DeMarco Debates GSE Reform Approaches
The House Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises held the first of what will probably be a large number of hearings on legislative proposals to overhaul the government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae. The hearing came one day after the Subcommittee Chairman Scott Garrett (R-NJ) accounced eight bills intended to reform the GSEs. Garrett said the eight bills are merely the first of multiple rounds of Republican sponsored legislation on the subject.
Acting Director of the Federal Housing Finance Agency (FHFA) Edward J. DeMarco was the principal witness at the opening hearing. DeMarco said that FHFA which has served as conservator of the two GSEs since they essentially failed in August 2008 has three responsibilities; preserve and conserve the GSEs assets, ensure market stability and liquidity, and prepare the Enterprises for an uncertain future.
DeMarco also commented on each of the proposed bills introduced on Wednesday by House Republicans. One of which would, according to Garrett, ensure that the GSEs are not exempt from new risk-retention rules mandated by Dodd-Frank and that they face the same retention standards as private market participants. Demarco responded by saying GSE single-family mortgage securities are structured with 100 percent risk retention, far beyond the 5 percent retention required under Dodd-Frank. "Furthermore," DeMarco said, "since the risk retained by the Enterprises is itself backed by the Treasury (through the Preferred Stock Purchase Agreements (PSPAs)), not by private capital, it is unique from any other 100 percent risk retention structure that might someday exist."
If the Enterprises were to be made subject to the risk retention requirements for non-QRM loans they would be required to hold on their balance sheet five percent of the securities they issued for such loans. This would add nothing further to the Enterprises "skin in the game" but it would require them to increase their portfolios by financing five percent of the MBS themselves. This is inconsistent with the ten percent per-year wind down in the retained portfolios in the PSPAs and other efforts to seek faster reductions in the retained portfolios. It is also not clear how such a requirement would encourage private capital to enter the market.
DeMarco said Treasury had recognized the risk posed by the Enterprises retained portfolios and have been reducing it in accordance with the PSPAs and are on track with that schedule. The only additions to the portfolios are now coming from moving delinquent mortgages from the Enterprises MBS and this has changed the portfolio to one primarily constituted by non-performing and illiquid whole loans and private-label securities. The bill mandating a significantly faster reduction could cost taxpayers unnecessarily as some of the illiquid assets may recover some or much of their lost value over time.
The bill to require specific Treasury Department approval for the Enterprises to issue debt could serve as another way to reduce the portfolios, DeMarco said, however faster reduction could be achieved in a number of ways and "it is unclear how adding an additional procedural hurdle would provide an effective mechanism."
FHFA is already preventing the GSEs from offering new products or entering new lines of business and in principle DeMarco said he could support the bill to codify this requirement. However, he said, the committee may wish to consider whether any exceptions should be provided. Too narrow a mandate could preclude development of products or activities which might advance other purposes of the transition.
The housing goals given to the Enterprises were done in a different environment than a conservatorship. They were a reflection of the unique benefits Congress had provided two private companies, making sure those benefits were available to targeted parts of the market. Today the goals should mirror the industry's participation in those markets but not lead the market. Eliminating the housing goals and the duty to serve requirements that were put into place under HERA would be consistent with the realities association with the conservatorship. This could reduce operational and compliance burdens but need not result in less attention to these market segments.
The requirement that an Inspector General be appointed within FHFA to report directly to Congress, DeMarco said, would reverse the responsibilities as they are presently constituted where FHFA has an IG overseeing its operation which would include oversight of the GSEs
DeMarco pointed out that FHFA has been steadily overseeing increases in guarantee fees to the Enterprises as legislated in The GSE Subsidy Elimination Act, and will complete its third annual report to Congress on those fees in July.
DeMarco said that any sudden changes in the compensation structure of the GSEs as would be required by the passage of a law introduced by Spencer Bachus (R-AL) would put the management of the $5 trillion in GSE assets at risk. Bachus's proposal would immediately make compensation for all GSE employees conform to the Executive Schedule and Senior Executive Service of the Federal Government and would make it a sense of the Congress that senior executives' pay was excessive in 2010 and the money should be returned. DeMarco said it is difficult to make comparisons between the GSE salary structure and that of Ginnie Mae or FHA as those have evolved as government salaries over time where the GSEs' compensation packages evolved in the private sector. The Bachus proposal, he said, would on balance increase costs to taxpayers and risk further disruptions in the housing market.
FHFA is striving to conserve the GSEs tangible assets that exist today which include the legacy, pre-conservatorship book of business and the post-conservatorship book of new business and the intangible assets that support the tangible ones including the business platforms, operations, and processes used in the business and the people who work for the GSEs. These assets are really being preserved for the taxpayer so that when the GSEs no longer exist each company, in whole or pieces, can be transformed in such a way that taxpayers realize maximum value.
Conserving each of the four categories of assets has different risks and challenges. With the legacy book of business the risk is further credit losses from delinquent mortgages and FHFA and the GSEs are focused on effective loss mitigation strategies to avoid foreclosure where practical and minimize credit losses through loss mitigation strategies.
FHFA has moved to shore up underwriting standards to increased pricing to better align the post-conservatorship book of business with risk. FHFA, DeMarco said, will continue to seek more progress in those areas but, because the GSEs currently constitute most of the mortgage market, pacing changes in underwriting standards and pricing needs to be balanced until private investors step back into the market.
The GSEs business platforms, operations, and process present multiple risk management challenges. FHFA has attempted to correct the shortcomings in these areas that contributed to the failure of the GSEs and progress has been made but planning for the future is difficult when you do not control that future. Thinking about whether and how to invest in and develop infrastructure and operations for companies that may cease to exist presents unique and difficult challenges. Again, a holding pattern is not possible. While some long-range investments may be inappropriate, the GSEs assets are 30-years in duration and the agency needs to develop and maintain the infrastructure to support securitizations to preserve their value.
Preserving human capital in the face of uncertainty is also challenging and several key executives have already departed in 2011. The Enterprises needs to be able to continue to attract and retain executive-level talent and professional staff to navigate through this period of uncertainty. The GSEs need qualified people to manage day-to-day business operations or risk more than $5 trillion in mortgage holdings and guarantees.
DeMarco noted that the ultimate resolution of the conservatorship is in the hands of Congress and that it may take some time to reach a conclusion. While some intermediate and near-term changes may be appropriate, he asked that care be taken to provide FHFA with sufficient flexibility to use its best judgment to preserve and conserve the Enterprises assets.