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Watt Tells Congress Conservatorship “Not Sustainable”

When the Congressionally-empowered conservator of Fannie Mae and Freddie Mac tells Congress the conservatorship is not sustainable lawmakers should believe him – and so should his colleagues in the Administration.

“We’ve been in conservatorship, Fannie and Freddie, for eight years. It is the longest conservatorship that has ever occurred under government control,” Federal Housing Finance Agency Director Mel Watt told members of the House Financial Services Committee Tuesday.

He added that Congress “should act” to address matter, according to Bloomberg.

He might be accused of merely stating the obvious. But senior officials of the Administration of which Watt is part do not share his sense of urgency.  White House and Treasury official have repeatedly said the decades-old role of the secondary mortgage market giants needed a major overhaul and recommended winding them down. But in over seven years there has been no action taken and no blueprint offered.

The Housing and Economic Recovery Act, the 2008 law that put the entities under FHFA’s stewardship, anticipated a short-term measure arrangement. It gave Watt and other officials a wide berth to fulfill the law’s mandate to put Fannie and Freddie back on sound and solvent footing.

Instead the Administration has paid some of the government’s bills with the GSEs’ revenues since 2012 with the Third Amendment Sweep and kicked the issue back to Congress, which, conveniently, has not been able to design a plan that has attracted sufficient support. In October, Treasury Secretary Jack Lew and other officials dug their heels deeper in opposition to recapitalizing and releasing the government sponsored entities.  This practically guarantees that Watt will end his tenure with the GSEs’ fate still in limbo – his apparent frustration notwithstanding.

Watt may well prefer it were otherwise. He has met with our members on a few occasions and listened politely to investors’ concerns. He served 12 years on the committee before which he testified Tuesday and has extensive experience in housing policy. He has acknowledged that a perpetual conservatorship is not a great arrangement but indicated his hands are tied. This has proven to be true, at least politically.

Nonetheless, there have been limited steps at creating a larger role for private capital, but Watt indicated the experience to date has not revealed a viable alternative.

“We’ve tried out a number of risk sharing methods. We are concerned that the private sector, the capacity of the private sector, to take on this risk, particularly in an economic downturn and a distress situation would concern us greatly,” he said. “If the entire system were converted to the private sector you would have that risk of not having a backstop during a downturn and you’d have that risk of increased cost to borrowers, both of which would need to be evaluated by Congress as they evaluate how to move forward.”

Indeed, as former FDIC Chairman William Isaac and others have noted, no one explained where the vast amounts of capital necessary to sustain liquidity on a scale Fannie and Freddie now make possible would come from if they did not exist. 

Last week, in a commentary in Quartz, author Bethany McLean quoted an unnamed analyst who provided a perfect metaphor.

 “Say you have a little pool by the edge of an ocean,” her source said. “You’re draining cups of water from the ocean into the pool. Are you making progress getting rid of the ocean? Sure! But you’ll never get there.”

Watt indicated his agency has weathered the stormy period that followed the 2008 financial crisis but important work remains, which the agency and GSEs must complete with limited resources.

“While the risk of the work that we are doing is much, much less now than it was at the onset of the meltdown, staying in conservatorship is just not sustainable. You have a high risk of losing the most qualified people to the private sector,” he said.

This is likely true and major banks would be probably considering hiring them.