DeMarco Debates GSE Reform Approaches

The House Subcommittee on Capital Markets, Insurance, andrnGovernment-Sponsored Enterprises held the first of what will probably be arnlarge number of hearings on legislative proposals to overhaul the governmentrnsponsored enterprises (GSEs) Freddie Mac and Fannie Mae.  The hearing came one day after thernSubcommittee Chairman Scott Garrett (R-NJ) accounced eight bills intended tornreform the GSEs. Garrett said the eight bills are merely the first of multiplernrounds of Republican sponsored legislation on the subject. </p

Acting Director of the Federal Housing Finance Agency (FHFA)rnEdward J. DeMarco was the principal witness at the opening hearing.   DeMarco said that FHFA which has served as conservatorrnof the two GSEs since they essentially failed in August 2008 has three responsibilities;rnpreserve and conserve the GSEs assets, ensure market stability and liquidity,rnand prepare the Enterprises for an uncertain future.  </p

DeMarco also commented on each of the proposed bills introducedrnon 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 percentrnrisk retention, far beyond the 5 percent retention required underrnDodd-Frank.  “Furthermore,”rnDeMarco said, “since the risk retained by the Enterprises is itself backedrnby the Treasury (through the Preferred Stock Purchase Agreements (PSPAs)), notrnby private capital, it is unique from any other 100 percent risk retentionrnstructure that might someday exist.”</p

If the Enterprises were to be made subject to the riskrnretention requirements for non-QRM loans they would be required to hold onrntheir balance sheet five percent of the securities they issued for suchrnloans.  This would add nothing further tornthe Enterprises “skin in the game” but it would require them tornincrease their portfolios by financing five percent of the MBS themselves.  This is inconsistent with the ten percentrnper-year wind down in the retained portfolios in the PSPAs and other efforts tornseek faster reductions in the retained portfolios.  It is also not clear how such a requirementrnwould encourage private capital to enter the market.</p

DeMarco said Treasury had recognized the risk posed by thernEnterprises retained portfolios and have been reducing it in accordance withrnthe PSPAs and are on track with that schedule. rnThe only additions to the portfolios are now coming from movingrndelinquent mortgages from the Enterprises MBS and this has changed thernportfolio to one primarily constituted by non-performing and illiquid wholernloans and private-label securities.  Thernbill mandating a significantly faster reduction could cost taxpayersrnunnecessarily as some of the illiquid assets may recover some or much of theirrnlost value over time.</p

The bill to require specific Treasury Department approvalrnfor the Enterprises to issue debt could serve as another way to reduce thernportfolios, DeMarco said, however faster reduction could be achieved in arnnumber of ways and “it is unclear how adding an additional proceduralrnhurdle would provide an effective mechanism.”      </p

FHFA is already preventing the GSEs from offering newrnproducts or entering new lines of business and in principle DeMarco said herncould support the bill to codify this requirement.  However, he said, the committee may wish tornconsider whether any exceptions should be provided.  Too narrow a mandate could precluderndevelopment of products or activities which might advance other purposes of therntransition.</p

The housing goals given to the Enterprises were done in arndifferent environment than a conservatorship. rnThey were a reflection of the unique benefits Congress had provided twornprivate companies, making sure those benefits were available to targeted partsrnof the market.  Today the goals should mirrorrnthe industry’s participation in those markets but not lead the market.  Eliminating the housing goals and the duty tornserve requirements that were put into place under HERA would be consistent withrnthe realities association with the conservatorship.  This could reduce operational and compliancernburdens but need not result in less attention to these market segments. </p

The requirement that an Inspector General be appointedrnwithin FHFA to report directly to Congress, DeMarco said, would reverse thernresponsibilities as they are presently constituted where FHFA has an IGrnoverseeing its operation which would include oversight of the GSEs  </p

DeMarco pointed outrnthat FHFA has been steadily overseeing increases in guarantee fees to thernEnterprises as legislated in The GSE Subsidy Elimination Act, and will complete its third annual report tornCongress on those fees in July.</p

DeMarco said thatrnany sudden changes in the compensation structure of the GSEs as would bernrequired by the passage of a law introduced by Spencer Bachus (R-AL) would putrnthe management of the $5 trillion in GSE assets at risk.  Bachus’s proposal would immediately makerncompensation for all GSE employees conform to the Executive Schedule andrnSenior Executive Service of the Federal Government and would make it a sense ofrnthe Congress that senior executives’ pay was excessive in 2010 and the moneyrnshould be returned.  DeMarco said it isrndifficult to make comparisons between the GSE salary structure and that ofrnGinnie Mae or FHA as those have evolved as government salaries over time wherernthe GSEs’ compensation packages evolved in the private sector.  ThernBachus proposal, he said, would on balance increase costs to taxpayers and riskrnfurther disruptions in the housing market.</p

FHFA is striving to conserve the GSEs tangible assets thatrnexist today which include the legacy, pre-conservatorship book of business andrnthe post-conservatorship book of new business and the intangible assets thatrnsupport the tangible ones including the business platforms, operations, andrnprocesses used in the business and the people who work for the GSEs.  These assets are really being preserved forrnthe taxpayer so that when the GSEs no longer exist each company, in whole orrnpieces, can be transformed in such a way that taxpayers realize maximum value.  </p

Conserving each of the four categories of assets hasrndifferent risks and challenges.  With thernlegacy book of business the risk is further credit losses from delinquentrnmortgages and FHFA and the GSEs are focused on effective loss mitigationrnstrategies to avoid foreclosure where practical and minimize credit losses throughrnloss mitigation strategies.</p

FHFA has moved to shore up underwriting standards tornincreased pricing to better align the post-conservatorship book of business withrnrisk.  FHFA, DeMarco said, will continuernto seek more progress in those areas but, because the GSEs currently constituternmost of the mortgage market, pacing changes in underwriting standards andrnpricing needs to be balanced until private investors step back into the market.</p

The GSEs business platforms, operations, and process presentrnmultiple risk management challenges. rnFHFA has attempted to correct the shortcomings in these areas thatrncontributed to the failure of the GSEs and progress has been made but planningrnfor the future is difficult when you do not control that future.  Thinking about whether and how to invest inrnand develop infrastructure and operations for companies that may cease to existrnpresents unique and difficult challenges. rnAgain, a holding pattern is not possible.  While some long-range investments may berninappropriate, the GSEs assets are 30-years in duration and the agency needs torndevelop and maintain the infrastructure to support securitizations to preserverntheir value. </p

Preserving human capital in the face of uncertainty is alsornchallenging and several key executives have already departed in 2011.  The Enterprises needs to be able to continuernto attract and retain executive-level talent and professional staff to navigaternthrough this period of uncertainty.  ThernGSEs need qualified people to manage day-to-day business operations or risk morernthan $5 trillion in mortgage holdings and guarantees.</p

DeMarco noted that the ultimate resolution of thernconservatorship is in the hands of Congress and that it may take some time tornreach a conclusion.  While somernintermediate and near-term changes may be appropriate, he asked that care berntaken to provide FHFA with sufficient flexibility to use its best judgment tornpreserve and conserve the Enterprises assets.   

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