On May 11, the Senate Banking Committee held a hearing at which FHFA Director Mel Watt fielded questions from lawmakers about the conservatorships of Fannie Mae and Freddie Mac (the Enterprises) and prospects for housing finance reform. In his opening statement, Committee Chairman Mike Crapo (R-ID) noted that Fannie and Freddie have been in conservatorship for close to nine years, and stated that “a housing finance system dependent on two government sponsored enterprises in perpetual conservatorship is not a sustainable solution.” According to Sen. Crapo, because approximately 70 percent of mortgages are backed by the federal government, “if the housing market experiences a downturn, taxpayers could again be on the hook for billions of dollars.” Ultimately, the Chairman set forth his position that housing finance reform should be considered the “most significant piece of unfinished business following the financial crisis.”
Meanwhile, FHFA Director Watt testified that, under his leadership, FHFA has “responsibly balanced” and met its “multiple statutory mandates to manage the Enterprises’ day-to-day operations.” He also identified some of the key changes and reforms that have taken place during the conservatorships, including: (i) requiring the Enterprises to emphasize sound underwriting practices in their purchase guidelines; (ii) reducing the Enterprises’ retained portfolios by over sixty percent since 2009; and (iii) developing effective loss mitigation programs, which include aligning the Enterprises’ loss mitigation standards and developing updated loan modification and streamlined refinance products to follow the Home Affordable Modification Program and the Home Affordable Refinance Program.
Director Watt also acknowledged that “FHFA knows probably better than anyone that these conservatorships are not sustainable” and urged Congress to act on several issues related to housing finance reform, including:
- developing a transition process to a new housing finance system to avoid disruption to the housing finance market;
- determining whether the federal government should provide taxpayer backing for the conservatorship, and if so, in what form;
- addressing the role the Enterprises might play in the reformed housing finance system and what statutory changes to their organizational structures, purposes, ownership and operations will be needed to ensure that they play their assigned roles effectively; and
- identifying what regulatory and supervisory structure and authorities will be needed in a reformed system, and who will have responsibility to exercise those authorities.
Furthermore, Director Watt noted that under the provisions of the Enterprises’ Preferred Stock Purchase Agreements, on January 1, 2018 the $1.2 billion buffer protecting the Enterprises against having to make additional draws of taxpayer support in the event of an operating loss in any quarter would be reduced to zero, at which time “neither Enterprise will have the ability to weather any loss it experiences in any quarter without drawing further on taxpayer support.” Director Watt warned that such a situation could erode investor confidence and “stifle liquidity in ways that could increase the cost of mortgage credit to borrowers.” Accordingly, the Director argued that the Enterprises “need some kind of [capital] buffer to shield against short-term operating losses” that could “result in an additional draw of taxpayer support and reduce the fixed dollar commitment Treasury has made to support the Enterprises.”
Reaction of Industry Organizations. In a statement issued shortly after the hearing, Camden R. Fine, President and CEO of Independent Community Bankers of America (ICBA), expressed support for Director Watt after his testimony, agreeing about the need for Fannie and Freddie “to retain their earnings and to start rebuilding their capital buffers.” Meanwhile, Competitive Enterprise Institute (CEI) financial policy expert John Berlau was critical of what he called “an unfair, ongoing government policy of confiscating all Fannie/Freddie shareholder profits.” According to Mr. Berlau, the Enterprises’ “perilous financial state is the direct result of the Obama administration’s 2012‘Third Amendment’ policy, which confiscates all of Fannie and Freddie’s profits for the US Treasury.” He argued that curtailing this policy would allow the Enterprises to “retain some earnings and build capital to spare taxpayers another bailout.”