Hearings on Fannie’s, Freddie’s Future

Rep. Paul E. Kanjorski (D-Penn.) — chairman of the subcommittee on capital markets, insurance and government sponsored enterprises — highlighted more than $150 billion in losses at Fannie and Freddie since the third-quarter 2007. He noted that the U.S. Department of the Treasury has purchased $85.9 billion in senior preferred stock of the two GSEs, and its investment might ultimately grow to as much as $400 billion under current agreements.

Another statement from Rep. Scott Garrett (R-N.J.) said Fannie and Freddie financed around 36 percent of U.S. subprime mortgages. The two firms “abused their governmentally granted advantages in the marketplace” and leveraged themselves 100-to-one.

James B. Lockhart III, director of the Federal Housing Finance Agency, testified that the two companies own or guarantee $5.4 trillion in single-family mortgages — 56 percent of the U.S. market. In addition to regulating Fannie and Freddie, the FHFA is the conservator of both firms.

Rep. Kanjorski said Federal Reserve purchases of GSE mortgage-backed securities currently stand at $365 billion, while its GSE bond holdings are more than $71 billion.

“Our hearing today will therefore examine the government’s financial support for Fannie Mae and Freddie Mac and explore options for the future of their relationship with the government,” Kanjorski said. “While the existence at this time of Fannie Mae and Freddie Mac is essential for our nation’s economic recovery, this is also an appropriate moment to begin to consider how we might modify their mission, operations, and ventures going forward.”

The Mortgage Bankers Association’s Michael D. Berman agreed about the important roll the two secondary lenders play, according to a copy of his prepared testimony. He noted that the two companies are involved in two-thirds of residential transactions and three-quarters of all multifamily activity.

But Berman said the two companies face severe management challenges as home price declines and foreclosures reach unprecedented levels. In addition, they are being used as public policy instruments — a practice MBA supports only for the short term.

MBA called for the extension of Treasury credit facilities beyond the end of this year and continued government purchases of GSE MBS. The trade group also recommended a permanent increase to the conforming limit.

Among the options on the table are making no changes to their structure, breaking them up into smaller companies as was done with AT&T, and regulating them like utilities, Rep. Kanjorski said. Other options include creating a cooperative, making them non-profit entities and “revolving them back into the government.”

FHFA’s Lockhart said he opposed government ownership “because government insurance programs are particularly high-risk and rife with moral hazard.”

But the National Association of Home Builders Chairman Joe Robson called for Congress to hold off on making any move until the current market turmoil passes. He did, however, have some suggestions for how they should come out of conservatorship.

“Fannie Mae and Freddie Mac should be recast, retaining federal backing but limited primarily to providing credit enhancement of mortgage-backed securities,” Robson said. “Limited portfolio capacity should be permitted to accommodate mortgages and housing-related investments that do not have a secondary market outlet, although Fannie Mae and Freddie Mac should have the flexibility to support the mortgage market in times of crisis.”

The two firms should be merged and operated as a mortgage clearinghouse owned half by investors and half by the government, according to a letter from the Consumer Mortgage Coalition.

Rep. Garrett warned about creating what amounts to a new set of GSEs through a systemic risk regulator.

“By creating a new systemic risk regulator, we could essentially establish a dozen new Fannie and Freddies that will be ‘too big to fail’ and have the inherent market advantages that will come with that distinction,” Garrett said. “Privatizing profits and socializing risk is a bad business model and we should learn from our past mistakes — not repeat them.“

Garrett went on to propose the use of covered bonds.

Kanjorski also discussed stripping the two firms of their government sponsored status, as was done with Sallie Mae in 1990, but he called for slow and cautious movement.

MBA recommended a private secondary market with an explicit federal credit guarantee on mortgage-related investments for single-family and multi-family mortgages.

“A careful, measured approach should be adopted so that current markets are not further destabilized,” MBA’s Berman stated. “Safeguards should be established to ensure a smooth transition from the present to whatever future model is developed.”

The National Association of Federal Credit Unions issued a letter to Rep.s Kanjorski and Garrett recommending that steps are taken to ensure the transition out of conservatorship is smooth and doesn’t disrupt the secondary mortgage market.

FHFA’s Lockhart said the regulator is in discussions with the Treasury about how to re-capitalize the mortgage insurance sector, which the two GSEs heavily rely on.