DeMarco Pushes Housing Finance Reform as Fannie Profits Soar

Fannie Mae and Freddie Mac, the two government-seized mortgage financiers, appear increasingly likely to pay billions of dollars to the U.S. Treasury, focusing attention in Washington on what should replace them.

Edward J. DeMarco, the acting regulator of the two companies, appeared before the House Financial Services Committee today and urged lawmakers to reduce or eliminate the mortgage market’s reliance on taxpayers. At the same time, a Senate panel heard testimony from the authors of an alternate plan for housing-finance reform issued in February by an independent commission.

“I have been observing a developing ‘consensus’ among private-market participants that the conforming conventional mortgage market cannot operate without the American taxpayer providing the ultimate credit guarantee for most of the market,” DeMarco said in testimony at the House hearing. “That clearly is one outcome, but I do not believe it is the only outcome that can give our country a strong housing finance system. I believe that our country, and its financial system, are stronger than that.”

Washington-based Fannie Mae (FNMA) and McLean, Virginia-based Freddie Mac have been under U.S. conservatorship since 2008 and have drawn nearly $190 billion in taxpayer aid to stay afloat during that time. Lawmakers who don’t want the companies to return to their previous status as government-sponsored enterprises, or GSEs, are becoming concerned that political momentum for winding down and replacing them could erode as the housing market rebounds and profits soar.

‘True’ Reform

“I am determined that this hearing will be the last time that Director DeMarco -- or, if you believe press reports, his successor -- will testify before this committee before we finally and belatedly markup a true GSE reform legislation,” House Financial Services Committee Chairman Jeb Hensarling, a Republican from Texas, said at the hearing.

One of the potential replacements for DeMarco is North Carolina Representative Mel Watt, a Democrat who sits on the Financial Services Committee and said he intended “to listen, not to engage” in today’s hearing.

Fannie Mae, in a regulatory filing on March 14, raised the possibility that it could soon be required to send as much as $62 billion to the U.S. Treasury because, once it is profitable, it may have to start counting potential tax credits as part of its net worth. The company said it would delay filing its earnings report for the quarter ended Dec. 31, 2012, while it studies the accounting issue.

‘Significant’ Income

Regardless of the outcome, Fannie Mae said it expects to report “significant net income” for the quarter.

The news helped send Fannie Mae’s preferred stock soaring to the highest point since September of 2008, when it was seized by the government and dividends were suspended. Fannie Mae’s $7 billion of 8.25 percent preferred shares climbed to $2.96 in New York on March 15 from $2.08 on March 13. They traded at $3.14 as of 1:35 p.m. today.

The company’s common shares, which reached as high as $69.49 in 2007, more than doubled to 68 cents from 29.5 cents on March 14.

The securities may be worthless unless the companies can pay off the funds they owe to taxpayers or see their bailouts reworked. Under the current terms of the companies’ aid agreements, any money sent to Treasury is considered a return on the taxpayers’ investment, not a repayment. That’s because the federal government structured the bailout so that they could not regain independence without a new housing finance system in place.

Government Role

DeMarco said he does not anticipate that legislative changes to the housing finance will end the government’s involvement entirely. “It’s not really what I’m expecting or would like to see,” DeMarco said.

“What I would envision is we’ve got to start moving that dial away from government, away from taxpayers and back toward a more private capital participation,” he said. “Between zero and $10 trillion there are a lot of places to reset that dial and I think we can make substantial progress away from taxpayers and still have a vibrant role for government.”

Republicans praised DeMarco’s work and often called his plans “courageous.”

“The steps being taken by the director are far more than any reform the administration has undertaken,” Representative Scott Garrett, a Republican from New Jersey, said. “It appears to me that they are more than content to keep their head in the sand and act as if no long-term reforms to our housing finance system are needed.”

Congressional Approval

Lawmakers including Senator David Vitter, a Louisiana Republican, and Senator Elizabeth Warren, a Massachusetts Democrat, on March 14 introduced a bill that would ensure Fannie Mae and Freddie Mac couldn’t emerge from government control even if they end up paying more to the Treasury than they took in aid. The measure would ban sales of senior-ranking U.S. Treasury-owned preferred shares without congressional approval.

“This bill shows that Republicans and Democrats do agree on the urgency required to reform the mortgage finance system,” Vitter said in a statement.

Senate banking Committee ranking member Michael Crapo, a Republican from Idaho, said in the “weeks to come” he will describe his views for long-term housing reform.

Differing Views

“For too long our differing views as to the optimal solution seem to have prevented substantive negotiations from even starting,” Crapo said at a Banking Committee hearing on housing reform options. “Although we do not agree on what should be the final product today, this should not preclude us from beginning negotiations, or even jointly identifying the problems in today’s market.”

Senate Banking Committee Chairman Tim Johnson, a Democrat from South Dakota, said he will work with Crapo for a series of hearings before moving onto a “consensus” bill.

“A partisan bill or a bill full of ideology that ignores the realities of our economy would be irresponsible, especially when the housing market is beginning to show signs of strength,” Johnson said.

Even without legislation, Treasury is extremely unlikely to change the rules to allow the companies to emerge from conservatorship, said Thomas Lawler, a former Fannie Mae economist who’s now a housing consultant in Leesburg, Virginia.

Not AIG

Investors are wrong to expect that Fannie Mae and Freddie Mac will emerge from government control in a manner similar to American International Group Inc., the insurer that repaid its government bailout in December, said Ed Mills, an analyst at FBR Capital Markets & Co. in Arlington, Virginia.

“The difference between AIG and Fannie and Freddie couldn’t be more stark,” Mills said in a telephone interview. The two mortgage companies were government-sponsored with long histories of implicit taxpayer support before their rescues. In addition, he said, Fannie Mae “has the greatest amount of political baggage of any company to have ever existed in the history of the United States.”

DeMarco urged lawmakers to not wait to begin housing finance reform and said the continued conservatorship of the entities is holding the private market back.

“There are a number of things inhibiting the full return. One of them is Fannie Mae and Freddie Mac (FMCC) are still the dominant players in the marketplace and they are operating with taxpayer support, which puts them in a place that other private investors cannot get to,” DeMarco said.

Divisions Remain

Democrats and Republicans remain divided on what should replace the two companies, and the Obama administration has yet to present a plan for a housing-finance overhaul. That leaves DeMarco, who leads the Federal Housing Finance Agency, to gradually shrink them on his own.

Democrats have pushed for a replacement for DeMarco because of his resistance to forcing the government entities to perform principal reductions for troubled homeowners.

“I am concerned that Mr. DeMarco has used his wide latitude in regulating Fannie Mae and Freddie Mac to make a number of controversial decisions during his tenure, including refusing to move forward with principal reduction modifications, even when they would benefit the taxpayer, and raising fees in states with strong consumer protection laws,” Committee ranking member Maxine Waters, a Democrat from California, said.

DeMarco’s opening statement was interrupted by protesters holding signs saying “Dump DeMarco” and “Principal Reduction.”

President Barack Obama is getting closer to nominating a replacement for DeMarco, 52, a career government employee who has been in his current post since 2009. DeMarco has been criticized by some housing advocates and Democratic lawmakers for refusing to let the two companies cut debt for borrowers whose mortgages exceed the value of their homes. At the same time, he has earned praise from Republican lawmakers for his focus on improving the companies’ bottom lines.

To contact the reporters on this story: Cheyenne Hopkins in Washington at chopkins19@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net

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