Improved Loan Quality and Transparency at GSEs Not the Only Solution: DeMarco

Federal Housing Finance Agency (FHFA) acting director Edward DeMarco, appearing today before the House Financial Services subcommittee on government-sponsored enterprises (GSEs), indicated legislation on the future of the GSEs should supplement recent moves for higher-quality loans and transparent data. His comments arrive after a letter he sent to ranking committee members in both the US Senate and House of Representatives on Tuesday concluded losses on private label mortgage-backed securities from 2005, 2006 and 2007 at the GSEs are directly responsible for the FHFA taking an oversight role in 2008. As the GSEs Fannie Mae (FNM) and Freddie Mac (FRE) take an increasingly large market share of mortgage originations, credit losses continue to mount. For example, Fannie and Freddie mortgage purchases and guarantees represented 76% of all originations in 2009, according to DeMarco’s testimony (download here). FHFA, as the GSEs’ conservator, requested nearly $145bn in total draw-downs from the Senior Preferred Stock Purchase Agreements with the US Treasury Department as of Q110. Once the most recent requests are granted, Fannie Mae will have drawn $83.6bn and Freddie Mac will have drawn down $61.3bn in Treasury support. The requests for aid come even after the GSEs took steps to cut back on Alt-A and interest-only mortgage purchases. Additionally, the GSEs are rolling out a new initiative that aims to streamline home appraisal and loan delivery data. The improved loan quality and underwriting standards translates to lower delinquency rates, although Alt-A and interest-only mortgages already on the GSEs’ books continue to account for significant quarterly losses, DeMarco said. He noted the FHFA expects Fannie and Freddie to continue as “critical supervisory concerns,” mainly due to credit losses and partly due to likely continued high delinquency rates for older books of business. “The risk associated with continued house price declines is a difficult challenge faced by both Enterprises,” he said. “Fannie Mae and Freddie Mac will continue to sustain credit losses on mortgages originated pre-conservatorship across the entire country but especially on loans originated in four states: California, Florida, Arizona, and Nevada. Each of these states has experienced significant house prices declines, with values dropping dramatically [as illustrated below].” DeMarco noted that, while “conservatorship is not a long-term solution,” the only post-conservatorship option available to the FHFA is to reconstitute Fannie and Freddie under their current charters. He added that any new legislation formed to produce large-scale restructuring of the mortgage-finance system must ensure adequate liquidity for the mortgage market, the ability to avoid and if necessary absorb credit risk, and the availability of mortgage credit. “Given the extraordinary losses to these companies and the need for financial support from the federal government resulting from the present mortgage crisis, to say nothing of the toll on individual households and communities, we as a nation need to ask and answer some hard questions about what we want out of our housing finance system,” he told the subcommittee. A house resolution (HR) currently under consideration in Congress details the timeline to take the GSEs out of conservatorship and eventually wind down Fannie and Freddie. Write to Diana Golobay. Disclosure: the author holds no relevant investments.

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