|In a keynote address delivered at the Bipartisan Policy Center yesterday, Federal Housing Finance Agency (FHFA) Director Mel Watt warned that Fannie Mae and Freddie Mac (the GSEs) will face increasing challenges and risks if they remain in conservatorship in the coming years. The only way to address these challenges, Watt suggested, is for Congress to advance a plan to reform the GSEs and the housing finance system.
Watt began his speech by reviewing what FHFA has accomplished since first placing the GSEs into conservatorship in September 2008. Both the GSEs and the housing market have improved substantially since then, Watt said, with the GSEs returning to the U.S. Treasury more than $50 billion over the amount of federal assistance they received. Watt attributed some of this improvement to decisions FHFA made during conservatorship, including directing the GSEs to increase the guarantee fees they charge for each mortgage they insure, improving the GSEs’ representations and warranties framework, strengthening counterparty standards for mortgage insurers and seller/servicers, and mandating that the GSEs enter into more risk-sharing arrangements with private investors. Watt also made a point to commend the staff at FHFA and the GSEs for their work during conservatorship.
Despite these improvements, Watt told the audience, a long-term conservatorship is untenable and poses major risks for taxpayers and the housing market as a whole. Watt noted that the GSEs are currently required, as a condition for receiving assistance from the federal government, to send Treasury any business income they generate at the end of each quarter. In addition, while the GSEs are allowed to keep enough assets to maintain a "capital buffer" to protect against losses temporarily, that buffer is required to be reduced each year until it is zero by the January 1, 2018.
These conditions prevent the GSEs from building up the capital they will need to pay off any future losses, Watt argued. Consequently, such losses, even accounting losses on investments, may force Treasury to provide assistance to the GSEs. Such draws from the Treasury could decrease investor confidence in the GSEs, reducing market liquidity. Watt also said that a Treasury bailout could prompt Congress to pass housing finance reform quickly without properly examining all the possible solutions.
Watt also said that, the longer the GSEs remain in conservatorship, the longer they and the overall mortgage finance system will be insulated from market forces. While FHFA has attempted to structure its policies regarding the GSEs, including their guarantee fees, in a manner that will encourage a competitive mortgage market, the GSEs have certainly benefited from their special status. The longer this remains the status quo, the harder it will be to transition to a new housing finance system without disrupting the market.
Another challenge, Watt told the audience, is that, because policymakers are considering housing finance reform but have not enacted legislation, FHFA and the GSEs must plan for the future without confidence in how the housing finance market will work. This lack of certainty hurts the housing market now. Watt recently approved a plan to increase pay for corporate executive officers and other senior executives at the GSEs, he said, because he believed the GSEs would need top-notch staff to handle these unique challenges. Congress later passed legislation, which President Obama signed, that rescinded Watt’s decision.
All of these challenges, Watt concluded, were likely to continue, and even escalate, as long as the GSEs remain in conservatorship. In response to an audience question about what he would suggest a future housing finance system should look like, Watt said that it was up to Congress to pass housing finance reform to address these issues. Watt turned down the opportunity to opine on how Congress should structure the future housing finance system, saying that while he has many personal opinions on the issue, his role as FHFA director is focused on implementing policies rather than shaping them.
Watt was also asked about how the challenges facing the GSEs will impact their ability to support affordable homeownership. He replied that, because FHFA is currently regulating which products the GSEs can offer, it is certainly possible that these restrictions are impeding the GSEs’ ability to offer products that could better meet the needs of low- and moderate-income borrowers. After fielding a follow-up question from former HUD Secretary Henry Cisneros, Watt said that he believed promoting homeownership for lower income families was good policy, but that it was his "personal opinion, not an FHFA opinion." When asked if he felt that the GSEs have an obligation to support financing for affordable rental housing, Watt answered that FHFA has taken steps to encourage the GSEs to support affordable rental housing, citing FHFA’s decision to exempt certain affordable housing loans from the annual cap it places on the GSEs’ multifamily business.