Not So Fast on GSE Reform

In the political heat of the 2010 Congressional debate over the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173), Republicans in both the House and Senate offered up amendments that would have eliminated the federal government’s $150 billion support of the beleaguered housing giants, Fannie Mae and Freddie Mac, and would have led the two Government-Sponsored Enterprises (GSEs) on a speedy path to full privatization.

In 2011, with a new House majority and the Financial Services Committee (HFSC) gavel in hand, the GOP and its previously-offered proposals for reigning in Fannie and Freddie—which collectively guarantee or own an estimated 50 percent of all new U.S. home mortgages—do not appear as simple or clear-cut in practice.

At the heart of the questions raised at this morning’s HFSC hearing over the Obama administration’s newly-released proposals for GSE reform were what the federal government’s long-standing role in the housing finance system should be and how a diminished federal role will affect U.S. homeownership, consumer access to credit, support for low-income communities, and a still-fragile U.S. housing market.

Providing testimony was Treasury Secretary Timothy Geithner, who relayed the Obama administration’s hope that Congress can approve legislation within the next two years to dismantle Fannie and Freddie over an extended timeframe and slowly shift the mortgage credit industry closer to the private market. Geithner cautioned against Congress moving too slowly or too quickly, stating that either move could further destabilize the U.S. housing market and potentially disrupt the broader economic recovery.

Overall, the Obama administration’s near-term proposals for winding down Fannie and Freddie received general praise from Republican committee members who described the proposals as positive first steps.

Rep. Scott Garrett (R-NJ), who will play a leading role in the House’s GSE reform efforts as Chairman of the Capital Markets and Government Sponsored Enterprises Subcommittee, enumerated a handful of near-term initiatives that he and the Obama administration can agree on. Among those include:

  • A gradual increase of the guarantee fees that GSEs charge investors in exchange for a guarantee of the timely payment of interest and principal on Mortgage Backed Securities (MBS).
  • A reduction in the GSE’s investment portfolio. By 2008, Fannie and Freddie held more than $300 billion in private-label MBS – MBS collateralized by subprime mortgages – ultimately exposing the GSEs to significant losses as the housing market plummeted during the financial crisis.
  • A gradual increase in down-payments for GSE home mortgages. The Obama Administration’s proposal calls for Fannie and Freddie- insured mortgages to eventually have at least a ten percent down payment.
  • A reduction in the GSE conforming loan limits. The Administration’s proposal calls on Congress to allow the temporary conforming loan limit ($729k) increase as approved in 2008 to expire as scheduled on October 1, 2011 and revert back to previous levels ($625k).

The longer-term housing finance options, however, appear to be more tricky. Members of the GOP expressed particular concern over one of the Obama Administration’s three long-term GSE reform options, which would maintain a privatized system of housing finance that would be coupled with government backstop to ensure credit access during a future housing crisis. HFSC Chairman Spencer Bachus (R-AL) argued that such a backstop would perpetuate a moral hazard created by allowing the GSEs to gain access to less costly credit through an implicit federal government guarantee of GSE-issued debt. In response, Geithner said that a privatized housing finance system with no federal backstops would merely shift moral hazard to the private lending industry.

When compared to the contentious GSE debates of last year, Tuesday’s hearing provided an air of political civility that may eventually give rise to a bipartisan solution for GSE reform this Congress. But one thing remains abundantly clear, the debate still revolves around the reform of a multi-trillion dollar mortgage finance industry that is still highly complicated and highly political. With no easy solutions in sight, this debate may take a while.

In the Shadow of a Shutdown, the Beat Goes On

Resolving a Federal budget impasse that threatens the first government-wide shutdown since 1995 will undoubtedly be Congress’s top priority when it returns on Monday following a week-long President’s Day recess. But who says lawmakers can’t walk and chew gum at the same time? Below is a preview of next week’s critical financial services hearings on Capitol Hill, as both chambers continue to oversee the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and discuss various proposals for reforming the housing finance sector.

GSE Reform

Treasury Secretary Timothy Geithner will make his first appearance of the year before the full House Financial Services Committee (HFSC) on Tuesday to discuss the Obama Administration’s long-awaited report to Congress—unveiled on February 11—that details both short-term administration initiatives and long-term options for reforming Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac. House Republicans have targeted GSE reform as a key agenda item for the 112th Congress, as the HFSC has already conducted three separate hearings related to housing finance this Congress.

In addition, HFSC Chairman Spencer Bachus (R-AL) announced yesterday that his committee will be marking up four separate bills that will seek to terminate Obama administration foreclosure and housing assistance programs that Bachus argues are “doing more harm than good for struggling homeowners.” The Home Affordable Modification Program (HAMP), the Neighborhood Stabilization Program, the FHA Refinance Program, and the Emergency Homeowner Relief Program would all be terminated under the GOP proposals.

Republicans have been particularly critical of HAMP, a program spearheaded in March of 2009 by the Obama administration to assist struggling homeowners avoid foreclosure by providing federal incentives for borrowers, servicers and investors to modify delinquent home loans. HAMP has led to over 500,000 permanently modified home loans, yet has fallen far short of the Obama administration’s initial goal of 3 to 4 million modifications.

Consumer Financial Protection Bureau (CFPB)

On Wednesday, the House Financial Services Subcommittee on Financial Institutions and Consumer Credit – chaired by West Virginia Republican Shelley Moore-Capito – will conduct a hearing entitled "The Effect of Dodd-Frank on Small Financial Institutions and Small Businesses.” The CFPB’s potential impact on U.S. job creation and commercial credit access are likely to dominate the discussion.

The hearing follows the House’s passage on February 19 of a Continuing Resolution (CR) – a bill to fund government operations through September 30, 2011—that would cap the Federal Reserve’s funding for the CFPB at $80 million, representing a steep cut from the $134 million the White House requested for the agency’s FY11 start-up costs. Under the Dodd-Frank legislation, once the CFPB is officially established in July 2011, its funding will derive from the Federal Reserve’s operating expenses budget and could be as high as $500 million in FY12.

During the House budget debate, Chairwoman of the Appropriations Subcommittee on Financial Services Jo Ann Emerson (R-MO) defended the hefty cuts. "Providing half a billion dollars a year without any congressional oversight to the bureau is, I believe, a very irresponsible abdication of a constitutional check and balance," said Emerson.


Newly-minted Chairwoman of the Senate Agriculture, Nutrition and Forestry Committee, Debbie Stabenow (D-MI) will hold a hearing on Thursday to review agency implementation of Dodd-Frank’s provisions related to the regulation of over-the-counter swaps markets.

The hearing will primarily focus on Dodd-Frank’s imposition of enhanced regulatory requirements on the derivative market and its participants, including a requirement for stringent margin and capital requirements for all derivative market participants. During a HFSC oversight hearing on February 15, Commodity Futures Trading Commission Chairman Gary Gensler attempted to alleviate lawmaker and industry concerns that the new derivatives regulations will negatively impact so-called commercial “end-users” – those businesses ranging from farm equipment manufacturers to breweries -- who seek to hedge against interest rates and raw material prices through derivatives contracts. Gensler testified that the CFTC, which has been given broad leeway in determining the businesses who will be exempted under the law, does not intend to target legitimate commercial end-users.

Stay tuned for hearing updates next week.

Fed Closes Its Wallet on MBS...Private Investors to Fill the Void?

After 15 months of unprecedented intervention in the secondary mortgage market, the Federal Reserve—currently the proud owner of nearly 25 percent of mortgage debts—is calling it quits. The Fed's $1.25 trillion emergency program to stabilize the U.S. housing market through the purchase of mortgage-backed securities (MBS) officially expires today.

First announced in November 2008, the Fed initiative to purchase MBS issued by government sponsored enterprises (GSEs )—including Fannie Mae, Freddie Mac, and Ginnie Mae—has largely been viewed as a catalyst in spurring the nascent recoveries in both the housing and stock markets, helping to lower home mortgage rates and free up capital for private investors. In particular, market analysts credit the Fed purchasing program with paving the way for a record $375.4 billion of investments into bond mutual funds in 2009, as lower returns on mortgage securities led investors to corporate bonds, equities, and other riskier assets.

At a time when the U.S. economy remains fragile, the Fed’s departure from the housing sector may help determine just how fragile economic conditions really are. For months, market observers have raised concerns that a Fed exit could cause significant spikes in mortgage rates, leading to higher foreclosures and a slump in investor confidence. In fact, Fannie Mae's and Freddie Mac’s February announcement that they will repurchase $200 billion in delinquent mortgage loans, was a tacit acknowledgement that government backstops cannot be removed swiftly.


However, a number of analysts are also predicting that the effects of the Fed pullout will be rather minimal, as the current shortage of AAA-rated debt has made private fund managers increasingly eager to begin reinvesting in MBS, especially when such securities are backed by propped-up GSEs like Fannie Mae and Freddie Mac. In addition, these analysts also project that U.S. banks—which have steadily increased capital levels and are now flush with extra cash—will step up to fill the void left by the Fed.


The role of both Fannie and Freddie in ensuring a smooth transition for the housing finance system will be something to watch closely over the next few months. The GSEs are under intensified scrutiny on Capitol Hill, as the Obama administration prepares a sweeping proposal for a GSE overhaul. Treasury Secretary Tim Geithner told Congress last week that the administration will initiate a public comment period on April 15 in order to solicit ideas for Fannie and Freddie’s restructuring.

Details of the Draft Rescue Package

According to our contacts, Congressional leaders do not expect to finish drafting the financial rescue legislation before early this evening. As reported earlier, House Speaker Nancy Pelosi promised to post the final legislation on the Internet by noon today. The timing indicates the House will not vote on the package before tomorrow afternoon at the earliest, given that all sides will need time to review the final package. At a news conference this afternoon, key negotiator Sen. Judd Gregg (R-NH) said he would like to see the Senate vote on Monday. We expect the Senate will vote on the House-passed bill later in the week, following the Jewish holiday. In the meantime, we have received outlines from House and Senate staff privy to the negotiations.

Following is the list of what we understand will be in the legislation.

  • $700 billion – The Secretary will have access to $250 billion immediately. The next $100 billion will be available after the president reports to Congress, and the remaining $350 billion will require additional congressional action.
  • Insurance – In order to reduce taxpayer exposure, the Treasury will set up a mandatory insurance program for participating companies, and outlays will be reduced by the premiums collected.
  • Executive Compensation – Where the federal government completely takes over a firm (e.g. AIG), there will be no "golden parachutes" or severance pay. Where the government takes equity in firms, amounting to $300 million or more, those firms' will not be able to deduct compensation above $500,000 for their top five executives, and there will be a 20 percent surtax on any "golden parachute."
  • Oversight and Transparency – The legislation will establish a bipartisan oversight committee, evenly split between Democrats and Republicans. The committee will regularly report to Congress and the public. There will be a new "Special Inspector General." It will also create a " Financial Stability Oversight Board." There will be strict, new conflict of interest rules and "unjust enrichment rules." After five years, if the rescue has produced a net loss, the president must submit a plan to Congress explaining how to recoup taxpayer losses from the participating firms.
  • Mark-to-Market Accounting – The General Accountability Office must study the effects of this accounting rule and how it may have affected the current situation. The legislation will also affirm the government’s authority to suspend mark-to-market accounting standards.
  • Equity/Warrants – Where government completely takes over a firm, the government must take equity interest in that firm. Where there is a partial government takeover, the Treasury Secretary has the discretion to take proportional equity interest based on the percentage of assets sold.
  • Tax Benefits for Community Banks – The legislation will allow for community banks to take capital losses on Government Sponsored Enterprise losses against ordinary income.

The Democratic leadership agreed to remove entirely three provisions they had been pushing – "Say on Pay" or "Proxy Access" provision to mandate shareholder votes on corporate governance issues for rescued firms; an affordable housing fund that would have directed money to organizations that Republicans claim are unethical; and bankruptcy provisions that would have allowed bankruptcy judges to reduce mortgage principal amounts.

We will send further updates as we receive more details.