Federal Housing Finance Agency Mel Watt's speech at the Bipartisan Policy Center in Washington, D.C. [1], Thursday morning touched on two important facets of the FHFA’s conservatorships of Fannie Mae and Freddie Mac.
First, Watt talked about accomplishments among the GSEs since the establishment of the conservatorship. Second, he provided a future outlook on some of the challenges and risks associated with the conservatorship.
The conservatorships continue, now in their eighth year, with no end in sight; key officials in the Obama Administration such as Treasury Secretary Jack Lew have stated the GSEs will remain in conservatorship of the FHFA until at least the end of the Administration. The continuation of the conservatorships may present some problems, according to Watt.
“I am signaling my belief that some of the challenges and risks we are managing are escalating and will continue to do so the longer the Enterprises remain in conservatorship,” Watt said. “Consequently, I believe that I have a responsibility, both as regulator and as conservator, to identify and discuss this concern more openly.”
The chief risk with the most potential for escalating is the lack of capital for Fannie Mae and Freddie Mac. Several lawmakers have expressed concern that the GSEs’ capital buffer, set up specifically to absorb losses and which is required by law to be reduced to zero by 2018, might eventually force them to take another taxpayer-funded bailout, should the GSEs' losses exceed their capital buffer. Most recently, U.S. Reps. Stephen Lee Fincher (R-Tennessee) and Mick Mulvaney (R-South Carolina) wrote a letter to Treasury Secretary Jack Lew and Watt in early February [2] asking the regulators to consider what effect the zero capital requirement will have on the economy and the potential risk it poses to taxpayers and the financial system. The lawmakers asked Lew and Watt what steps their respective Agencies can take in the near term to “rectify the situation.” They requested a reply by March 1.
“I can assure you that these challenges are certainly not going away, and some of them are almost certain to escalate the longer the Enterprises remain in conservatorship.”
Mel Watt, FHFA Director
“Starting January 1, 2018, the Enterprises will have no capital buffer and no ability to weather quarterly losses—such as the non-credit related loss incurred by Freddie Mac in the third quarter of last year—without making a draw against the remaining Treasury commitments under the PSPAs,” Watt said on Thursday. “There are a number of non-credit related factors that could lead to a loss and result in a draw on those commitments: interest rate volatility; accounting treatment of derivatives, which are used to hedge risk but can also produce significant earnings volatility; reduced income from the Enterprises’ declining retained portfolios; and, the increasing volume of credit risk transfer transactions, which transfer both the risk of future credit losses as well as current revenues away from the Enterprises to the private sector. A disruption in the housing market or a period of economic distress could also lead to credit-related losses and trigger a draw.”
Mel Watt
Watt noted that future draws might result in hasty legislation being passed without proper forethought.
“We know that the stakes are high for the housing finance market and for the broader economy,” Watt said. “However, as I have indicated in my remarks today, there are substantial challenges and risks associated with the unprecedented size, complexity, and duration of the conservatorships of Fannie Mae and Freddie Mac. After more than two years at FHFA, I can assure you that these challenges are certainly not going away, and some of them are almost certain to escalate the longer the Enterprises remain in conservatorship.”
On the topic of accomplishments, since the GSEs were put into conservatorship in September 2008, Watt stated that we have a “safer and more stable housing finance system.” In his speech he noted that guarantee fees have increased by two and a half times since 2009 to an appropriate level, stronger credit standards have removed unsound risk layering, and the FHFA is focused on how to support sustainable access to credit for homeowners.
“In all of these things, we have also placed greater attention on diversity and inclusion in the Enterprises’ business operations, consistent with legal standards and with projections that the future composition of homeowners, renters, and the country as a whole will be more diverse,” Watt stated.
He continued, “FHFA’s conservatorship decisions have helped navigate the Enterprises through a financial crisis and, despite the substantial negative impact of the crisis, helped prevent it from being far worse.”
Click here [3]to view Watt's full speech.