FHFA: GSEs Focused on Core Businesses and Responsible Lending

by devteam February 26th, 2010 | Share

The central goal of the Federal Housing Finance Agencyrn(FHFA) in managing its conservatorship of Freddie Mac and Fannie Mae is and  conserving the assets of the corporations by minimizing theirrncredit losses from delinquent mortgages.

This goal and others were outlined in a letter earlier this month from EdwardrnJ. DeMarco, Acting Director of FHFA updating leadership of the House FinancialrnServices and Senate Banking, Housing, and Urban Affairs committees on thosernconservatorships.  

The letter was released as part of a presentation made byrnDeMarco to the U.S. House of Representatives Committee on Financial ServicesrnThursday.  The presentation was primarilyrnconcerned with outlining FHFA's approach to executive compensation at the tworngovernment sponsored enterprises while the letter addressed the history of thernconservatorship and its plans for the future.

One mechanism by which FHFA plans to minimize credit lossesrngoing forward is a commitment of the Enterprises to their core businesses ratherrnthan on developing or engaging in new products. rnFHFA published an interim final rule last July under the Housing andrnEconomic Recovery Act of 2008 (HERA), implementing a public review process forrnnew products that may be undertaken by the enterprise.  DeMarco said, after considering the statutoryrnrequirement and the goals of conservatorship, he has concluded that permittingrnthe Enterprises to engage in new products is inconsistent with the goals ofrnconservatorship and has instructed the Enterprises not to submit any suchrnrequests under the rule.

Demarco said he had reached this conclusion as variousrnproposals seek Enterprise involvement that, “even if within charterrnlimitations, could require large expenditures of funds, entry into new businessrnlines with little prior experience, or dedication of personnel alreadyrnoperating in a stressed environment.  Newrnproducts could also require new risk measuring tools, compliance procedures,rnand additional oversight from FHFA” rnThis type of limitation on new business activities, he said, isrnconsistent with the standard regulatory approach for addressing companies thatrnare financially troubled and is even more pertinent for the Enterprises givenrntheir uncertain future and reliance on taxpayer funds.

The acting director said that establishment of three fundingrnfacilities – the liquidity facility and the mortgage-backed securitiesrnfacility, both of which expired at the end of 2009 – and the Senior PreferredrnStock Purchase Agreements (PSPAs) which provide ongoing financial support tornthe Enterprises has supported market stability. rn”As nearly all other non-governmental participants in housingrnfinance abandoned the market, the Enterprises in conservatorship, operatingrnwith the benefit of the PSPAs have ensured that credit continues to flow tornhousing.” 

He pointed out that thernEnterprises share of financing or guaranteeing new single family mortgages rosernfrom 54 percent in 2006 to 73 percent in 2008 and 78 percent during the firstrnthree quarters of 2009.  Their marketrnshare in multifamily housing finance during those same periods grew from 33rnpercent to 79 percent and was 64 percent through September 2009.

DeMarco stressed that conservatorship, however, cannot be arnlong-term solution.  In September 2008rnwhen the government took over the Enterprises former Treasury Secretary HenryrnPaulson described the arrangement as a “time-out” to allowrnpolicymakers to reevaluate the role of the government and the Enterprises inrnfuture housing finance.  “There arerna variety of options available for post-conservatorship outcomes,” DeMarcornsaid, “but the only one that FHFA may implement today under existing lawrnis to reconstitute the two companies under their current charters.”

In December the basis for calculating the required annualrnreduction in Freddie Mac and Fannie Mae's retained portfolios was changed to thernmaximum allowed balances rather than the actual balance at the end of the year.  This, DeMarco said, will give the Enterprisesrnthe flexibility to purchase delinquent mortgages out of guaranteedrnmortgage-backed security pools and DeMarco said he expected any net additionsrnto the retained portfolios would be related to that activity.  He also expects that other private partiesrnwill begin to invest in new Enterprise MBSs as the Federal Reserve withdraws itsrnpurchase activity.  FHFA is directingrneach Enterprise to develop a detailed plan for keeping its portfolio withinrnthose limitations.

The FHFA will also continue to stress its mandate tornmaximize assistance to homeowners through the various programs available tornminimize foreclosures.  DeMarco pointedrnto the various programs such as HOPE for Homeowners and the Making HomernAffordable Program as critical to minimizing the Enterprises' creditrnlosses.  He said that current and futurernefforts surrounding foreclosure prevention will focus on mitigating losses butrnwhere there is no available, lower-cost alternative to foreclosure he expectsrnthe Enterprises to move to foreclose expeditiously.

FHFA expects thernEnterprises to continue to fulfill all of their statutory purposes includingrnsupport for affordable housing and FHFA will soon publish a purposed rulernsetting housing goals for 2010 and 2011 and a framework for ensuring thernEnterprises support for that segment of the housing market.  FHFA does not intend for this to includernundertaking “uneconomic or high-risk activities in support of the goals, norrndoes it intend for the state of conservatorship to be a justification forrnwithdrawing support from these market segments,” the letter said.  Under conservatorship, the Enterprisesrnhave tightened their underwriting standards to avoid the poor quality mortgagesrnthat have contributed so much to past losses.

DeMarco told the Financial Services Committee that muchrnthought has gone into the role of executive compensation in achieving the goalsrnfor the Enterprises in conservatorship.  WhilernFHFA no longer sought to employ those executives most responsible for thernconditions leading to receivership, they recognized that they needed to retainrncapable and knowledgeable staff.  ThernAgency consulted with the FDIC which has considerable experience inrnconservatorships and hired Hay Group, an executive compensation consultant tornhelp “design a plan to encourage the best employees to say, while notrnrewarding poor performance.

The pre-conservatorship CEOs left the Enterprises after arnbrief transition period and received no severance.  Since most of their pay had been in the formrnof Fannie Mae and Freddie Mac stock, roughly 2/3 of their past compensation wasrnalso lost.  Unfortunately, DeMarco said,rnmany of the 11,000 rank and file employees at the Enterprises also had largernportions of their life savings in their companies' stock and suffered accordingly.

Under the new compensation structure, the CEOs of eachrnEnterprise will receive $6 million a year; CFOs will receive $3.5 million andrnExecutive Vice Presidents and below will be capped at $3 million.  This is half of the target pay for EnterprisernCEOs before the conservatorship and Fannie Mae and Freddie Mac have reducedrntarget pay by an average of 40 percent for all executive officers.  However, these salary amounts will be paid inrnthree parts.  Salaries are generallyrncapped at $500,000 and there will be incentive pay limited to one-third ofrntotal compensation and a deferred salary. rnIncentive pay will be determined by a formula that does not rewardrnrisk.  Deferred salary will be paid withrna one year lag only to executives still working for their Enterprise at thatrntime.  This portion will also be based onrncompany performance based on the 2010 scorecard.  In addition there are limitations onrnperquisites, retirement plans will be equalized across all employee ranks, andrndeferred salary and incentive pay will be subject to clawbacks in the event ofrngross negligence or misconduct, conviction of a felony, or erroneousrnperformance metrics.

DeMarco said that, as Congress considers resolution regimesrnin the future it will be important to consider an orderly resolution and sufficientrncompensations will be necessary to accomplish this.  “This is especially important in arnsituation where the future of the firm in question is uncertain.  In the case of the Enterprises, the executivernmanagement teams may do a great job in meeting the goals of conservatorship butrnthe future of the companies rests with Congress, not with them.

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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