June 27, 2013

Questions for FHFA Nominee Watt

The Constitution requires Senate consent of many senior executive branch nominations. This affords the Senate a critical opportunity to review the President’s policies. Congressman Melvin Watt has been nominated to be director of the Federal Housing Finance Administration (FHFA). In addition to advising the President on housing issues, the FHFA director serves as regulator and conservator of Fannie Mae and Freddie Mac. Here are a set of questions that would inform how Rep. Watt, if confirmed, might fulfill his duties on issues critical to our economy.

Power of the Position

Congress created the FHFA in 2008 and gave it authority to oversee Fannie Mae, Freddie Mac, and the Federal Home Loan Banks – key components of our country’s secondary mortgage markets. On September 7, 2008 the FHFA placed Fannie Mae and Freddie Mac under conservatorship due to their deteriorating financial condition. Since then, the Treasury Department has given FHFA more than $116 billion to stabilize Fannie’s assets to offset its liabilities, and more than $73 billion for Freddie Mac. In addition, the Federal Reserve has purchased $1.1 trillion in bonds and mortgage-backed securities (MBS).

As we approach the fifth anniversary of the federal takeover of Fannie and Freddie, the government dominates the housing market in a way that has never been seen before in this country. The government touches more than 90 percent of mortgages. Combined, Fannie and Freddie hold $7.5 trillion in outstanding debt. By comparison, the largest bank in the U.S., JP Morgan Chase, has $2.3 trillion in assets. The status quo is unsustainable and exposes taxpayers to unnecessary risk.

  • The legislation creating FHFA explicitly requires the director to “have a demonstrated understanding of financial management or oversight, and have a demonstrated understanding of capital markets, including the mortgage securities markets and housing finance.” Please detail your demonstrated understanding of each of these areas. 
  • The acting director of FHFA has taken seriously the objectives of the conservatorship: to conserve the value of the institution for those with ownership interests, taxpayers and bondholders. He has received praise for his political independence and focus on the safety and soundness of its regulated entities. He has resisted efforts that he believed would use Fannie and Freddie assets and operations to expand housing subsidies at the expense of taxpayers and bondholders. If confirmed, will your primary objective be to protect the taxpayers and bondholders in conservatorship?
  • The acting FHFA director, along with Administration officials like former Treasury Secretary Tim Geithner, have said that the Fannie Mae and Freddie Mac should never return to their old position in the market, but should gradually be wound down and eliminated as government-sponsored enterprises (GSEs). Do you agree that the GSEs should be eliminated and, if so, how would you wind them down?
  • Various proposals have emerged to reform Fannie and Freddie and our nation’s housing financial market. Absent congressional action, what steps would you take? 
  • The GSEs have been the primary means of direct access for community banks to the secondary mortgage market for many years. Recently, the GSEs have put forth a policy to charge fees for low-level activity that could discourage community bank participation. What is your view of the GSEs imposing low-activity fees on seller/servicers with limited activity? Do you believe it will disadvantage smaller institutions? 

FHFA Moving Forward

Treasury support for Fannie and Freddie has come in the form of purchases of senior preferred stock. This stock is senior to all other stock issued by Fannie and Freddie and is the only stock paying dividends. Under the terms of their bailout, neither Fannie nor Freddie has the ability to pay off the $188 billion infusion they received. All profits are sent to the Treasury as dividends. Including an expected dividend announced in May, Fannie will have paid dividends of $95 billion since 2008. By next month, Freddie expects to have paid a total of $37 billion. Hedge funds and other investors have begun to buy shares in both companies based on expectations of continued priofits. 

  • How should private shareholders of Fannie and Freddie be treated once these entities are removed from conservatorship? 
  • Investors appear to be buying shares of Fannie and Freddie with the expectation that some of the profits will flow back to shareholders. What would you say to investors on this matter? 

The acting FHFA director has pursued a number of measures to rebuild the secondary mortgage market so that participants can compete with one another, fully aware of the risks involved and rules in place, to ensure an efficient flow of credit. The FHFA has proposed establishing a common securitization platform that would support Fannie’s and Freddie’s existing businesses, upgrade their aging infrastructures, and attract private capital to share credit risk that is now carried by Fannie and Freddie. FHFA is also pursuing efforts to improve the contractual and disclosure framework to support a more efficient and effective secondary mortgage market with the development of a single security.  

  • As FHFA director, would you continue these modernization efforts?
  • What efforts will you pursue to increase private sector activity in the secondary market to share in risk?

Use of Eminent Domain

Local governments across the country are considering the use of eminent domain to address the high level of properties in foreclosure or mortgages that are “underwater,” those where a mortgage balance exceeds the home’s current market value. Typically eminent domain is used by a government to forcibly purchase a property that is reused in a way considered good for the general public. Under the current proposal, a city could use eminent domain to seize mortgages with a private financial partner, cut the loan principal, and then sell the refinanced mortgage to new investors at a lower interest rate, with a fee paid to the private partner. 

  • What is your view on the use of eminent domain to seize and restructure mortgages as has been considered in a number of jurisdictions? What problems do you see such an approach causing for a national secondary mortgage market? 
    • The FHFA released this statement last year: “FHFA has significant concerns about the use of eminent domain to revise existing financial contracts and the alteration of the value of the companies’ securities holdings. FHFA has determined that action may be necessary on its part to avoid a risk to safe and sound operations at its regulated entities and to avoid taxpayer expense.” Do you agree?
    • As an attorney, do you believe use of eminent domain in this context would violate the U.S. Constitution? 
    • Do you agree with the position of the securitization industry that the use of eminent domain seeks to seize assets that would be profitable to the private partner rather than to address a public purpose of aiding the housing market? Do you believe eminent domain would undermine the national mortgage market, would make credit less accessible for homeowners, devalue the investments of pension funds, mutual funds, and other investors holding MBSs? 

Loan Modification Implications

Fannie Mae and Freddie Mac currently have various programs to assist borrowers struggling to pay their mortgages. These programs include allowing some borrowers who are underwater on their mortgages to refinance or enter into repayment plans, principal forbearance plans (in which a homeowner can miss mortgage payments or make smaller payments for a short period of time), mortgage modifications, and deed-for-lease plans. There also are programs that permit borrowers to avoid foreclosure through short sales or deeds-in-lieu of foreclosure. In response to pressure from the Administration and some in Congress to forgive mortgage principal, FHFA explained that it was obligated to conserve the value of the assets it controls and “principal forgiveness results in a lower present value than principal forbearance.” It also determined that the Home Affordable Modification Program Principal Reduction Alternative program with the Treasury determination to use Troubled Asset Relief Program funds to make incentive payments to Fannie and Freddie, “did not clearly increase foreclosure avoidance while reducing costs to taxpayers relative to the approaches currently in place.” 

  • Do you believe managing GSE assets in a way that reduces mortgages or involves more write-downs of mortgages undermines the conservatorship? 
  • Would you have agreed to or resisted the Administration’s call last year for more loan forgiveness?

Affordable Housing Goals

Dating back to 1992, the government required Fannie and Freddie to direct a portion of their financing to borrowers who were at or below the median income level in their communities. Originally, the quota was set at 30 percent. The Department of Housing and Urban Development adjusted this number over time until it reached 55 percent in 2007. To meet that goal, Fannie and Freddie had to significantly lower their underwriting standards. According to one estimate, by 2008, 27 million loans were subprime or otherwise weak -- borrowers had blemished credit, made little or no down payment, had no documentation, or were required only to make interest payments. 

  • Do you agree that there is a conflict between government rules requiring affordable housing and government rules requiring good risk standards in mortgage lending? 
  • Do you believe government should continue to lower risk standards in pursuit of affordable housing goals, and thus repeat the mistakes that led to the recent financial crisis? 
  • What are your thoughts on the cause of the subprime crisis?
  • What are your thoughts on the proper role of the federal government in promoting affordable housing? Is this something that should be a mission of the secondary market through Fannie and Freddie (or a likely successor), or is this function more appropriately done directly through other federal programs? 

Issue Tag: Housing