Senators Prepare to Tackle GSE Reform (Again)

Monday, 22 Apr 2013 02:44 PM

By Robert Feinberg

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The Senate Banking Committee held a hearing on the state of the housing government-sponsored entities (GSEs), Fannie Mae and Freddie Mac, grilling Ed DeMarco, director of the Federal Housing Finance Agency (FHFA), which has acted as conservator for the two companies for the past four years, and then hearing from Steve Linick, inspector general of the FHFA, about deficiencies in the operations of the regulator itself.

The hearing was dramatic at times and could go down as another classic example of why Congress is unable to legislate effectively with respect to the “too big to fail” financial institutions at the center of the ongoing financial crisis.

Leaders of the congressional banking committees are asking the public to believe that they are about to enact legislation on so-called reform of the housing finance system real soon now.

Committee Chairman Tim Johnson, D-S.D., proclaimed in his opening statement that maintaining the GSEs indefinitely in a state of conservatorship “is not an option.” A cynic might observe that the legislators have already achieved this dubious outcome.

Johnson went on to express high hopes for legislative action based on a unanimous vote to attach an amendment to the budget resolution providing that the GSEs are not to be used as a piggy bank for the federal government. One could explore at length the deeper meaning of this statement.

I would venture that perhaps it means that the federal government will continue to be used as a piggy bank to support the GSEs, mortgage bankers and other elements of the “Housing Industrial Complex,” so that their owners and managers can continue to receive handsome compensation during the boom phase of the volatile housing cycle and exercise the “Bernanke put” to avoid the financial consequences of the inevitable busts.

Readers will recall that when the Dodd-Frank Act was enacted in 2010 as the answer to the financial crisis, its sponsors studiously avoided taking up GSE reform. Two years earlier Congress had enacted the authority to place Fannie Mae and Freddie Mac under conservatorship under the Housing and Economic Recovery Act of 2008, a very detailed and complex bill that did almost everything but resolve whether the GSEs should be wound up, wound down or reconstituted in some form.

The plan appeared to be to wait for the scandal to blow over and let the GSEs return to business as usual, and this could well be the outcome of any process intended to “jumpstart” action that has already been delayed for many years, since 1992 legislation created the latest iteration of this reckless industry and its feckless regulator, then known as Office of Federal Housing Enterprise Oversight.

If this is in fact going to be the year that Congress produces a GSE bill, last week’s hearing spotlighted some issues that call for close attention:

Principal reduction. Since last summer, DeMarco has resisted demands by Democrats that he accede to wholesale reductions of principal in the modification of delinquent loans. This was meant to be an election-year gift to the housing industry, and then-Treasury Secretary Tim Geithner promised the House Financial Services Committee that he would deliver it from DeMarco in a matter of weeks.

At the hearing, DeMarco stood up to cross-examination by Jack Reed, D-R.I., and insisted that it would not be appropriate in his role as conservator for the benefit of taxpayers to allow this relief to proceed. The proponents, led by Robert Menendez, D-N.J., will press the issue again as part of any reform bill.

Government guarantee. Former Senate Banking Committee Chairman Richard Shelby, R-Ala., elicited from DeMarco agreement that the conservative status of the GSEs is to be distinguished from the private status of the largest banks, and he specifically named JPMorgan Chase.

So this senior legislator remains in denial that the too big to fail banks are, in effect, themselves GSEs, depending on the government for their sustenance while they pay huge compensation to their executives, just as the GSEs did before they were placed under conservatorship. The industry is calling for the establishment of an explicit federal guarantee as the basis for so-called reform of Fannie Mae and Freddie Mac.

Private capital. Both Shelby and Bob Corker, R-Tenn., discussed the conditions they expect to be included in legislation intended to attract private capital back to the housing finance industry. Shelby spoke in terms of better transparency and due diligence, while Corker mentioned specific devices, such as credit-linked notes and senior subordinated debt, to provide a 10 percent capital buffer in front of the federal guarantee.

DeMarco was asked whether an FDIC-like mechanism might be put in place as one form of a buffer. He responded that it could work, and he warned that it should be real capital, because one day it would be needed.

I have warned for several years that the toxic products of tomorrow are being created today by some of the same people who cooked up the 2008 episode of the ongoing financial crisis.

The crucial, overriding point for readers to keep in mind is that whatever the legislation is, it will be the product of the same constellation of interest groups and is virtually certain to lead to the same result, since it will be designed, once again, to enable the mortgage finance industry to operate with high leverage that will blow up whenever conditions in the housing market, now bolstered by the latest round of quantitative easing, once again turn adverse.

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