thelobbyist Interviews Congressman Ed Royce

thelobbyists’ Dustin Siggins had the pleasure to interview Congressman Ed Royce this past week.  You can find the transcript of the interview below and the audio file (Click to stream or Right-Click, Save as.. to download the .mp3) here: Siggins-Royce Interview.

Representative Ed Royce (R-CA) is a nine-term Congressman who serves on the House Foreign Affairs and Financial Services Committees. For more than a decade Royce has called for a stronger federal regulator to limit Fannie Mae and Freddie Mac’s excessive risk taking at the expense of taxpayers. In 2003, he offered the first legislation that sought to bring Fannie Mae, Freddie Mac and the Federal Home Loan Bank System under a strong federal regulator.

Siggins: So I don’t know if you remember but I asked one or two questions when you spoke at the Heritage Bloggers Briefing?

Royce: I do. I do remember.

Siggins: I asked you about mark-to-market Accounting.

Royce: Yes.

Siggins: So that’s really the basis of some of the questions I wanted to ask you about. Obviously the financial reform is one of the biggest deals going through Congress right now.  And it’s going to have very many, long term consequences if the current bill passes…mostly negative.

You had talked a lot about Freddie and Fannie.  And I know the Gregg bill was shot down in the Senate.  And I read an opinion online that said it was a bill that people on the right and the left agreed would have very negative effects because it wound Freddie and Fannie down too quickly.

So I didn’t know if you might be able to explain what your House Republican view is on winding down Freddie and Fannie in an appropriate way so that it wouldn’t hurt the housing market but would allow better lending standards so that we don’t have a repeat of ’08.

Royce: Well it wasn’t just the lending standards that were the problem.  That was part of the problem.  But just to recap very quickly, the other aspect to the problem was that Fannie and Freddie were pushed off of their primary line of business which was very safe 30-year fixed mortgages into a virtually unknown portion of the market at the time.  And that was subprime and ULTA loans.  It’s important to remember that it was Congress that passed that legislation in 1992. That was the Government Sponsored Enterprise Act which the Democrats passed.  And it was that legislation that put in place the current regulatory structure over the GOC’s, and basically had them going into the business of arbitraging and overleveraging and 100 to 1, and placed on them mandates that eventually led to 50% of their portfolio being subprime and ULTA loans. Those portfolios exceeded $1.6 trillion.

As a consequence Fannie and Freddie took this decisive step into the junk loan market to meet their affordable housing mandates instituted in the early 1990s on them by Congress.  Once the government backed Fannie and Freddie got into the junk loan market it was believed throughout the financial system that there was little risk associated with these types of mortgages. And that false assumption was exactly what Fannie and Freddie and their allies in Congress were hoping for. They were eager to signal to the rest of the financial sector that the junk mortgage loans were actually safe investments.  What we are dealing with now is the aftermath of the meltdown where a trillion dollars in value was lost as a consequence.

So certainly there were other mistakes made along the way.  But the distortions of the mortgage market caused by Fannie and Freddie along with the excessively low interest rates pursued by central banks; the FED and the European central banks, were at the heart of the inflated housing bubble; and the financial collapse that followed.  What we are now trying to do is to slowly, slowly un-wind this catastrophe.  Deleveraging is always very painful and it’s going to take awhile for this to work its way out in the marketplace.  So it is not possible right now to convince investors to go back into the mortgage market.  One of the additional reasons investors are on the sidelines, is because you also have legislation advocated by Chairman Barney Frank to reduce the principle amounts on loans. There is legislation on what is called a mortgage cram down which would allow those that borrow money to simply come back and have part of the principle that they borrowed removed.

And so the very actions Congress is taking right now, or at least actions of the House, this passed in the Senate, have created this apprehension on the part of investors.  And so as a corollary to that, the market is going to be very slow to respond because investors don’t know what additional surprises Congress may have in store for them.  And certainly removing the protection of the sanctity of contract is one thing that is being pursued with gusto.  We find ourselves in a very tough predicament without investment capital coming back in the housing.

Siggins: How would you wind them down though?  Obviously, you have talked about the difficulty in doing so and their involvement in the 2008 crash. Republicans who comment verbally, their rhetoric, and what you said at the Heritage Bloggers Briefing, was that we have to get rid of them.  And I happen to agree with you.

Royce: Long term we have to basically privatize them.  Long term we have to create a situation where they evolve into businesses that don’t operate with the mandates that Congress put on them to put them into arbitrage.  To put them into a situation where they go into arbitrage and over leverage in order to compensate for the risk that they take on because of mandates from Congress.  In other words we need to allow them to be run like a business rather than to be run on the basis of whims of Congressmen who decide that 3% or zero down payment loans would be nice rather than 20%, and mandating that half of their portfolio be in sub-prime and all-day loans. It would be an advantageous step for affordable housing. We cannot have them run as an experiment in government intervention into the economy- where we introduce that sort of moral hazard and systemic risk. Instead, they should be converted into businesses that operate on market principles. The problem is that when Freddie and Fannie were finally taken over by the government, they had more than ten million subprime and other weak loans- either on their books or in the form of mortgage-backed securities that they had guaranteed. So it is going to take a while to handle this situation, and I think the first step is for people to really comprehend how much difficulty we are in right now, as well as the reasons for it- because almost 2/3 of all the bad mortgages in our financial system, many of which are now defaulting at unprecedented rates, were bought by government agencies or required, basically, by government regulation. So this is the crux of the problem.

Siggins: So how long- in a one, two-word answer- how long would this take if we did it efficiently?

Royce: It’s gonna take the return of the private market.

Siggins: Oh. So that could be decades.

Royce: Well, not necessarily. If we take the right steps, a market will return, but at this point it’s gonna require a return of investors into the market. And it’s gonna take careening, or moving away, from the government policies that create the moral hazard to begin with.

Siggins: I think I’ll have about two minutes more to your time. Two final questions. The first one is: you had mentioned, I believe, at the Bloggers Briefing, that the Federal Reserve was really at the crux of the problem.

Royce: Right.

Siggins: Artificially-low interest rates and other issues with it. I happen to agree with you, as well. But, what do you think of the Senate, the very weak audit of the Fed. Do you think Rep. Paul- Rep. Paul wrote an opinion piece on The Daily Caller the other day saying it was basically a worthless audit, because a one-time deal and then forever nothing else happens. What do you think of the audit and, just very briefly, how do you think we should be looking at the Fed?

Royce: Well, in the first place, there is little question that excessively-low interest rates resulted in an excess of credit throughout the economy, and I think- the theory behind allowing the Federal Reserve to manipulate interest rates is that, if used correctly, the central bank can ease ups and downs that are natural in an economy. But unfortunately, because it is politically unpopular to slow what appears to be a strong economy, the Federal Reserve tends to err toward interest rates that are lower than appropriate, and this was one rationale behind the Federal Reserve and other nations’ central banks setting real interest rates at a negative level from 2002 through 2006, so when adjusted for inflation those interest rates are negative. And the effect of these negative interest rates were [sic] devastating; and if we go through this cycle again, it will have similar consequences. Instead of mitigating the ups and downs of the economy, the Fed’s actions often lead to the opposite effect. So what Ron Paul would like to get to, and what I would like to see as well, is an understanding on the part of the Fed governors that, for example, Ben Bernanke’s agitation in 2002 for negative real interest rates- we’d like to see an understanding on their part that that intensified the boom-and-bust cycle, and encouraged excessive risk-taking throughout the economy, and an understanding of what that means in terms of the effect of that balloon on the financial sector and on housing. And we don’t see an admission out of the Fed as to the nature- that would indicate they understand what economists understand. And we don’t see an admission on the part of the Federal Reserve as to this problem. This is why we want to see an auditing of the Fed and a real understanding as to the consequences of these perennial policies that compound the boom-bust…help create a boom-bust cycle in real estate and the marketplace. So this is, and again, there were other mistakes made along the way. I think we need to point that out. There were speculators in the mortgage market, and large banks on Wall Street-

Siggins: Well, plus mark-to-market accounting.

Royce: And mark-to-market accounting. But these were symptoms of a much deeper illness. The distortion of the mortgage market caused by Fannie and Freddie, and the excessively low interest rates pursued by central banks- as I said- were at the heart of the inflated housing bubble, and the financial collapse that followed, and it’s the inability of participants in the Fed for the culpability of the Fed with the low interest rates or in Congress- in terms of the abilities of Members of Congress to admit their mistakes in terms of the 1992 GSE ACT that caused Ron Paul and me great concern.

A great concern over the ability of people in government to learn from mistakes that were so recently made.

Siggins: OK, I guess I have one last question, which is: I’m sure you’re involved with the program coming out of the Whip’s office?  YouCut- where Americans tell Republicans what programs they want to cut out of the federal budget. Steve Benen is a writer for PoliticalAnimal.com, calculates $1.1 Billion a year in cuts (I think it’s closer to three billion, personally) but I don’t know the exact number. But, of the five cuts, they include a half a million here, $600 million there, $2.5 billion- none of it is really getting at the systemic problem of Social Security, Medicare, Medicaid, perhaps high defense spending (depending on who you talk to). I was wondering, briefly, about what your thoughts were about the YouCut program, and second of all, if you think it will lead to real systemic reform in Congress?

Royce: Well, first, remember that in addition to the unfunded liabilities and Social Security and Medicare, and that will come about as a result of the passage of the Health Care entitlement, you also are facing a situation where we have deficits that will, this year, will total over $1.5 trillion. So in terms of focusing on the ongoing growth of these appropriations, we see these double-digit increases in appropriations bills- that’s where you see the increases in the deficits over recent years. When the Democrats took over Congress the budget deficit was $162 billion, and at the time I and other fiscal hawks were decrying the $162 billion deficit. Today it’s ten times that. And so, the spending bills  coming out of Congress are increasing government agency funding by double-digits and I think that one of the advantages of the YouCut program is getting the American public to better understand that aspect of the problem, which is half of the problem. The current deficits are half of the problem. The other half of the problem, as you correctly point out, is the unsustainability of Medicare and Social Security, long term; because the debt held by the public is going to double over five years, and it’s growing to triple over 10 years, at this rate of growth and the consequences of that are not unlike what we see in Greece today. So at some point we are going to have to come together with a Base Commission type of procedure, or a more recent example would be the Base Closure Commission process. We are going to have to- I would argue- everything would have to be on the table. You would have to get both Democrats and Republicans involved in the process, with an eye toward sustainability, or an eye toward the requirement that we reform these entitlement programs. I would also argue that if Republicans do retake the majority in the House or the Senate, I expect the first order of business to be the repeal of the Health Care entitlement legislation that passed, so at least that portion of the problem would be removed in the future but that still leaves….and at some point we are going to have to have a President elected that would sign it.

Siggins: I was going to say the Senate has too many Democrats to over-turn a Presidential Veto…

Royce: Right, right, so at some point after we pass it initially, and then we are going to have to wait until we have a Republican or a New Democrat (and I don’t see a lot of those around recently), or a New Democrat as president who is going to take a different tact, and move back to the issue of fiscal responsibility and balanced budgets. But, the first half of that is getting the budgets balanced- that is essential. The second half of it is doing something about the long-term legacy costs, or the long-term entitlement costs; we have to do that sooner than later, because as you see in Greece today if you put it off, if you continue to put it off, and continue to build entitlements, it’s…

Siggins: Devastating.

Royce: Yeah, it’s devastating and eventual government expands to a point where, how many people are working a 32 hour work week in Greece and are expecting to retire at age 52? So you set up this expectation for early retirement, for basically part-time work, and you create an entitlement mentality on top of the entitlement itself. So when you go and try to go in, and address the entitlement, the entitlement mentality floods out into the streets of the capital, as you see in Athens, with “No Compromise” as the rallying cry. I think that this tells us why it is so important to address this immediately rather than putting it off.  We are not going to get Speaker Pelosi’s attention on this because she is busy building entitlements. But come the aftermath of November’s election, I think it has to be addressed immediately.