It will be “several more years” before Fannie Mae and Freddie Mac fix accounting and management problems, says the federal official in charge of overseeing them, and the government-backed lenders continue to pose “substantial systemic risk” to U.S. banks.
In a speech to banking and finance lawyers Wednesday, James B. Lockhart III, director of the Office of Federal Housing Enterprise Oversight, said Fannie Mae and Freddie Mac are making progress in fixing their problems, “but it is slower than they or we would like or expect. It will take several more years. Remedial actions taken to date will help, but legislation is needed to make sure that these two companies do not falter again.”
Fannie and Freddie, Lockhart said, were allowed to grow too fast and with too little government oversight.
“From the beginning, OFHEO has been no match for the responsibility assigned to it of being the safety and soundness regulator of Fannie Mae and Freddie Mac,” Lockhart said. “Together, they represent more than a 40 percent share of the residential mortgage market, a share that has doubled since 1990. This unconstrained growth led to significant operational problems, mismanagement and earnings manipulation.”
To prevent a repeat of accounting scandals that led Freddie Mac and Fannie Mae to jettison top executives, restate earnings by a combined $16 billion, and pay more than $500 million in fines, Lockhart said Congress should create an independent oversight agency and grant it powers similar to those given bank regulators.
The House in October passed H.R. 1461, the Federal Housing Finance Reform Act of 2005, which would create a new regulatory agency, the Federal Housing Finance Agency (FHFA), with powers similar to those given to bank regulators, to oversee the government-sponsored lenders. The current Senate version of the bill, S. 190, would require Fannie and Freddie to cut their portfolios.
Fannie Mae’s mortgage assets have grown at a rate of 13 percent a year since 1990, to about $727 billion, while Freddie Mac’s mortgage portfolio grew at an annual rate of 26 percent to $710 billion. The residential mortgage market as a whole grew by 8.5 percent a year during the same period.
Lockhart maintains Fannie Mae and Freddie Mac were able to keep their triple-A credit ratings as they grew because they had the backing of the government, not because their balance sheets were sound.
Lockhart said Fannie Mae and Freddie Mac are “highly leveraged for financial institutions of their size.” With 60 percent of U.S. banks investing more than half their capital in Fannie and Freddie’s securities, the accounting problems at the companies pose a risk to the entire system, he said.
Even if problems with internal controls, corporate governance and risk management were corrected today, “each enterprise would still pose substantial systemic risk,” Lockhart said.
Freddie Mac spokesman Doug Duvall told Inman News the company manages risk “exceedingly well. We have more capital than required, and our monthly disclosures prove we have a stable risk profile, even in volatile markets.”
If Freddie Mac is required to reduce its mortgage portfolio, the risks of financing those debts will only be shifted to others, not eliminated, Duvall said.
“Risks are inherent in what we do. They don’t disappear by forcing us to sell off our assets,” Duvall said. “All you do is shift them to someone else’s balance sheet — to large banks which are explicitly federally backed.”
A Fannie Mae spokesman declined to comment on Lockhart’s speech.
Lockhart said the bills in the House and Senate would give regulators stronger oversight powers to make sure Fannie Mae and Freddie Mac fulfill their mission: supporting affordable housing, and providing stability to the mortgage market by repurchasing loans from originators.
Congress can set stricter limits on Fannie and Freddie’s mortgage portfolios, Lockhart said, while still allowing them to provide market stability and liquidity by buying mortgages and repackaging them as guaranteed securities.
All told, OFHEO estimates that less than 30 percent of Fannie Mae and Freddie Mac’s portfolios contribute to affordable housing. The companies could do better if they invested less of their assets in their own mortgage-backed securities, Lockhart said. About 54 percent of Fannie and Freddie’s combined mortgage portfolios of $1.4 trillion are invested in their own mortgage-backed securities, Lockhart said.
Lockhart said FHFA, the new regulatory agency that will oversee Freddie and Fannie, needs the powers given to bank regulators — including the ability to sue companies and take them over if they become insolvent.
“The absence of receivership authority, which bank regulators have, creates uncertainty and contributes to the possibility of a systemic disruption in the financial sector,” Lockhart said. The new agency should be able to impose penalties on employees and directors, seek damages from affiliated parties, and have a longer statute of limitations “to go after separated employees.”
To insure its independence, FHFA needs to be free of the Congressional appropriations process, Lockhart said. In the past, when OFHEO has needed money to pursue an investigation, the subjects of the investigation have gone to lawmakers to slow down the process down, he added.
The solution, Lockhart said, is to combine the agency with the Federal Housing Finance Board (FHFB), which regulates the Federal Home Loan Banks.
The new agency, not HUD, should determine the mission and products offered by Fannie Mae and Freddie Mac, Lockhart said. HUD would “continue to play an important role” in fair housing oversight, he said, as the HUD Secretary would serve on the agency’s board.
A HUD spokesman declined to comment on Lockhart’s speech.