Regulator hints he’ll withhold a dividend payout to keep mortgage companies’ finances healthy if he has to.
Market Watch - Andrea Riquier - 12 May 2017
In 2008, as the financial crisis swirled, the federal government rushed Fannie Maeand Freddie Mac into conservatorship. The two giant mortgage-finance companies became wards of the state under a new regulator that would manage their affairs until they were healthy enough to stand on their own.
Nearly nine years later, they’re still under government control. And while in some ways their crisis has receded, in other—and what some would call self-inflicted—ways, Fannie FNMA, -1.42% and Freddie FMCC, -0.56% still teeter on the edge of needing another taxpayer bailout.
As congressional testimony from their regulator revealed Thursday, that precarious position is starting to make policymakers nervous.
Mel Watt, director of the Federal Housing Finance Agency, which has oversight over the enterprises, told the Senate Banking Committee that reform is “urgently” needed. “These conservatorships are not sustainable and they need to end as soon as Congress can chart the way forward on housing finance reform,” he said.
The current state of affairs has less to do with the 2008 crisis-era legislation than with a 2012 amendment to the earlier agreement. It directed the companies to send their quarterly profits to the U.S. Treasury and progressively reduce capital buffers down to zero by 2018.
Fannie and Freddie’s zero-capital target was a self-created ultimatum. In a way, it was meant to replicate Congress’s own self-imposed sequester, in which lawmakers set a hard cap on government spending while moving toward a more comprehensive budget agreement.
With no capital, there’s little margin for error. One bad earnings period—whether due to credit losses or accounting vagaries—could send Fannie or Freddie back to the government for another bailout. That’s the last thing anyone in Congress wanted just a few short years after the crisis.
Instead, it was believed, that risk would force Congress to take action to enact a comprehensive overhaul of the housing finance system that could keep the mortgage enterprises from trying to survive quarter to quarter. At least that’s how the thinking went.
It hasn’t exactly gone according to plan.
Some congressional attempts have been made, and those ideas may just need more time. Efforts largely centered on a more market-oriented structure that would combine private capital while retaining some level of federal government backstopping. Analysts considered bipartisan Senate efforts developed over the past few years to be important starting points.
And still, 2018 is drawing near.
In his testimony, Watt repeatedly drew a distinction between his stewardship of the enterprises and broader housing finance reform, which he said was Congress’ responsibility.
If Fannie or Freddie needed to draw funds, Watt argued, it would undermine private investors’ confidence in the broader housing finance system. He likened his situation to knowingly driving passengers in a car with a faulty airbag: there’s a low risk that something bad will happen, but if it does, the impact could be catastrophic.
And, Watt told the committee, he has the right to suspend a quarterly dividend payment if he believes that payout would jeopardize the safety and smooth functioning of the enterprises. And, it’s just this kind of decision-making that lack of broader reform forces upon the regulator, he said.
Some lawmakers bristled at that.
Sen. Bob Corker, a Tennessee Republican who helped draft one of the earlier stalled reform efforts, told Watt that the federal money available to the enterprises in case of emergency is no different than a firm tapping a line of credit to smooth out fluctuations in cash flow.
“Go ahead and draw on it,” Corker said.
Mike Crapo, the Republican who chairs the committee and who also participated in earlier reform efforts, tried to smooth the differences between Watt and Corker.
If Watt made a change to the 2012 amendment by preemptively deciding to withhold a dividend, Crapo argued, it might roil markets just as badly as an unplanned draw would.
But Watt pointed out that it’s his agency that would bear the brunt of any negative fallout from an unscheduled draw. “If the two parties can’t dance then I may have to dance by myself,” he said. “It may not be pretty, but I have the ultimate risk here.”
Shares of both Fannie and Freddie were up about 2% in Thursday trading. Holders of the companies’ stock were wiped out when the government began to sweep the quarterly profits, but the stocks have rallied on hopes that the Trump administration will be more friendly to investors, and that the approaching zero-capital milestone may just be the hard deadline that forces some action from Congress or FHFA.