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Watt: “These Conservatorships are Unsustainable”

In what is being widely viewed as his last testimony as Director of the Federal Housing Finance Agency [1] (FHFA), Melvin Watt appeared before the Senate Banking Committee [2] to appraise them on the status of the housing finance system on Wednesday.

Setting the tone of the hearing titled “Ten Years of Conservatorship: The Status of the Housing Finance System” Sen. Mike Crapo, Chairman of the Banking, Housing, and Urban Affairs Committee said that housing finance reforms remained one of his top priorities as Chairman of the committee. “The status quo is not a viable option. The government plays too big a role in the mortgage market today,” Crapo said in his opening remarks.

Speaking about the recent programs of the GSEs, Crapo said that over the past couple of years FHFA, Fannie Mae [3], and Freddie Mac [4] had all been busy. “Both enterprises have experimented with pilot programs that allow certain lenders to sell loans with 1 percent or even 0 percent down; Additionally Fannie and Freddie have continued to expand into other markets, such as single-family rentals,” Crapo said. “I also appreciate that Fannie’s and Freddie’s underwriting standards remain tighter than they were at the peak of the housing boom.”

Despite this progress, Crapo said that the overall trends that leaned towards greater taxpayer risk and greater government presence in the mortgage market were a concern and “further demonstrate the need for Congress to turn to housing finance reform expeditiously.”

Speaking on FHFA’s role as the conservator the GSEs, Watt said that FHFA’s role was unprecedented in “its scope, complexity, and duration especially when you consider Fannie and Freddie Mac’s role in supporting over $5 trillion in mortgage loans and guarantees. This is an extraordinary role for a regulatory agency also because we are obligated to fulfill both the role of supervisor and conservator at the same time.”

“I have expressed this opinion, perhaps using different words on numerous occasions since then. I have also expressed repeatedly my firm belief that these conservatorships are unsustainable,” Watt told the committee adding that it was the prerogative and responsibility of Congress, not FHFA, to decide on housing finance reform.

Speaking about the challenges that were compounded by conservatorship, Watt said that one of the challenges was the ability to plan and manage in the face of uncertainty about the future. “Our experience as conservator confirms that it is extremely difficult to manage the Enterprises in the present without establishing some kind of plans for the future.”

Ensuring market discipline was another challenge that Watt outlined during the hearing. “Because the Enterprises have been insulated while operating in conservatorship from normal market forces that would otherwise inform their operations and business decisions, FHFA has had the responsibility for creating its own regime for market discipline,” he told the committee.  FHFA had taken several steps to address this challenge, the most important one being “to require the Enterprises to use an aligned capital framework when evaluating business decisions even though they were not able to build capital beyond the limited buffer agreed,” Watt said.