GSE Reform Perspective: More Legislation Proposed

By: Jann Swanson • Mon, Jun 6 2011, 2:11 PM

The House Subcommittee on Capital Markets and Government Sponsored Enterprises has approved eight bills to end what it calls the bailout of Freddie Mac and Fannie Mae, the two government sponsored enterprises (GSEs) which have been in government conservatorship since August 2008. Seven of those bills, all sponsored by Republican members of the committee, were the focus of a hearing held in late May. Here is a brief description of each bill:

Prevent Dividend Payment Decrease. This legislation mandates continuing the 10 percent dividend currently paid to the Treasury Department as part of the Senior Preferred Stock Purchase Agreement (PSPA). The Administration has suggested amending this requirement as it is a driving factor behind the ongoing need for cash infusions form Treasury to the GSEs.
Abolish Affordable Housing Trust Fund. According to the sponsor, with the GSEs in conservatorship and losing billions of dollars per quarter, "there is no need to have an additional requirement on them to send a portion of their revenue to special interest groups at the expense of American taxpayers."
Ensure an Exact GSE Replica is Not Created. The Housing and Economic Recovery Act (HERA) requires that if either Fannie Mae or Freddie Mac is placed in federal government receivership a new entity is created with a government charter and private stockholders. This bill prohibits such action.
Require Disposition of Non-Mission Critical Assets. The legislation directs the Federal Housing Finance Agency (FHFA) Director to require Fannie Mae and Freddie Mac to dispose of all non-mission critical assets, including, but not limited to, patents and data.
Set a Bailout Cap for the GSEs. The legislation sets a cap on the amount of money that the American taxpayers will be charged for the bailout of Fannie Mae and Freddie Mac
Subject Fannie and Freddie to FOIA. The legislation subjects Fannie Mae and Freddie Mac to the Freedom of Information Act (FOIA) from which they are currently exempt. As private entities they have been exempt from FOIA but conservatorship has essentially made them government companies, it only makes sense that they should be subject to FOIA standards.
Prohibit Taxpayer Funding of GSE Employee Legal Fees. The legislation limits taxpayer exposure to the mounting legal expenses of Fannie Mae and Freddie Mac. Since 2008, the American taxpayers have spent more than $162 million defending Fannie, Freddie and their former top executives in civil lawsuits. This bill would minimize taxpayer liability to GSE legal fees by allowing FHFA to put limits on the advancement of legal fees for Fannie and Freddie executives involved in cases of fraud.

There was no information given on the above referenced eighth piece of legislation.

Testimony was given at the hearing by Edward J. DeMarco, acting director of FHFA; Dr. Anthony Sanders, Mercatus Center Senior Scholar and Distinguished Professor of Real Estate Finance, George Mason University; Mr. David John, senior research Fellow, The Heritage Foundation; and Dr. Sheila Crowley, president National Low Income Housing Coalition.

After making a plea to the committee that FHFA as regulator and conservator of the GSEs be allowed to use its best judgment to preserve and conserve the GSE assets as it transforms and winds them down, DeMarco gave his thoughts on each of the seven proposals. Here is his feedback...

Prevent Dividend Payment Decrease: While FHFA has no plans to seek a change in the dividend rate, fixing the dividend at 10 percent may limit some of the resolution options and limit the ability of the GSEs to build retained surplus and exit from conservatorship.
Abolish Affordable Housing Trust Fund: DeMarco said in reality the GSEs had never made any contributions to the Housing Trust Fund and it would be inappropriate for them to begin doing so while under conservatorship and in debt to taxpayers.
Ensure an Exact GSE Replica is Not Created: While current rules require the recreation of the GSEs under certain circumstances, DeMarco said there appears to be general agreement that Freddie Mac and Fannie Mae should not be reconstituted in their current form, "but we leave it to Congress to decide what should replace them and what level of government support to provide for the market."
Require Disposition of Non-Mission Critical Assets: FHFA has already begun to fulfill the intent of this legislation regarding the sale of non-mission critical assets but, DeMarco again stated the need for the conservatorship to exercise its best judgment to preserve and conserve the assets saying that discretion is particularly important when disposing of assets.
Set a Bailout Cap for the GSEs: The legislation requiring a bailout cap specifies the greater amount of $200 billion or $200 billion plus the cumulative total of Deficiency Amounts determined for calendar years 2010-2012 less any surplus at the end of that period. DeMarco said this cap is consistent with that already in place under the PSPAs.
Subject Fannie and Freddie to FOIA: The core purpose of the Freedom of Information Act (FOIA), DeMarco said is to enhance public understanding of the operations or activities of the government. This core purpose is not served by applying FIOA to the GSEs which did not cease to be private legal entities when they were placed into conservatorship. Furthermore, subjecting them to FOIA would incur significant operational and compliance costs which would undermine FHFA's mandate to preserve and conserve the GSEs' assets.
Prohibit Taxpayer Funding of GSE Employee Legal Fees: DeMarco raised strenuous objections to several issues raised by the prospect of limiting the advancement of funds to pay legal fees or provide settlement reimbursements. First, this would affect the GSEs' ability to attract and retain employees and, unless made prospective, would undermine current employee agreements. Such a limit would also differentiate the two entities from other regulated regimes.

Dr. Anthony Sanders, Mercatus Center Senior Scholar and Distinguished Professor of Real Estate Finance, George Mason University, argued in his presentation that there is really no need for Fannie Mae or Freddie Mac. "If the private sector can replicate Fannie and Freddie's only unique 'virtue' - a federal government guarantee - then there is no justification for keeping (them) around either in conservatorship or in their pre-conservatorship form.

There needs to be a hard look at where mortgage-lending is today, he said. Even with the shrinking of the market, the GSEs continue to grow rapidly. The banks are selling nearly all of the loans they originate while at the same time purchasing back the same paper from the mortgage-backed securities market (MBS) for their portfolios. Getting rid of favorable capital treatment for the GSEs for banks would stop the capital arbitrage that exists, encouraging banks to hold MBS.

The first task of reform is to find investors who are willing to take the first-loss positions in mortgage loans. If the reformed markets are able to attract new capital without any change in the funding, the size of the mortgage markets will remain the same. However, if some investors are hesitant to hold anything but GSE MBS because of the guarantee, the markets will shrink in size. Funding would not evaporate, but it would be a matter of at what price investors would supply the funds.

He urged that that available products be modeled more like those in other countries; specifically that alternatives be developed to prohibiting pre-payment penalties and to the routine use of 30-year fixed rate mortgages both of which, he said, penalized borrowers who do not necessarily need to utilize those features.

He criticized the government's policy of "chasing homeownership" and recommended that Congress and the administration start unwinding subsidies to homeownership starting with the GSEs. Saunders laid out a number of suggestions to help the mortgage market reduce its dependence of government including: Covered Bonds, Reviving the private label MBS market, Increasing portfolio lending for banks fund through a mix of covered bonds and securitization, a privatization model for the GSEs in which they would be franchised and operate more like non-depository banks or financial institutions, Moving affordable housing mandates from the GSEs to HUD. He said that weaning the economy off of the GSEs should be done over a five-year sunset period defined by the following steps,

Reduce conforming loans limits but not by the drastic steps others have recommended. Saunders suggested 10 percent per year coupled with a review of the progress of market recovery each year. The goal would be to achieve limits at 50 percent of the current levels at the end of five years.
End the purchase of non-prime affordable-housing goal mortgages including those with downpayments of less than 20 percent unless accompanied by private mortgage insurance.
Freeze and unwind retained portfolios.
Eliminate nonmortgage investments.

He made an "educated guess" about the market without GSEs but with FHA, covered bonds, and private label MBS. First, new mortgage rates would probably be 50-100 basis points higher in the short term which would cause home prices to fall slightly or take longer to recover. In the longer term the rate would be 40-100 basis points higher.

There would be more short-term variable rates mortgages as well as more rollover mortgages where the borrower's rate changes to the market rate after a fixed period. While the higher mortgage rates would lead to decreased homeownership rates the higher down payments would produce safer mortgages for lenders, investors, and insurers.

He sees two possible outcomes for lenders. Either the mortgage markets would shrink because investors are unwilling to fund the loans or, more likely, banks and other entities would expand to fill the gap left by the exit of the GSEs.

Mr. David John, senior research Fellow at The Heritage Foundation, told the subcommittee that he basically agreed with all seven of the proposed bills except for a slight technical adjustment to prevent conflict between the proposed bailout cap and the bill to prevent a lowering of the dividend. He urged the members to focus on the elimination of the GSE portfolios and recommended that a temporary subsidiary of FHFA be established to handle that task.

In addition to managing their portfolios the two additional responsibilities of the GSEs should be handled separately. The private sector must be encouraged to replace the GSEs financial activities including a private market for MBS and covered bonds. Second, the subsidies and policy goals of the GSEs should be transferred to HUD and all affordable housing goals imposed on the GSEs should be repealed.

Dr. Sheila Crowley, president National Low Income Housing Coalition, spoke only to the bill seeking to abolish the Affordable Housing Trust. She told the members that the National Housing Trust Fund (the correct name of the entity) has a single goal, to eliminate the shortage of housing for persons of extremely low income. This, she said, is a proper role for government as it is clear that the market will not fill the gap.

The fund was envisioned to be funded in part by the GSE's but the law mandating this was passed only a short while before they were placed into conservatorship and no payment has ever been made. "Regardless of the future of Fannie and Freddie or what Congress decides the future of housing finance policy will be," Crowley said, "the statutory basis for the National Housing Trust Fund should stand alone and the profits realized by the sale of warrants received from banks under TARP. Another method would be to tap any taxes raised through the proposed changes in the home mortgage deduction.