Mortgage Daily

Published On: February 7, 2008
Regulators Call for Tighter GSE OversightOFHEO, Treasury testify to Senate on Fannie, Freddie

February 7, 2008

By SAM GARCIA

Among concerns that the regulator of Fannie Mae and Freddie Mac has about raising loan limits at the two government sponsored housing enterprises is the level of debt they guarantee exceeds that of the United States. His calls for tighter oversight of the two companies were supported by a Treasury Department official in congressional hearings today.

James B. Lockhart III, Director of the Office of Federal Housing Enterprise Oversight, made the comments in testimony before the Senate Banking, Housing and Urban Affairs Committee, according to a transcript of his prepared testimony.

Fannie and Freddie earn 70 percent of their income from guaranteeing and issuing mortgage-backed securities, he said. Because of risks the two companies have taken, they are expected to report their first losses in 22 years.

Lockhart acknowledged that the two companies have been fulfilling their mission of providing stability and liquidity to the secondary mortgage market as credit markets have tightened by securitizing almost $100 billion monthly.

But he explained that MBS guaranteed by Fannie, Freddie and the 12 Federal Home Loan Banks — which are also classified as GSEs, increased $0.9 trillion last year to reach $6.3 trillion. The FHLB portion is just $1.2 trillion, while the remaining $4.4 trillion is guaranteed by Fannie and Freddie.

As of Dec. 31, Fannie reported its total book of business at $2.9 trillion while Freddie indicated its total mortgage portfolio ended the year at $2.1 trillion.

In comparison, public U.S. debt was just $5.1 trillion. And since $0.7 trillion is owned by the Federal Reserve, only $4.4 trillion is publicly outstanding.

While they managed to minimize market share loss to private label securities in 2006 by becoming the biggest buyers of the AAA tranches of subprime and Alt-A private label securities, their share grew from 38 percent that year to 76 percent by the fourth quarter of 2007 as investors fled the private label market. Factoring in FHLB activity, GSE market share jumped to 90 percent.

As their market share increased, so did their leveraging — which exceeded 80 times the fair value of their equity as of Sept. 30.

“For the first three quarters of 2007, they have each lost $8 to $9 billion in fair value of equity,” Lockhart stated. “Their combined fair value equity at the end of the third quarter was $58 billion compared to $5.1 trillion in mortgage exposure. I should hasten to add in the fourth quarter they raised almost $14 billion in equity in the form of perpetual preferred stock and cut their dividends as well.”

He called on the legislators to give his agency more authority — the same powers granted to banking regulators. He suggested OFHEO should have more than conservatorship authority; it should have receivership authority.

Among the most critical reforms recommended by the director was the flexibility to adjust capital requirements, as the current risk-based capital requirement is failing.

“It has yet to capture the risks we are currently observing,” he explained. “The problem was that [risked-based capital] parameters were specified in law and this does not really give OFHEO the flexibility bank regulators have, which is needed to create a modern economic capital framework.”

Both companies are feeling political and market pressure to expand into subprime and jumbo lending — which concerns the regulator given current oversight capabilities, and he wants more say in the matter.

“Unlike any other financial regulator, OFHEO is lacking mission and new product authority,” Lockhart continued. “What needs to be done is that significant new products and programs must be evaluated on a balanced basis at one time through both mission and safety and soundness lenses, before they are launched.”

But he said any temporary increase in the conforming limit, as outlined in President Bush’s economic stimulus package, should be accompanied by reform. Lockhart warned jumbo loans have unique prepayment and credit risks, and the geographic areas that would most benefit from such an increase are also the riskiest real estate markets.

“Roughly half of all jumbos are in California,” he said. “Underwriting them successfully will require new models and systems to ensure safe and sound implementation.”

In addition, Lockhart noted more focus is need on affordable housing, as just 30 percent of the two companies’ mortgage assets represent funding for units that count toward HUD’s affordable housing goals beyond that provided by securitization.

Lockhart also requested that OFHEO should know what its annual budget is ahead of time and be adequately staffed.

Assistant Treasury Secretary David G. Nason, who testified at the same hearing, supported OFHEO’s position.

“It is the Treasury Department’s view, and it appears to be generally recognized, that the housing GSEs’ regulators have neither the tools, nor the resources, to deal effectively with the current size, complexity, and overall importance of these enterprises,” he said, according to a transcript of his prepared testimony. “In addition, the FHLBanks were not immune to similar risk management issues, as the regulatory actions associated with problems at the FHLBank of Chicago and the FHLBank of Seattle illustrated. The severity of the problems in the case of the FHLBank of Chicago is evident as discussions are underway regarding a potential merger with the FHLBank of Dallas.”

He testified that any new GSE regulator must have the authority to set both minimum and risk-based capital requirements; all the receivership authority that is necessary to direct the liquidation of assets and otherwise direct an orderly wind down of an enterprise; and the ability to deny new activities that are inconsistent with their charters, prudent operation or public interest.

Nason also said shareholders, and not the government, should appoint Fannie’s and Freddie’s directors. He added that the FHLBs and Fannie and Freddie should have the same regulator.


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