Senate committee examines efforts of FHFA

Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA), went before the Senate Banking Committee to report on FHFA’s oversight of Fannie Mae, Freddie Mac and the Federal Home Loan banks.

“It is important for this committee to understand how FHFA evaluates new opportunities and programs at Fannie Mae and Freddie Mac during conservatorship, including the decision to allow them to participate in certain Making Home Affordable programs and the decision not to participate in or initiate other programs,” said Tim Johnson, D-S.D., chair of the Senate Banking Committing during opening statements. 

“FHFA is tasked with regulating two of the largest entities in the mortgage market, Fannie Mae and Freddie Mac, which together backstop approximately $5 trillion in mortgages and help support the nearly $11 trillion U.S. mortgage market. Unfortunately, that market is now supported by $170 billion in assistance from the taxpayers.  As we’ve heard from other witnesses before this Committee, the mortgage market would be even worse-off than it is today if they had not been placed into conservatorship during the Bush Administration,” Johnson continued. 

What the FHFA has been doing
DeMarco outlined several initiatives the FHFA has been involved in to complete its mission to preserve and conserve the government sponsored enterprises’ (GSEs) assets.

He noted that the FHFA has filed lawsuits against 18 financial institutions to recover losses suffered by Freddie Mac and Fannie Mae that it believes are the legal responsibility of others.

In August, FHFA, the U.S. Department of Housing and Urban Development and the Treasury Department issued a request for information (RFI) seeking input on new options for selling single-family real estate owned property held by Fannie Mae and Freddie Mac.

“We are looking for approaches to reduce the REO portfolios of the enterprises in a cost-effective manner, as well as to reduce the losses on individual distressed properties,” DeMarco said. “We are seeking alternatives that will maximize value to taxpayers and increase private investments in the housing market, including approaches that support rental and affordable housing needs. We are not trying to develop a single, national program for REO disposition. We are most interested in proposals tailored to the needs and economic conditions of local communities. Based on the input of RFI responders, we understand the magnitude of the task at hand. FHFA is proceeding prudently, but with a sense of urgency, to lay the groundwork for the development of good initial pilot transactions.”

DeMarco also touched on the changes to the Home Affordable Refinance Program (HARP). He noted that the refinances should reduce the enterprises’ credit risk, and thus losses to taxpayers, but pointed out that HARP is not a mass refinancing program.

“It is impossible to project accurately how many homeowners will benefit from the enhancements to HARP because of unknowable factors, such as future interest rate fluctuations and the desire of borrowers to enter into a refinance transaction,” he said. “Since HARP was introduced in 2009, more than 900,000 homeowners have refinanced through the HARP program. We believe the announced changes may double the number of homeowners helped through HARP. Since industry participation in HARP is not mandatory, implementation schedules will vary as individual lenders, mortgage insurers and other market participants modify their processes.”

Getting out of conservatorship
A topic that has been heating up lately is how to wind down the GSEs, with two bills being introduced in the U.S. House to do just that.

“Finding a path out of conservatorship is a task for both the FHFA and this committee,” Johnson said. “I would like to thank Senator Shelby and his staff for working so closely with me and my staff in laying out the hearings the committee has held so far this year. I hope we can continue to work together to do our homework and create a sustainable system for the housing market going forward that can protect taxpayers and spur economic growth.”

DeMarco assured the committee that FHFA was working to transition to greater private capital participation in housing finance.

“Recent Congressional efforts to begin serious discussion of a gradual transition to greater private capital participation in housing finance and greater distribution of risk to participants other than the government are important,” he said. “Since conservatorship, underwriting standards have been strengthened and several price increases have been initiated to better align pricing with risk. Additionally, we have had several guarantee fee price increases and we will continue to gradually increase guarantee fee pricing to better reflect that which would be anticipated in a private, competitive market. Also, we will soon be exploring more private sector risk-sharing opportunities. Such steps are consistent with actions already taken in conservatorship and we are examining further options along these lines in support of a stable transition over time.

“While debate over the future of the housing finance system progresses, FHFA has and will continue to focus on meeting the goals of the conservatorships through a series of initiatives aimed at retaining value in the business operations of Fannie Mae and Freddie Mac, maintaining their support for the housing market, and mitigating losses to taxpayers,” he continued.

Executive compensation
Another issue that has heated up recently is the compensation of Fannie Mae and Freddie Mac’s executives. The House Financial Services Committee has approved a bill to stop future bonuses and significantly reduce pay at the GSEs. H.R. 1221, the Equity in Government Compensation Act, ensures that executives and employees of Fannie Mae and Freddie Mac will receive compensation that is in line with pay practices at federal financial regulatory agencies. The bill does not make them Federal employees, but it aligns their compensation with that of Federal employees.

Organizational structure and compensation were also of concern to the Senate Banking Committee.

“The internal operations at FHFA are also important, as staffing of the regulator will affect its oversight of the GSEs,” Johnson said. “Oversight of executive compensation structures and evaluations of executive performance goals both require the regulator’s attention. FHFA must have proper management of operational risks, as well as secure and updated information systems and privacy policies. I am concerned about recent reports that show problems in each of these areas, and that FHFA does not have adequate certified staff to perform examinations of the entities under its supervision.”

DeMarco noted his own frustrations with compensation issues in conservatorship before explaining his reasoning for the compensation structure currently in place.

“Nothing like this has been done before — placing two of the largest private financial institutions in the world into government conservatorship and then overseeing their operations in that state for multiple years,” he said. “Determining appropriate compensation in this situation is vexing. As a career-long federal employee, I too perceive the compensation agreements as large. I also share the frustration of many that past leaders of these companies received enormous compensation pre-conservatorship. Yet, while frustration with the past business decisions of Fannie Mae and Freddie Mac leadership, past policy failures and the resulting enormous taxpayer costs is understandable — and I share it — it cannot distract us from the task at hand.

“As conservator, I need to ensure that the companies have people with the skills needed to manage the credit and interest rate risks of $5 trillion worth of mortgage assets and $1 trillion of annual new business that the American taxpayer is supporting,” DeMarco continued. “I have concluded that it would be irresponsible of me to risk this enormous contingent taxpayer liability with a rapid turnover of management and staff, replaced with people lacking the institutional, technical, operations and risk management knowledge requisite to the running of corporations with thousands of employees and more than $2 trillion in financial obligations each. That conclusion is further buttressed by the realization that, from an enterprise executive’s or staff’s point of view, continued employment at the enterprises risks substantial job and career uncertainty. The public scrutiny and criticism is often harsh, and almost everyone expects the enterprises to cease to exist, at least in their current form, in the future. At the same time, the taxpayer is backing enterprise financial commitments that have 30-year lives, and we will need expert management of those guarantees for years to come. Given the amount of money at risk here, small mistakes can easily be amplified to losses far greater than the compensation paid to enterprise executives.

“In short, as Congress considers executive compensation at the enterprises, the basic fact is that despite the large amounts of government support provided to the enterprises, they remain private companies with uncertain futures, not government agencies. They employ thousands of people. We cannot maintain operational effectiveness with suddenly treating them as ongoing government agencies — something they are not. Major changes to compensation, for executives or staff, cannot be done safely and soundly in a short period of time and attempting to do so would pose substantial risk to the mortgage market and a greater loss to taxpayers,” DeMarco concluded.