June 2005
Everything You Wanted to Know about HR 1461 But Were Afraid to Ask
Since its adoption on May 25, HR 1461--which would create a new regulator for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--has received serious attention as a precursor to congressional action later this year. Supporters of Fannie and Freddie are said to be jubilant; opponents see the bill as worse than current law. At a June 30 AEI event, experts reviewed the bill in detail, pointing out its flaws and positive aspects, and how Congress should strengthen the new regulatory regime.
Thomas H. Stanton
Johns Hopkins University
The misleading language of HR 1461 limits the authority of the new GSE regulator. HR 1461 creates a combined regulator for the three housing GSEs (Fannie Mae, Freddie Mac, and the Federal Home Loan Banks). The board of this independent agency consists of a director, the secretaries of Housing and Urban Development (HUD) and the U.S. Treasury, and two qualified citizens.
The positive aspects of this bill include removing the regulator from the appropriations process, thereby reducing political control over the agency. The regulatory agency will have a greater scope of authority over prudential management, operations standards, and affiliated parties such as lawyers and consultants. To see that Fannie and Freddie improve affordable housing goals, HR 1461 lets the regulator target specific GSE actions and enforce changes. Currently, HUD can do nothing besides force the GSEs to “submit a plan” if they do not reach their goals. The new regulator also has authority to bring the GSEs directly to court.
Of HR 1461’s two greatest deficiencies, the first is a one-year regulatory gap. The new agency would not have its authority until one year after the bill’s passage. Yet during that year, the current regulators--the Office of Federal Housing Enterprise Oversight (OFHEO), the Federal Housing Finance Board (FHFB), and HUD--can do nothing but wind up operations. Thus, for that year, there is no active authority over the GSEs.
The other chief problem concerns one of the regulator’s principal duties: to ensure that the GSEs “minimize the cost of housing finance” (Section 102). Since GSEs already promote low costs, this provision of HR 1461 effectively pushes the regulator to support GSE expansion. Indeed, the regulator’s first principal duty is to ensure safety and soundness. Yet the aforementioned duty makes it highly difficult for the agency to slow the growth of new programs. HR 1461 also provides for a flawed board organization. The bill’s language does not designate to the board an explicitly advisory role. Because of the board’s ambiguous role, members may tend to meddle in inappropriate matters. Further, the ambiguity regarding board members’ specific roles diminishes accountability.
Other problems include the $540,000 mortgage limit, which is absurd given the GSEs’ affordable housing mission. In addition, the regulator will lack the discretion to adjust minimum levels of capital and issue capital directives. There is no definition of a high-cost area, and the affordable housing fund will place billions of dollars under GSE control. This fund gives Fannie and Freddie even more clout in Congress and the housing market.
Solid GSE legislation should contain the following: (1) a board structure that permits effective decision making; (2) strong external institutional support; (3) a clear statutory mandate to ensure safety and soundness, protect against systemic risk, and limit untrammeled expansion; (4) regulatory tools and authority that resemble the tougher model used for banks; and (5) no hidden traps, such as a regulatory gap or subversive principal duties.
Peter J. Wallison
AEI
In considering the regulation of Fannie Mae and Freddie Mac, one must bear in mind the immense market and political power of the two GSEs. To overcome pressure from Congress and powerful economic groups, the regulatory agency needs very specific statutory authority. The broad language of the charters governing Fannie and Freddie make this necessity even greater. For instance, although the charters authorize the GSEs to “provide stability in the secondary mortgage market for residential mortgages,” this statement does nothing to actually confine Fannie or Freddie’s operations to this specific market.
Moreover, the charters’ broad language inhibits the current regulators from slowing the expansion of “new programs” for the GSEs. Under current law, “The (HUD) Secretary shall approve any new program . . . unless” the program is not authorized by statute [charter] or the director of OFHEO “determines that the new program would risk significant deterioration of the financial condition of the enterprise.” The charters’ broad language places a heavy burden on a regulator attempting to prove that a new program is “unauthorized by statute.”
Regarding the expansion of new programs under HR 1461, GSEs will have carte blanche for a year following the passage of the bill. During that year, the new regulator will have yet to receive its authority. Meanwhile, the secretary of HUD may do nothing but wind down the agency’s operations with respect to GSEs. During that year, any new programs that Fannie and Freddie report to HUD will be automatically approved because HUD will have lost the authority to disapprove them.
Following that year, the regulator will have a slightly greater capacity to disapprove of new programs. However, HR 1461 still applies the charters’ broad terminology; and given the political context, restricting GSE expansion will again prove difficult. Along those lines, HR 1461 does little to enable the regulator to prohibit “new business activities.” Like “new programs,” Fannie and Freddie have a year to carry out “new activities” without the possibility of being denied.
Once the director assumes the authority to disapprove “new business activities,” one of his “principal duties” makes this a challenging task. According to Section 102, one of those duties is to ensure that “the operations and activities of each regulated entity foster liquid, efficient, competitive, and resilient national housing finance markets that minimize the cost of housing finance.” This language permits the GSEs to push the regulator to allow them access to all kinds of markets, under the pretext that doing so will “minimize the cost of housing finance.” Moreover, Section 122(c) grants the director authority to prohibit business activity, only if such activity is inconsistent with purposes of the act, the charters, the safety and soundness of the enterprise, or not in the public interest. Given the political context, this standard does little to strengthen the regulator’s ability to inhibit GSE expansion.
Beyond new programs and activities, Fannie and Freddie pose tremendous systemic risk due to their multi-trillion dollar mortgage portfolios and the associated interest-rate risk. While limiting the size of GSE portfolios is a prudent course of action, HR 1461 does nothing to facilitate this. According to Section 113, the regulator may require a GSE to “dispose or acquire any asset or liability, if the Director determines that such action is consistent with the safe and sound operation of the enterprise or with the purposes of this Act or any of the authorizing statutes” (Section 113).
Given the fact that the GSEs garner 75 percent of their profits from the portfolios, Freddie and Fannie will fight portfolio limitations with a vengeance. Section 113 provides insufficient authority for regulators to overcome the pressure of GSE allies. Save clear authority from Congress, the regulator will have a hard time arguing that portfolio levels violate the “safety and soundness test.” To deal with this issue, legislation must give the director explicit authority and clear standards by which he can limit the size of portfolios.
Lastly, to afford the regulator with the ability to enforce its decisions, Congress should adopt language from banking law. For instance, consider corrective action that must take place in case of undercapitalization. Whereas banking law says the appropriate federal banking agency shall appoint a receiver, HR 1461 says that the director may establish a receivership. Also, downgrades in classification and cease and desist orders are harder to procure under HR 1461 than under corresponding banking statutes.
AEI staff assistant Dan Geary prepared this summary.
