The House Financial Services Committee recently approved legislation to curb executive compensation at Fannie Mae and Freddie Mac, the two secondary mortgage market government-sponsored enterprises. The vote was an overwhelming 52-4 in favor to rein in compensation.

The primary driver of the legislation was the report that Michael Williams, CEO of Fannie Mae, received $5.6 million in compensation, while Charles “Ed” Haldeman, CEO of Freddie Mac, received $5.4 million. These multimillion-dollar pay packages went out the door while the two GSEs cost taxpayers $148 billion in draws from Treasury, as of June 30. Then, after the House committee approved the legislation, we learned that Fannie Mae and Freddie Mac spent more than $640,000 on a mortgage conference in Chicago, a figure the two agencies now say was a mistake and will be more tightly controlled in 2012.

The executive pay legislation, H.R. 1221, known as the Equity in Government Compensation Act, would lead to executives and employees of Fannie Mae and Freddie Mac receiving compensation in line with pay at federal financial regulatory agencies. CEO compensation at Fannie Mae and Freddie Mac could not exceed $218,978 for this year. (for 2011 or 2012?)

There is an obvious slippery-slope concern that Congress is trying to legislate private-market labor compensation. As a general principle, government should stay out the private market in terms of what companies are willing to pay employees. The wrinkle here, however, is Fannie Mae and Freddie Mac are in conservatorship with the Federal Housing Finance Agency.

This brings up a fundamental question: since Fannie Mae and Freddie Mac are being backstopped by the Treasury, should their chief executives and other officers receive private-sector wages or federal government wages?

One thing we have to keep in mind is that Fannie Mae and Freddie Mac are still extremely large financial entities with large retained portfolios. Hence, taxpayers would prefer to have the best people managing these mammoth mortgage portfolios, all things being equal. That would suggest paying those executives private-market wages would be a good idea.

But all things are not equal. Think of Fannie Mae and Freddie Mac as the Federal Housing Administration with large retained portfolios of mortgages that have to be managed and hedged. Is there any reason to pay Fannie Mae’s CEO a private-sector premium to the tune of $5.6 million in compensation while the FHA commissioner earns about $200,000 a year?

The answer is no.

OPERATIONS SPLIT MAKES SENSE

In fact, I would split Fannie Mae and Freddie Mac into two operations: the loan purchase and securitization segment and the retained portfolio and hedging operations. I suggest paying the Fannie Mae and Freddie Mac chief executives and other officers the same as the FHA commissioner and the head of the portfolio and hedging operation the same as the FHFA director or Federal Deposit Insurance Corp. director or chairman.

Splitting the companies’ operations in two allows the securitization operating function to continue and the retained portfolio function to be dedicated solely to unwinding the portfolio and acting as a workout entity for bad mortgages. While Sen. Johnny Isakson, R-Ga., has proposed merging Fannie Mae and Freddie Mac into Ginnie Mae 2.0, my recommendation separates the enterprises into smaller pieces making an eventual sale to the private sector more likely. Folding Fannie Mae and Freddie Mac into Ginnie Mae creates a truly “too big to privatize” entity.

REDUCED SALARIES MAKE SENSE

Until there is a reasonable exit strategy from conservatorship, Fannie Mae and Freddie Mac are essentially wards of the state. In that sense, H.R. 1221 is a reasonable piece of legislation. And given the accumulated draws from the Treasury of $148 billion, it is reasonable to reduce executive compensation since Fannie Mae and Freddie Mac are likely to be in conservatorship for a long time. But if a reasonable exit strategy comes forth, then compensation can be determined by the private sector. In short, if Fannie Mae and Freddie Mac executives want private-market compensation, then return those GSEs to the private sector as soon as possible.

One of the roadblocks to getting Fannie Mae and Freddie Mac back into the private sector is the constant tinkering. First, the Obama administration ordered streamlined mortgage refinancing with credit scores or appraisals. Then Isakson proposed merging Fannie Mae and Freddie Mac with Ginnie Mae to virtually guarantee the companies stay under government control.

And finally, there is the proposal by Senate and House Democrats for payroll tax reductions to be paid for by Fannie Mae and Freddie Mac (additional 0.125% guarantee-fee increase) So, it appears that rather than trying to get Fannie Mae and Freddie Mac out of conservatorship, the increase in G-fee must be shipped directly to Treasury. And once there, it won’t be used to help Fannie and Freddie’s current pediment. In other words, Fannie Mae and Freddie Mac remain the “slush funds on the Potomac.”

So, why should taxpayers pay multimillion-dollar executive salaries for continued losses with no exit strategy from a government conservatorship?