|Members of the House Financial Services Committee questioned Federal Housing Finance Agency (FHFA) Director Mel Watt on a variety issues related to oversight of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac during a hearing held yesterday. Committee members also asked for Watt’s thoughts on how a future housing finance system should be structured.
In his opening statement, Committee Chair Jeb Hensarling said that "it is well past time" for Congress to enact comprehensive housing finance reform and that the hearing would provide a good first step toward such an effort by allowing the Committee to assess the current status of the GSEs. Hensarling reiterated his long-standing support for reform that would put private capital at the center of the housing finance market.
Hensarling offered a mixed assessment of Watt’s tenure at FHFA. He complimented the director for encouraging the GSEs to enter into more risk-sharing agreements with private investors and for advancing the development of a common securitization platform. Hensarling raised concerns about FHFA’s decisions to resume GSE contributions to the Housing Trust Fund and to allow Fannie Mae and Freddie Mac to loosen their underwriting standards through higher loan-to-value (LTV) and debt-to-income (DTI) ratios. These decisions, Hensarling argued, risk the GSEs’ financial health and could bring back the lax lending standards that contributed to the financial crisis.
In her opening statement, Ranking Member Maxine Waters (D-CA) criticized Hensarling for continuing to advocate for privatizing the housing finance system, an approach she said had little chance of being enacted into law. For housing finance reform to be successful, she asserted, it must include a government backstop, a strong affordable housing mission, support for the Housing Trust Fund, and strong regulatory oversight. She praised Watt for taking actions to improve the GSEs’ operations and expand access to affordable mortgage credit.
In both his written and verbal testimony, Watt told the committee that his focus as FHFA Director has been solely on carrying out the agency’s responsibilities to ensure that the GSEs support a liquid housing finance market and protect their financial health. He outlined several steps FHFA has taken in recent years to reform the GSEs. Watt classified such actions as "GSE reform." Watt differentiated such policies from "housing finance reform," which he described as larger reforms to the entire housing finance system that are the responsibility of Congress. Watt urged lawmakers to pass housing finance reform quickly, saying that FHFA’s conservatorship of the GSEs is unsustainable over the long-term.
Throughout the hearing, Committee members from both parties asked Watt to share his opinion on how housing finance reform legislation should address various topics, such as the role of private capital in the housing finance market and what level of support the system should provide for affordable housing. Watt consistently declined to answer such questions, saying that, as FHFA Director, his responsibility is to carry out whatever policies Congress enacts, and that he did not feel that it was appropriate for him to take a position.
GSE Support for High LTV Lending
Both Hensarling and Rep. Mia Love (R-UT) questioned Watt’s decision to allow both Fannie Mae and Freddie Mac to offer loan products with a maximum LTV ratio of 97 percent. Such lending, they both claimed, is particularly risky and could trap borrowers in loans they cannot afford, essentially repeating the mistakes of the financial crisis.
Watt responded that FHFA had closely studied high-LTV lending before approving the high-LTV product and that he was confident such lending could be done responsibly. He noted that the GSEs have originated around 130,000 loans with LTVs of 97 percent since 2015 and that such loans have a delinquency rate of less than one percent, on par with the performance of the GSEs’ larger loan portfolio.
Housing Trust Fund
While Hensarling criticized Watt’s decision to have to the GSEs begin to make contributions to the Housing Trust Fund, Committee Democrats came to his defense. Waters and Carolyn Maloney (NY) noted that the Trust Fund is one of the few sources of funding available to support housing for extremely low-income families. Waters gave Watt the opportunity to discuss the initiative further. Watt replied that starting the GSE contributions to the Trust Fund was simply following the law, which requires the GSEs to contribute when financially able to do so. He said he could not speak about the work being supported by the Trust Fund, since it is administered by HUD.
GSE Capital Reserves
Watt also faced questions about whether he will allow Fannie Mae and Freddie Mac to retain some capital instead of their gradually reducing it to zero by January 1, 2018, as the existing preferred stock purchase agreements between Fannie Mae and Freddie Mac and the Treasury Department currently require. In response to a query from Michael Capuano (D-MA), Watt said that he would like the GSEs to be able to keep a capital buffer to ensure they don’t need future federal assistance. He said he is working with Treasury on this issue.
Representative French Hill (R-AR) told Watt he was worried that allowing the GSEs to build up capital would remove the impetus for GSE reform. Watt disagreed, saying that his goal was simply to allow the GSEs to have a small buffer to guard against potential losses, not to build up long-term operating capital.
QM Patch for GSE Loans
Many committee Republicans questioned Watt about the provision of the Consumer Financial Protection Bureau’s Ability-to-Repay/Qualified Mortgage rule that defines all mortgages that meet Fannie Mae’s or Freddie Mac’s underwriting standards as "Qualified Mortgages" (QM) until 2021. Sean Duffy (R-WI), Chair of the Housing and Insurance Subcommittee, asserted that the "QM Patch" gives the GSEs a substantial advantage in the marketplace and helps to crowd out private capital. Duffy asked Watt if he would consider requiring Fannie Mae and Freddie Mac to conform their policies to the QM rule to even out the playing field.
Watt noted that he drafted the legislation establishing the Ability-to-Repay principle while in Congress. He said that one of the benefits of the QM Patch for GSE loans is that it allows federal officials to examine whether lending done outside of the QM box is sustainable. Duffy replied that he agreed that non-QM lending can be sustainable and suggested that the standards in CFPB’s Ability-to-Repay rule are too rigid. Later, in response to a question from Andy Barr (R-KY), Watt clarified that GSE underwriting standards are aligned with all of the QM requirements except for the 43 percent maximum debt-to-income DTI ratio.
Credit Risk Transfers
Republicans also pressed Watt to quicken the pace of the GSEs’ efforts to engage in risk-sharing transactions with private investors. Ed Royce (R-CA) noted that, while the GSEs have transferred a portion of the risk on $1.6 trillion worth of mortgage loans, the actual amount of risk transferred is $54 billion, or only 1.3 percent of their total loan balances.
Blaine Luetkemeyer (R-MO) said most GSE credit risk transfers have involved the transfer of back-end risk that only kicks in after the GSEs have realized some losses. He asked Watt what FHFA is doing to promote more front-end risk transfer deals. Watt answered that FHFA and the GSEs were working to engage in front-end risk transfers, but that the GSEs have had a difficult time securing acceptable pricing for such deals.
During his opening testimony, Watt said both Fannie Mae and Freddie Mac have implemented disaster assistance protocols for homeowners living in areas impacted by recent hurricanes. This includes an automatic 90-day forbearance period, which can be extended for up twelve months, for borrowers who are struggling to repay their loan in the aftermath of the storm.
Nydia Velazquez (R-NY) asked Watt how FHFA and the GSEs were ensuring that homeowners in Puerto Rico and the U.S. Virgin Islands were aware of these assistance options, given the widespread power and communications outages impacting the territories. Watt said that he was not sure what could be done to reach such borrowers until power was restored, but that he would look into it.
Alternative Credit Scoring
Jim Himes (D-CT) expressed disappointment that Fannie Mae and Freddie Mac would not begin to utilize alternative credit scores from firms such as VantageScore until 2019. This delay, Himes contended, could prevent many responsible consumers from being able to purchase homes. He asked Watt if FHFA would be willing to authorize a pilot program utilizing the alternative credit models so that some consumers could benefit.
Watt told Himes that conducting such a pilot would be difficult, partly because the GSEs would not be able to include loans originated through the pilot in risk-sharing transfers. Watt said that the reason for the delay was that, after studying the issue further, FHFA became concerned about the issue of competition in the market for alternative credit scoring. He said FHFA intends to issue a request for input on this topic in the near future.
Watt also said that he did not believe that delaying the GSEs’ use of alternative credit modeling would hurt access to credit because the GSEs’ current underwriting procedures consider a variety of borrower characteristics, not just credit scores.