WASHINGTON — The top regulator for Fannie Mae and Freddie Mac signaled Tuesday that he was not prepared for the government-sponsored enterprises to continue to lose their capital cushion, calling the current situation “irresponsible.”

Though Federal Housing Finance Agency Director Mel Watt stopped short of saying he would break with a Treasury agreement that forces all profits of the firms to go to the government, he emphasized that it couldn’t continue indefinitely.

“We need a buffer because any business to operate effectively needs to have some capital cushion for things that could go wrong or things that really, in our case … fluctuations that take place,” Watt told lawmakers at a House Financial Services Committee hearing.

FHFA Director Mel Watt.
“A capital buffer, that is all I ever talked about,” said FHFA Director Mel Watt, rejecting plans to fully recapitalize Fannie Mae and Freddie Mac. Bloomberg News

He also warned that a draw on the government-sponsored enterprises’ line of credit would erode investor confidence.

“This could stifle liquidity in the mortgage-backed securities market and could increase the cost of mortgage credit for borrowers,” Watt said.

Under a 2012 agreement with Treasury, Fannie and Freddie must transfer quarterly dividends to the U.S. Treasury in an effort to stoke housing finance reform discussions on Capitol Hill. Those dividends have continued to deplete the capital the two mortgage companies' hold against potential losses, but will be completely depleted if Watt makes another transfer at the end of the year.

Watt told the Senate Banking Committee in May that he believed he had the unilateral authority to stop making the dividend transfer, but that he would rather reach an agreement with Treasury Secretary Steven Mnuchin.

“I believe we have the authority to” not make the payment, Watt said on Tuesday. “But at the same time, we are under a contractual arrangement with the Department of Treasury and my strong preference would be to work through this in coordination with the secretary of the Treasury. And we have been having some constructive conversations that will hopefully lead us to that conclusion.”

Mnuchin hasn’t elaborated on the progress of those conversations, but has said he expects Watt to deliver the next dividend in December.

Watt wouldn’t say whether he and Mnuchin had come to an agreement on how to handle the December payment, but his characterization of those discussions as “constructive” suggested that they were further along than when he testified in the Senate.

While Fannie and Freddie will be devoid of capital by 2018, they would still be able to draw on a $258 billion line of credit that Treasury pledged to Fannie and Freddie after they were put into conservatorship in 2010.

Some lawmakers have pushed back on the notion that Fannie and Freddie need to retain capital because of the line of credit. They fear that retaining capital could lead to full recapitalization before Congress passes legislation to overhaul the housing finance system.

“What is the difference between rebuilding capital and capital buffer?” said Rep. French Hill, R-Ark. “You have the full faith and credit of the United States and over $200 billion standing behind Fannie Mae and Freddie Mac.”

Watt maintained that he wanted some sort of operating capital and has no intention of recapitalizing the two companies.

“A capital buffer, that is all I ever talked about,” he said.

However, the director elaborated on what sort of buffer would be appropriate if the two mortgage companies were not in conservatorship.

Fannie and Freddie would almost certainly be considered systemically important financial institutions and subject to prudential regulation by the Federal Reserve Board if they wre freed of government control.

“They certainly would qualify as SIFIs if they were not in conservatorship,” Watt said. “I think the range of 2-3% of $5 trillion would be the capital requirements,” which would amount to $100 to $150 billion.

During the hearing, Watt declined to weigh in on how Congress should move forward with housing finance reform even though lawmakers asked for input.

“My personal views I left behind when I became the director of FHFA,” said Watt, a former Democratic congressman. “The FHFA has no views on which of these bills is more preferable.”

That position elicited some frustration from lawmakers, who said it is hard to chart a course forward without active participation from the agency and the Trump administration.

“We need leadership from your position and either with the Jack Lew Treasury or the Mnuchin Treasury to submit concrete reviews, react to proposals from Congress and move on with this,” Hill said.

The top Democrat on the panel, Rep. Maxine Waters of California, blamed the lack of reform on the Republican-controlled Congress.

“Unfortunately, for the last seven years under Republican control, the House has entirely failed to advance broader legislative reforms to end the GSEs’ conservatorship,” she said. “In fact, this committee has not convened a single hearing since Director Watt’s last appearance before us more than two and half years ago on any topic related to reforming the GSEs.”

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