The Federal Housing Finance Agency (FHFA) said Tuesday that, with its conservatorship of Fannie Mae and Freddie Mac (the Enterprises) now in operation for more than three years "and no near-term resolution in sight," it was time to assess its goals and directions.  In a letter submitted to the chairs and ranking members of the House Committee on Financial Services and the Senate Committee on Banking, Housing, and Urban Affairs, Acting FHFA Director Edward J. DeMarco set out a Strategic Plan for Fannie Mae and Freddie Mac Conservatorships with three goals:

1. Build a new infrastructure for the secondary mortgage market;
2. Gradually contract the Enterprises' dominant presence in the marketplace while simplifying and shrinking their operations;
3. Maintain foreclosure prevention activities and credit availability for new and refinanced mortgages.

DeMarco said in moving forward FHFA has to consider that:

• The Enterprises' losses are of such magnitude that they will not be able to repay taxpayers in any foreseeable scenario;
• The operational infrastructures of each are working but require substantial investment to support future business which presents an issue of whether to rebuild or start anew;
• Minimizing taxpayer losses, ensuring market liquidity and stability requires preserving the Enterprises as working entities but this requires some things such as retaining private sector pay comparability that have generated concern because of taxpayer involvement;
• Although the housing finance system cannot be called healthy it is stable and functioning, albeit with substantial government support;
• Congress and the Administration have not reached consensus on how to resolve the conservators and define a path forward.

The absence of any existing meaningful secondary mortgage market mechanisms beyond the Enterprises and Ginnie Mae is a dilemma for policymakers who want to replace them and was a key motivation for conservatorship in the first place.  The elements for rebuilding the system are already known and work can begin without knowing whether there will be a government guarantee other than through FHA.  A secondary market structure without the Enterprises would likely include:

• A framework to connect capital markets to investors to homeowners - i.e. a securitization platform that bundles mortgages and provides support to process and track payments from borrowers through to investors.
• A standardized pooling and servicing agreement that corrects the many shortcomings in the agreements used in the private-label mortgage-backed securities (MBS) market pre-housing crisis.
• Transparent servicing requirements that set forth servicers responsibilities to investors and borrowers.
• A servicing compensation structure that promotes competition rather than concentration of servicing, takes into account servicers' costs and requirements, and considers the appropriate interaction between origination and servicing revenue;
• Detailed, timely and reliable loan-level data for investors that is maintained through the life of the MBS.
• A sound, efficient system for document custody and electronic registration that respects local property laws and enhances the liquidity of mortgages.
• An open architecture for all these elements to facilitate entry to and exit from the marketplace and an ability to adapt to emerging technologies and legal requirements over time.

Since entering conservatorship the Enterprises have guaranteed roughly 75 percent of the mortgages originated in the U.S. with FHA guaranteeing most of the rest.  Shifting mortgage credit risk away from the Enterprises to private investors could be accomplished in several ways.  The following are either under consideration or actively being implemented.

• Increase guarantee fee pricing. In September, 2011 FHFA announced its intention to continue a path of gradual prices increases based on risk and the cost of capital. In December Congress directed it to increase guarantee fees by at least 10 basis points as part of the revenue raising aspects of the Temporary Payroll Tax Cut Continuation Act and Congress also encouraged FHFA to require guarantee fee changes that reduce cross-subsidization of relatively risky loans and eliminate differences in fees across lenders not clearly based on cost or risk.
• Various approaches, including senior-subordinated security structures that could result in private investors bearing some or all of the credit risk.
• Expand reliance on mortgage insurance through deeper mortgage insurance coverage on individual loans or through pool-level insurance policies that would insure a portion of the credit risk currently retained by the Enterprises.

The Enterprises do not dominate the multi-family credit guarantee business and approach it very differently from their single-family business.  For a significant portion, Fannie Mae shares risk with loan originations and for a significant and growing part Freddie Mac shares credit risk with investors through securities.  Given these conditions, generating potential value for taxpayers and contracting the multifamily market footprint should be approached differently and each Enterprise will undertake a market analysis of its operations.

Capital market activities have long been considered the Enterprises' source of greatest profits, controversy, and risk.  These have been used to fund the retained portfolios and is a complex business activity requiring specialized and expert risk managers.  This business line is already on a gradual wind-down path with the Treasuring requiring a 10 percent reduction in the retained portfolio each year.  New mortgages are primarily delinquent ones removed from MBS and other legacy assets have little liquidity.  Over time the retained portfolios are becoming smaller but also less liquid. 

Maximizing taxpayer value on these assets is a key consideration and there is argument for holding some for a longer period.  This in turn requires management, either by retaining in-house expertise or by contracting to a third party.  The first is less disruptive but requires human capital risk which increases with the proposed legislation on Enterprise compensation.  The second would hasten the shrinkage in Enterprise personnel but would be more costly and would pose new control and oversight issues for FHFA.

The third strategic goal is maintaining foreclosure prevention efforts and credit availability.  The Enterprises must continue and enhance:

• Successful implementation of the Home Affordable Refinance Program (HARP) along with the program changes announced last October.
• Continued implementation of the Servicing Alignment Initiative including its approach to loss mitigation through loan modifications and early outreach to distressed borrowers;
• Renewed focus on short sales, deeds-in-lieu, and deeds-for-lease options;
• Further development and implementation of the REO disposition initiatives announced by FHFA last year including efforts to convert properties into rental units.

The Enterprises almost need to resolve other long-standing concerns in the marketplace that may be suppressing a more robust recovery and limited credit.  One major issue is concerns over representations and warrantees.  These policies must be made more transparent and conditions for their implementation defined.

In accomplishing the three goals, there must be consideration of human capital as well.  The boards and executives responsible for the business decisions that led to conservatorship are long gone and shareholders of the Enterprises have effectively lost their investments. The public interest is best served by ensuring that the Enterprises have the best possible leaders to carry out the work and a search is underway for new CEOs for each company and other executives willing to take on the necessary challenges in the face of ongoing criticism of the companies and uncertain legislative environment.  FHFA and the Enterprise boards have taken seriously the Congressional criticism of compensation structure and are working to create new ones that will be all salary with the largest portion deferred and at-risk.