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The Administration has proposed a strong and effective new regulator for the housing GSEs because expanding homeownership is a top priority, and the GSEs play an important role in doing that. Appropriate oversight of them is necessary to ensure that the housing GSEs will be able to continue to play this role now and into the future.
MR. PFLIEGER: It has been widely acknowledged that housing has played an incredibly important role over the last couple of years in keeping the economy strong. What, in your view, is housing’s overall contribution to the growth of the economy, recently and over the long term? And what role have the housing GSEs played in that growth?
MR. ABERNATHY: There are two parts to that. First of all, let’s talk about the importance of homeownership to the economy. Treasury’s Office of Economic Policy estimates that residential investment accounts for about 5% of Gross Domestic Product overall, and sometimes it accounts for a significant portion of the growth of GDP — over 1% in the third quarter of FY 2003. The building, furnishing and maintaining of homes are extremely important as a share of our economy.
But I think probably the most significant impact that homeownership has on the economy is what it does for communities. Go to a community where most of the people rent their home. Compare that with the community where most of the people own their home, and it’s a world of difference. There’s a world of difference in the way the people take care of their homes, the investments they make in their homes, the investments they make in their communities, the roots that they put into their communities and how they participate in the life of the community. Knowing that you own your home means not only that you take better care of your home, but you tend to take better care of your community.
MR. PFLIEGER: You mean housing’s social benefits?
MR. ABERNATHY: You get more involved in local politics because you figure you’re going to be there a while, and so you’re much more likely to be a participant in the choice for the local alderman than you would be if you were renting there and not planning to be there very long. And there’s a myriad of other kinds of — you’re probably more involved in the schools. You’re more involved in the churches and other good things that take place. People tend to become more involved in the places where they own their property and the home that’s there. That’s what I think is the most significant benefit of homeownership in this country.
GSEs play a role by helping to make the 30-year, fixed-rate mortgage into a very commonplace, liquid investment that allows a lot more of our tremendous financial resources to be devoted toward helping people buy their first homes and their second home, or to expand and build upon their homes. Without that, the 30-year, fixed rate mortgage might be seen by lenders as a riskier investment.
DAVE CROWE: Why do you describe a mortgage as being a potentially dangerous investment?
MR. ABERNATHY: From the lender’s point of view, long-term mortgages are subject to a wide variety of risks, particularly when you’re talking about a fixed-rate loan. When you have a fixed-rate loan, you’re tying up money over a long period of time, and so you increase the amount of exposure that you have to whether or not someone’s going to honor their payments over that period of time. You have exposed the person who provides that money to liquidity risks, and to the risks that financial institutions may need that money for other things because they have a lot of other demands. That financial institution is exposed to interest rate risks that can occur over the life of that particular loan as rates rise and fall. The secondary markets help mitigate a large portion of that risk by spreading it among a greater pool of investors.
In a lot of other countries a 30-year, fixed-rate mortgage is a very hard thing to find. In this country, for a long period of time, the 30-year fixed-rate mortgage was something that was hard to find. We needed to find mechanisms by which financial institutions would be willing to commit large sums of money for long periods of time, and the housing GSEs have played a major role in creating those instruments and providing liquidity that allows financial institutions to make those kinds of investments an everyday occurrence.
MR. PFLIEGER: And continue to play?
MR. ABERNATHY: And they continue to play that role, they certainly do in a variety of ways. And I think it’s interesting the way the different pieces work together. You have, by and large, Fannie and Freddie that are focusing on what you might call standardized, cookie-cutter types of loans, which is what you need to do in order to securitize them. The Federal Home Loan Banks play a very important role in providing liquidity for conforming as well as non-conforming loans. A member of a Federal Home Loan Bank can use these assets as collateral to get funds from a Federal Home Loan Bank to take care of any liquidity needs that institution may have, and thereby make that bank or thrift or credit union more likely to engage in that kind of investment.
MR. PFLIEGER: What is Treasury’s view of the wide range of federal policies that support a strong housing delivery system — everything from the mortgage interest deduction, to the low-income housing tax credit, to housing’s share of the federal budget, to the government’s support of the housing GSEs?
MR. ABERNATHY: As I mentioned before, the Bush Administration has made increased homeownership a top priority, and has proposed numerous ways to make this dream a reality for more American families. Secretary Snow shares the President’s strong commitment to housing and believes that the housing sector is a crucial component of our economy. Housing is making a tremendous contribution to the current economic recovery.
It certainly is no secret that this Administration is a strong supporter of the mortgage interest rate deduction. That has been a key element, a key piece of our tax code for a long period of time and a lot of people rely upon it. It allows a lot of people to get into homes earlier than they otherwise might, and to able to free up the funds they need in order to make their monthly payments.
With regard to a number of the other pieces that are designed to help increase homeownership, President Bush proposed the American Dream Downpayment Fund in 2002, and Congress enacted it a few days ago. This program will help low-income Americans overcome what is sometimes the number-one obstacle to buying a new home — amassing the money for the downpayment. A lot of people are making rent payments that are the same or more than what a mortgage payment would be and they would love to own their own home, but they can’t put together the downpayment. They’re paying all their money in rent. They can’t put aside enough money in savings for a downpayment, but they have demonstrated the ability to make a regular monthly payment, they just do it in rent. If they can find help to get that downpayment in place, they could turn that rent into equity and homeownership. The Administration estimates that this new program will help approximately 40,000 families a year with their downpayment and closing costs.
MR. CROWE: Can you elaborate on the Administration’s homeownership goals?
MR. ABERNATHY: President Bush has set very aggressive housing goals. In June 2002, he announced that he was setting a new minority homeownership goal of at least 5.5 million new minority home owners by the end of the decade. But even though homeownership levels are higher than they have ever been before, the President is still not satisfied. He has recognized that there are still segments of the population that are below the overall national level of homeownership that we can reach with various types of assistance. That’s why this Administration has put forth numerous programs to help serve minority populations in particular. Sometimes it’s just outreach. You get folks and help them understand that homeownership is within their reach, but they just don’t have the knowledge or the understanding to put together all the different pieces. So there’s a lot of outreach being done to show them just what the steps are.
I think that the proposal that the Department of Housing and Urban Development is looking at to try to simplify RESPA and all of the processes involved with settlement are excellent ideas to try to make that whole process — which can be very bewildering to people — a lot simpler and more understandable. People hear these horror stories about home buyers going into settlement and having surprises, and they are never pleasant surprises; they’re always unpleasant. If people knew before they walked into that settlement room what their expenses were going to be, you would be taking away one of the additional obstacles to homeownership today.
MR. CROWE: Looking at the Administration’s goal to increase homeownership rates among minorities, would Treasury be willing to support federal initiatives designed to address the problems you just mentioned and expand homeownership opportunities?
MR. ABERNATHY: President Bush and this Administration are committed to helping more Americans, especially communities that have been traditionally underserved, such as minority Americans, own their own homes. In addition to the housing programs which the President has put forth that I have already mentioned, part of the package that Secretaries Snow and Martinez have proposed to Congress would give HUD additional resources to enforce the various housing goals, and part of that is to break the housing goals into some segments. This would help us achieve not just the overall goal of increasing homeownership among all Americans, but also concentrate on the sub-goals that focus on increasing levels of homeownership among various minorities.
With regard to innovation that helps us reach those goals, one of our concerns is that the GSEs, as they grow, continue to stay focused on their mission, which is to expand the envelope of people who can get their homes, who can buy homes, who can purchase homes and not that the GSEs go experimenting in other things that may have only a tangential connection to homeownership.
MR. PFLIEGER: Do you believe that the GSEs have gone beyond their mission?
MR. ABERNATHY: I don’t know if they have or not. That’s something that the supervisor would need to be able to look at. We want to make sure the supervisor has full authority to be able to look at that, so if they see a proposal that somebody wants to put forth, the supervisor needs to be able to say, “Well, that might be a very interesting proposal and it might increase the financial resources of the entity, but it doesn’t have a whole lot to do with housing. We would prefer that you did your innovating on how you can find new ways to put people into homes as opposed to new ways to increase your bottom line, which may or may not have a direct bearing upon housing.”
MR. CROWE: It could be argued, however, that a profitable balance sheet also puts the GSEs in a position to expand their support for the housing market?
MR. ABERNATHY: We are all in favor of innovation. Increasing profits isn’t the sole or the primary responsibility of the GSEs, however. In fact, there may be situations where the GSEs should be obtaining a below-market return to provide additional funding to housing markets. That might not bring the full 15% return that they might be accustomed to. It might bring them only a 5% or a 10% return, but it’s still a positive return, and that’s the kind of market that Congress said they ought to be involved in.
MR. PFLIEGER: You have been quoted in the media recently questioning the financial condition of Fannie Mae and Freddie Mac, and, let me quote you directly,“we really don’t know what’s going on.” Do you believe that taxpayers face an imminent threat?
MR. ABERNATHY: No, I don’t think they pose an imminent threat. I think if there were an imminent threat, there would be certain signs that we would see. But the real issue is that we need a strong, credible regulator that will be able to detect developing problems before they become major problems, and currently we don’t have the kind of regulator or the kind of disclosure from the GSEs that would allows us to do that.
For example, Freddie has yet to live up to its commitment to register under the 1934 Securities Exchange Act, and they said that they most likely will not do so until 2005. They have finally put forward their annual report, but they said they aren’t going to give any quarterly data for 2003 until at the earliest June of 2004. I can’t imagine that investors are well served by a major corporation like Freddie Mac conducting business that way. While Fannie Mae was able to register under the 1934 act almost a year ago, Freddie has not, and until Freddie does that, there are important elements of disclosure that are not available, and so our ability to catch problems early on is compromised.
MR. CROWE: Would you say that’s a major concern?
MR. ABERNATHY: I am concerned that there could be significant problems developing, and the current level of disclosure does not allow regulators to catch those problems before they become disruptive to the role the GSEs play in the housing markets and the financial system. This is a further reason that we need a new, strong and credible regulator.
MR. PFLIEGER: Isn’t that OFHEO’s job right now?
MR. ABERNATHY: I think it is, but OFHEO, doing the best they can with what they have, were still caught by surprise when Freddie had its accounting problems. I think that suggests that over time, in spite of the people at OFEHO doing the best they can, they just do not have the resources, focus, stature and authority to do the job that needs to be done.
MR. CROWE: Do the GSEs pose an imminent threat?
MR. ABERNATHY: No, I have no reason to believe that is the case, but that being said, we don’t have the same disclosure for those corporations as we do for other corporations in America, and certainly not the world-class disclosure rules required for financial institutions. In fact, if you look at corporations in America, the level of disclosure we have for financial corporations is even greater than what we have for corporations in general. The reason why you need that is because, as we saw — as we have seen in many financial institutions that have melted down in the last 20 years or so — when they go bad, they can go bad very quickly just because of the nature of financial institutions. Money is so fungible and it moves so quickly, and because confidence is such an important part of the health of any financial institution, that’s why, perhaps more than a corporation that’s in the manufacturing business, we need to be able to have the confidence that they’re operating in a safe and sound manner early on.
MR. PFLIEGER: That leads me to another question. Wall Street doesn’t seem to have expressed any lack of confidence in the GSEs. It seems, though, that you have lost confidence in them.
MR. ABERNATHY: I would say that we are concerned that the level of supervision and disclosure is not adequate, and we believe that the housing finance markets will be better served if there is a new, credible regulator.
I believe that the market has responded to the problems at Freddie differently and perhaps not as severely as if similar problems had been uncovered at a non-GSE. That may be due to the fact that many market participants believe that the federal government would step in if one of the GSEs were to default, even though the bonds state on their face that they are not guaranteed by the federal government.
MR. CROWE: Do you think that’s what’s supporting the stock prices of Fannie and Freddie?
MR. ABERNATHY: I don’t know if it affects their stock prices as much as it affects their bond prices. Their cost of funds certainly benefits from that assumption. Their stock prices, I think, have been influenced to some degree. If you compare Freddie’s stock prices with Fannie’s, there is a very significant difference in terms of the price-to-earnings ratio. I think Freddie’s is about half of what Fannie’s is in terms of price-to-earnings ratio, reflecting at least some unease, some disquiet, about Freddie’s condition.
MR. PFLIEGER: During a Senate Banking Committee hearing on Sept. 23, Senator Sarbanes asked all the panelists to express their views on the idea of privatizing the GSEs. Let me ask you the same question. Does the Treasury Department — the Administration — support privatizing the GSEs?
MR. ABERNATHY: We don’t have any plans to promote privatization. We’re not supporting any proposals for privatization. That has not been on our agenda or even in any of our discussions.
MR. CROWE: What about the line of credit extended to Fannie and Freddie?
MR. ABERNATHY: The discussion that we have been engaged in and our focus over the last several months have been on establishing the appropriate supervision for Fannie and Freddie. We’ve been focusing on getting the right regulatory structure. But let me just point out that, with regard to a line of credit, you have to understand that it is not really a line of credit, but rather the opportunity — the authority that the Treasury has to purchase the securities of Fannie and Freddie.
But we have also said on multiple occasions that if Congress wants to look at other issues and would like us to engage in discussion with them, we will do that. But the discussions that we have initiated and our focus are on getting the regulatory system right.
MR. CROWE: But opening that door does suggest you might be amenable to it.
MR. ABERNATHY: It means if Congress wants to open the door we will have that conversation, and then we will have to decide what kind of policy we have on it. We have not taken a policy position on it nor have we had a policy discussion about whether that is a good idea or a bad idea. But if Congress thinks that there is merit to it and wants us to engage in that, then we will engage in a policymaking process and see if we have a view on it.
MR. PFLIEGER: Have you encouraged Congress?
MR. ABERNATHY: In that regard, no. I think if you look carefully at what Secretary Snow said when he testified before the House and I think re-echoed when he testified before the Senate, he emphasized that the most important thing we need to do is get the regulatory system right, and that’s what our main focus has been. But again, if Congress wants to deal with this issue or others, we’re certainly open to engage in that conversation.
MR. CROWE: Let’s shift to a discussion about who should regulate the GSEs. Recently, there’s been speculation in the press and elsewhere about appointing a totally independent regulator. And you have stated previously that Treasury’s first priority is setting up a solid, world-class regulator for the GSEs. What are the characteristics of a truly independent regulator that you would feel comfortable with? Is this a point where the housing community can find some common ground and reach a compromise?
MR. ABERNATHY: What’s most important is that we get the details of the regulator right. The supervisor has to have all the authorities that are needed to carry out its job. That includes full authority over both elements of capital, with minimum capital and risk-based capital. It includes authority over all of the elements of prudential supervision, including authority over new activities. And it includes having an independent source of funding. It includes being able to go to the courts on its own dime, on its own ticket, without having to solicit permission to do that from the Justice Department.
Then people want to get into the question of where to put that entity. We have made it clear that if you want to put it in Treasury, there are certain requirements that need to be met, but that’s only if people want to place that entity into Treasury.
MR. CROWE: Those are the only conditions for an independent regulator?
MR. ABERNATHY: Well, again, the Administration has consistently said that there are certain elements that are essential to an effective, prudential regulator. Secretary Snow outlined those elements in his testimony before the House of Representatives Financial Services Committee in September. The Administration’s requirements for this new regulator are drawn from the powers and authorities that other world-class regulators have in this country and elsewhere.
MR. CROWE: And you said new program activity?
MR. ABERNATHY: Yes, we believe the new regulator must have authority over new activities.
MR. PFLIEGER: You’ve reportedly taken the position that new program authority for the GSEs should be placed under the new regulator, that it cannot remain at HUD and that that position is non negotiable. Is that correct?
MR. ABERNATHY: One of the essential elements of an effective regulator is the ability to approve new activities, not just new programs. You cannot point to an effective, world-class regulator of financial services that doesn’t have that authority.
MR. CROWE: The regulator’s ability to essentially veto a program on financial safety and soundness grounds is not sufficient?
MR. ABERNATHY: It’s not just safety and soundness. There are other elements that tie into it. There are a whole variety of risks that financial regulators look at when they’re looking at the activities of the institutions they are regulating. There are certainly the safety and soundness issues with regard to the financial aspects, but there’s also reputational risk, there are legal risks that they look at, there are management risks. Does this institution have the ability to manage these activities and how do these activities interact with the other activities of the institution? Do they have appropriate ability to understand all the aspects of the activity and where it might lead? All of those things need to be taken into account and looked at.
It’s done in a very effective way with those agencies that have that power, and it’s done in a way that doesn’t slow down the ability to bring to market new products. If you look at America’s banks today, they are the world innovators. When it comes to financial services, it’s the United States that develops the new financial services, and they do it within a system where the bank regulators have authority over those new products.
MR. CROWE: Could you see this independent regulator — independent of Treasury —operate as a “board,” with equal standing between HUD and Treasury?
MR. ABERNATHY: As you know, the type of regulator, whether it is within the Treasury Department or a separate agency entirely, is still an issue that Congress is examining.
MR. PFLIEGER: As part of this discussion over how the new regulator is set up, is there an opportunity for industry to participate?
MR. ABERNATHY: There is, particularly for those who are the users and beneficiaries of Fannie’s and Freddie’s products.
MR. PFLIEGER: Like the home builders.
MR. ABERNATHY: Yes, like the home builders, like home buyers and people who supply other aspects of that, the financial institutions that originate the mortgages; all of those need to be looked at.
I think there need to be some conversations with Fannie and Freddie, but keep in mind that these institutions were created by Congress to serve certain purposes of Congress. Therefore, Congress, the government, will play the major role, because these are government-sponsored enterprises, and the government ought to have the significant say in how they’re going to be supervised. And so, while they ought to be consulted with, I don’t think their views ought to determine what the final product is.
MR. PFLIEGER: So you might see a role for the housing industry in that dialogue. Again, I don’t want to put words in your mouth, but in the event that there is a discussion about creating an outside agency board to regulate the GSEs, you see a role for the housing industry to have a seat at the table for those discussions.
MR. ABERNATHY: I think whatever we do with regard to GSE supervision that that process ought to include a discussion with those who rely upon the services of the GSEs to make sure that what we’re creating is going to be able to meet their needs. And as I say, that includes the people who build the homes as well as the people who sell the homes as well as the people who buy the homes and the ones who finance them and originate the mortgages. I think all of those people ought to be involved in that process to make sure that we’re having a system that will be robust enough to continue the great benefits we have of this wonderful financial system for housing and finance.
MR. CROWE: Fannie and Freddie both supply capital to the multifamily market as well as the single-family sector. Do you envision a major a role for Fannie Mae and Freddie Mac in facilitating the flow of capital to the multifamily market?
MR. ABERNATHY: I think in our discussion we have been talking about basically the context of single homes, but the GSEs do play an important role in the multifamily market as well. And frankly, if you include the Federal Home Loan Banks, a lot of that money also goes into providing rental homes, and that’s important as well. There are a number of people for whom, for whatever reason, their best option is a rental home, and we don’t want that segment of the housing market to be neglected either.
MR. PFLIEGER: You have stated a preference for regulating the Federal Home Loan Banks under the same regulatory umbrella being proposed for Fannie and Freddie. Does this make sense given the significant differences in the structure and operation of Fannie Mae and Freddie Mac versus the Federal Home Loan Banks?
MR. ABERNATHY: They are different. They’re similar in the markets that they serve, but I think they’re complementary in many ways as well.
But I think you can accommodate supervision of Fannie and Freddie and the Federal Home Loan Banks in the same agency, provided you have two divisions within that agency. There is some area for overlap, but there are also separate structures. You have 12 institutions that are cooperative in nature. They are created as mutuals, mutual institutions in essence, in effect. And then you have two that are for-profit entities, and they have different structures and different market forces that affect what they do.
There’s also a good deal of overlap. Certainly in the backroom operations, making sure you have your legal team, your financial analysts, your accounting staff and your examination staff. You could have that same set of staff to provide you the kind of resources you need, whether you’re looking at the Federal Home Loan Banks or Fannie or Freddie. In fact, one of the benefits of putting them together in one institution is you would address one of the problems you have with examination staff for Fannie and Freddie today. If you’re a career examiner at OFHEO, your whole career you’re going to look at either Fannie or Freddie, and it’s hard to discover what best practices might be.
The examination process is a give and take. The examiners are on the one hand coming in with a jaundiced eye, with a critical eye to see what can be improved, but they’re also learning. They’re learning about the good practices underway in one place that they can then carry to the next institution they look at. That happens in the banking world all the time. When you’re dealing with Fannie and Freddie, they are so much alike it’s hard to bring anything new to one or the other. But if your examiners are examining Fannie Mae this year, and next year they’re looking at the Federal Home Loan Bank of San Francisco, there may be some good lessons that they can learn from those different reviews that they can benefit each of them.
MR. PFLIEGER: One reason you have given for having new GSE programs approved by the safety and soundness regulator is to eliminate the bifurcation of Fannie and Freddie’s oversight by HUD and OFHEO. But under your proposal, HUD would still continue to establish and enforce Fannie and Freddie’s affordable housing rules. Doesn’t this also represent a bifurcation of mission oversight if new program approval powers are moved to a different regulatory entity? Why are you concerned about bifurcation in one case but not in the other?
MR. ABERNATHY: The best place for housing goals to be set and monitored is with the experts at HUD. The goal setting is not part of the supervisory process. But, while Fannie, Freddie and the Federal Home Loan Banks help us meet those goals, they are ultimately financial institutions. The new supervisor should have all the powers necessary to be a world class financial regulator, including new activity approval.
The benefit in keeping goal setting and new activity approval somewhat separate is that HUD can look at those goals without being subject to the day-to-day supervisory responsibilities and concerns and worries. HUD can focus on what the housing market needs, and whether or not the GSEs need to stretch a little bit to meet these goals. The supervisor will look and say, “Go ahead and stretch, but as you’re stretching we’re going to make sure you’re not snapping. My job is to make sure you don’t snap and that you stay focused.”
HUD sets the target, the supervisor looks at it to see whether or not the bow you were using is a good bow, whether your arrows are straight. But let HUD set the target.
MR. PFLIEGER: Let me conclude by thanking you for participating in this interview. Before closing, are there any other points you would like to leave with NAHB’s 215,000 members?
MR. ABERNATHY: Well, perhaps — and the only thing I would add that we haven’t covered here yet is our view that the need for having a good, effective supervisor is not going to go away. The need is probably going to increase, the mission responsibility that they have is so important that we can’t allow ourselves to get by much longer with inadequate supervision of these housing GSEs. We have to make sure that they’re safe today and that they will be safe tomorrow to be able to continue their mission.
To read an accompanying interview with NAHB Executive Vice President Jerry Howard, click here.
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