Ed DeMarco, current acting director of the Federal Housing Finance Agency, urged lawmakers to shrink or eliminate the hold Fannie Mae and Freddie Mac have over the market, which ultimately hinders the development of private capital back into housing.
The FHFA recently outlined a plan to create a new business entity between the government-sponsored enterprises, which falls in line with the ongoing push for a single-securitization platform. However, GSE domination is making the option for a private sector comeback unrealistic.
"So long as there are two government-supported firms occupying this space, full private sector competition will be difficult, if not impossible, to achieve," DeMarco said, during testimony for House Financial Services Committee hearing titled: Sustainable Housing Finance: An Update from the Federal Housing Finance Agency on the GSE Conservatorships.
The broad consensus seems that the Enterprises will not return to their previous corporate forms prior to the conservatorship. As a result, the Administration’s preferred course of action is to wind down Fannie Mae and Freddie Mac, the current acting director stated.
In opening an introductory statement, Congressman Scott Garrett (R-N.J.) said reform still needs to be attempted. "I believe these changes will allow us to examine new approaches and better ways to facilitate more private sector involvement in the mortgage market," he said.
"With a $16 trillion debt and annual trillion dollar deficits, we cannot afford to continue also keeping $11 trillion of mortgage credit risk on the back of the U.S. taxpayer," Garrett.
DeMarco provided three options for the Committee’s consideration, which were originally set forth by the Administration in a white paper more than two years ago.
A standard-setting approach would not rely on a government guarantee to attract funding to the mortgage market, but rather would look to standardization and rules for enforcing contracts that provide a degree of confidence to investors.
"The focus in such an approach could be on setting standards around key features that investors need to know to be willing to price credit risk in the mortgage market. These include standards associated with underwriting, pooling and servicing, and disclosures," DeMarco explained.
If a standard approach without a government guarantee setting was taken, it would be important to consider how such a market would operate in a time of stress.
"Having clear standards and greater transparency would certainly improve market operations," DeMarco stated.
The final option is similar to what is currently in place, a housing financing system with some type of government guarantee.
"In these structures, much like the banking system and deposit insurance, private sector capital through equity investment would stand in a first loss position, with a government guarantee that was funded through an insurance premium being available to cover other losses. This type of structure requires a significant amount of regulatory safety and soundness oversight to protect against the moral hazard associated with providing a government guarantee," DeMarco explained.
Admittedly, DeMarco stated he did not imagine that in 2008 FHFA would be approaching five years after placing Fannie Mae and Freddie Mac in conservatorship with no end in sight.
As lawmakers remain divided on what could replace the Enterprises and who could replace the current director, DeMarco is left to shrink the GSEs on his own.
"The U.S. housing finance system cannot really get going again until we remove this cloud of uncertainty and it will take legislation to do it," DeMarco said.