WASHINGTON — Federal Housing Finance Agency Director Mel Watt appears poised for a showdown with Congress over how to handle Fannie Mae and Freddie Mac’s dwindling capital buffers.

During testimony before the Senate Banking Committee on Thursday, Watt warned that to prevent a potential draw on the Treasury Department by the government-sponsored enterprises, he is willing to act unilaterally to rebuild capital at Fannie and Freddie.

Watt said that he would prefer to come to an agreement with the Treasury to change the current arrangement, under which all GSE profits are swept to the Treasury, but that he did not feel bound by doing so.

“There are ways to address this" by making "minor adjustments to the” arrangement, but “if the two parties can’t advance, then I may have to dance by myself," Watt said. "That is not a pleasant position to be in, and it may not be pretty.”

Mel Watt
“I want to make unequivocally is that it is the role of Congress, not FHFA, to make the decisions that chart the path out of conservatorship and to the future housing finance system,” said FHFA Director Mel Watt. Image: Bloomberg

But Republican lawmakers strongly objected to such a move, arguing that it gets ahead of policymakers' attempt to chart a new course for the housing finance system.

“The administration is working with us, working with others to move ahead on reform, but all of a sudden a unilateral step by you. … It just creates a different direction, which sends a signal to the world that something different is occurring when it's not,” said Sen. Bob Corker, R-Tenn. “The two entities have $258 billion worth of capital available to them. … This whole notion of them running out of resources is just a baseless issue.”

Under the current Treasury-FHFA arrangement, the GSEs are banned from rebuilding capital and are expected to run out by the end of the next year. If that happens, Watt said, any losses would force the GSEs to draw from their line of credit, potentially provoking a crisis in the mortgage market. Such a scenario could be triggered by, among other things, a reduction in the corporate tax rate, which would force the GSEs to take a one-time accounting adjustment, Watt said.

The FHFA has a duty to prevent a possible crisis, Watt said.

“It won't be you [Congress] that [the GSEs] come to and talk to about it, it will be the conservator because we are the responsible parties for this during conservatorship,” he said.

But Corker challenged Watt’s assumption that a Treasury draw would be perceived negatively by the market. During a testy exchange, Corker dared Watt to invoke the line of credit now as a test.

“Why don't you go ahead and draw $10 billion on it right now and see? I'm telling you it's going to have no effect,” Corker said.

Watt, meanwhile, urged lawmakers not to interfere in negotiations to allow Fannie and Freddie to build more operating capital.

“The problem is that if the committee sends to the secretary of the Treasury the message that this is a no-no to have those discussions or try to resolve this in a coordinated way, then it leaves us … to have to unilaterally deal with it, which is something I would prefer not to do,” said Watt, who added that discussions with the Treasury have already started.

But Senate Banking Committee Chairman Mike Crapo, R-Idaho, said Watt should not act on his own to change the arrangement with the Treasury, even asking for clarification on the FHFA's legal power to do so.

Wouldn’t “adjusting those agreements also create unease?” Crapo said.

Watt reiterated that “the better solution to this would be a joint solution,” but said acting unilaterally would not cause a problem if it were done to “address a short-term-loss situation.”

During the hearing, Watt acknowledged that one reason for the capital reduction at the GSEs is to provide an incentive for Congress to pass housing finance reform. The government seized the GSEs in 2008, but lawmakers have struggled ever since to decide what to do with them. The Treasury sweep agreement was widely viewed as giving Congress a deadline to act before the GSEs ran out of capital and needed to turn to taxpayers for help.

Watt said he hopes Congress will act quickly on reform.

“It is the role of Congress, not FHFA, to make the decisions that chart the path out of conservatorship and to the future housing finance system,” Watt said.

He later added that a move to change the sweep arrangement should not be seen as an effort to recapitalize Fannie and Freddie for purposes of releasing them from conservatorship.

While some investor groups saw Watt’s remarks that way, observers said they shouldn’t be viewed in that light.

“The FHFA director is describing a very different scenario in which the GSEs keep a small capital buffer to ensure accounting losses in one quarter do not require a draw,” wrote Jaret Seiberg, an analyst with the Cowen Washington Research Group.

During the hearing, Democrats also repeatedly brought up the availability of the 30-year fixed-rate mortgage, which has become a staple product that most consumers rely on.
“Do you think it's possible to have the 30-year note without an explicit government guarantee?” asked Sen. Jon Tester, D-Idaho.

Watt, who was also asked the same question by other Democrats on the panel declined, to give a direct answer but said, “Let me put it like this: I have read a number of experts in this area who do not believe it would be possible to do.”

Housing finance reform appears to be a top priority for the panel in this Congress. In his opening questions, Crapo said he believed a bipartisan deal was possible. He was seconded by other lawmakers.

“There's sort of a lefty think tank and a righty think tank and some in the middle folks that appear to be coming together around some conclusions," Corker said. "And my sense is that — that the chairman and ranking member wish to take that up in the near future.”

Crapo also noted that the same panel was able to pass a housing finance reform bill three years ago.

“Three years ago, seven Republicans and six Democrats on this Committee voted in support of a comprehensive housing finance reform bill,” Crapo said.

Twelve of the 23 panel members were a part of those discussions and three Democrats and three Republicans who voted for the bill that passed on the panel are still on the committee.

However, Sen. Charles Schumer, D-N.Y., who was on the committee at the time and is now the Senate minority leader, voted against the bill, as did the influential Sen. Elizabeth Warren, D-Mass., and the top Democrat on the panel, Sen. Sherrod Brown of Ohio.

Sens. Richard Shelby, R-Ala., and Pat Toomey, R-Pa., also voted against the bill and are still panel members.

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