Just after Thanksgiving, draft revisions to the House GSE legislation (HR 1461) began to circulate on Capitol Hill.
Peter J. Wallison
The new language reflected a purported agreement between the Treasury Department and Rep. Barney Frank, the incoming chairman of the House Financial Services Committee, and set off alarm bells around Washington. For those who have fought for six years to rein in the government-sponsored enterprises Fannie Mae and Freddie Mac, the administration's compromise--if that's what it is--was a bit of a shock.
The language amended the original House bill, which when passed was worse than no bill at all, and did not use the term "systemic risk" in connection with the legislation's key issue: whether the new regulator would have authority to control and reduce the size of the GSEs' mortgage portfolios. The compromise had some laudable provisions. It contained relatively strong language on the important question of new products, giving the regulator the authority to determine whether a GSE initiative is in fact a new product.
In addition, the language would eliminate the president's authority to appoint any GSE directors, thus reducing the apparent connection between the government and the enterprises. Finally, and most important, the language would give the new regulator the authority to raise minimum capital levels for the enterprises above the level now required by statute--a powerful tool to assure their safety and soundness.
But the key issue associated with any reform legislation was always the question of the new regulator's authority with respect to the GSEs' portfolios.
Those of us who saw this as the principal reason for any new regulatory legislation had always argued that the enormous size of the portfolios--which had reached $1.5 trillion before Fannie and Freddie ran into accounting problems--created a risk to the stability of the entire U.S. economy (hence "systemic") and not simply the risk of a taxpayer bailout. Our view was that the regulator would need authority to curb the source of systemic risk--i.e., the size of the portfolios--before any GSE legislation would be satisfactory.
In avoiding any reference to systemic risk, does the compromise language meet this test? My conclusion is that the language is workable for controlling the portfolios and thus deserves the support of those who have sought this goal.
The relevant provision begins, "The director shall, by regulation within 180 days, establish standards by which the portfolio holdings, or rate of growth of the portfolio holdings, of the enterprises will be deemed to be consistent with the mission and the safe and sound operations of the enterprises."
It then lays out seven elements that the director "shall consider," including "the need for the portfolio in maintaining liquidity or stability of the secondary mortgage market," "the need for an inventory of mortgages in connection with securitizations," "the need for the portfolio to directly support the affordable housing mission of the enterprises," and "any potential risks posed by the nature of the portfolio holdings."
Together, these statutory elements leave the decision on the portfolios firmly to the director's discretion. In other words, the language gives the director the necessary authority, if he chooses to use it. And if one believes, as I do, in the good judgment and steadiness of OFHEO Director Jim Lockhart--whom I assume will be appointed by the president as the director of the new regulator--this language would produce the right result for the economy and the taxpayers.
I have come to this conclusion for several reasons. First, it is important to understand that the danger of systemic risk always rested on the possibility that problems with the portfolios would initially have to impair the "safe and sound operation" of the enterprises. Thus, if the director were to conclude that the portfolios could impair the GSEs' safe and sound operation, he would be making a judgment that would have been necessary, in any event, to a finding of systemic risk.
In fact, the standard in the compromise language would be lower than a systemic risk standard, because the director is not required to conclude that an impairment of the safe and sound operation of the enterprises would likely produce a systemic result.
Thereafter, each of the items the director must consider should not pose difficult conceptual or factual hurdles if he believes that standards ar enecessary to control the size of the portfolios.
It's reasonably clear, for example, that the portfolios are not necessary to maintain the "liquidity or stability of the secondary mortgage market." To the extent that the enterprises create liquidity or stability in the secondary market, they do it by acquiring mortgages from originators. Whether they hold those mortgages in portfolio, or securitize and sell them, should have no effect on the secondary market. That has been clear recently, as Fannie and Freddie have been reducing their portfolios and emphasizing securitization, with no noticeable change in the secondary market.
Similarly, in addressing the factors that must be considered in connection with regulating the portfolios, the director could readily find that the GSEs' enhanced use of securitization would not require a large inventory of mortgages, would as easily support their affordable housing mission as acquiring for portfolio, and would avoid the potential risks--particularly interest rate risk--inherent in holding large portfolios of mortgages.
Accordingly, while the regulator's enforcement authority must be enhanced, and there is still language to be negotiated on major issues--especially on the affordable housing fund--the fact that the compromise would give the regulator sufficient authority to control or reduce the GSEs' portfolios clears the way for a bill the president should sign.
Peter J. Wallison is a senior fellow at AEI.