and the chilling prospect of the prompt, corrective 
action.
    Chairman Moore of Kansas. The gentleman's time has expired. 
Can you wind up, sir?
    Mr. Hough. Yes, thank you. We urge you to keep these 
concerns in mind as you go forward in your deliberations in 
Congress. Thank you very much.
    [The prepared statement of Mr. Hough can be found on page 
118 of the appendix. ]
    Chairman Moore of Kansas. Thank you.
    Mr. Ohlendorf, you are recognize, sir, for up to 3 minutes.

   STATEMENT OF GREG M. OHLENDORF, PRESIDENT AND CEO, FIRST 
    COMMUNITY BANK AND TRUST, ON BEHALF OF THE INDEPENDENT 
    COMMUNITY BANKERS OF AMERICA AND THE COMMUNITY BANKERS 
                    ASSOCIATION OF ILLINOIS

    Mr. Ohlendorf. Subcommittee Chairman Moore, Ranking Member 
Biggert, and members of the subcommittee, I am Greg M. 
Ohlendorf, president & CEO of First Community Bank and Trust, 
located in Beecher, Illinois. I have been in banking for 25 
years,all of those years with my same institution, an $150 
million community bank that was founded in 1916. I am pleased 
to address the subcommittee here today at this field hearing. 
I'm also privileged to represent ICBA and its 5,000 community 
bank members nationwide as well as CBAI in this important 
hearing.
    First Community Bank and Trust, like almost all community 
banks, specializes in small business lending, including 
commercial real estate or CRE lending. Community banks support 
small business lending and support local economic activity not 
supported by Wall Street. Even during these challenging times, 
our Nation's nearly 8,000 community banks remain committed to 
serving their local small business and small business-lending 
customers. But my bank and all community banks face serious 
challenges that can hinder our ability to make small business 
and CRE loans.
    Community banks now confront the toughest regulatory 
environment in more than 2 decades. The banking regulatory 
agencies have moved the pendulum too far in the direction of 
overregulation at the expense of lending. As a result, capital 
standards above those required by regulations, questionable 
loan valuations, loan loss reserve policies, and overly strict 
implementation of CRE concentration guidance, my bank and 
community banks all over the country are avoiding making small 
business and CRE loans that we would otherwise have made in the 
past.
    While the tough regulatory environment is inhibiting new 
loans in many instances, loan demand from qualified borrowers 
is also down. Many of our best, small business and CRE 
customers cite their uncertainty about the economic recovery as 
their key reason for seeking additional credit. Our country 
needs to return to a more balanced regulatory environment that 
promotes lending and economic recovery as well as safety and 
soundness.
    Specifically, we support a proposal to amortize loan losses 
over 10 years for regulatory capital purposes. This proposal 
will not distort or misrepresent a bank's GAAP financial 
statements and was successfully used during the agriculture 
crisis of the 1980's. So this proposal is not unprecedented.
    The time has come to extend this reasonable lifeline to 
community banks. We support the Administration's proposed $30 
billion small business lending fund. A properly designed 
program will encourage additional small business lending, fuel 
job creation, and help create economic stability. And we 
support a regulatory proposal to include the entire amount of 
the allowance for loan or lease losses as part of the banks' 
risk-based capital. This proposal would favorably impact 45 
percent of Illinois banks and encourage all banks to reserve 
more.
    In our written statement, we discuss these and other 
recommendations in great detail.
    I would like to thank you for the opportunity to testify 
and I would be happy to answer any questions.
    [The prepared statement of Mr. Ohlendorf can be found on 
page 158 of the appendix.]
    Chairman Moore of Kansas. Thank you, sir. I thank all the 
witnesses for their testimony. I recognize myself for up to 5 
minutes for questions.
    Mr. Borzak and Mr. Cosenza, one idea your organizations 
both propose is accelerated depreciation to improve CRE 
investment incentives and improve cash flow, but something our 
government must do a better job on, in my estimation, as we 
emerge from the financial crisis is getting back to fiscal 
responsibility and a balanced budget. What would the impact be 
on Federal tax revenues with this accelerated depreciation 
proposal and what would the costs be?
    Mr. Askew?
    Mr. Askew. I don't have those numbers, but we could 
calculate that and get those back in a written statement.
    Chairman Moore of Kansas. I would like to have those, sir, 
and we will share those with the committee. I would appreciate 
that very much.
    Mr. Askew. Yes, sir.
    Chairman Moore of Kansas. Mr. Borzak, any thoughts?
    Mr. Borzak. I also don't have those numbers here, but I can 
get them.
    Chairman Moore of Kansas. All right. Mr. Cosenza?
    Mr. Cosenza. I don't have the numbers, but you do 
understand why we're behind this. It's because it allows new 
money to come into someone's existing property, much like Mr. 
Beef's situation where a new investor would own part of that 
existing person's deal. What are the incentives to do this? One 
of them is to have an accelerated depreciation for the income 
that you're going to make, and the second one is for the 
Federal Government, that it pays down the existing person's 
debt and furthermore improves the property. None of the money 
goes into the person's pocket.
    Chairman Moore of Kansas. I understand that, but I think 
our government has to be concerned about the debt our country 
has at the present time, which has increased over the past 
several years.
    I was surprised to see how many of you call for the 
extension and even expansion of TALF to help with the CRE, the 
commercial real estate market.
    Mr. Askew, will you explain this idea and why the Federal 
Reserve and Treasury should consider extending the program?
    Mr. Askew. Yes, sir. What is needed in the market right now 
is a secondary financial market, a securitization market. There 
has only been one issue of TALF on the CMBS that has gone 
through the DDR deal and that helped narrow the spreads in the 
market, but that's just one deal. The market is still--we still 
have not had any other CMBS securitizations to speak of. So 
what we're proposing in the paper is that Treasury would create 
the warehouse for pooled conduit loans. Right now, there are a 
lot of loans across small banks and large banks that are good, 
performing commercial real estate loans and the idea is to 
securitize those loans so that the banks, as Mr. Gutierrez 
says, can make more loans for commercial real estate. But we 
have to be able to securitize them, pull them together, pool 
them together, and we're asking Treasury to do a warehousing 
function. It's similar to the PPIP that was defined or talked 
about by the Congressional Oversight Panel, and it was a very 
profitable program, what they did with PPIP, so this one would 
return money to the government, but we just--the program 
expires in June, the CMBS program. So we just think it would 
help if they kept that a little bit longer. And also, it would 
be a good possibility for the government to start the program.
    Chairman Moore of Kansas. Thank you, Mr. Askew. Do any 
other witnesses have a comment?
    Mr. Cosenza?
    Mr. Cosenza. I do, because the reason why an extension is 
needed is because it didn't have long enough of a time 
originally the first time to work out its quirks. The reason 
why there was only one that was done is because it was such a 
doggone tough program. One of the aspects of it which I don't 
think anybody realizes is that when a transaction is already 
done, let's say there are 40 or 50 properties in this one bond 
issue and an investor wants to buy into that bond issue, goes 
to the Federal Government, asks him for 85 percent of a non-
recourse funds to allow him to buy that, so that the money can 
move in the marketplace, that's wonderful. The problem was that 
there were regulations within the Federal Government where they 
could say, we don't like one of the assets in this pool, and 
therefore, we're not going to give you, the investor, the money 
to invest in it. It was too late. The pool was already done. 
And whoever did it, whether it was J.P. Morgan or whatever bank 
it was, it was too late. They're stuck with the paper. That's 
one aspect of it.
    Chairman Moore of Kansas. Thank you. And I see my time has 
just about expired. I will recognize Ms. Biggert next, for up 
to 5 minutes for questions.
    Mrs. Biggert. Thank you, Mr. Chairman, and thank you all 
for being such excellent witnesses today. I wish that we had 
more time, and Mr. Askew, thank you for the Financial Services 
Roundtable paper. I think that puts so much together and 
obviously we could probably talk about the 51 issues well into 
the night. But since we don't have that time, I would just like 
to go over a couple of things and really talking mostly about 
the regulatory and statutory. For example, Mr. Hough, you said 
in your testimony that ill-fitting accounting rules are 
undermining the banks' ability to extend credit.
    Mr. Askew, you said that the final interagency joint rule 
on FAS 166 and 167 should be reexamined. And Mr. Ohlendorf, you 
talked about despite the guidance on CRE loan workouts, 
community banks continue to report that they're forced to write 
down performing loans.
    So briefly, have any of your financial institutions had 
discussions with FASB officials about these accounting rules? 
We'll just go right down the line.
    Mr. Cosenza. Any of the accounting rules for banks? I'm 
going to let the banks speak.
    Mr. Askew. We had all of the regulatory agents, we had OCC, 
the Fed, the Treasury, and FDIC at our meetings, Congresswoman 
Biggert, but we did not have FASB and in retrospect, I wish I 
had them at the table. I did not. But we do have meetings set 
up and we are going to visit FASB and talk to them about our 
suggestions.
    Mrs. Biggert. Mr. Hough?
    Mr. Hough. FASB has great power. They're very independent. 
They're the so-called five gnomes who sit in this office and 
make up these rules and it affects everybody and the whole 
economy, and it is very frustrating not to be able to have any 
access to these folks.
    Mrs. Biggert. Mr. Ohlendorf?
    Mr. Ohlendorf. One of the concerns that we have had with 
the whole FASB regulation is the cyclicality and 
countercyclicality of the loan loss reserve issue. We, in our 
industry, had some good times and banks made good profits and 
we can't complain about that. But we were prohibited from being 
able to reserve for a rainy day because FASB rules do not allow 
for that. We had to test our allowance. We have an 11-component 
evaluation now that's done every single quarter, and if I can't 
show that my portfolio has strength or weakness in it, then I 
can only reserve a certain dollar amount.
    I wish in these times that my rainy day fund could have 
been a little deeper, because we had profits that we could have 
set aside that could have been used to help us through these 
troubling times. Now in this environment we come in and have to 
apply those same accounting rules, both from a regulatory 
perspective and an accounting perspective and those two people 
don't always come from the same perspective. And now they're 
coming in, downgrading loans, reclassifying assets, looking at 
very short-term windows.
    We used to be able to look at a 3- to 5-year loss history. 
Now, regulators are coming in saying, your loss history needs 
to be looked at over 18 months, maybe 2 years at the most. We 
all know what has happened over those 2 years and you can 
understand very easily how much more money has to be set aside 
just at the time where capital is very, very dear and every 
dollar we set aside from our capital account and our allowance 
account limits small business lending.
    Mrs. Biggert. We have been told that regulators have the 
flexibility to interpret FASB accounting rules and we have also 
heard that some regulators are more overzealous than others 
when it comes to the CRE valuations. Is there a particular 
regulator, the FDIC, the OCC, the OTS or the Fed whose 
examiners are requiring performing and current loans to be 
devalued?
    Mr. Ohlendorf. We have heard anecdotal evidence from banks 
across the country and I think it just depends who your 
regulator is. If you're in a tough market, and Chicago is a 
challenging CRE market, I'm not sure it matters what regulator. 
We have heard anecdotal evidence that all have been pretty 
dominating on loan valuations.
    Mrs. Biggert. Mr. Hough?
    Mr. Hough. I don't think there's any objective evidence. I 
think most bankers would say the problems are more with the 
Federal regulators than the State regulators because we have 
all heard, you have talked about it too, Congresswoman, about 
hearing one thing from the regulators in Washington, but then 
when it gets down to the field level, Chicago and my examiner 
is out of Champaign and Springfield, Illinois, when it gets 
down to the field level and they're examining my bank or my 
members' banks, that it's a different type of a thing. And 
examiners have--they are risk averse. There's no incentive for 
them to be anything but conservative.
    Mrs. Biggert. Just one other thing. From hearing everybody 
and the way that this is--I would love to host a roundtable 
with the regulators and the banks. Would your industry 
participate in a roundtable with FASB and Federal agencies on 
this issue?
    Mr. Hough. Yes.
    Mr. Askew. I think that is a great idea and I think that's 
what we should do. I think that's the only way we're going to 
address all the issues in commercial real estate.
    Mrs. Biggert. Thank you. And I don't know if the Realtors 
and whomever wants to participate, but any stakeholders we 
would be happy to have. Is my time up?
    Chairman Moore of Kansas. Thank you. Your time has expired. 
I will next recognize Mr. Gutierrez for up to 5 minutes.
    Mr. Gutierrez. Thank you so much. I guess we have--
listening here today, I just want to quickly go to Mr. Hough 
and Mr. Ohlendorf. Is there a difference by the regulators? 
When the examiners come down to examine your books are they 
being unfair?
    Mr. Ohlendorf. Congressman, anectdotally, from both my own 
situation as well as others that we represent, what is 
happening during the exam, a typical exam at a community bank 
may be a 2-week process.
    Mr. Gutierrez. Let me ask you the process more succinctly 
since I only have 5 minutes. What we have heard here is that 
the regulators are telling the examiners to take other things 
under consideration other than the underlying value of the 
property. That is, is the loan performing? Are they telling you 
that performing loans no longer will be part of your portfolio? 
You have to bring in more capital if you want them on your 
books?
    Mr. Ohlendorf. On certain loans, absolutely.
    Mr. Gutierrez. Mr. Hough?
    Mr. Hough. I have never experienced it at my bank, but 
members have told me that is the case.
    Mr. Gutierrez. I understand, you don't want somebody 
hearing what you said and the big regulators send the examiners 
and say well--
    Mr. Hough. Correct.
    Mr. Gutierrez. We weren't following the rules. We'll have 
them come later on, but I think it's a critically important 
question, that is, here's what the Federal Government says it's 
going to do and the regulators say they're going to do, and 
guess what? As Mr. Cosenza said it doesn't cost any money, 
right? It doesn't cost any money. So in other words, there are 
things that we can do from a regulatory point of view, right? 
Just taking into consideration where we're at today that won't 
cost us any money, that will help us get through the tsunami 
that's coming. Because when I asked Mr. Bernanke what the 
greatest threat is to community banks, I said community banks, 
Mr. Askew, you're not the community banker, but community 
banks, he said CRE and the economy.
    I just want to go back because I think we have a wonderful 
Chicago experience, not wonderful that it happened, but 
wonderful in how it enlightens us. Midwest Bank, one of the 
reasons--and just think about TARP money. TARP is the solution, 
right? TARP is part of the solution, right? But it isn't a 
solution because Midwest Bank got TARP money, got $80 million 
of it. And you know what they did once they got the TARP money, 
the regulators told them to stop lending money and shut down 
Mr. Beef. That's a true story. That happened. So I think we 
need to focus on that because that's very, very important.
    I want to ask because I'm not sure which one of the 
agencies is implicated, but there is guidance on prudent CRE 
loan workouts from last fall, 2009.
    And I think, Mr. Moore, it would be an important question 
if I and others move forward. We're going to have a hearing on 
this on my subcommittee in the coming weeks just what kind of 
legislation and regulatory evidence we have and regulatory 
issues that we should take into consideration because what I 
see is the guidance and what the examiners are doing. And I 
want to say look, there are going to be different things that 
are going to have to be done. Some are going to be the same for 
everybody in the industry because on the other hand you folks 
that have this commercial real estate, you really have to get 
together and have one message. Because if I hear from the 
roundtable that represents the JPMorgan's of the world, and the 
Citibanks of the world and the Bank of Americas of the world, 
all who got TARP money, that it's a bad idea to allow the small 
community bankers to amortize differently their money, then 
here's what we get. We get these financial institutions, the 
fact is, you're all important and we're not going to come here 
to beat up the big banks versus the small banks. You're all 
important. But 40 percent, 4 out of 10 loans on commercial real 
estate are issued by community banks, banks $10 billion and 
smaller and they didn't get many of those hundreds of billions 
of dollars in TARP money.
    So I think what we're talking about in changing rule and 
because a rule doesn't benefit you, big bank or your particular 
situation, but benefits someone else within the whole circle, I 
would just encourage you not to simply look at your own self-
interest and what is good for you and your industry, but what's 
good for America because that's what you're demanding that 
Chairman Moore and Ranking Member Biggert and I do, set aside 
Republicans and Democrats and set aside our difference and our 
own personal interests. I simply encourage you and ask you 
because we're here to help you. This is a big important thing. 
Those mom-and-pop shops are out there and we want to help them 
and if you make a lot of money, God bless you. But I just want 
to make sure that there are businesses out there that are 
thriving and are encouraged to move forward. Thank you so much. 
You're all very, very important to us and I hope you will work 
more collaboratively in the future. Thank you.
    Chairman Moore of Kansas. I thank the gentleman, and I now 
recognize the gentlelady from Illinois, Ms. Bean, for up to 5 
minutes for questions.
    Ms. Bean. Thank you, Mr. Chairman. Mr. Ohlendorf, if you 
can give me a quick answer to this one, because I have a few 
other questions. In your testimony, you reference the benefit 
of the NOL carryback that we extended to 5 years in the 
stimulus that we did last February. Do you know what either 
your bank or those in your association, what were they able to 
do with those recouped taxes once they received them?
    Mr. Ohlendorf. Congresswoman, it certainly helped our 
capital position and others' capital positions and the bottom 
line is if we don't have capital available to us and if we 
don't have capital that we can leverage, we can't lend. And so 
anything that we can do to bring those dollars back, it gave us 
money to be able to leverage again. Had we not been able to do 
that, those losses would have just sat out there forever. 
Capital would have been depleted and those lending 
opportunities wouldn't have been there.
    Ms. Bean. You also in your testimony expressed support for 
the Administration's proposal to take $30 billion of TARP money 
or other money and make that available to community banks. Many 
of the executive compensation provisions of what we had done in 
the broader TARP proposals didn't scale to small banks, so that 
really limited participation of our smaller banks. Can you 
explain the potential of that investment, particularly given 
the scenario that we're in?
    Mr. Ohlendorf. Congresswoman, we have seen obviously a 
number of significant Illinois failures. Seven community banks, 
a couple of weeks ago. A lot of those banks with just a little 
bit of capital could have made it. We have seen estimates that 
in the low hundreds of billions of dollars, you could 
recapitalize every community bank in the country, when $2 
trillion of capital was infused or loan guarantees or zero 
interest loans went to our big brethren. We understand they 
were important in the industry, but some of the creativity that 
was going on at that time to save the largest financial 
institutions, we would like to see at the community bank level 
some of that similar creativity, come up with ways that we can 
extend and give us some time.
    We all have to believe we will come out of this recovery at 
some stage in the game. As Congressman Gutierrez said, the 
tsunami is coming, we just don't know how long that's going to 
last, but if we can just get through it and have some capital 
in the kitty, I think we can make it through and the industry 
is going to make jobs available and make loans available and 
it's going to make a difference.
    Ms. Bean. My final sort of comment and question for the 
whole panel is, many of you talked about countercyclical, and I 
know Congressman Foster and I worked on putting countercyclical 
mechanisms into the Wall Street reforms that we did. 
Essentially, when we see a bubble in the formation increasing 
capital requirements on the way up, easing them on the way down 
so the fallout isn't so deep and broad.
    There wasn't a lot of call from industry participants on 
the way up for those increased capital requirements. Nobody 
wants to be the buzzkill. Even the regulators didn't step in 
when the party is on. And so it's interesting. We hear it, of 
course, after the fact when it improves one's balance sheet to 
treat mark to market a little differently in a downward 
scenario than when it was improving everyone's balance sheets. 
Again, there wasn't a lot of call for looking at more 
regulation then.
    So what should we be doing in terms of as we did mortgage 
reform and the Wall Street reforms for residential, we really 
didn't address underwriting standards, loan to value ratios. So 
I would like some comments on that and specifically if you 
consider that at the peak to where we are in values right now, 
there has been about a 43 percent drop since 2007 so that's in 
the last 3 years. How much did it go up before that peak in the 
previous 3 to 5 years and shouldn't there have been some 
caution?
    Mr. Cosenza. I'll give you an example of this, a very 
particular one because I buy a tremendous amount of real 
estate. And during the last 14 months, I bought about $2.7 
billion worth. Of that real estate, the capper-rates, the 
returns I got on my investment were similar to what I was 
getting 7, 8, 9, and 10 years ago. During that time, much of 
that inflationary period wiped out. So therefore, let's assume 
for a minute that in 2001, 2002, and 2003, you were buying 
properties for somewhere around an 8 percent return, give or 
take. By the time it got to 2006, it was 6.5 percent. And all 
of us had to contend with that, otherwise sit back and don't 
buy anything.
    Well now, similarly, all of the banks' rates came down. I 
still had the same spread, my same cash flow. The mistake we 
all made was we did 5-year loans. And so the mark-to-market, 
even though we do 50 percent loans, the mark-to-market killed 
us too because if the real estate was $100 million, our loan 
was $50 million, and all of a sudden, the real estate became 
only worth $70 million or $65 million, my loan had to get paid 
down.
    Ms. Bean. So if everyone had bought a little less when it 
seemed out of control, wouldn't that have been helpful?
    Mr. Cosenza. It would have been. There's no question about 
it, but it's not as if you made more money. It's the whole 
economy just kept churning.
    Ms. Bean. Will others weigh in on the values of what they 
had been before the peak and how much it increased in that 3 to 
5 years prior?
    Mr. Borzak. Yes. The spread has increased by and capper 
rates decreased. Prices went up by a significant amount between 
2003 and 2007 when they peaked. However, it's a more 
complicated issue. Real estate pricing is much more supply and 
demand of capital. And over the last 26 years since I have been 
in the business, the commercial real estate industry has become 
much more institutional and much less entrepreneurial. There 
was a lot more private equity capital and other institutional 
and pension fund money that was finding its way into real 
estate in the mid part of this past decade. That forced prices 
to unprecedented levels, but there was a lot of talk about 
whether that was a permanent shift and whether they were 
permanently going to be more dollars allocated to commercial 
real estate, so it wasn't always apparent that it was a pricing 
bubble. On the residential side, it was a little bit more 
apparent. The kind of financial mechanisms that were being used 
to finance homes, maybe were suggesting that there was a 
bubble.
    Ms. Bean. So more specifically, there's limited time--
    Chairman Moore of Kansas. The gentlelady's time has 
expired.
    Ms. Bean. Okay. I'll follow up with you on that.
    Mr. Cosenza. Thirty percent. The answer is 30 percent.
    Ms. Bean. Thank you.
    Chairman Moore of Kansas. Mr. Foster is recognized for up 
to 5 minutes, sir.
    Mr. Foster. Yes. First, Mr. Ohlendorf and Mr. Hough, do you 
have any reaction to Mr. Cosenza's and the Realtors' proposal 
to raise the cap on credit union business lending?
    Mr. Ohlendorf. I struggled with it from the standpoint of 
the financial situation between credit unions being nontaxed 
entities and the banks being taxed entities. It's just a 
significant difference. Credit unions were set up to deal with 
small business--not small business, but small consumer, small 
loans, small things. And it made a lot of sense in areas that 
were underserved and that's all well and good. I think you have 
to question the structure of those credit unions is such that 
the expertise is there. There are a lot of smart people in this 
business all around that made some terrible mistakes as far as 
what was going to happen in the business lending area. I think 
it's potentially very dangerous and I also struggle with just 
the level playing field isn't there.
    Mr. Foster. Mr. Hough?
    Mr. Hough. There's only a small handful of large credit 
unions that would make any significant difference here, but we 
felt was well with the fact that they don't pay income tax and 
we're talking about balanced budgets and things, it's 
troubling.
    But on the other hand, clearly, it would help a little bit 
to provide more funding, but not very much to the CRE market.
    Mr. Foster. Mr. Cosenza, do you have an estimate for how 
much additional support this might bring to the commercial real 
estate market?
    Mr. Cosenza. I do not have that, but we will get it to you 
and every single dollar that goes into the economy that doesn't 
cost the government or the United States citizens any money is 
certainly a smart thing to do at this time.
    Mr. Foster. Thank you. Let's see. I would like to talk a 
little bit more about procyclical accounting policies. We're 
going to be having at the American Enterprise Institute, 
actually, a workshop on a specific proposal having to do with 
changing the loan to value ratios during the upswing where you 
basically would not--let's see. The easy way to explain it is 
you would automatically turn up downpayments by the amount that 
the housing market has gone up in the last say 4 years.
    And so what you're doing is it's a mechanism to 
automatically turn up the required downpayment or limiting the 
loan to value automatically by formula during the upswing.
    I was wondering if you have any reaction to this because 
it's obviously politically almost impossible to pull away the 
punch bowl as the party is going. But on the other hand, it 
seems in retrospect to be absolutely necessary. I was 
wondering, are there mechanisms that you would support, 
specific mechanisms that would deal with the countercyclical 
problem on the upswing.
    Mr. Cosenza. Speaking personally, I would not have a 
problem with those kinds of restrictions. But in this respect, 
I'm not speaking for the National Association of Realtors, or 
all of those little guys who can't possibly put down 50 percent 
or refinance to the tune of 50 percent when they had a loan 
which was 70 percent or 80 percent loan to value.
    Mr. Borzak. I think that's a difficult proposition. I think 
those prices are set by so many different dynamics and to try 
to regulate whether the increase in pricing is due to a bubble 
that's artificially induced because of financing techniques or 
because of real market fundamentals. Those increases in value 
may be sustainable and they may be permanent. And so to 
penalize certain areas based on certain arbitrary regulated 
pricing restrictions, that sounds like it could be 
overregulation.
    Mr. Foster. No, this is not an attempt to change the long-
term value of markets. This is simply--
    Mr. Borzak. Right, to change the amount of money--
    Mr. Foster. --when they're rising rapidly to say wait, you 
can issue a mortgage with 90 percent loan to value on the value 
of the property 4 years ago, but not on the fraction of the 
appreciation that has happened in the last few years.
    Mr. Borzak. And my only point is that the appreciation that 
has happened in the last few years in certain markets may be 
permanent, sustainable increases in pricing and to apply those 
lending standards differently. There are too many dynamics that 
are affecting the values. If it's clear that there is a bubble, 
that there is an artificially-induced increased, then limiting 
the loan to value ratios might be healthy, but it's difficult 
to determine.
    Mr. Askew. Congressman Foster, I would commend looks at 
countercyclical approaches. I don't know about the specifics of 
what you're talking about here. I would love to look into it 
and we would be glad to do that and give you our feedback, but 
anything that we could do on the countercyclical side when we 
get through this hole that we have ourselves in would be 
helpful because anything you talk about, whether it's the 
Resolution Fund right now, whether it's FDIC assessments, loan 
loss reserves, there are several areas that we could prevent 
this type of problem if we were very proactive on the other 
side. So we would be glad to participate and we would like to 
participate to help look at those countercyclical solutions.
    Chairman Moore of Kansas. The gentleman's time has expired. 
We do have some extra time, though, and with the consent of the 
members of the committee here, we'll go one more round for 2 
minutes each this time, and I'll recognize first the ranking 
member for up to 2 minutes.
    Mrs. Biggert. Thank you, Mr. Chairman.
    Mr. Borzak, have there been any assets that you have not 
been able to work out or get placed with a new lender and were 
all your workouts placed with your existing lender? Do you have 
additional debt maturing? And how do you expect to refinance?
    Mr. Borzak. We have been fortunate that we have been able 
to find resolutions to all of our debt issues. We have only in 
a couple of cases been able to find those resolutions with 
alternate financial institutions.
    Generally, our resolutions were either with our existing 
bank, through equity paydowns and loan extensions or by 
financing the acquisition of that debt with 100 percent equity. 
So I know that it has been very difficult in the past 18 months 
to find alternative banking solutions or loan solutions to 
those workouts.
    Mrs. Biggert. In your testimony, you talked a little bit 
about CMBS special servicers. Could you mention them?
    Mr. Borzak. Correct. The CMBS paper, the securitized paper 
is administered by a master servicer until there's a problem 
and when there's a problem, the special servicer steps in and 
because this is the first time since the CMBS concept really 
became so popular in the early 1990's, this is the first time 
that industry has faced the kind of distress that it's facing 
right now.
    The special servicers in the entire industry are really 
just trying to get up to speed and trying to find their way 
right now. So it's very difficult at the moment to get ahold of 
special servicers, very difficult to get responses. It takes a 
while. And the solutions that the servicers are able to 
effectuate are more limited than with a bank that has a loan on 
their balance sheet and can do what they want inside of the 
capital constraints.
    So we do have one situation with a special servicer right 
now and we're in dialogue, but it is a slow moving process.
    Mrs. Biggert. Thank you. I yield back.
    Chairman Moore of Kansas. I thank the gentlelady, and next, 
the Chair will recognize for up to 2 minutes, Mr. Gutierrez, 
please?
    Mr. Gutierrez. I just have one question. Okay, so Mr. 
Borzak and Mr. Cosenza, what's the peak, what year was the peak 
in real estate?
    Mr. Cosenza. The peak was really toward the middle and end 
of 2006. That's when I saw the--
    Mr. Gutierrez. The middle of 2006?
    Mr. Borzak. I think prices continued to go up into the 
middle of 2007. It was about July of 2007 that we kind of saw 
the peak.
    Mr. Gutierrez. So by the end of 2006--
    Mr. Borzak. But Mr. Cosenza would know better than I would.
    Mr. Gutierrez. By the end of 2006, middle of 2007, right? 
That's the peak of it. And that's where a lot of these loans, 
the tsunami that I'm talking about are going to come from 
because if prices went down after that, people who in 5 years, 
that's 2011, 2007, right, 2011, 2012, 2013, they're the ones 
who are going to have the big problem, right, of loan to value 
because they got their loan when real estate was way up here 
and it came down in 2008, 2009 and really hasn't substantially 
come up.
    Okay, I just wanted to focus and target on those years, 
because I think from a legislative point of view, Mr. Moore, 
and Congresswoman Biggert, we should focus on where the problem 
is really going to be the worst. Thank you so much. Thank you, 
Mr. Moore.
    Chairman Moore of Kansas. Certainly. The Chair next 
recognizes Ms. Bean for up to 2 minutes.
    Ms. Bean. Thank you, Mr. Chairman. One of the questions I 
wanted to get back to was underwriting standards in general and 
do you think there should be a better look at underwriting 
standards, whether it's loan to value ratios, should we 
consider things like as we did credit rating agency liability 
for derivatives where we had AAA rated securities that should 
never have gotten them, we did that in our Wall Street reforms. 
Should there be, as I understand in some countries, appraiser 
liability? Just your thoughts on those kinds of things.
    Mr. Hough. There were situations I saw in banking where a 
bank competitor would hire a certain appraiser and they might 
want to lend the full value of the property and the appraiser 
will appraise it for 120 percent. I don't know how they did it, 
but you do wonder sometimes of the qualifications of the 
appraiser.
    Ms. Bean. Any other comments?
    Mr. Askew. Overall, the commercial real estate market, 
unlike what happened in the residential market where there were 
some gaps in regulation, there were unregulated loan 
originators in some of our States. To underwrite overall is 
good in the commercial real estate space and also the loan to 
value ratio. Most of the loans average somewhere around 70 
percent, so even 65 percent. So it's a little bit different. 
But as far as values just falling right now, that's what has 
created the problem. Values could have fallen, but they have 
fallen so much that is where the gaps, the equity gap has been 
created.
    Mr. Cosenza. In the commercial real estate business, I 
don't think I have really seen any abuse from the appraisal 
industry per se. I think though because just like mark-to-
market, as the values start going up, they really have to go 
with the values because that's exactly what something will sell 
for. So they're caught in the same spiral going up as the banks 
got caught with the mark-to-market going down. And you could 
never balance it off.
    Ms. Bean. Would you say though there weren't loans ever 
written that were almost not justifiable based on even maximum 
occupancy rates and rents?
    Mr. Cosenza. Some of the ones I have seen in The Wall 
Street Journal are absolutely stupid, including a large 
apartment complex that was in New York.
    Chairman Moore of Kansas. The gentlelady's time has 
expired. The Chair will next recognize Mr. Foster for up to 2 
minutes.
    Mr. Foster. Yes. Let's see, Mr. Cosenza's suggestion was 
extending the cap on SBA 504 loans and to allow them to be used 
for refinancing of commercial properties. Does anyone have any 
comments on that? What's the downside?
    Mr. Askew. I agree with him. I think it's a good idea.
    Mr. Foster. No objections at all?
    Mr. Askew. None, whatsoever. But it has to be an easier 
process. Forty percent of the people can't fill out the forms. 
It's so tough in that industry, honestly.
    Mr. Foster. Is there a way to do that without compromising 
underwriting standards?
    Mr. Askew. Yes, there certainly is. If I gave a test to my 
students when I was a teacher and 40 percent of them failed and 
the other ones had to have help doing the test, either I taught 
wrong or I made the test wrong. It's me, it's not them.
    Mr. Ohlendorf. And I think getting some of the other 
institutions involved. A lot of SBA lending is concentrated in 
a small number of institutions. And I think finding a way to 
get more institutions participating in those programs, they 
certainly have viability, but the underwriting and the 
application process is pretty rigorous.
    Mr. Foster. There's a related suggestion to generate a new 
class of SBICs that are allowed to participate in commercial 
real estate, mezzanine finance and so on and is that something 
that you have discussed or heard about, have any comment on?
    Mr. Askew. I have, and even though the SBA program from the 
Administration doesn't fit our industry because they made it 
for the smaller banks, we have still supported that all along 
and we have been meeting with them on all the meetings, trying 
to help that process along because we think at the heart of it, 
it's a good program. And the point about the complexity, we 
tried to make that clear and your point about the commercial 
real estate we have added those thoughts in for how we might 
expend the program.
    Mr. Foster. One of my hopes is that if you concentrate on 
the mezzanine finance segment of the market, then you have a 
third set of eyes so you can reduce the paperwork because you 
have external validation that this is a viable project.
    Mr. Askew. Right.
    Mr. Cosenza. And the National Association of Realtors would 
love to help work with Congress on that issue.
    Mr. Ohlendorf. As long as they can scale.
    Chairman Moore of Kansas. The gentleman's time has expired. 
I want to thank our first panel for your testimony. You're now 
excused. I'll invite the second panel of witnesses to please 
take your seats. We're going to have a 3-minute recess, so if 
anybody has any business to take care off, they can do that, 
and we will be back to start in about 3 minutes.
    [recess]
    Chairman Moore of Kansas. This hearing will come back to 
order and I'm pleased to introduce our second witness panel. 
First will be Mr. Anthony Lowe, Regional Director, Division of 
Supervision and Consumer Protection, for the Chicago Regional 
Office of the FDIC. Second, Mr. Bert A. Otto, Deputy 
Comptroller, Central Office of the OCC. We're pleased to have 
you both testify again, as you did at our Michigan hearing on 
small business lending. And third, we'll hear from Mr. Daniel 
McKee, Regional Director, Central Region of the OTS. And Ms. 
Cathy ``Lemieux''--is that pronounced correctly?
    Ms. Lemieux. Yes.
    Chairman Moore of Kansas. --Senior Vice President, 
Supervision and Regulation, at the Federal Reserve Bank of 
Chicago.
    Without objection, your written statements will be made a 
part of the record and you will have up to 3 minutes to 
summarize your statements.
    Mr. Lowe, you are recognized, sir, for 3 minutes.

 STATEMENT OF M. ANTHONY LOWE, REGIONAL DIRECTOR, DIVISION OF 
 SUPERVISION AND CONSUMER PROTECTION, CHICAGO REGIONAL OFFICE, 
             FEDERAL DEPOSIT INSURANCE CORPORATION

    Mr. Lowe. Thank you. Chairman Moore, Ranking Member 
Biggert, and members of the subcommittee, I am Anthony Lowe, 
Chicago Regional Director for the FDIC. I appreciate the 
opportunity to testify on behalf of the agency on the state of 
commercial real estate and bank lending.
    Adverse credit conditions brought on by an ailing economy 
and stressed balance sheets have created a difficult 
environment for both borrowers and lenders. Continued 
resolution of the current economic crisis will depend heavily 
on creditworthy borrowers having access to lending.
    Nationwide, expenses for troubled loans continue to weigh 
heavily on insured depository institutions. And total loan and 
lease balances at FDIC-insured institutions declined by $129 
million during the fourth quarter of 2009.
    Illinois, like many States in the industrial Midwest, has 
been hard hit by the recent recession. Nearly 7 percent of the 
State's jobs have been lost since the fourth quarter of 2007. 
Average home prices are well below peak levels of early 2007 
and commercial real estate markets have been strained by higher 
vacancy rates.
    The financial condition of Illinois banks has deteriorated 
and remains weak. Illinois institutions' loan loss provisions 
have reached record levels. Loan delinquencies are above 
national levels and Illinois institutions reported negative 
loan growth rates for 2008 and 2009. These conditions have 
caused a number of bank failures. From October 2008 through 
April of 2010, 32 Illinois insured depository institutions 
failed.
    I am going to briefly turn to bank examination and 
regulation in the current environment. FDIC bank examiners work 
out of duty stations in 85 communities across the country, 
including 5 here in Illinois. FDIC examiners are not directly 
involved in bank credit decisions. We do not instruct banks to 
curtail prudently managed lending activities, restrict lending 
to strong borrowers, or deny a refinance request solely because 
of weakened collateral value. We would not require a 
reappraisal for a healthy, performing loan.
    FDIC examiners focus on borrower case flow as the primary 
source of repayment during our credit reviews, not on 
collateral support which serves as a secondary source of 
repayment. The borrowers' willingness and ability to keep 
payments current is always the primary criteria for our loan 
reviews.
    In February of this year, the regulators jointly issued an 
inter-agency statement on meeting the credit needs of 
creditworthy business borrowers to encourage prudent lending 
and emphasize that examiners will apply a balanced approach in 
evaluating small business loans. We believe this statement will 
help banks become more comfortable extending soundly written 
and structured small business loans.
    While many challenges remain before us, I'm confident the 
banking industry as a whole is moving in the right direction, 
towards sounder lending practices, stronger balance sheets, and 
a greater capacity to meet the credit needs of their 
communities. I'll be happy to answer questions.
    [The prepared statement of Mr. Lowe can be found on page 
136 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Lowe.
    Mr. Otto, you are recognized for up to 3 minutes, sir.

    STATEMENT OF BERT A. OTTO, DEPUTY COMPTROLLER, CENTRAL 
      DISTRICT, OFFICE OF THE COMPTROLLER OF THE CURRENCY

    Mr. Otto. Chairman Moore, Ranking Member Biggert, and 
members of the subcommittee, my name is Bert Otto and I am the 
Deputy Comptroller for the Central District of the Office of 
the Comptroller of the Currency. I have been a National Bank 
Examiner for almost 37 years and I have been involved in the 
direct supervision of community and mid-sized national banks 
for nearly my entire career. I appreciate the opportunity to be 
here today.
    The OCC's core mission is to ensure that national banks 
remain safe and sound and meet the credit needs of their 
communities and customers. Part of an examiner's job is to 
determine if banks make loans on prudent terms based on sound 
analysis of the borrower's financial condition, recognize 
weaknesses and existing credits and work with borrowers to 
develop corrective plans whenever possible, maintain sufficient 
reserves and capital to buffer and absorb losses and actively 
reflect the condition of their loan portfolio and their 
financial statement. It is not the examiner's job to dictate 
loan terms, products, or borrowers. These are decisions that 
bank management must make.
    The critical part of our job is determining when potential 
risk exposures or weaknesses require corrective action by 
bankers. Knowing when to make these calls requires judgment and 
a balanced supervised reproach. We strive to get this balance 
right through strong, thoughtful, and consistent supervision 
and clear, two-way communication with banks we supervise. 
Maintaining this balance is critical in supporting a 
sustainable economic recovery and restoring the health of the 
commercial real estate market.
    Commercial real estate issues confronting the Chicago 
metropolitan market mirror what we have been seeing nationwide. 
Vacancy rates are still rising nationally and cash flows 
produced by CRE properties are continuing to decline.
    While there is some evidence of a slight improvement in the 
CRE markets, we expect that many banks will experience further 
deterioration in their loan portfolios. These conditions have 
strained both CRE borrowers and the CRE loan portfolios of many 
banks. The OCC has been addressing the build-up of risk in this 
market for the past several years and my written statement 
includes details about targeted CRE examinations we have 
conducted at banks at risk due to the nature and scope of their 
CRE activities, guidance we have issued, and outreach to 
examiners and bankers we have conducted.
    Last October, we and the other banking regulators issued 
additional guidance on CRE loan workouts to provide greater 
clarity and certainty on our policies and expectations. The 
guidance also promotes consistency across the agencies in our 
evaluation of CRE credits and stresses two of our long-standing 
policies that examiners will not classify a loan based solely 
on the decline and underlying collateral values, nor will they 
criticize prudent loan workout arrangements. Indeed, such 
workouts are often in the best interests of financial 
institutions and the borrower.
    In summary, we are aware of the critical role that bank 
credit plays in the health of our Nation's economy. Our message 
to bankers is to make new loans to creditworthy borrowers using 
prudent underwriting standards, realistically recognize and 
address problem credits, and work constructively with troubled 
borrowers to the extent possible.
    Thanks again for the opportunity to appear here today and I 
will be happy to answer your questions.
    [The prepared statement of Mr. Otto can be found on page 
172 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Otto.
    The Chair next recognizes Mr. McKee. You are recognized, 
sir, for up to 3 minutes.

STATEMENT OF DANIEL T. McKEE, CENTRAL REGIONAL DIRECTOR, OFFICE 
                     OF THRIFT SUPERVISION

    Mr. McKee. Good afternoon, Chairman Moore, Ranking Member 
Biggert, and members of the subcommittee. Thank you for 
inviting me here today. My name is Daniel McKee and I'm the 
Regional Director of the OTS Central Region here in Chicago.
    Our region provides day-to-day supervision of OTS-regulated 
thrifts in 10 Midwestern States, including Illinois. In the 
Chicago area, we supervise 27 savings associations with total 
assets of about $7.1 billion. Approximately 23 percent of those 
assets or approximately $1.6 billion consists of commercial 
real estate, known as CRE.
    The nationwide contagion that began in the home mortgage 
market has reached CRE and although thrifts are limited in the 
amount of CRE lending they can do, some OTS-regulated thrifts, 
particularly the small community-oriented institutions, have 
suffered significant CRE losses. In some cases, those losses 
have contributed to thrift failures.
    In light of elevated delinquency rates of all types of 
loans, thrifts and banks are understandably more careful in 
extending credit than they were during the height of the real 
estate boom a few years ago. This is generally a good thing. No 
one advocates returning to the kind of standards for loan 
underwriting that helped bring about the financial crisis. 
However, no one wants the pendulum to swing too far in the 
other direction and unduly restrict credit to creditworthy 
borrowers.
    The key is achieving a balance between the safety and 
soundness of financial institutions and the proper flow of 
credit that is essential to a vibrant economy. The OTS takes 
the position that thrifts should never turn away good 
customers. We have conveyed those supervisory expectations to 
the thrift industry and have joined in interagency guidance 
that drives home the point.
     The reality remains, however, that credit will continue to 
be somewhat constricted as long as the economy suffers from 
pressures such as high unemployment and the impact continues to 
show on the balance sheets of banks and thrifts in the form of 
delinquent loans.
    Regarding recommendations for the future, the OTS has 
advocated easing restrictions on commercial lending and small 
business loans by thrifts. This proposal which passed the full 
House of Representatives twice in the past is fully consistent 
with the traditional focus of thrifts on consumer and community 
lending and it would make badly needed CRE credit more 
available in communities across America.
    Thank you again, for having me here, Mr. Chairman, and I'm 
happy to answer any questions.
    [The prepared statement of Mr. McKee can be found on page 
153 of the appendix.]
    Chairman Moore of Kansas. Thank you very much, Mr. McKee.
    And now, the Chair recognizes Ms. Lemieux for 3 minutes, 
please.

  STATEMENT OF CATHY LEMIEUX, SENIOR VICE PRESIDENT, FEDERAL 
                    RESERVE BANK OF CHICAGO

    Ms. Lemieux. Chairman Moore, Ranking Member Biggert, and 
members of the subcommittee, thank you for the opportunity to 
testify at this timely and important hearing. I should note 
that I'm testifying today in my role as Head of Bank 
Supervision at the Federal Reserve Bank of Chicago and what I 
say does not necessarily represent the views of the Board of 
Governors of the Federal Reserve System.
    Conditions in commercial real estate markets pose a threat 
to the banking industry nationwide, and in the Chicago area, 
many local banks have heavy concentrations in commercial real 
estate lending. There are signs that CRE markets are firming, 
however, the time needed to fully recover might be measured in 
years, not months.
    In my written testimony, I place this challenge in the 
context of overall financial and banking conditions and survey 
a wide range of Federal Reserve initiatives. However, I will 
focus my remaining comments on bank supervision.
    Federal Reserve supervision has focused on CRE exposures 
for a number of years. Most recently, we have been working 
vigorously to implement the interagency guidance on prudent 
loan workouts issued last October. It's key messages are: (1) 
that prudent workouts are in the best interest of both banks 
and borrowers; (2) examiners should take a balanced and 
consistent approach in their view of banks' workout activities; 
and (3) restructured loans will not be adversely classified 
solely because the collateral has declined to an amount less 
than the loan balance.
    Since the guidance was issued, the Federal Reserve has 
conducted extensive staff training and industry outreach to 
underscore the importance of sound lending practices. For 
example, at the Federal Reserve Bank of Chicago, we have 
devoted 2 days to training our 300 examiners to ensure they had 
a thorough and consistent understanding of this guidance. We 
have also hosted a number of forums where supervisors and 
bankers can exchange views on CRE lending and credit 
availability.
    Current real estate market conditions are unlike any we 
have seen in some time. This has raised safety and soundness 
concerns at some banks. We are committed to working with our 
banks as they deal with these challenging conditions. A healthy 
banking system is a prerequisite for providing credit to sound 
borrowers.
    I would be pleased to answer any of your questions.
    [The prepared statement of Ms. Lemieux can be found on page 
122 of the appendix.]
    Chairman Moore of Kansas. Thank you, Ms. Lemieux. I very 
much appreciate your testimony. I will start. I have 5 minutes 
for questions.
    Ms. Lemieux, I was struck by how many of our witnesses on 
the first panel called for the extension of TALF to help 
stabilize the commercial real estate market. What's your 
reaction to that broad support for extending TAFL? Is that 
something the Federal Reserve should monitor and consider, 
especially with the expiration of the program to occur in the 
next month or so.
    Ms. Lemieux. I did hear the comments and will certainly 
relay them to the policymakers in Washington. I'm focused on 
bank supervision, but I will say that we are pleased that the 
TALF program has spurred the beginning of issuance and our 
contacts in the industry tell us that the private market is 
beginning to work and there are plans for private issuance of 
TALF, but I can provide you with further comments from our 
policymakers.
    Chairman Moore of Kansas. Thank you. This next question is 
for all the witnesses. I appreciate very much the efforts of 
all of your agencies to provide more clarity and certainty on 
responsible small business lending and CRE loan workouts, but 
the message from D.C. doesn't seem to be making its way down to 
the officials doing the bank examinations.
    We heard at our field hearing in Michigan last November and 
we have heard it today, so two questions: One, yes or no, do 
you acknowledge this is the case? And two, what steps is your 
agency taking internally to get that message all the way down 
to the front-line examiners.
    Mr. Lowe, do you have thoughts, sir?
    Mr. Lowe. Yes, sir. I do. First off, is it the case that 
there's a disconnect? Personally, I do not believe that there 
is. There may be some differences of opinion about the 
interpretation of how we're looking at loans and looking at 
credit and the factors that we take into determining how 
credits will be classified, but I don't believe there's any 
disconnect between our policy statements, the financial 
institution letters that we have issued jointly with the other 
agencies. And some of the things that we have done at the FDIC 
and I think the other regulatory agencies have also, we have 
issued internal memorandums. We have had nationwide conference 
calls with all of our examiners across the country to make sure 
everyone knows what the expectations are. And that expectation 
is that we're going to be looking at cash flow. We're going to 
be looking at performance in determining the quality of credits 
and determining if there should be some type of impairment that 
needs to be recognized.
    Chairman Moore of Kansas. Thank you. Mr. Otto, your 
thoughts?
    Mr. Otto. Yes, I would agree with Anthony's comments and 
then extend it a little bit further. I think we have done a lot 
of work in getting the message out to the examiners, but also 
bankers. We have held CEO roundtables. We have had chief credit 
officer roundtables where we really do ask for feedback on our 
policies. And if something is not clear, we would hope that we 
would have that two-way communication.
    But something I don't think any of the agencies did a very 
good job of at the last downturn of the economy and we have 
kind of learned from that, that was a lessons learned and we're 
really trying to stress the importance of that two-way 
communication. We can't really deal with the issue unless we 
have bankers stepping up and talking to us about what their 
feeling is in their examinations.
    Chairman Moore of Kansas. Thank you, Mr. Otto. Mr. McKee, 
sir?
    Mr. McKee. As Bert indicated, we have done the same at the 
OTS, and in the last couple of months, I have had 4 CEO 
outreach meetings where we invite between 15 to 25 CEOs 
together. I had one here in the Chicago office about a month, 
month and a half ago. And through that type of forum, we do get 
good feedback from the bankers, really what they're seeing, 
what problems they are having. And we ask them during that 
process, what can we do better, what can we do differently 
through our exam process?
    I have a call with all of the examiners from the central 
region, the 10 States that I'm responsible for, later this 
month. And I'll be going through the results of that type of a 
discussion with the examiners at that point. And nationally, 
the OTS has reached out to all the examiners on a conference 
call to discuss these types of issues as well.
    Chairman Moore of Kansas. Very good. Ms. Lemieux, do you 
have any comments?
    Ms. Lemieux. I certainly agree with my regulatory 
colleagues. At the Chicago Fed, we really have four lines of 
defense to make sure that the application of the guidance is 
consistent and effective. The first is examiner training, and I 
mentioned that in my opening statement. As the FDIC does, we 
have calls with the industry and calls with all our staff 
across the system to address questions that come up in the 
field as this guidance is applied.
    The second is outreach to the banking industry. The Chicago 
Fed conducts a community banking symposium. We had one last 
November and it was co-sponsored by the individuals here at 
this table. We had over 200 bank CEOs and Governor Duke was our 
speaker who discussed, in depth, that guidance which at that 
time had just been issued.
    Third, we have internal quality management programs that 
ensure that our guidance is supplied consistently. No one 
examiner gets to decide these things by themselves. There's a 
group of people, not only the exam team, but the officers and 
managers in the office as well as we consult with our 
specialists as well as our colleagues in Washington to make 
sure we get that answer right.
    Fourth, as is the case with all agencies, bankers have the 
right to appeal examination decisions. And to date, the Chicago 
Fed hasn't had appeals on this issue from our bankers.
    Chairman Moore of Kansas. Thank you. My time has expired. 
The Chair will next recognize Ms. Biggert for questions for up 
to 5 minutes.
    Mrs. Biggert. Thank you, Mr. Chairman. I appreciate all of 
your testimony and the issue you have been talking about as far 
as the loan valuations. Would you all be willing to participate 
in a roundtable with the stakeholders to discuss this?
    Mr. Lowe?
    Mr. Lowe. Absolutely.
    Mrs. Biggert. Mr. Otto?
    Mr. Otto. Yes.
    Ms. Lemieux. I might offer that the Chicago Fed has hosted 
a number of hearings for different task forces and we would be 
happy to work with you on that.
    Mrs. Biggert. Thank you. I appreciate that. Then Ms. 
Lemieux, on page 7 of your testimony, you mentioned that the 
Fed recognized in the 1980's and the 1990's the problems with 
the rising CRE concentrations and as a result you led an 
interagency effort to develop supervisory guidance on CRE 
concentration. When did you propose this guidance?
    Ms. Lemieux. I'm a little confused with the reference.
    Mrs. Biggert. It's on page seven.
    Ms. Lemieux. Do you mean the 1990 guidance or the most 
recent guidance?
    Mrs. Biggert. It was 2006.
    Ms. Lemieux. Yes, we actually in the Chicago Fed began 
identifying this issue much earlier. In 2004, we worked with 
our colleagues throughout the system and our bankers to really 
fully understand the issue. The guidance was developed and went 
through an inter-agency process and was eventually issued.
    Mrs. Biggert. It concerns me that for a decade and a half 
some banks continued to make these risky CRE loans and 
increased the concentration in their portfolio.
    Ms. Lemieux. I guess I'm a little confused, because 
certainly a lesson learned from the 1990's was the impact 
commercial real estate can have on--and concentrations can 
have. And in terms of our focus on risk management at banks, we 
certainly viewed concentration as a risk and worked with our 
banks to make sure that they had the procedures and the 
internal controls and the audit to mitigate the results of 
those concentrations.
    Mrs. Biggert. We looked at the Midwest Bank and Trust 
failure last Friday. It seems that was a concentration that 
wasn't--that the various regulators didn't really look at.
    Ms. Lemieux. There is never just one reason a bank fails. 
And certainly Midwest Bank was subject, had invested heavily in 
commercial real estate and the management there tried valiantly 
to adjust their operations to overcome the dramatic change in 
real estate values. As someone mentioned before, preemptory 
action requires certain actions. It's just limited the time 
management had to make adjustments.
    Mrs. Biggert. I was just summarizing a report that says the 
FDIC failed to supervise the bank and failed to take any 
action. There was a risky CRE loan concentration and 
essentially failed to do the job. And then finally, it is no 
secret that our State Treasurer's family bank, Broadway Bank, 
recently failed. And looking at that timeline, they issued more 
risky CRE loans over the course of several years and the press 
reports tell us that in 2007, 2008 the shareholders of the bank 
walked away, the family walked away with $70 million in 
dividends and in 2009, the Broadway Bank was told to raise $85 
million by April and they didn't meet that and failed. And the 
cost to the FDIC Fund is reported to be about $400 million. And 
in addition, some say that the family could walk away with 
millions in tax write offs. And the jury is not out. Now we 
have another perhaps cost to the FDIC Fund of Corus Bank and 
any--we have to work for the MLRR report from the Treasury 
Inspector General on that. So we don't know what's going to 
happen there. And it could cost over $100 million. So there's 
something wrong with this picture. And the regulators did 
nothing to stop this wave of these loans and I see he's going 
to bang the gavel on me. Maybe I'll get another chance to come 
back to that.
    Chairman Moore of Kansas. You still have a minute or so, if 
you would like.
    Mrs. Biggert. Okay, good. Can anybody tell me why, for so 
many years, nothing has been done while your agencies knew that 
there was a problem if you all had an interagency, I would call 
it a summit or a meeting, saying that there was a problem and 
why weren't these loans talked about and these unsafe and 
unsound practices of so many banks?
    Would anybody care to talk about that?
    Mr. Lowe. Yes, Congresswoman, I'll try to attempt to answer 
parts of that. Back through the early part of the decade and 
leading up to the real estate crisis, if you were to look at 
our examination reports from any of the agencies of pretty much 
any of these banks that did fail, we were consistently warning 
the banks about concentrations of credit, concentrations in 
commercial real estate and specifically ADC and that type of 
lending. We were usually also making recommendations for the 
banks to strengthen their underwriting, to hold additional 
capital and again to strengthen the oversight of that and 
measurement and monitoring of that particular facet of a bank's 
operations.
     The majority of those institutions at that point in time 
before the real estate market crashed were continuing to make 
profits. The credits were continuing to perform at that time 
and I think this goes to what we have been talking about. If a 
credit is performing, if it is cash flowing, we're looking at 
the collateral as a secondary form of repayment. So those 
credits were performing at that point in time. The market was 
still performing, so that did factor into our staff decisions.
    Chairman Moore of Kansas. The gentlelady's time has 
expired, so if you would like to ask that the witnesses make 
written comments available to the entire panel, we can do that 
as well.
    Mrs. Biggert. I appreciate that.
    Chairman Moore of Kansas. Certainly. The Chair will next 
recognize for up to 5 minutes, Ms. Bean, the gentlelady from 
Illinois.
    Ms. Bean. I actually may pick up where my colleague left 
off. Five years ago, before this problem in the real estate 
market, what was done to try to change the allocation of loans 
at community banks since there does appear to have been this 
overconcentration in commercial real estate?
    Mr. Otto. I'll make a couple of comments. I think that one 
of the things that we looked at, we do monitor concentrations 
and we will make sure that the Board, the Board of Directors 
have approved limits and if the limits get out of line, we will 
have discussions with them. Do they have the staff necessary to 
handle high concentrations? And quite honestly in some cases, 
we will ask the bank to add capital, raise capital in some of 
these. What we have found in this crisis, what has caused a lot 
of the banks' problems has been high concentrations of out-of-
area lending and growth. Concentrations and growth over my 
career, those are the two things that get banks into trouble. 
And we ask management to make sure that they have the controls 
in place, the MIS to monitor that and when it gets too high 
that the Board of Directors understand where they're at.
    A lot of banks did not really know the level of 
concentrations.
    Ms. Bean. I actually am going to take the rest in a written 
report as the chairman had recommended just so I can get to 
some other questions. The committee will be considering this 
week legislation similar to the President's proposal to provide 
up to $30 billion of investment in community banks for the 
purpose of increasing small business lending.
    Not only what impact do you think that would have on small 
business lending in Illinois, but how will the supervision of 
the bank that receives that investment be altered? To whomever 
wants to address that.
    Ms. Lemieux. There are two ways to interpret that, 
certainly, we don't supervise banks that have received TARP any 
differently or any other type program any differently than we 
do other banks. We want to be sure they operate in a safe and 
sound manner and serve the needs of their communities. 
Certainly, TARP banks have extra reporting requirements 
concerning lending, so that would be up to the designers of the 
program.
    Ms. Bean. Any other comments on that? Another question, you 
talked about sometimes banks appealing a decision. We hear, I 
think all of us have heard from community banks who have felt 
that regulators have been overly stringent. They hesitate to 
appeal because they're fearful about ramifications. So who 
knows when a bank appeals a decision and should they be?
    Mr. Lowe. At the FDIC, we have made it clear, because we 
have also had several venues across the region where we have 
had director's colleges and meetings with bank directors and 
chief executive officers where we have clearly indicated to 
them this is the process, if you don't concur with our findings 
during the examination process or the processing of a report or 
before the rating is issued, there are clearly some steps that 
can be taken. We try to resolve our differences of opinion 
during the examination process. If that doesn't occur and the 
bank still wishes to appeal or to have us consider some 
additional information we can usually do that at the regional 
office level. So that process has been made public to all our 
institutions that there is a process for them to pursue and we 
have had several appeals here over the last couple of years and 
we go through the process. We have a fresh set of eyes to look 
at the findings, look at the conclusions, look at the 
recommendations, and come to a conclusion as to whether the 
findings were well supported.
    Ms. Bean. So you're saying no, they shouldn't be here on 
appeal?
    Mr. Lowe. No banks should be afraid to appeal.
    Mr. McKee. I just might add to that the CEO meeting that I 
referred to earlier, two of those meetings we had the ombudsman 
which is the person in our organization who would oversee any 
type of an appeal in attendance there to try to get the 
dialogue, for them to get comfortable that it's not a bad thing 
for them to appeal, that we will take an independent review of 
it and make a decision at that point.
    Ms. Bean. I appreciate that and if I have time, and I'm 
sure you'll gavel me if I don't, my last question is about some 
of the proposals to amortize real estate losses at community 
banks over a period of years instead of immediately.
    From your perspective, what are the positives and/or 
concerns? It does kind of align with some of the 
countercyclical recommendations that we have talked a lot 
about, but some also say that's kicking the can down the road 
and making a problem fester. What are your thoughts?
    Mr. Lowe. I'll tell you one of my concerns would be that 
you potentially have this gap between the regulatory capital of 
an institution and gap capital where if you have this 
forbearance potentially, the bank is showing that it has more 
capital to protect against losses than it actually does. I 
think that takes away the transparency in the financial process 
for investors, for bank customers, a lot of that transparency 
is eliminated in that type of a process.
    Ms. Bean. Other comments?
    Mr. Otto. We feel that it delays the problems. I think we 
have tried that in the past, and from our perspective, it 
hasn't worked well.
    Mr. McKee. I believe it would delay really the true capital 
position reflecting that. The thrift industry back in the late 
1980's had deferred loan losses, the same type of principle and 
I think it was a lesson we learned, that was maybe not a good 
thing to pursue.
    Ms. Bean. Thank you.
    Ms. Lemieux. I agree with my colleagues. I think one point 
I would like to underline that Anthony emphasized is 
transparency to the market. So it's not only the ability of our 
examiners to understand the financial condition of the 
organization, but also the investors in that organization and 
market participants.
    Ms. Bean. Thank you. I yield back.
    Chairman Moore of Kansas. The gentlelady's time has 
expired. I now recognize Mr. Foster for 5 minutes.
    Mr. Foster. Thank you. One thing that we have heard from 
several witnesses, I guess, is the statement that loans will 
not be reclassified solely on the basis of the drop in 
collateral value. And it sounds like that is crying out for 
some fine print and a little asterisk. So I was wondering, 
under what conditions will the value of the underlying 
collateral become relevant in the examination process and so 
on? If we could just march down the line.
    Mr. Lowe. Basically, when we start looking at collateral we 
have come to a conclusion that the borrower does not have the 
wherewithal, either the willingness or the ability, to continue 
to amortize a loan as contracted. They either don't have the 
cash flow, the global cash flow or assets that can be 
liquidated, to continuing amortizing and at that point in time, 
we will start to look at the collateral since that is the 
secondary source of repayment.
    Mr. Foster. Do you look at the overall--across the whole 
portfolio, the total amount of collateral compared to the loan 
size and so on in such a way that a bank would have an 
incentive to try to get rid of or not renew loans that were not 
well collateralized? If you understand my--what I'm trying to--
whether you look at the total collateral position of a bank 
when you're evaluating its health, I guess--
    Mr. Lowe. You mean for an individual credit?
    Mr. Foster. No, not on a loan-by-loan basis, but overall.
    Mr. Lowe. We generally will do our credit reviews on a 
loan-by-loan type of basis and not by looking at the--
    Mr. Foster. So it's strictly only true how well 
collateralized it is after you have concluded that the thing 
has gone belly up and you're looking at liquidation as a 
possibility. Okay.
    Mr. Otto. Yes, if the primary source of repayment obviously 
is cash flow, if that is gone, then we look at the collateral 
that the collateral covers, but the primary source of repayment 
would have to be gone.
    Mr. McKee. But if the primary source of repayment is still 
sufficient, the collateral may not be sufficient to 
collateralize the loan, but it doesn't mean it's a problem loan 
at that point. Again, we look at the primary source which in 
real estate is going to be your cash flow.
    Mr. Foster. So a bank that has lots and lots of performing 
loans all of which are undercollateralized would not be a 
source of concern for you?
    Mr. McKee. It potentially could be a source of concern. We 
would have to look at each loan on an individual basis.
    Mr. Foster. If each were performing individually, you would 
say okay, that's fine, and that's really the way it works in 
reality. Okay.
    Mr. McKee. Because some banks can make unsecured loans.
    Mr. Foster. Okay. Let's see, I guess it strikes me that one 
of the fundamental questions that we have to face when we're 
talking about schemes to recapitalize banks as Melissa 
mentioned or just CRE market supports, whether we're going to 
establish programs and policies that effectively put the 
taxpayer on the hook if there's a double dip in commercial real 
estate prices. And from that point of view, the TARP program 
was a success. There wasn't a double dip in toxic asset 
valuations and the taxpayer got out, in fact, with a profit.
    In the CRE, it's less clear. I was wondering if you have 
any words of wisdom on how well defended we should be against a 
double dip in commercial real estate and prices as we're 
thinking about these programs?
    Ms. Lemieux. We can refer it to the policymakers in 
Washington.
    Mr. Foster. It's a fundamental question. We can 
recapitalize a bunch of marginal banks and lose that whole 
investment if, in fact, there is a further drop. And so it's a 
fundamental question and I wonder who we should turn to for 
advice on the risks that we're putting out for the taxpayer?
    Ms. Lemieux. It is a serious question and one of the 
criteria for TARP was that the money went to viable banks and 
that requirement was important to the market because they knew 
that was a requirement, so it was a signaling mechanism for 
others that might have the ability to invest in that bank. So 
that's just an observation.
    Mr. Foster. Any words of wisdom you have would be very 
welcome because that's the fundamental question we're facing. 
Thanks. I yield back.
    Chairman Moore of Kansas. The gentleman yields back, and I 
think we do have a few extra minutes here, so with everybody's 
consent, we're going to do one 2-minute round of questions 
again, and then we'll start on our third and final panel.
    Mr. Lowe, I would like to get your view on a couple of 
items with respect to bank failures given the FDIC's role in 
that. Knowing that more banks will likely fail and there will 
be some ongoing consolidation within the banking sector, what 
steps has the FDIC taken to make sure that any banks sold are 
sold to a wide variety of other firms and not just the largest 
banks? And what is your reaction to the suggestion that CRE 
assets from failed banks be securitized as they were following 
the S&L crisis?
    Mr. Lowe. With regard to the sale of institutions, we're 
required under the law right now to make sure these 
transactions are done at the least cost to the Deposit 
Insurance Fund. When we go through the process of coming up 
with the bid list and actually when we put the bank out for 
bid, we do look at a lot of factors, the capital of the 
institution that's going to be acquiring it, the management 
expertise, the business plan, different factors, but when we 
make a final decision we do still have to make sure it is the 
least cost, regardless of the type of transaction that we do 
decide is the best that we need to be pursuing.
    I'm sorry, what was the second part of the question?
    Chairman Moore of Kansas. What's your reaction to the 
suggestion that the CRE has from failed banks be securitized as 
they were following the S&L crisis?
    Mr. Lowe. That's an issue I would like to consider for a 
follow-up response.
    Chairman Moore of Kansas. Ms. Biggert, you are recognized 
for 2 minutes.
    Mrs. Biggert. Thank you, Mr. Chairman. I still don't 
understand why it took 16 years for agencies to issue the 
guidance on CRE loan concentrations. I know John Dugan, the 
Comptroller of the Currency, in The American Banker, said we 
know that significant CRE concentrations and economic downturns 
can lead to an increase in problem banks, an increase in bank 
failures, loss of jobs, loss of income, loss to communities, 
loss to the Deposit Insurance Fund, and higher costs for all 
banks, even those that do not have CRE concentrations. I think 
it's just a shame that--particularly with the FDIC. I have a 
bank in my District that failed and the way that--when it came 
out, the Inspector General for the FDIC said it was--that the 
FDIC failed to do the job and it is costing us so much money 
with--to take over banks.
    Is there going to have to be another special assessment to 
the banks for the FDIC? Is that in the works?
    Mr. Lowe. At this point in time, I'm not aware that we're 
considering another special assessment. We continue to look at 
our pricing and our premiums. Just a couple of weeks ago--last 
month, actually, our Board of Directors did approve for notice 
of a proposal to look at--looking at the larger, more complex 
institutions and making sure they were appropriately pricing 
their deposit insurance coverage. But at this point in time, to 
my knowledge, there are no plans for an additional special 
assessment.
    Mrs. Biggert. That's good news, because every special 
assessment then raises the capital which then lowers the 
ability of the banks to make the loans. Does anybody have 
anything additional to add to how this is going to change?
    Mr. McKee. I just might mention on the concentration piece 
that the thrift industry, OTS, we have a statutory limitation 
of 400 percent and that's been in effect for many years, so we 
did not join the other regulatory agencies with their guidance 
because of the fact that we had the statute that already 
limited the CRE concentration.
    Mrs. Biggert. I worry about this, but on the other hand, I 
worry about an overreaction too, so there's such regulation 
that it goes too far. Work on that, please. I yield back.
    Chairman Moore of Kansas. Thank you. Ms. Bean, you're 
recognized for 2 minutes.
    Ms. Bean. Thank you, Mr. Chairman. You can get back to me 
in the interest of time so we can get you the third panel, but 
I had asked the last panel about underwriting standards for 
commercial real estate loans. If you can give me a yes or no on 
whether you think further congressional action is necessary in 
that regard, that would be helpful. If we can go right down the 
line?
    Mr. Lowe. No.
    Mr. Otto. We would have to look at it.
    Mr. McKee. Same here. We would have to study that.
    Ms. Lemieux. I think that's in the realm of bank 
management. That's a decision that different managers of banks 
and boards make, depending on the risk appetite of their 
organization. But again, we can get back to you on that.
    Ms. Bean. I yield back.
    Chairman Moore of Kansas. Thank you. Mr. Foster, you are 
recognized, sir, for 2 minutes.
    Mr. Foster. I was wondering if someone could explain 
briefly how the different classes of commercial real estate 
loans are handled in terms of capital requirements? And whether 
there are any changes in these requirements that could provide 
some capital relief without really changing the overall risk to 
the FDIC Fund, this sort of thing? Are there any specific 
proposals out there that would allow you to say that there is a 
certain class of real estate loans is not really a risk and you 
shouldn't hold as much capital against it as other classes? Is 
that already done to the extent possible? Are there further 
enhancements of that, which might provide some relief?
    Mr. Lowe. The risk-based capital is, and I'm struggling 
with what the numbers are, the limits are, but there are 
different percentages of capital that's assigned, based on 
risk-based capital.
    Mr. Foster. There are several of these different classes?
    Ms. Lemieux. This is the FOSL 1 rules, so there are big 
buckets, residential real estate. So they're not very risk 
sensitive. That's how we determine our risk-based assets.
    Mr. Foster. Is there a chance that you could better match 
the real risk to what's there?
    Ms. Lemieux. Certainly, we're working with all the 
regulators internationally on risk-based capital standards. And 
while in the United States, we have elected to apply those only 
at the largest banks, there are ramifications and proposals 
being considered to adjust the FOSL 1 requirements in light of 
what we have learned, but they certainly won't be as 
individually tailored as they are for the largest banks.
    Mr. Foster. Have there been any easy to explain systematic 
differences in the lending practices and the degree to which 
commercial real estate is a problem among the different 
chartered organizations? It's sort of an open-ended question. 
But if you just look, different banks. Maybe if you could 
respond in writing, I guess.
    Ms. Lemieux. Okay.
    Chairman Moore of Kansas. I would ask the witnesses, if 
they would, please respond in writing, because the members 
certainly have the right to ask the questions. We're just out 
of time now.
    I want to thank our second panel for your testimony. You're 
now excused. I'll invite the third and final panel of witnesses 
to please take your seats. Thanks again for coming today and 
for testifying.
    I'm pleased to introduce our third and final panel: Ms. 
Paula Dubberly, Associate Director, Division of Corporation 
Finance, at the SEC: Mr. Kevin Stoklosa, Assistant Technical 
Director, Financial Accounting Standards Board; Mr. Leslie 
Sellers, president of the Appraisal Institute; Mr. Kent Born, 
senior managing director, PPM America, testifying on behalf of 
the CRE Finance Council; and Mr. Bruce Cohen, CEO, Wrightwood 
Capital, testifying on behalf of the Real Estate Roundtable.
    Without objection, the written statements of each of the 
witnesses will be made a part of the record, and you will each 
have 3 minutes to summarize your statements and touch on the 
key messages you would like to share.
    Ms. Dubberly, you are recognized for 3 minutes.

  PAULA DUBBERLY, ASSOCIATE DIRECTOR, DIVISION OF CORPORATION 
        FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION

    Ms. Dubberly. Chairman Moore, Ranking Member Biggert, and 
members of the subcommittee, I am Associate Director of the 
Division of Corporation Finance at the SEC and I'm pleased to 
testify on behalf of the Commission today on the topic of 
securitization. Securitizations may serve as a vehicle for 
financing commercial real estate, so my comments today will 
provide an overview of the Commission's work in the 
securitization area, specifically focusing on a recent proposed 
rulemaking that the Commission published for public comment on 
April 7th that proposes significant revisions to the rules 
governing offers, sales, and reporting with respect to asset-
backed securities.
    Securitization generally is a financing technique in which 
financial assets, in many cases illiquid, are pooled and 
converted into instruments that are offered and sold in the 
capital markets as securities.
    At its inception, securitization primarily served as a 
vehicle for residential mortgage financing, but since then has 
provided liquidity to nearly all major sectors of the economy, 
including the residential and commercial real estate industry, 
the automobile industry and the consumer credit industry.
    Many of the problems giving rise to the financial crisis 
involved asset-backed securities, including residential 
mortgage-backed securities. As the crisis unfolded, investors 
increasingly became unwilling to purchase these securities. The 
absence of this financing option has negatively impacted the 
availability of credit.
    The Commission's proposal is intended to provide investors 
with timely and sufficient information. Although these 
revisions are comprehensive and therefore would impose new 
burdens, if adopted, the Commission believes they would protect 
investors and promote efficient capital formation.
    I will briefly summarize the proposal. The proposal would 
change the eligibility requirements for ABS offerings to 
qualify for expedited treatment. One of the current eligibility 
requirements for these expedited offerings is that the 
securities are rated investment grade by a nationally 
recognized statistical rating organization. Much has been 
written about the failure of ratings. The proposal would repeal 
the expedited offering criterion relying on ratings and 
establish new requirements for expedited ABS offerings. These 
proposed requirements are designed to provide for a certain 
quality and character for ABS securities that are eligible for 
expedited issuance.
    Because many ABS investors expressed concerns that they did 
not have enough time to consider the disclosures about the 
potential investment, the proposal would require issuers doing 
an expedited offering to provide at least five business days 
for investors to consider a preliminary prospectus about the 
offering.
    The proposal would require, in addition to aggregated pool 
data, disclosure of specified loan level data and machine-
readable standardized format. The data points the Commission 
proposed to require for commercial mortgage-backed securities 
are primarily based on the definitions included in the CRE 
Finance Council's investor reporting package, current 
regulation AB requirements and staff's review of current 
disclosure.
    The Commission also proposed to require the filing of a 
computer program of the contractual cash flow provisions of the 
securities. Significant concerns have been raised about 
investor protection in the private ABS market where a 
significant portion of securitization transactions take place.
    The Commission proposed to require enhanced disclosure by 
ABS issuers who wish to take advantage of the safe harbor 
provisions for these privately-placed ABS. In addition, the 
Commission proposed amendments to require ABS issuers to file a 
public notice.
    The comment period for the proposed rules expires on August 
2nd. The Commission looks forward to reviewing and considering 
all comments.
    Thank you again for the opportunity to testify.
    [The prepared statement of Ms. Dubberly can be found on 
page 105 of the appendix.]
    Chairman Moore of Kansas. Thank you, Ms. Dubberly.
    Mr. Stoklosa, you are recognized for 3 minutes, sir.

  STATEMENT OF KEVIN STOKLOSA, ASSISTANT TECHNICAL DIRECTOR, 
              FINANCIAL ACCOUNTING STANDARDS BOARD

    Mr. Stoklosa. Mr. Chairman and members of the subcommittee, 
my name is Kevin Stoklosa, Assistant Director of Technical 
Activities at the Financial Accounting Standards Board.
    Thank you for inviting me today to participate in this 
important hearing.
    Since 1973, the FASB has established standards of financial 
accounting and reporting for nongovernment entities including 
both businesses and not-for-profit organizations. Those 
standards are recognized as authoritative, generally accepted 
accounting principles. GAAP is essential to the efficient 
functioning of the U.S. economy because investors, creditors, 
donors, and other users of financial reports rely heavily on 
credible, transparent, comparable, and unbiased financial 
information to make resource allocation decisions.
    Because the actions of the FASB affect so many 
organizations, the FASB carefully considers the views of all 
interested parties including users, auditors, regulators, and 
preparers of financial information in its decision-making 
process. Although the FASB and regulators have different 
objectives, because of their keen interest in GAAP financial 
statements as the starting point in their assessment of the 
safety and soundness of an entity's financial position, the 
FASB members and staff regularly meet with regulators to obtain 
their input and better our understanding of their views.
    The subcommittee is examining the causes of the turmoil in 
the commercial real estate market, and the state of the market. 
I would like to focus my remarks on the FASB's accounting 
guidance that most significantly affects these companies.
    From the perspective of entities that develop, purchase, or 
own commercial real estate, the accounting guidance requires 
those entities to measure the investment at historical cost. 
Under this accounting model, entities are required to 
capitalize certain costs incurred in the development or 
acquisition of commercial properties. GAAP provides 
prescriptive guidance on what costs should be capitalized and 
when capitalization of those costs should cease to continue. 
Testing properties for impairment during both the construction 
stage and once the property is available for occupancy is also 
required.
    As a result of input from both preparers and users of 
financial statements, the FASB has recently added a project to 
its agenda to reconsider whether entities should be permitted 
to measure investment properties at fair value, instead of 
historical cost. International accounting standards currently 
permit investment properties to be measured at fair value.
    From the perspective of entities that finance commercial 
real estate, the accounting guidance is based on whether the 
creditor holds the loans or whether the creditor transfers or 
securitizes the loans. Last year, the FASB issued Statements 
166 and 167 which were needed improvements to the accounting 
and reporting for transfers of financial assets, including 
securitizations, and other involvements with special purpose 
entities. This guidance, which still allows for entities to 
obtain sale accounting, where appropriate, it should result in 
more assets involved in such transactions staying on the books 
of the sponsoring financial institutions, by significantly 
reducing the ability to get off-balance sheet treatment for 
securitizations and other similar arrangements where 
significant risk is retained by the entity. Although this 
guidance will better reflect financial institutions' exposure 
to risks, it may affect their ability to comply with the 
regulatory capital requirements and therefore affect the 
liquidity available to the CRE industry.
    Mr. Chairman, that concludes my prepared remarks. I would 
like to thank you and the subcommittee for the opportunity to 
testify this afternoon.
    [The prepared statement of Mr. Stoklosa can be found on 
page 193 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Stoklosa for your 
testimony.
    Mr. Sellers, you are next recognized for 3 minutes, sir.

  STATEMENT OF LESLIE SELLERS, PRESIDENT, APPRAISAL INSTITUTE

    Mr. Sellers. Being here at the site of the Great Chicago 
Fire of 1871 is reminiscent of mass destruction and rebuilding, 
not unlike the work that we face to rebuild our financial 
system today. Hundreds of banks are expected to fail in the 
next 2 years. Financing for commercial real estate is nearly 
nonexistent as trillions of dollars of commercial paper comes 
due.
    Based on my discussions with government officials, 
investors, and borrowers throughout the world, there's a 
striking concern that we conduct real estate financing with a 
Wild West attitude. The United States has lost credibility as a 
financial leader of the world. Clearly, if we are going to 
retain and attract new investment, we must earn back the trust 
of investors.
    We firmly believe that collateral risk assessment must be 
enforced. We cannot rely on credit risk alone. We must account 
for collateral risk. We need to promote quality and competency 
over speed and volume. We need to consistently enforce lending 
regulations and guidelines. We need to elevate risk management 
to be on par with loan production.
    We believe there are specific actions that can help put out 
the fires and help in the rebuilding process. First, to help 
with the CRE workouts, lenders should engage competent 
appraisers to provide multi-value appraisals, providing as-is 
market value, liquidation value, and fair value. These 
represent the most likely, the most pessimistic, and the most 
optimistic measurements applied to risk.
    Second, financial institutions should engage independent 
valuation experts in the periodic monitoring of CRE assets, 
much like pension funds and institutional investors do now.
    Third, we need to strengthen the interagency appraisal 
guidelines to demand competency, quality, and accountability.
    And finally, we need to strengthen the institutional 
capacity of collateral risk within the financial institutions 
and the bank regulatory agencies for better oversight and 
enforcement.
    In closing, professional appraisers stand prepared to 
battle the fires confronting the commercial real estate market 
today. As we look to win back the confidence of investors 
worldwide, we believe enhanced collateral risk assessment is 
one of the building blocks necessary to chart that path.
    Thank you, and I am happy to answer any questions.
    [The prepared statement of Mr. Sellers can be found on page 
184 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Sellers, for your 
testimony.
    The Chair will next recognize Mr. Born. You are recognized, 
sir, for up to 3 minutes.

STATEMENT OF KENT BORN, SENIOR MANAGING DIRECTOR, PPM AMERICA, 
              ON BEHALF OF THE CRE FINANCE COUNCIL

    Mr. Born. Thank you, Chairman Moore, Ranking Member 
Biggert, and members of the subcommittee.
    My name is Kent Born. I manage a $6 billion commercial 
mortgage-backed securities portfolio for PPM America. I also am 
a past president of the CRE Finance Council which represents 
lenders, issuers, servicers, and investors of all kinds.
    Today, I would like to focus on three points: first, the 
challenges facing commercial real estate finance; second, the 
unique structure of CMBS; and third, policies to support a 
lasting recovery.
    As a lagging indicator, the $7 trillion commercial real 
estate market is now feeling the full impact of a prolonged 
recession. The contagion from the collapse of the subprime 
market spread quickly to CMBS even though loan defaults and ARM 
market remained less than one percent for more than a year 
after the subprime meltdown.
    Today, a perfect storm exists in four interconnected 
challenges. First, there's virtually no lending in the CMBS 
market and this is down from nearly $250 billion of lending as 
recently as 2007.
    Second, approximately, $1.4 trillion in commercial real 
estate loans mature over the next several years.
    Third, at the risk of stating the obvious, we are in the 
midst of a recession.
    And finally, a severe equity gap exists in commercial real 
estate. Commercial properties have lost anywhere from 30 to 50 
percent of value since the fall of 2007, and this is arguably 
the biggest challenge that we face in the market today.
    The centerpiece of the financial stability plan is 
restarting securitization to meet borrower demand. In order to 
do this, there are four key differences that need to be 
understood in any policy.
    First, CMBS borrowers are sophisticated businesses that own 
income-producing properties. Second, the CMBS structure 
typically includes anywhere from 100 to 300 loans averaging $8 
million in size. Third, we have the COE Finance Council 
Investor Reporting Package, a standardized database that is now 
being used as a model for the residential market. And finally, 
we're the only market with first loss investors who re-
underwrite all of the loans in a pool prior to issuance.
    There are four key areas that provide a framework for 
recovery. First of all, we need increased coordination in 
accounting and regulatory reforms and we support a House-passed 
study on these issues.
    Second, we need reforms that are customized by asset class. 
In this regard, House and Senate-passed language to consider 
the best form of skin in the game for commercial mortgages is 
crucial.
    Third, we need new capital sources for the commercial real 
estate market. TALF was extremely helpful in terms of bringing 
liquidity back to the secondary market, but we need to explore 
ways to address the equity gap issue such as RTC-like 
structures, guarantees for small loans and/or covered bond 
frameworks.
    And finally, we need to provide investors with certainty. 
Investors need certainty in regulation and they need confidence 
in areas such as credit ratings and in underwriting and really 
the market as a whole.
    So I thank you for the opportunity to testify and I look 
forward to taking your questions.
    [The prepared statement of Mr. Born can be found on page 65 
of the appendix.]
    Chairman Moore of Kansas. Thank you to all of our witnesses 
for your testimony. I recognize myself for up to 5 minutes for 
questions.
    Mr. Born, you first, sir. Taking a step back from 
commercial real estate, I find that most Americans may not 
understand how securitization works from a fundamental level 
and how it impacts their everyday lives.
    I'm sorry, excuse me. I apologize. Mr. Cohen, you're 
recognized. I apologize. I didn't mean to leave you out there. 
You have 3 minutes, sir.

STATEMENT OF BRUCE R. COHEN, CEO, WRIGHTWOOD CAPITAL, ON BEHALF 
                 OF THE REAL ESTATE ROUNDTABLE

    Mr. Cohen. My name is Bruce Cohen, and I'm the chairman and 
chief executive officer of Wrightwood Capital. I appreciate the 
opportunity to testify today on behalf of the Real Estate 
Roundtable.
    I commend you, Mr. Chairman, and the members of this 
committee for holding this hearing. The capital-related issues 
facing the commercial real estate industry are real and pose 
meaningful risks to the overall economy. We are grateful for 
your efforts to identify critical policy actions that can 
address this increasingly troublesome situation.
    The bottom line is this: Despite some stabilization of the 
broader credit market since the fall of 2008, and modest 
improvements in credit availability for a small segment of 
commercial real estate markets, the current financial system in 
America simply can't meet the financing needs of the broader 
commercial real estate market.
    Absent a significant change to the current landscape, the 
jeopardy to the overall economy is material. Some might ask, 
why should we care? Let me offer some reasons for concern.
    First, we're in a time in which budgetary pressures on 
State and local governments are extraordinary. Many people are 
unaware that local governments on average receive 50 percent of 
their revenue from commercial real estate-related transactional 
activities. A sick commercial real estate market will naturally 
exacerbate the problems these communities face.
    Second, the absence of capital translates to an inability 
to build new buildings or meet the construction-related needs 
of older ones. This will lead to a dramatic reduction in jobs, 
given the prominent role construction plays in our overall 
economy, as well as fewer opportunities for building owners to 
make their properties more energy efficient.
    Beyond the effects on jobs and building needs themselves, 
most are unaware of the sizable economic stakes that citizens 
have in healthy commercial property markets. Estimates are that 
Americans have approximately $160 billion of retirement savings 
invested in commercial real estate. So as commercial real 
estate goes, so go local budgets that are already pinched, jobs 
which are already in short supply, and retirement accounts, 
pension plans, endowments, and foundations that have already 
been diminished.
    We recognize and appreciate the steps taken so far by the 
Congress, the Federal Reserve, and the Treasury Department to 
try to address the vast liquidity crisis that's crippling the 
economy, destroying jobs, and causing a free fall in commercial 
property values, but much more needs to be done.
    Our overall economy needs to see job growth, but estimates 
suggest that 50 to 60 percent of all job growth comes from 
companies with less than 100 employees. Simply put, additional 
measures must be taken to create credit capacity in the 
regional and community banks which in turn will stimulate the 
availability of capital for small and mid-market companies.
    Moreover, even if traditional portfolio lenders to 
commercial real estate such as commercial banks and life 
insurance companies return to the market in force, these 
institutions simply do not have the capacity to satisfy the 
credit demand of this industry. Therefore, additional steps 
must be taken to restore asset-backed and commercial mortgage 
securitization markets.
    In my written statement, I detail the policy mix the Real 
Estate Roundtable believes would be most helpful. First, the 
TALF program has compressed spreads and catalyzed some asset-
backed and commercial mortgage-backed securitizations. The 
program has ended for legacy assets and will end in June for 
new CMBS. As this program has unwound, policymakers need to 
examine other measures that can help the securitization market.
    As for small banks, one idea being considered in Congress 
involves a measure that will allow small and medium-sized banks 
to amortize their write-down and losses on commercial real 
estate loans on a quarterly straight-line basis over a 7-year 
period. Beyond the need to restore credit, the industry also 
faces a large equity gap. We think it's time to reform the laws 
applicable to foreign investment in U.S. real estate. Simple 
reforms to the current law, called FRPTA, could be made that 
would stimulate foreign capital flows. Lastly, we do not think 
it is the time to increase taxes on real estate, most 
specifically, the carried interest tax hike would discourage 
risk taking on the part of the real estate entrepreneur at a 
time in which we most need it.
    Thank you for this opportunity. I would be happy to answer 
any questions the committee might have.
    [The prepared statement of Mr. Cohen can be found on page 
85 of the appendix.]
    Chairman Moore of Kansas. Thank you, Mr. Cohen, for your 
testimony. At this time, I recognize myself for up to 5 minutes 
for questions.
    Mr. Born, taking a step back from commercial real estate, I 
find that most Americans may not understand how securitization 
works from a fundamental level and how it impacts their 
everyday life. Would you explain briefly how securitization can 
help expand credit availability for small businesses, loans, 
credit cards, student loans, things of that nature, please?
    Mr. Born. I think in general, securitization as a concept 
works quite well. There were obviously some abuses in the 
application of securitization which got us to the point where 
we are, generally speaking. It is a great way actually to, I 
think, to disperse capital throughout the system. Using the 
CMBS market as an example, you have banks who used to originate 
loans and warehouse loans. To the extent that they kept them on 
their balance sheet, at a certain point in time, they would be 
unable to continue to lend. By securitizing them and then 
selling the bonds to investors such as myself, you're able to 
basically take a pool of loans, tranche it into different areas 
of risk, sell it to the investors, different investors, who 
have an appetite for that risk, and then start lending money 
again, providing capital to the system which I think is for the 
most part a positive for the economy.
    Chairman Moore of Kansas. Thank you. During committee mark-
up on financial regulatory reform in the House, I, along with 
Representatives Walt Minnick, Melissa Bean, and others wanted 
to make sure the special nature of CMBS securitization was 
taken into account with respect to risk retention.
    Ms. Dubberly, on securitization of risk retention, also 
known as ``skin in the game'' how would SEC's proposed rule 
affect commercial real estate securitization?
    Ms. Dubberly. The SEC's risk retention piece only relates 
to what we call shelf offerings, which are expedited offerings, 
straightforward regular offerings where you file a registration 
statement. Those aren't impacted at all by the proposal. The 
proposal which has the risk retention piece in it is for 
expedited treatment. Currently, there is a requirement that the 
securities have to be investment grade. The Commission is 
trying to eliminate reliance on rating agencies, and so it 
tried to come up with another criteria for higher quality 
securities, so the 5 percent vertical slice risk-retention 
piece would apply there for any ABS issue. It's a 5 percent 
vertical slice. It's a piece of each tranche that's being sold.
    Chairman Moore of Kansas. Mr. Cohen, do you, and then Mr. 
Born, have any comments on that question?
    Mr. Cohen. On the issue of risk retention?
    Chairman Moore of Kansas. Yes.
    Mr. Cohen. Congresswoman Bean asked the question earlier 
about rating agency underwriting credit decisions. The best 
solution for credit decisions is the requirement to retain 
risk. So long as we have had a system where risk could be 
distributed, there wasn't anybody who had a responsibility for 
credit decisions in the system. So our view is, to the extent 
that there is credit discipline that's imposed, it will be 
imposed by people who have to bear the risk as opposed to any 
type of regulatory oversight.
    Chairman Moore of Kansas. Mr. Born, any additional 
thoughts?
    Mr. Born. I would say yes. Within the CMBS market, we 
originally tried to address this issue by virtue of these first 
loss investors as I described before who would literally re-
underwrite every loan in the pool to get comfortable with that 
and then they would be buying essentially the equity piece and 
we're in the first line of defense, if you will. I think where 
that started to go astray was once they began to package up 
these securities and sell them off, they no longer had the 
vested interest that they had originally, so in terms of CMBS, 
I'm not opposed to retention, but I think something more along 
the lines of a requirement that these first loss investors, 
after they do all this diligence, have to hold on to these 
securities for some specified period of time, I think would 
address that issue.
    Chairman Moore of Kansas. My time is about to expire. I'm 
going to next recognize the ranking member, Ms. Biggert, 
please.
    Mrs. Biggert. Thank you, Mr. Chairman. As we just learned 
during Panel 2, the regulators knew for quite a period of time, 
almost 2 decades, that there was high concentration of risky 
CRE loans and tried to issue some guidance about it. But the 
guidance didn't work and according to Panel 1, the guidance on 
valuation of performing loans also didn't seem to be working, 
so as I mentioned to the other panels, would you and your 
agency or association participate in a roundtable?
    Mr. Born. Sure.
    Mr. Cohen. Absolutely.
    Mrs. Biggert. Mr. Sellers?
    Mr. Sellers. Absolutely.
    Mrs. Biggert. What are the real barriers to recovery in the 
CMBS market?
    Mr. Born?
    Mr. Born. I'll take it. I think for us, it's really this 
equity gap. You have a lot of properties out there whose 
current cash flow can cover the existing debt service payment. 
But once they reach refinance, depending on when that date 
occurs, there could be a significant gap between what their 
property is now worth by virtue of the depreciation of property 
values, generally, and what the loan amount is. So that, to me, 
is critical.
    The other issue that's been problematic in terms of 
generating new lending in CMBS is the warehouse risk. There was 
so much volatility in CMBS prices in 2008, particularly, the 
last part of 2008 that you couldn't really originate a new loan 
or pool of loans and know that you could ultimately sell the 
bonds at a profit.
    One other point I would make, a number of people have 
talked about the importance of extending TALF for new issue 
CMBS. Candidly, I don't agree with that. I think TALF for 
legacy CMBS was enormously successful in terms of spurring 
secondary market liquidity, but TALF for new issue was never 
really designed to address the two problems I just referenced. 
It was incapable of doing that.
    Mrs. Biggert. And you have talked about the 5 percent 
retention or ``skin in the game.'' Will that work with the 
securities?
    Mr. Born. As outlined by Ms. Dubberly in terms of the 5 
percent vertical slice, I'm not sure how well that works for 
us. I think there are a couple of things that we have been 
looking at, this notion of the first loss investor being 
required to hold that risk for a period of time. I think that 
would address it in CMBs.
    And the other issue, Congresswoman Bean has been asking 
several people about the government getting involved in 
underwriting standards. I think something along the lines of a 
best practices for commercial mortgage underwriting that both 
the government and trade associations could work on would be 
good and then perhaps have the loan originators represent or 
warrant that they, in fact, did follow these best practices in 
originating the loans. If you did that in conjunction with the 
first loss investors having to keep the riskiest piece, I think 
that gets you there.
    Mrs. Biggert. Thank you. Ms. Dubberly?
    Ms. Dubberly. I think one of the biggest problems with the 
CMBS market is investors. Investors aren't ready to come back 
to the market and I think that hopefully the Commission's 
program will help them have restored confidence in the market, 
and have the tools to make informed investment decisions so 
they don't rely on the rating agencies.
    The Commission has asked a lot of questions about the first 
loss approach, about whether that makes sense. One of the 
problems with taking the first loss is the first loss person 
usually is also the master servicer and they will have a 
potential conflict of interest with the other tranches, with 
the other investors, because they will want to hold on to the 
real estate longer than maybe the other investors would if 
there's a problem. But the Commission has asked a lot of 
questions about that.
    Mrs. Biggert. So the SEC is really doing a lot to trying to 
spur the activity in this market?
    Ms. Dubberly. The whole April 7th proposal, the Commission 
feels will really benefit the market by helping to restore 
investor confidence in the market, yes.
    Mrs. Biggert. Mr. Sellers, did you have something you 
wanted to say?
    Mr. Sellers. In regards to the ``skin in the game'' I'm old 
enough to remember back in the 1970's when we had banks that 
made loans and held it for the whole length of the loan and 
they were extremely conservative in their lending practices. 
But we have gone from one extreme to the other in that we don't 
have any ``skin in the game'' to where you have gotten in a 
situation where we're just passing paper and passing risk.
    I think the real answer is somewhere in between. In regards 
to the CMBS market, we have an issue where investors are 
expecting their money when the bond comes due. While we may not 
really want to be able to refinance that loan, we may have to 
force them to refinance the loan in order to pay that loan off. 
So we have a timing issue that's related.
    The other problem is we have many investors that have cash 
in their properties, pension funds, and rents. They're not 
really worried, but they have some properties, 11, 12 percent 
we're told, that are underwater. That doesn't bother them. They 
can weather the storm. But when the other properties go under 
because the bonds are coming due and forcing these people to 
refinance under new underwriting guidelines, then we're going 
to be bringing down the other people who are able to hold their 
property values as well. So it's a very complex issue.
    Mrs. Biggert. Thank you.
    Chairman Moore of Kansas. The gentlelady's time has 
expired. The Chair next recognizes Congresswoman Bean for 5 
minutes.
    Ms. Bean. Thank you, Mr. Chairman, and thank you all for 
your testimony today.
    Mr. Cohen, in your testimony, you highlighted that while 
the TALF program did not produce many CMBS deals, it did spur 
$3 billion in private sector deals.
    Would you agree with Mr. Born that we should then allow 
that program to expire at this time?
    Mr. Cohen. I think the position we're taking is that the 
program itself is not as critical as much as other steps 
necessary to spur the secondary market. We really need to do 
things that will spur the secondary market. That's the only way 
we can meet the proverbial tsunami of debt maturities that the 
Congressman was speaking about. That has to come from the 
secondary market.
    Ms. Bean. So would you support some of the things that Mr. 
Born had spoken about, covered bonds, additional loan 
guarantees. I know also in your testimony you talked about 
FRPTA to bring--if we could repeal FRPTA, which disincentivizes 
foreign capital to come back to the market, those would be 
things that you would support?
    Mr. Cohen. That's correct. And just to amplify that for a 
second, to the extent that we have had a 40 percent 
deterioration in values, we now have a situation where lenders 
are coming back in at even lower financing levels than they had 
in the past. That's calling for an enormous amount of equity to 
be able to meet these refinancing gaps. So we have to do things 
necessary to spur equity aggregation, equity allocation, and 
equity flows to this market.
    Ms. Bean. My other question is that one of our colleagues, 
Mr. Minnick on the committee, has a proposal that would for a 
premium of 350 basis points provide a Treasury guarantee on new 
CMBS for CRE loans that are under $10 million each. The concept 
is to provide liquidity to community banks who issue sound, 
commercial real estate loans and bring investors back into the 
market. What's your opinion of what that would do in terms of 
providing a temporary guarantee and what residual effect do you 
think there would be?
    Mr. Cohen. Again, I think our view is that you have to 
restore credit. You have to restore capital flows. Congressman 
Foster asked, how do you protect against further deterioration 
or additional declines in commercial real estate values? It is 
directly correlated to whether or not there's capital and 
credit availability.
    So our view is anything that restores credit availability 
has to be for the secondary market and it has to be for the 
small and midsized banks. They, in particular, are the ones who 
are going to deliver credit to the market.
    Ms. Bean. My last question, if I have some time, is for Mr. 
Born. You talked about the risk retention and actually having 
some concerns about that, not being opposed to it, but not 
limiting that as a way to better understand. And you talk about 
customizing by asset class. Given the way securities have been 
done recently, those who created the securities, those who 
rated the securities, and those who invested in the securities, 
the vast majority had no idea what was in those securities. So 
how do you customize that when nobody knows what's going on?
    Mr. Born. I guess--some people know what's going on.
    Ms. Bean. If you read, ``The Big Short,'' it was a really 
small number of people.
    Mr. Born. As I said in response to Chairman Moore's 
question about securitization. I think securitization is a good 
concept. There were obviously abuses in the system that got us 
to the point where we are.
     Ms. Bean. Not just abuses, but a real lack of 
understanding and risk management tools in place that were 
being used or practiced to really understand. It was mostly 
gross incompetence.
    Mr. Born. There were bad decisions made. There was a lack 
of oversight at steps along the road. I don't disagree with 
that. But I think we are on the road to recovery. It's early, 
but I think back to a year ago, looking at not only were there 
no new loans being made, but there were no bonds trading the 
secondary market in CMBS. Every bond you bought or sold was 
price discovery. It was an adventure. It took me from the last 
2 months of 2008 when we were actually a pretty active buyer 
because we recognized the prices were so depressed it was a 
good investment.
    It took me 6 weeks to buy the same amount of bonds I could 
have done in a couple of hours back in 2006. It was just a 
complete dearth of liquidity. We are now at a point where I can 
put bonds out to sell. I get 12 bids back. There's a fairly 
defined market in terms of what the price should be. I try to 
buy bonds, the same kind of thing.
    So now the--and I'm a little off point here, but I think 
now the next step is this equity gap. Risk retention is 
extremely important. I don't disagree with that, but I'm 
hesitant to set something up that results in one of the parties 
to the transaction having to keep all of the loans essentially 
on their balance sheet. That's not going to get anybody to 
lend. That just fundamentally won't work. So we just need to 
recognize some of the differences in CMBS versus other 
structured asset classes and just craft something that will get 
better oversight, but at the same time not shut down the 
lending market.
    Ms. Bean. I know I'm out of time, but if I can request the 
Chair's permission for a second to suggest that if you could 
give us some further suggestions on exactly how you would do 
that, that would be greatly appreciated.
    Mr. Born. All right.
    Chairman Moore of Kansas. The gentlelady's time has 
expired. The Chair will next recognize Mr. Foster for up to 5 
minutes.
    Mr. Foster. Yes, Ms. Dubberly, I am fascinated by your 
April 7th proposal to get away from using credit rating 
agencies with computer-readable descriptions of the mortgaged-
backed assets. And so let's see, as I understand it, what you 
do is provide underlying data in a machine-readable format and 
also an actual piece computer code that would allow you to look 
at what happens as different tranches degrade and so on. Is 
that a correct understanding?
    Ms. Dubberly. Yes, that's correct. It's actually--I'm very 
excited about this because it's the first time the Commission 
would require the filing of a computer program. So the way the 
pools are put together and the way the securities are actually 
structured is through the use of a computer program, the 
analysts run different models to figure out--
    Mr. Foster. I'm a former Python programmer.
    Ms. Dubberly. Then you know, so--
    Mr. Foster. There are all sorts of issues about changes in 
the compiler or the interpreter, actually, but you would have 
to make sure there's an agreed upon--this is going to be a 
legally binding version of the computer program.
    Ms. Dubberly. Right now, they take the computer program, 
translate it into English and put it in the prospectus and so 
they already have that. And then if you're an investor, you 
have to translate it from the English back into--trying to put 
it in a program if you want to run your models yourself.
    Mr. Foster. Right. So how many entities are there out there 
that could actually use that level of detailed information? Are 
there ten or a thousand?
    Ms. Dubberly. Oh no. I think the way it's structured 
because the data points will be standardized and because it's 
in XM Owl and because Python is open source, I think most 
investors in ABS will utilize this. ABS investors aren't ``ma 
and pa'' investors. They're institutional investors. I think it 
will be easy for third-party vendors to develop software that 
will make it very useful for investors.
    Mr. Foster. I think that is potentially a great advance. 
I'm a little confused on how this might work in the commercial 
MBS realm. Because if you're just talking about normal 
mortgage-backed securities, you have your credit scores and 
your income and your Zip Codes and relatively small number of 
things can fairly well characterize the mortgages well enough 
to get an estimate of what it's worth. But in the case of 
commercial things, you're so dependent on the details of the 
business operations, of each one of these loans that I'm a 
little bit skeptical, frankly, that it's ever going to apply 
there. Or if people attempt to apply it, it will sort of be 
abusable in the sense that it will be easy to mischaracterize 
things with a simple set of numbers, what the true riskiness 
is.
    Ms. Dubberly. We need you to comment on our rule proposal. 
We hope it will apply well to commercial mortgages. It's 
smaller pools, definitely, but it's standardized data and it 
will still be in a format that can be utilized. A lot of it 
does depend on who are actually on the rent rolls for any 
shopping center or who are on the rent rolls for whatever the 
commercial property is, but we still think it will be a 
valuable tool for CMBS.
    Mr. Foster. So you have business interest on the commercial 
mortgage-backed security application of this?
    Ms. Dubberly. I'm sorry?
    Mr. Foster. I can usually understand a lot of enthusiasm. 
In fact, I know a couple of people who were based a couple of 
years ago, proposed this to me as something I might want to 
push. On the commercial--I'm sorry, on the residential MBS, but 
on commercial MBS, is there a real commercial interest in this? 
Do businesses want to use these tools for commercial MBS?
    Ms. Dubberly. Yes, I think it will make the job of 
analyzing the pools just faster and easier for them to do. If 
it's not standardized, it will just take longer to do and this 
you'll be able to do it much quicker.
    Mr. Foster. It could be a big help in trying to resurrect 
the whole securitization market.
    Mr. Stoklosa, are there countercyclical accounting 
standards that are going to cause bigger rainy day funds on the 
upswing that are under discussion, as opposed to just having 
relief once the bubble has burst?
    Mr. Stoklosa. I don't know if accounting standards are 
countercyclical or not. I guess that is for other people to 
judge. I think our goal is to have the accounting standards 
reflect the economics to the best they can.
    I know impairment was a big issue on one of the earlier 
panels and from an impairment perspective, we do have a 
proposal on the table to provide some new impairment guidance, 
to provide more flexibility, to provide more judgment for 
people and entities to better identify the risks that they have 
and the potential losses they may have. So we should be coming 
out with that proposed guidance in a couple of weeks.
    Mr. Foster. Also, Mr. Sellers, this thing also gets into 
the appraisal principles. If you were--if the appraisal was 
based more on backward-looking historical value of the 
property, I think that would have a huge countercyclical 
element that you would simply treat skeptically the value of 
recently-appreciated assets and that principle to the extent 
that it got into our accounting standards and then appraisal 
standards, I think would be tremendously valuable in 
stabilizing our whole system.
    I would appreciate your reaction to that.
    Mr. Sellers. I agree. The appraisal process is completely 
misunderstood. We do forecast the future. That is part of our 
proposal. You need to have competent appraisers who are using 
good, fundamental market analysis, not inferred, market 
analysis, but good and fundamental market analysis.
    And if you do that, you have a reasonable opinion or value 
based on specific trends and specific anticipated movements in 
the marketplace. The market completely moves backwards and 
forwards, up and down. We, as appraisers, can give you values 
and give you opinions of values of different types for 
different time periods.
    Chairman Moore of Kansas. The gentleman's time has expired. 
But we will, I think--Ms. Biggert indicated she would like to 
have an additional 2 minutes, and the other members will have 
an opportunity for up to 2 minutes.
    Mrs. Biggert. Thank you, Mr. Chairman.
    Mr. Stoklosa, we have been hearing some talk about the FASB 
or the FASB Chairman Herz, gave a speech recently that 
highlighted both the confusion about and the distinction 
between FASB's role to set accounting standards for disclosure 
purposes and the need for banking regulators to ensure the 
safety and soundness of financial institutions. So I don't 
know--there's kind of a who does what. Would--how much of a 
role have stakeholders or perhaps the SEC had--as overseers of 
FASB and therefore all accounting rules and how they take it 
into account FASB changes to the accounting standards that 
effect commercial real estate such as the adoption of the 
financial accounting standards 166 and 167?
    Mr. Stoklosa. Yes, I think the Statements 166 and 167, 
they're all about transparency of risk. And whomever has the 
risk will do the accounting. So if the entity that's setting up 
some sort of securitization, if they transfer the loans off 
their books, but if they retain a certain amount of risk, and 
if they retain enough risk such as first loss risk, have they 
really transferred anything? And therefore, that guidance will 
come up and say, if you haven't transferred the risk, then you 
retain the accounting. You retain the loans on your books. If 
you transfer the risk, you get to take it off.
    Prior to 166 and 167, there were bright lines that allowed 
entities to even though they retained the risk were still able 
to get it off balance sheet. So we made those improvements.
    In terms of the SEC's oversight, I leave it up to the SEC. 
I'm sure if that's your role to talk about the SEC oversight. 
But the SEC, they're involved in our process as are any other 
constituents. We have an open due process. We issue exposure 
drafts. We have roundtables where we invite all of our 
constituents to roundtables, that being auditors, preparers, 
users, regulators. So anyone who wants to participate in a 
roundtable to talk about the issues are free to do so.
    Mrs. Biggert. Do you have public opinion for these?
    Mr. Stoklosa. Pardon me?
    Mrs. Biggert. Do you solicit comments from the public?
    Mr. Stoklosa. Yes. Our exposure drafts go out, normally for 
about 90 days for public comment, and we get the comments back 
and we present all that information to the Board for their 
redeliberations of the issues.
    Mrs. Biggert. Thank you.
    Chairman Moore of Kansas. The gentlelady's time has 
expired. The Chair next recognizes Ms. Bean for up to 2 
minutes.
    Ms. Bean. Thank you, Mr. Chairman. Just two things. Thank 
you again for hosting the hearing and by doing it here, we 
didn't get interrupted and called to votes. So we were actually 
able to really hear the testimony which never happens in 
Washington.
    My only other comment is to say I think Congressman Foster 
is arguably the only Member of Congress who has programmed in 
Python before. So that's all I have. Thank you.
    Chairman Moore of Kansas. Thank you, Ms. Bean. Mr. Foster, 
if you have any comments?
    Mr. Foster. I was wondering if any of you are optimistic 
that covered bonds may be an important part of the way forward 
for commercial real estate. Any opinions, one way or the other 
on that?
    Nothing. You're pretty much--
    Mr. Born. I don't know that it necessarily solves the 
problem, but it is one tool that can be explored. It's not a 
cure-all for what ails us.
    Mr. Foster. So it's not being actively developed by any 
segment?
    Mr. Born. Not that I'm aware of.
    Mr. Foster. Okay, and I guess one last question on what I 
mentioned about the waterfall programs and so on, is that being 
retroactively applied to some of the MBSs that are out there as 
a way to maybe reliquify some part of that market?
    Ms. Dubberly. No. It would only be forward-looking. It 
would apply to new issuances after any rule was adopted. The 
problem would be the trusts are formed and they're sort of 
self-running. It would be hard to put a new requirement on them 
after they have been--
    Mr. Foster. They might voluntarily do it to increase the--
    Ms. Dubberly. That would be fine. We would obviously love 
that.
    Mr. Foster. Thank you very much. I yield back.
    Chairman Moore of Kansas. Thank you. I ask unanimous 
consent that the following items be made a part of the record: 
Number one, Biggert 1, I call it, is a letter from the Kansas 
Realtors for this area. I remind you that this issue does not 
just affect Chicago or Illinois, but Kansas, the rest of the 
country.
    Number two is a written statement with attachments from our 
friend and colleague, Representative Ken Calvert of California 
who has been active on this issue.
    Exhibit Number Three is our reports on CRE by the 
Congressional Research Service.
    And Exhibit Four is a Congressional Oversight Panel Report. 
If there are no objections, these will be received in the 
record. Thank you.
    Again, I want to thank all of our witnesses for your 
testimony today. It has been very, very helpful. I thank this 
panel. I very much appreciate that.
     Ranking Member Bean has a parting comment or something she 
would like to say--excuse me, I'm sorry.
    Mrs. Biggert. If the gentlemen will yield?
    Chairman Moore of Kansas. I apologize. I do. She has not 
been advanced yet. This is the ranking member.
    Mrs. Biggert. It's very confusing to him too--Congresswomen 
from Illinois whose names start with a ``B.''
    I have always liked to be a ``B,'' because usually you get 
to go first, but now she's ``B-E'' and I'm ``B-I.'' Anyway, 
thank you.
    I would like to thank all the witnesses for coming to this 
hearing. I think it has been very, very helpful to us and we 
really have had the time to sit and listen to all of you and 
that's so important for us as we move forward in this very 
complicated financial services reform, so we appreciate that.
    And I do really thank again my colleagues for coming in and 
particularly the chairman who did come from Kansas and has 
spent the time with us and we are really going to miss him as 
he is retiring this year. It's going to be a big loss. I think 
we came in at the same time.
    Chairman Moore of Kansas. Thank you very much.
    Mrs. Biggert. I didn't realize when you came in, but we 
were colleagues and have spent the time in Congress together, 
so I appreciate it.
    Chairman Moore of Kansas. That's right. Thank you. The 
Chair notes that some members may have additional questions for 
our witnesses which they may wish to submit in writing. Without 
objection, the hearing record will remain open for 30 days for 
members to submit written questions to our witnesses and to 
place their responses in the record.
    The hearing is adjourned. Thanks to all.
    [Whereupon, the hearing was adjourned at 3:48 p.m.]





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                              May 17, 2010