[Senate Hearing 112-408]
[From the U.S. Government Publishing Office]
S. Hrg. 112-408
OVERSIGHT OF THE FEDERAL HOUSING FINANCE AGENCY
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING THE OVERSIGHT OF THE FEDERAL HOUSING FINANCE AGENCY
__________
NOVEMBER 15 AND DECEMBER 13, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Charles Yi, Chief Counsel
Erin Barry Fuher, Professional Staff Member
Beth Cooper, Professional Staff Member
William Fields, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Dana Wade, Republican Professional Staff Member
Chad Davis, Republican Professional Staff Member
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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TUESDAY, NOVEMBER 15, 2011
Page
Opening statement of Chairman Johnson............................ 1
Prepared statement........................................... 26
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Menendez............................................. 4
WITNESS
Edward J. DeMarco, Acting Director, Federal Housing Finance
Agency......................................................... 5
Prepared statement........................................... 26
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TUESDAY, DECEMBER 13, 2011
Page
Opening statement of Chairman Johnson............................ 39
Prepared statement........................................... 54
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 40
WITNESS
Steve A. Linick, Inspector General, Federal Housing Finance
Agency......................................................... 42
Prepared statement........................................... 54
(iii)
OVERSIGHT OF THE FEDERAL HOUSING FINANCE AGENCY--PART I
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TUESDAY, NOVEMBER 15, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I call this hearing to order.
I would like to thank Mr. DeMarco for being here today.
As I mentioned at our hearing on November 3, we have been
planning to hold an FHFA oversight hearing and am pleased it
was able to come together so quickly.
As Ranking Member Shelby and others have so accurately
noted during the consideration of the Housing and Economic
Recovery Act in 2008, one of the most important aspects of the
bill was the establishment of the Federal Housing Finance
Agency as an independent regulator. This ensures that it can
operate without undue political interference and that the
appropriations process cannot be used to hold the regulator
hostage. With this independence, the Banking Committee must
exercise Congressional oversight to ensure that the agency is
balancing its attention among the entities it regulates and the
role as conservator of Fannie Mae and Freddie Mac.
To give the Committee and the public greater confidence in
the new regulator, HERA also established the FHFA Office of the
Inspector General to investigate potential concerns and ensure
transparency of the regulator's operations. I plan to invite
Inspector General Linick before the Committee at a date to be
determined. It is only appropriate that we should hear from
him, as well. The Inspector General's role is even more
important while FHFA is acting as both conservator and
regulator.
It is important for this Committee to understand how FHFA
evaluates new opportunities and programs at Fannie Mae and
Freddie Mac during the conservatorship, including the decision
to allow them to participate in certain Making Home Affordable
programs and the decision not to participate in or initiate
other programs.
The internal operations at FHFA are also important, as
staffing of the regulator will affect its oversight of the
GSEs. Oversight of executive compensation structures and
evaluations of executive performance goals both require the
regulator's attention. FHFA must have proper management of
operational risks as well as secure and updated information
systems and privacy policies. I am concerned about recent
reports that show problems in each of thee areas and that FHFA
does not have adequate certified staff to perform examinations
of the entities under its supervision.
FHFA is tasked with regulating two of the largest entities
in the mortgage market, Fannie Mae and Freddie Mac, which
together backstop about $5 trillion in mortgages and help
support nearly $11 trillion in the U.S. mortgage market.
Unfortunately, that market is now supported by $170 billion in
assistance from the taxpayers. As we have heard from other
witnesses before this Committee, the mortgage market would be
even worse off than it is today if they had not been placed
under conservatorship during the Bush administration. But as we
have said over and over again, we need to find ways to end the
need for future support without destabilizing the housing
market further.
Finding a path out of conservatorship is a task for both
the FHFA and the Committee. I would like to thank Senator
Shelby and his staff for working so closely with me and my
staff in laying out the hearings the Committee has held so far
this year. I hope we can continue to work together to do our
homework and create a sustainable system for the housing market
going forward that can protect taxpayers and spur economic
growth.
An adequately staffed and engaged regulator is a key
component to a stable housing market. Mr. DeMarco, I look
forward to hearing about the steps you have taken as Acting
Director of FHFA since the last time you were before the
Committee.
With that, I turn to Senator Shelby for his opening
statement.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman. Thank you for
calling this hearing.
Today, the Committee will hear from the Federal Housing
Finance Acting Director Ed DeMarco, as the Chairman has
indicated. The FHFA is the regulator of Fannie Mae, Freddie
Mac, and the Federal Home Loan Banks. Since 2008, the FHFA has
served as the conservator for Fannie and Freddie. It has been
more than 2 years since this Committee has heard from Director
DeMarco on the conservatorships of Fannie and Freddie and the
future of the GSEs. Since then, the taxpayer has lost an
additional $84.1 billion, bringing the total cost of these
conservatorships to $169 billion. Worse yet, Fannie and Freddie
have already stated that they will need another $14 billion for
last quarter's losses.
These conservatorships were never intended to last for 3
years, yet because Congress has failed to address the future of
GSEs, the conservatorships go on with no end in sight. This has
cast a cloud of regulatory uncertainty over our mortgage market
while taxpayers have had to continue to inject money into
Fannie and Freddie to keep them afloat.
If at any point during the last 3 years the administration
and the majority party had done more than talk about the need
for reform, we might be looking at a very different picture in
the housing market. If Congress had acted, Fannie and Freddie
could have been prevented from crowding out the private sector
by backing 71 percent of mortgage originations. If Congress had
acted, a comprehensive solution could have been devised to deal
with foreclosures and struggling homeowners. If Congress had
acted, taxpayers would not be subsidizing the pay of Fannie and
Freddie executives. Instead, there has been no action, despite
the fact that the GSEs were a significant player in the
financial crisis.
In calling for this hearing, the Chairman has focused on
the over $12 million in bonuses paid to senior officers at
Fannie and Freddie. I hope today that Director DeMarco will
tell us exactly how these compensation packages were designed
and which officials were involved and why. The American
taxpayers should not have to subsidize million dollar
compensation packages for Fannie and Freddie executives. This
is just another example of the flawed structure of the GSEs.
Their public-private structure has always meant that taxpayers
were effectively subsidizing the pay of their CEOs. This is one
of the many reasons I have long advocated reforming the GSEs.
Mr. Chairman, last week here, I asked that a representative
of the Department of the Treasury be present at today's
hearing. I am disappointed that Secretary Geithner or his
representatives were not asked to participate. The U.S.
Treasury Department played an important role in creating the
bonus structure in question. The Treasury and the FHFA are both
parties to the preferred stock purchase agreement, which is the
contract that governs how the U.S. taxpayer will support Fannie
Mae and Freddie Mac.
Section 510 of that contract requires that the Federal
Housing Finance Agency consult--this is important--consult with
the Treasury Secretary before allowing Fannie and Freddie to
enter into any new compensation arrangements. I understand that
Treasury was actively consulted by the Federal Housing Finance
Agency on these compensation arrangements and never disapproved
them.
Furthermore, while the Treasury Secretary has no authority
to direct the Federal Housing Finance Agency in matters
involving conservatorship, the purchase agreement prevents the
FHFA from taking a variety of actions without, quote, ``the
prior written consent of the Treasury Department.'' These
matters include permitting Fannie and Freddie to issue stock,
transfer assets, and incur certain indebtedness. Given the
ability to veto and these other actions, the Treasury
Secretary, I believe, has a lot of authority in matters dealing
with the conservatorship.
Finally, the administration has been actively involved with
the Federal Housing Finance Agency in making changes to the
Home Affordable Refinance Program. The President stated that
he, quote, ``directed his economic team to work with the
Federal Housing Finance Agency'' in the lead-up to the recently
announced changes and has referred to executive actions he took
in this matter. These changes to HARP could have a significant
impact on the financial health of GSEs and could impact housing
finance reform.
Accordingly, if the Treasury Secretary were here today, we
could have had a discussion on the future of Fannie and Freddie
that included the two officials with the most knowledge and
responsibility for the GSEs. Apparently, that discussion, Mr.
Chairman, will have to wait for another day.
Thank you.
Chairman Johnson. Thank you, Senator Shelby.
Are there any other Members who wish to make a brief
opening statement?
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman. I, just briefly,
I want to thank you first for holding this hearing. I think it
is overdue and an important one. There are a lot of issues to
explore in getting our housing market moving again, so many
that it is difficult to know where to begin.
Let me just say, first, that I applaud the FHFA's recent
initiative to remove barriers to help underwater homeowners
refinance, and I think that is a step in the right direction.
The problem is that it is a bright spot in what I believe has
otherwise been a dismal lack of initiative at the FHFA in
taking aggressive steps that could get the housing market
moving again.
Congressional intent for the conservatorship is to save
taxpayers money, but it is clear that taxpayers will do much
better with a housing market that is functioning again and the
resulting economic boom that will be derived from that, and I
believe that that can be done without sacrificing taxpayers'
interests because Fannie and Freddie's financial health is
directly tied to how quickly the housing market recovers.
So I look forward to discussing the many ways in which we
can do that, including principal reduction, converting vacant
and foreclosed properties to rental in certain areas, and
better outreach to borrowers, among others, as a way in which
we both get this housing market moving and improve the status
of taxpayers that right now are the focus of the
conservatorship's efforts, but in my mind, we are just not
doing what is necessary to enhance their position at the end of
the day.
Thank you, Mr. Chairman.
Chairman Johnson. I thank the Ranking Member for his
comments, but would note that this hearing is an oversight
hearing of the Federal Housing Finance Agency. As the Ranking
Member has stressed during the consideration of the Housing and
Economic Recovery Act which created the FHFA, it is an
independent regulator. Recognizing that independent role, I
invited the Acting Director, Mr. Ed DeMarco, to testify before
the Committee regarding the responsibilities of FHFA.
As my staff discussed with your staff 2 weeks ago, the
minority is permitted to invite a witness. As has been the
traditional practice of the Committee, your staff invites that
witness and my staff sends a confirmation letter with
procedural details. Nothing has prevented you from doing that.
Alternatively, a representative from the Treasury Department
will be before the Committee next month and Members can ask
questions regarding the consultative role at that point.
Are there any other questions?
Thank you all. I want to remind my colleagues that the
record will be open for the next 7 days for opening statements
and for any other materials you would like to submit.
Now, I would like to briefly introduce our witness here
today. Mr. Ed DeMarco is the Acting Director of the Federal
Housing Finance Agency and is no stranger to this Committee.
Mr. DeMarco has served as Acting Director since 2009, having
previously served as Deputy Director and Chief Operating
Officer at OFHEO, the former regulator of both Fannie Mae and
Freddie Mac.
We welcome you here today, Mr. DeMarco, and thank you for
your time. Mr. DeMarco, you may proceed with your testimony.
STATEMENT OF EDWARD J. DeMARCO, ACTING DIRECTOR, FEDERAL
HOUSING FINANCE AGENCY
Mr. DeMarco. Thank you, Chairman Johnson. Good morning,
everyone. Chairman Johnson, Ranking Member Shelby, Members of
the Committee, I am pleased to be here today.
My written statement provides updates on a range of topics
regarding FHFA's oversight of Fannie Mae and Freddie Mac, or
the Enterprises, as I will refer to them, and the Federal Home
Loan Banks. I would be pleased to discuss any of those issues
with you.
In the few minutes I have, I would like to focus on two
matters. First, Fannie Mae and Freddie Mac have been in
conservatorship for more than 3 years. The draws from the
Treasury now exceed $180 billion, reflecting losses from
mortgages originated during the years leading up to
conservatorship. Minimizing those losses as much as possible
while maximizing assistance to homeowners is a key focus of
FHFA and the Enterprises. Since conservatorship, the
Enterprises have completed more than 1.9 million foreclosure
prevention actions, including nearly one million permanent loan
modifications.
While in conservatorship, we are also seeking to ensure the
country continues to have a reliable supply of mortgage
finance. The Enterprises have guaranteed roughly three out of
four conforming mortgages since conservatorship.
While we await Congressional action in the future of
housing finance, FHFA has initiated several projects to prepare
for that future system. These are detailed in my statement and
include standards for mortgage servicing, reconsideration of
mortgage servicing compensation, and establishing loan level
disclosures for mortgage-backed securities.
Second, I recognize that there is a great deal of concern
today with executive compensation at the Enterprises. My
written statement details the background and history
surrounding the compensation program and my views about it. I
would like to make just three observations here.
First, the executives most responsible for the poor
business decisions that led the Enterprises into
conservatorship and that led to these taxpayer losses are long
gone from the companies.
Second, the best way to address concerns with executive
compensation is action by Congress to restructure the nation's
housing finance system and dissolve the conservatorships.
Conservatorship is not designed to be a multiyear holding
state.
Third, as conservator, I need to ensure that the
Enterprises have people with the skills needed to manage $5
trillion worth of mortgage assets and $1 trillion of annual new
business that the American taxpayer is supporting. Others may
believe that this sort of talent is easily and quickly hired at
compensation far below that of competing private firms, but I
do not. Bottom line: This is a question of judgment, judgment
exercised by balancing the need to limit compensation as much
as possible while ensuring stable, continuous operations at the
Enterprises in support of the country's housing finance system.
It has been FHFA's judgment that taxpayers who are
providing financial support to the Enterprises and their
guarantees on $5 trillion of mortgages would not be better off
if we provoke a rapid turnover of senior management by further
slashing compensation. Indeed, such pay cuts would increase the
risk of higher losses in the future. Executive compensation was
already reduced by 40 percent on average when the compensation
program was put into place.
I would also note that continued employment at an
Enterprise risks substantial career uncertainty. By working at
Fannie Mae or Freddie Mac, your work comes under a much higher
degree of scrutiny and criticism than exists at other private
firms. Executives who have spent a career developing their
reputations risk tarnish to their reputations under the highly
charged environment in which these companies operate today.
This is regardless of how well they perform their duties or how
great a financial sacrifice they may have made by forsaking
other private sector opportunities in order to assist the
country's housing finance system.
There has been intense criticism launched at corporate
executives not even employed by the companies when the bad
loans leading to the majority of today's losses were booked,
people who arrived after conservatorship to try and make things
better. I am trying to encourage these people to stay and
continue to mitigate losses and keep the current infrastructure
of the country's housing finance system operating.
To repeat myself on one point, the only way to finally
resolve this question is for Congress to act to end the
conservatorships and chart a new course for the country's
housing finance system, and Mr. Chairman, I certainly heard you
in your opening remarks and FHFA stands ready to work with you
and all the Members of this Committee on that very important
effort.
So with that, Mr. Chairman, thank you again for this
opportunity to be here today. I do look forward to responding
to the Committee's questions.
Chairman Johnson. Thank you for your testimony.
As we begin questions, I will ask the Clerk to put 5
minutes on the clock for each Member.
Mr. DeMarco, in August of 2009, you probably never imagined
you would still be the Acting Director 2 years later.
Mr. DeMarco. That is correct.
Chairman Johnson. Has the lack of a confirmed Director
created additional challenges for FHFA? Are there oversight
responsibilities that cannot be executed without a confirmed
Director?
Mr. DeMarco. That is a fair question, Mr. Chairman, and you
are right in your opening remarks. I did not anticipate being
Acting Director for more than 2 years. But I did not know when
I took it over how long I would be Acting Director, so from the
first day on, I have tried to lead the agency and conduct the
agency's activities without paying much mind to what the
ultimate tenure of me in this position would be.
So I do not think that it has altered or affected things
that we have done. I do think that it certainly has created
another hole in the agency, which meant I stepped up into an
acting role. I had to ask others to likewise step up. So it
created a domino effect where we did have fewer people at the
top leading the agency. I was a little slow to start filling
that under the belief that I would not be acting for very long,
but I have since changed direction on that and have created
some additional senior positions in order to fill out these
responsibilities more completely and permanently with other
senior executives at the agency.
Chairman Johnson. With several executive level vacancies to
fill at the Enterprises, how involved will FHFA be in the
hiring process? Will its involvement include negotiating
compensation?
Mr. DeMarco. So certainly for any of the senior officers,
any of the named executive officers at Fannie and Freddie that
need to be hired, we do delegate, at least below the CEO level,
to the management to initiate the recruitment process. But in
terms of the interview process, the selection, and then
ultimately the compensation for a selected individual, that is
all subject to the review and approval of FHFA. So both the
selection and then ultimately the compensation, and with the
compensation, as has been noted, we do then, after we are
comfortable with a compensation package, we consult with the
Treasury Department on it before it is finalized.
Chairman Johnson. The Preferred Stock Purchase Agreement
provides a consultative role for the Treasury Department
regarding executive compensation. Does the PSPA limit FHFA's
authority to approve or deny a compensation package? In other
words, are you forced to accept the suggestions from the TARP
Special Master?
Mr. DeMarco. We are not forced to, Mr. Chairman. It is a
consultative role and that is how it has been carried out. I
would say that, particularly back in 2009 when the compensation
structure was being developed, I believe FHFA benefited from
the consultations with Mr. Feinberg, who at the time was the
Special Pay Master, and it enhanced what we were doing in fine-
tuning that. But the ultimate decisions here remain the
responsibility of FHFA.
Chairman Johnson. You have stated that competitive
executive compensation is necessary to attract qualified
executives. Do you have evidence that higher compensation
yields better results in recruiting and retaining qualified
executives?
Mr. DeMarco. Well, I certainly think we have an entire
competitive marketplace in the financial industry that suggests
that compensation is an important factor in attracting and
retaining high-quality talent. I would also say that in our
time as conservator, we have had quite a number of senior
executives depart both companies and it has not always been
easy to fill these positions with people from the outside, and
compensation and the uncertain future of the companies are both
often cited as key reasons why potential--why candidates for
these positions end up backing out or not wanting to continue
the process further or ultimately turn us down when an offer is
made.
Chairman Johnson. On the issue of conservatorship, FHFA did
not permit the Enterprises to participate in the FHFA Short
Refinance Program. Can you describe how you came to that
conclusion and how the evaluation of the program differed from
the recent decision to expand the HARP program?
Mr. DeMarco. Certainly, Mr. Chairman. It was the judgment
of the FHFA that the Short Refi Program, and, frankly, the
principal reduction alternative in the HAMP program, did not
meet our mandate as conservator to minimize losses on these
mortgages.
With regard to the HARP program, we reached a different
conclusion and believe that the HARP program, which, in fact,
has been in place since early 2009, which we have made several
adjustments to since that time, including some larger
adjustments last month, we believe that that program is
consistent with our conservatorship responsibility and our
other statutory responsibilities to support the housing market
and maximize assistance to homeowners.
But with regard to the program you mentioned, that would
impose certain losses on the Enterprises without an opportunity
to recoup that.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you.
Mr. DeMarco, the Housing and Economic Recovery Act of 2008
requires you to, and I will quote, ``preserve and conserve the
assets and property of Fannie and Freddie,'' is that right?
Mr. DeMarco. That is correct, Senator.
Senator Shelby. Explain how you determined that the bonus
structures of Fannie and Freddie fulfilled this requirement.
You have already alluded to this.
Mr. DeMarco. Right. It essentially boiled down to this,
that we were overseeing two companies with $5 trillion worth of
mortgages----
Senator Shelby. Five trillion dollars.
Mr. DeMarco. Five trillion dollars--that these are large
companies, 10,000, 12,000 employees or more, with complex
operations, operating in global financial markets with
challenging hedging operations and credit and interest rate
risk management responsibilities.
These are specialized skills, and with the American
taxpayer backing this $5 trillion worth of mortgage guarantees,
it was our judgment that we needed to ensure we had highly
competent people coming in to operate the companies to ensure
that these losses were mitigated, that the companies run well.
Otherwise, we risked far greater losses to the American
taxpayers.
Senator Shelby. And how do you get these people? I mean,
they are in the marketplace, are they not?
Mr. DeMarco. They are, Senator, and so we are recruiting
people away from other major financial institutions to fill
these positions.
Senator Shelby. In your bonus structure, did you have
incentives for these executives to do things, or how do you
structure them?
Mr. DeMarco. We----
Senator Shelby. I know it is probably very complex.
Mr. DeMarco. Well, it is a little complex, Senator. We
modeled it after the compensation structure that was developed
for the exceptionally assisted TARP firms, although I will say
it largely reflects what we put in place in the first days
after conservatorship. It has three basic components to it. It
has a base salary that is paid over the course of the year, a
deferred base salary that is paid out over the following year.
Half of that has incentive components to it.
Senator Shelby. Is that how you keep people----
Mr. DeMarco. It is, very much----
Senator Shelby. ----otherwise they would----
Mr. DeMarco. The deferred salary, Senator Shelby, is a very
key component in the retention aspects of this compensation
structure. So executives that leave during the course of the
year are leaving a considerable amount of their compensation
for that year on the table.
And then, finally, the last one-third of target
compensation for executives is what we call a target incentive
opportunity and it is based on the corporate performance.
Senator Shelby. The Preferred Stock Purchase Agreement--I
alluded to that earlier--established the rules by which the
taxpayer funds the bailout of Fannie and Freddie. That contract
requires you to consult with the Secretary of the Treasury on
any new executive compensation arrangement, does it not?
Mr. DeMarco. It does.
Senator Shelby. Did you consult with the Treasury
Department while you were establishing the current compensation
arrangement?
Mr. DeMarco. Yes, Senator.
Senator Shelby. Did that consultation result in Treasury
being aware of the compensation arrangement prior to their
ultimate adoption?
Mr. DeMarco. It did.
Senator Shelby. Did Secretary Geithner or any of his
representatives at Treasury express disapproval of the final
structure of the executive compensation arrangement that you
had proposed?
Mr. DeMarco. No, Senator.
Senator Shelby. How does the compensation arrangement of
Fannie and Freddie compare with that of AIG and other TARP
recipients? Did you base it on that, or what?
Mr. DeMarco. Yes, Senator. The structures are comparable.
The key difference is AIG and the other exceptional assistance
TARP firms remained private firms with trading stock and they
were not in a conservatorship or receivership. So the deferred
base salary component of our compensation in the TARP world,
that was done in the form of stock, but it made no sense to use
equity grants to Fannie Mae and Freddie Mac employees and so we
replaced that with cash, deferred cash.
Senator Shelby. I am going to get into another area while I
have got a minute. Recently, Director DeMarco, the Senate
approved language to raise the conforming loan limits for FHA,
Fannie Mae, and Freddie Mac. What message did that send to the
Enterprises by voting to raise these loan limits?
Mr. DeMarco. Well, the Enterprises certainly know from me
that we are working to gradually step back their imprint on the
mortgage market and to try to, over time, reduce the taxpayers'
exposure to the mortgage market. And the fact that the
reduction in the conforming loan limit was something that
everybody saw coming, was prepared for both by Fannie and
Freddie and by the marketplace, it sends a different signal to
now be stepping back in after we had started to step away.
Senator Shelby. It is my understanding, although it has not
yet passed Congress, that the Conference Report for the
appropriations bill is probably going to contain or will
contain a compromise on conforming loan limits that would raise
the loan limit made for FHA but not for Fannie and Freddie.
That is kind of a strange deal there. If that happened, what
would be the result of that?
Mr. DeMarco. Well, it certainly could lead in certain
markets to some confusion about what loan limits we are
applying to what loans a borrower might make. So I think that
it certainly could contribute to some confusion and another
sense of in which direction are we moving with regard to the
Government's role in the mortgage market.
Senator Shelby. Thank you. Thank you, Mr. Chairman.
Chairman Johnson. Senator Tester.
Senator Tester. Well, thank you, Mr. Chairman, for holding
this hearing, and thank you, Mr. DeMarco, for being here today.
And I appreciate your offer to meet last week. Unfortunately, I
was on a jet plane flying back to Montana and then I did not
get back until late last night, but I appreciate the contact.
This hearing is important as we deal with executive
compensation for Fannie Mae and Freddie Mac consistent with
protecting taxpayers, yet keeping these institutions running.
As you have said yourself, Mr. DeMarco, the Enterprises operate
today only with the support of taxpayers. It is obvious. And
yet the compensation packages and the description of
performance-based that these executives--I think has failed to
recognize that point.
Now, you have suggested that the salaries for executives
should be benchmarked against private firms in the banking and
mortgage sector. Freddie Mac's corporate filings list companies
like Wells Fargo and U.S. Bank for comparison. There is a big
difference, and the big difference is that these companies are
profitable and they are solvent and they do not rely on
taxpayer funds to keep their lights on.
We are talking about the CEOs of Fannie and Freddie
receiving $12.2 and $7.5 million in compensation in 2009 and
2010, respectively, to run a large but insolvent housing GSE.
The taxpayers is what we need to keep in mind. Even the
executives of many of the TARP banks and CEOs of Detroit
automakers in hearings held by this Committee that got bailed
out, decided to forgo their salaries. Quite frankly, they had
to be shamed into it in some cases, but they did it.
Did it ever cross your mind when dealing with these
compensation packages to say, hey, this is a tough year. The
housing market is in a bad place. The taxpayers are on the hook
for the Government Enterprises. Let us revisit this and use of
common sense on the executives' pay for this year.
Mr. DeMarco. In fact, that judgment was applied in 2008 in
the year in which the Government placed these two companies
into conservatorship. All bonuses, awards, incentives, and so
forth were dispensed with in 2008. At the same time, there was
a great deal of turnover in the executive leadership at both
Fannie and Freddie, including bringing in new executives from
outside the firms that were not involved in making the loans
here but were being asked to come in and manage highly complex
financial institutions.
Where to set this dial on CEO compensation, what I can say
about that is that from my predecessor, this was a challenging
determination, and the CEO compensation, as large as it is--and
I will readily admit, Senator, it is large, it is--the last
time Fannie and Freddie's CEOs saw that level of compensation
prior to conservatorship was 1999, which is an indication of
two things, an indication that the executives that have been
leading Fannie and Freddie during the years running up to
conservatorship were being paid an extraordinary amount of
money. It also is indicative that our major financial
institutions, in competing for talent to run these companies,
they all pay a considerable amount of money.
Senator Tester. I understand that. I understand what you
are saying. The problem is, at this point in time, where we are
at, heck, there are even ``Occupy Wall Street'' demonstrations
as you were developing these--would it not have been more
prudent on your part--and I am not in your shoes but I am in
mine and I deal with folks when I go home every week that want
to know about executive compensation with taxpayer dollars--
would it not have been more prudent just to say, let us take a
step back. This is a special time, we are dealing with the
worst economic problems since the Great Depression, we are not
out of it yet, to say, let us dial them back.
Now, let me give you an example. You guys oversee the Home
Loan Bank of New York, for example, that you folks oversee. The
executive compensation is $4.9 billion--$4.9 million, I will
make that clear--$4.9 million--it is a much smaller entity, but
it is profitable. Would it not have been--I mean, there is
plenty of room there for reasonableness, unless you think you
were just going to lose your executive staff if that happened.
Mr. DeMarco. Basically, that last point, Senator, is the
biggest concern that has driven where these compensation levels
have settled out. I do not believe that the Federal Home Loan
Banks generally are the appropriate market comparables for
Fannie and Freddie. They are much simpler and much smaller
institutions. They employ far fewer people. But I certainly
take the point, Senator, and I agree with it.
The one thing I can say, I do not know if it will help you
or not, but we set these--there were judgments made in 2009 to
set both the compensation structure and the level. Since that
time, I have, with each opening of an executive position, and
we have had plenty of those, worked to step down the
compensation. So just like we are trying to gradually withdraw
Fannie and Freddie's footprint in the market, just like we are
trying to gradually shrink their retained portfolio, we are
trying now to go from where we set it in 2009 to gradually pull
compensation back further.
Senator Tester. OK. Just as a sidebar, and I have run out
of time, but just as a sidebar, I will just say this. Twelve-
point-two million dollars is pile of money. I mean, it is a
pile of money. And when we are dealing with folks in the State
of Montana or in the State of Tennessee or in the State of
Colorado that are having a hard time paying their electric
bills or paying for their prescription drugs or making their
books balance at the end of the month and they see these kind
of compensations come down utilizing taxpayer dollars, there is
a reason people are protesting on the streets.
Mr. DeMarco. Yes. I understand that, Senator. I think the
point that you are making, the concern that Americans have
about this, is something that I well understand and I
appreciate them. We will continue to focus on this issue and
see what we can do to further address the concerns you are
raising, Senator.
Senator Tester. Thank you for being here. I only say this
because there are folks in this body that want to see Fannie
Mae and Freddie Mac done away with so that there is no backstop
on the housing. This does not help. This does not help.
Thank you very much, Mr. Chairman.
Chairman Johnson. Senator Corker.
Senator Corker. Thank you, Mr. Chairman.
Mr. DeMarco, thank you for being here and for the work you
are doing. I find these hearings a lot of times semi-humorous
in that we have really given you no clarity whatsoever as to
the future of these organizations, or if we have, could you
share that with me.
Mr. DeMarco. Not a whole lot of clarity, Senator.
Senator Corker. Let me ask you, are there concerns about--
is there a danger with having a permanent conservatorship as we
now have?
Mr. DeMarco. I do, and I think that Senator Tester's
questioning starts to get at some of those various concerns. I
mean, before conservatorship, Fannie Mae and Freddie Mac were
these odd institutions. They were not Government agencies, but
they were not fully public, right? I am sorry, they were not
really private firms, and they often sort of operated in this
sort of gray area in between. Being in conservatorship is
actually continuing that weird place between being a Government
agency and being a truly private firm. We have got the
taxpayers even more explicitly on the hook here.
But as conservator, when you are overseeing a company, you
are trying to make long-term decisions about the direction of a
company, both the investment in human capital, the investment
in business processes and platforms, and it is very difficult
to try to decide how to make those judgments while we are in
this holding state of conservatorship.
Senator Corker. So, in essence, we have a conservatorship
that has been set up and Congress has not done its job as it
relates to telling you what you would like these organizations
to be. I would expect that the CEOs and others who run these
companies have no idea whether Fannie and Freddie will exist as
they are forever or whether they are going to be out of
business. Is that the case?
Mr. DeMarco. That is the case. It is difficult for the CEOs
and the boards.
Senator Corker. To that end, I have offered a piece of
legislation to deal with these two organizations and I have
offered it in a way to actually try to solve the problem and
hope to bring some bipartisan support toward that end and to
really backfill. In other words, as Fannie and Freddie decline
in the amount of percentage that they have of mortgage
originations in the country and guarantees, that we backfill
that with the private sector.
Let me ask you, what have you seen as we have these
declining amounts, from 729 to 625, what actually took place in
the private sector to backfill those?
Mr. DeMarco. Well, it is a little early to tell, Senator,
since the loan limit just went down a couple of months ago, but
I have not been presented with any information or evidence
suggesting that there has been a sudden disruption in the local
markets where that happened. I am sure that there has been a
change in pricing for mortgages that are in that affected band.
But, frankly, Fannie and Freddie didn't purchase a whole lot of
mortgages above the 625 limit when they had the capacity to. It
is still a fairly small market.
Senator Corker. What would be a reasonable amount of time
to wind down the efforts of Fannie and Freddie? And I think
there has actually been consensus that that needs to occur, and
people have talked about replacement mechanisms and all that.
But what would be a reasonable timeframe to wind down the
actual operations? I know the mortgages will run on for some
time, but what would you view to be a reasonable time?
Mr. DeMarco. It would--I would have to qualify this in one
way. It sort of depends on how much legal certainty is in place
or what private capital engagement in the mortgage market would
look like as Fannie and Freddie are stepping back. But I would
think that over the course of a few years, we should be able to
start making meaningful progress to seeing the Enterprises'
imprint on the marketplace be able to recede without causing
major disruption in the marketplace.
Senator Corker. And so do you think if we had a wind-down
of, say, a 10-year period, would that be something reasonable
to look at?
Mr. DeMarco. That would certainly seem plenty gradual to
me, Senator.
Senator Corker. So, again, I thank you for what you are
doing, and we, in order to try to fill the vacuum, have offered
a piece of legislation that, again, we are getting input from
both sides of the aisle right now, trying to make it better. We
will probably reintroduce it again. But in order to place a
marker and to move us ahead, we have looked at limiting the
amount that the Federal Government guarantees on the mortgages,
not by the loan limit but by saying 90 percent of the mortgage
itself will be guaranteed, 80 percent. That way, you have some
market signals. You can tell the difference in pricing between
what the Government is guaranteeing and what it is not. We can
get a good indication of how the private sector is responding.
Does that seem like a reasonable approach to look at how we
might unwind Fannie and Freddie?
Mr. DeMarco. It certainly is a reasonable approach,
Senator. In fact, it is one that is not dissimilar from one I
mentioned in a speech a couple of months ago, where I said that
I was looking to gradually increase the Enterprises' risk
sharing with the private sector so that some of the mortgage
credit risk that Fannie and Freddie are taking on board today
with the taxpayers backing, if we cannot find some way of
gradually putting some of that on private capital. So I believe
your approach is well consistent with that thought process.
Senator Corker. Well, we certainly welcome your input and I
thank the Chairman for having this hearing. I encourage Members
on both sides to look at how we might do that.
I will say that unless Congress comes forward and gives you
concrete direction, we are going to end up in a permanent
conservatorship, and Mr. Chairman, it seems to me that Mr.
DeMarco ought to be interviewing us instead of us interviewing
him because the fact is, we have taken no action. There has
been a lot of chest beating about Fannie and Freddie, a lot of
people saying what ought to happen, but candidly, we have done
nothing. Hopefully, that will change very quickly. And again, I
thank you for your service.
Mr. DeMarco. Thank you, Senator.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair, and thank
you, Mr. DeMarco, for your testimony.
You note in your testimony on page 3, and I think you
mentioned in your opening comments that you have three goals:
minimizing taxpayer losses, first; second, providing stability
and liquidity to the market; and third, maximizing assistance
to homeowners to avoid foreclosure. In your testimony, you do
address the revisions of the HARP program on page 7. Those have
been pretty widely discussed. Largely, the impression I have
received from just about everyone in the housing world is that
rather than a sense of urgency and leadership, FHFA has been
more in the role on those HARP revisions of fighting them and
finally acceding to them.
In terms of actually helping homeowners, there is a
reference in your testimony that says FHFA is proceeding
prudently but with a sense of urgency to lay the groundwork for
development of good initial pilot transactions. I must say, we
are years into this now and here is FHFA testifying--you are
testifying that you are kind of thinking about some possible
initial pilots. That does not convey any sense of urgency. And
indeed, it has been enormously frustrating to FHFA to have
Fannie and Freddie very resistant to their Short Refinance
Program. It has been very frustrating to folks throughout the
rest of the housing world, the administration, that have been
pushing for the HARP revisions.
And in terms of the pilots, the hardest hit funds, a good
share of--a good chunk of the hardest hit funds went to Oregon
for a pilot in which they have worked with your agency--Oregon
has worked with your agency to try to acquire mortgages that
are in severe risk of default, highly underwater, income vastly
reduced. And after a great deal of effort, 100 tentative
mortgages were sent out to Oregon and they identified, I think,
37 of those.
But it has been--even those 37, well, now there is an
accounting problem and it took a long time to get the
accounting problem sorted out. And then there was an issue over
selling the mortgages versus short-sale strategy and that took
forever. Then FHFA was insisting on individual appraisals while
Oregon was pushing for a block approach, and now FHFA says it
wishes it had done a block approach rather than doing
individual appraisals.
In other words, at every point, no sense of urgency, no
sense of leadership. We are years into this crisis. We are not
at the beginning of this in 2007. This is 2011 and we are still
talking about initial pilots and there is still no sense of
top-level drive saying we have got to find ways to keep
families in their home.
The reason this is so troubling is because we have millions
of foreclosures yet to come. You are at the head of the agency
that has the biggest potential influence to be powerful,
creative, in driving a vision of how we can seize this
opportunity. We have so many working families, that if they
could buy homes now at these low prices and low interest rates
would be empowered for the rest of their lives and help absorb
this overflow of empty homes that has been driving down the
price of houses.
So I say all of this to basically encourage you to shift
gears, to shift out of neutral and into drive, to really help
lead this conversation about restoring the housing market
rather than being this highly resistant force that has not
taken the third piece of the mission seriously.
Mr. DeMarco. I appreciate your concern, Senator. I will
just briefly respond with a couple points. First, with regard
to HARP, you are correct that it has been characterized that
FHFA was dragged into these HARP changes. I do not agree with
that characterization. I think FHFA showed a lot of leadership
in actually pulling together the mortgage industry and the
mortgage insurance companies to figure out how we could make
this program that had already been around for 2\1/2\ years work
more effectively.
For the benefit of the rest of the Senators, the pilot that
you are referring to in my written statement has to do with our
look at how we can otherwise dispose of real estate owned, that
is foreclosed properties that Fannie Mae and Freddie Mac have.
We did solicit public comment on this in August and we received
4,000 comment letters with regard to that. This is not
something new. We--in fact, Fannie and Freddie have each tried
some bulk approaches to REO disposition in the marketplace and
the results were clearly not satisfactory from a conservator
standpoint, and we decided to take this approach of inviting
market input into how to do this better so that maybe we could
have a more robust framework for REO disposition, one that was
more transparent and competitive. I am sorry this does take a
little time, but I am--I want you to know, Senator, I am
committed to this REO program moving forward.
And with regard to everything else in the housing market, I
have in past forums addressed some of these concerns about what
FHFA is or is not doing in its role as conservator. I do think
hard about the statutory framework in which we operate as
conservator, the mandate that we have and the funds that were
provided to FHFA--to Fannie and Freddie through the Treasury
Department and the purpose for that, and I have contended in
the past that if there were things that the lawmakers felt were
in the best interest of the country and the country's housing
finance system to legislate the use of taxpayer money for these
things, FHFA would be ready to participate in that. But with
the authorities that we have today, we made decisions about
certain programs we just felt that the authority was not there
for us given our conservatorship responsibilities. It is a
respectful disagreement that I have with certain people
regarding that.
But we are trying to be consistent in our application of
the law and we certainly recognize the trouble and hardship
that is out there in the housing market around the country, and
so I appreciate your concern. We will continue to press ahead,
Senator, to provide the assistance and support to the market
that we are charged with doing, and I appreciate your comments.
Senator Merkley. I will say, even in your response, I do
not sense that you have come to embrace that third mission
seriously, and I just--there was a hope, and certainly the
Treasury Department, the Treasury Secretary had this hope that
the general market would recover in a way that would make
serious direct action to support homeowners unnecessary. I
think we all know that did not happen. I think it is time to
reframe our conversation again, 4 years into this, and realize
that, for example, the Short Refi Program that FHA put forward
would be enormously improved if it had the full encouragement,
partnership, desire to sit down and say, how can we make this
happen, as opposed to what feels like that is not our concern
and not our interest.
Mr. DeMarco. I will say, Senator, because this FHA Short
Refi Program is focused on underwater borrowers, I do not think
it is appreciated enough in sort of public discussions, that
while Fannie and Freddie certainly are guaranteeing mortgages
that are underwater. The majority of these American homeowners
that are underwater, continuing to perform in their mortgage,
they are honoring their financial obligation, and I think that
is the best thing to minimize taxpayer losses, is that folks
that have committed to paying a mortgage, they have seen their
house price decline. They are continuing to make good on that
payment, and that is why I think things like the HARP program
changes we made are actually the more appropriate way for us to
reach out and provide added support to these folks to be able
to continue to perform in their mortgage and provide stability
to the marketplace.
The one other thing that might be useful with regard to
your comments, I think that one of the really important things
FHFA did earlier this year was through our Servicing Alignment
Initiative with Fannie and Freddie. We established a new set of
standards for mortgage servicers dealing with a mortgage from
the moment it first goes delinquent, and what we did here is we
tried to learn from the mistakes of the last couple of years.
We tried to simplify the process and to provide very uniform,
for Fannie and Freddie, uniform guidance to mortgage servicers
what to do the next day after that mortgage payment has been
missed, because the experience has been that the best way to
help a homeowner in a troubled situation is to get hold of that
homeowner right away when they first start missing their
payments and work with them in those early days. That maximizes
the opportunity for success, and we have invested a lot of
resources this year in terms of Fannie and Freddie working with
servicers to reorient mortgage servicing to take that approach.
Chairman Johnson. Senator Kirk.
Senator Merkley. Thank you.
Senator Kirk. Thank you, Mr. Chairman.
Mr. Chairman, I just would like to ask that, again, that we
do do a Committee hearing on the European debt crisis and
especially the exposure of U.S. institutions to that. I would
just note this morning, the market is rendering a fairly
surprising judgment on U.S. debt. German 30-year bonds are
selling at 2.48 percent, while U.S. bonds are selling at 3.9
percent. That means that the U.S. is borrowing at 24 percent
more cost than the Germans, and I think it shows a fairly
devastating expectation for the supercommittee and where we are
going.
And also with regard to the FHA, I just ask, I know you
have probably read Morganstern and Rosner's book, right,
Reckless Endangerment?
Mr. DeMarco. I have, Senator.
Senator Kirk. Yes. Robert Reich--I have not read it, but I
read Robert Reich's summary of it in the New York Times and he
talks about Fannie and Freddie losing another $13.8 billion of
taxpayer money, worsening the perception that we are quite bad
with being able to repay our loans. These institutions--one of
the colossal failures in U.S. history, $182 billion now that
taxpayers have squandered on these institutions.
James A. Johnson pocketed, according to the book, $100
million for himself, and the GAO said that of the subsidies
Congress provided starting in the 1990s, that Fannie and
Freddie pocketed one-third for themselves. That Franklin Raines
followed this policy, that Lawrence Summers buried a report
recommending privatization of the institution, that Ken Starr
intimidated Members of Congress for asking about compensation.
Now, we have dealt with that issue a lot. I want to touch
on two things. First, the Wall Street Journal reported that
since last year, the White House has been pushing DeMarco's
agency to embrace the biggie of housing bailouts principal
write-downs in which lenders would be required to outright
forgive a portion of homeowners' outstanding mortgage debt. The
White House sees it as a free stimulus, no Congressional
approval or official spending estimate needed. Fannie and
Freddie would then swallow additional losses, quietly adding to
the $141 billion already sunk into the loss of the insurance.
But DeMarco, a 51-year-old regulator who is a career
professional, will not play ball. Thank you. He pushed back on
these housing schemes because he takes his mission as
conservator seriously while still posting an impressive record,
it says, of engaging in 1.9 million transactions to actually
help homeowners out. You pushed back because you have said, and
you told this Committee earlier that there is no upside to the
taxpayers in what the White House is trying to push on you.
And then I note this morning the Wall Street Journal
reports the Federal Housing Administration's cash reserves have
fallen so low there is close to a 50 percent chance the agency
will run out of money and require a taxpayer bailout next year,
according to an annual independent audit of FHA's finances. The
audit, to be released Tuesday by FHA, estimated the value of
the agency's reserves stood at $2.6 billion as of September 30,
down 45 percent from the $4.7 billion last year.
So I wonder if you could comment on that, and I commend you
for being a career professional who took conservatorship
correctly. We are already now running on close to $200 billion
in losses from these corrupt institutions, and with the credit
rating of the United States under attack and markets now saying
that it is probably safer to lend Germany money in the middle
of the European--than the United States, I think your
conservator message is well taken.
Mr. DeMarco. Thank you, Senator. I appreciate that.
Senator Kirk. Can you just comment on the fact that this
independent auditing agency now says there is a 50 percent
chance that the agency will run out of money, requiring a
taxpayer bailout next year?
Mr. DeMarco. Senator, I have seen the same headlines you
have referenced, but I am afraid I am not familiar with the
report and I have kind of got my hands full with Fannie and
Freddie's finances, so I am probably not the best one to speak
to FHA's current financial condition.
Senator Kirk. Well, I would just say that I would
underscore the conservator side of your mission because we have
already lost enough and it is imperative for the Congress and
for you to differentiate our exposure from practices that we
see in Europe. I just noted yesterday, I heard that the average
Italian retirement age was 58, and so they were basically
banking 15 years' work for 30 years' pension, and we need to
differentiate ourselves from policies like that so that we once
again appear to be a good creditor, and I commend you for your
leadership on this conservator issue.
Mr. Chairman, thank you.
Mr. DeMarco. Thank you, Senator.
Chairman Johnson. Senator Reed, are you----
Senator Reed. No.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman. Thank you for
holding this hearing.
Mr. DeMarco, I wanted to shift gears a little bit while we
have you here today to ask you a couple of questions about the
Property Assessed Clean Energy, the PACE Program, which, as you
know, Colorado actually was a leader in implementing that
program before the FHFA halted it in 2010, I think, because of
concerns about second lien status. Are you familiar with what I
am talking about?
Mr. DeMarco. I am, Senator.
Senator Bennet. The puzzle that I have is that there are, I
think, 37,000 Special Assessment Districts in the United
States, including many that are similar to PACE Districts. They
have different purposes, but there are, for example, Septic
Tank Remediation Districts, Geologic Hazard Abatement
Districts, and others that are similar in many ways to PACE,
although what we liked about PACE in Colorado was that we were
actually seeing substantial retrofits and job creation as a
result. And just as in these other programs, property owners
can voluntarily opt into them or out of them. The assessments
are a similar size and duration to PACE Districts.
So I wonder--I would like to get to a place, and as you
know, I have some draft legislation to do it, to a place where
a program that seemed to make all the sense in the world could
actually go forward, but that you are reassured that your
position is what you need it to be, and I wonder in that spirit
whether you would talk a little bit about where the FHFA is and
where we might be able to go together to try to get this
program moving again.
Mr. DeMarco. Certainly. Thank you, Senator. You know, the
general goal of PACE programs in Colorado and around the
country are certainly laudable. They are designed to enhance--
to provide financing for energy retrofits for an aging housing
stock so that we become more energy efficient as a country and
can reduce costs to homeowners of energy expense over time.
The challenge that FHFA saw with regard to the PACE program
as it was emerging was that it made a material change in the
credit risk exposure of the first mortgage after that first
mortgage had been made. Because the way the PACE was structured
is that this was a sizable advance, but essentially a loan to a
homeowner to make a home improvement to the house, and normally
that is done in a second lien position. By using the tax status
of the local jurisdiction, it was taking this home improvement
loan and making it something that came in advance of the first
mortgage.
And so the first mortgage holder would price the credit
risk on this transaction at the time the loan was made and was
suddenly being put in a subordinate position, and this really
is not like normal tax assessment jurisdictions here because it
is really designed for the benefit of a particular dwelling. It
is--oftentimes, these things as normally done are not voluntary
and they are not nearly the same dollar amount or duration as
these PACE loans are. We also, when this first emerged, raised
concerns with a number of the jurisdictions doing it regarding
consumer protections and disclosures regarding the cost of
these programs.
I really do look forward to working with you, because I
think that the principle of energy retrofits and these sorts of
home improvements have a lot of positive elements to it, but I
think that the financing structure for that is better done in a
traditional way of being subordinate to the first mortgage that
has already been in place.
Senator Bennet. Well, I would like to take you up on your
offer to work on it, because I think there is, both with
respect to PACE and some other work that Johnny Isakson and I,
Senator Isakson and I are doing in something called the SAVE
Act, a huge opportunity here if we can think about how to do
the financing, because the up-front costs that people have,
which we then know can be paid back if we do the math properly
and prudently, among other things, will make us more energy
efficient but also give the 25 percent of people in the trades
who are unemployed something to do before this housing market
actually comes back.
So I hope that we could look at this with some urgency and
try to figure out how to get it done.
Mr. DeMarco. OK. Thank you.
Senator Bennet. Thank you. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman.
Mr. DeMarco, the focal point of this hearing is the bonuses
that have been received by executives at Fannie and Freddie.
Just to try to, in my own mind, at least, clarify, these
contracts were approved by FHFA, not by the Department of
Treasury, is that correct?
Mr. DeMarco. Both the structure and the amounts were the
responsibility and approved by FHFA. FHFA has a contractual
responsibility to consult with the Treasury Department on it to
get and consider their feedback, but we are ultimately
responsible for the decision.
Senator Reed. So that there is no legal ability for the
Department of Treasury to veto your decision. You simply give
them--they give you their advice as to what you should do, is
that----
Mr. DeMarco. That is--consultation, yes, Senator.
Senator Reed. Typically, and I do not have to tell you, you
are quite aware of it and the country is aware, there are so
many people desperately looking for a job. The idea of these
huge bonuses just is inconceivable to so many people. But
typically in a bonus arrangement, there are some performance
criteria. Can you outline the performance criteria that would
entitle these individuals to bonuses?
Mr. DeMarco. Certainly, and these are actually detailed in
the public disclosures that Fannie Mae and Freddie Mac make in
their SEC filings, but I can give you a sample of them. It has
included loss mitigation activity, such as getting folks for
taking foreclosure prevention activities, getting folks into
loan modifications. It has included remediating the operational
and risk management deficiencies that FHFA in its supervisory
practice has identified for the companies so that they become
more efficient and less risky, more safe and sound as they go
forward. And it has gone to ensuring that they remain active
participants on the mortgage market so that we have stability
in the marketplace.
Senator Reed. There are many who would look at the
performance of Fannie and Freddie and say that, frankly, they
have not done a very good job in those areas that you have
pointed out--loss mitigation, getting people into
modifications. In fact, I think some troubling numbers, 2010
modifications were significantly far ahead of what we have seen
this year, and yet they are still collecting bonuses. And that
is one point, which is how do you sort of rationalize what we
are seeing and the award. And the second more specific
question, who makes the judgment that they have achieved these
objectives? Is it the Board of Directors or is it you or is it
a combination of the Directors and you?
Mr. DeMarco. So it is a combination. We do work with the
Boards of Directors, so the scorecards are there in advance.
The assessment of it is done by management. Those assessments
are reviewed by internal audit of the companies. Those
assessments are then reviewed both by the Boards of Directors
and by my own staff before the ultimate sort of determination
is left with me.
With regard to the question about bonuses and these losses,
I think it is a very fair observation, Senator, and it is one
that I think many citizens have, and I would like to maybe
expand on it for just a moment, if I may. Here is the real
challenge of overseeing Fannie Mae and Freddie Mac in
conservatorship. These losses that the American taxpayer has
been incurring are a result of business decisions that were
made at Fannie and Freddie, principally in the period from 2005
until the first half of 2008. So those were business decisions
that were made at a time past by a leadership team that is no
longer with the company.
We are now in conservatorship with a new leadership team
faced with the prospect of a lot of poorly underwritten
mortgages that were badly priced, but we cannot undo that. The
best we can do is to see, given these lousy mortgages, what can
we do to minimize the losses on them and what can we do to
strengthen the business going forward.
So we know that we are going to see over a period of
several years, from 2008 really certainly at least through next
year, we are going to see these losses start to wash through
the financial statements, but these are losses that are on
mortgages that were originated a while ago. But I need to have
a management team come in and be willing to do the hard work of
trying to clean this up and build something better for the new
mortgage book that we are having, and so getting that sort of
separation in mind is one of the things I feel I have to do and
it is a challenge in sort of recruiting people into these
positions.
Senator Reed. No, I think we understand that. But I think
my office has been in touch with you on several different
initiatives----
Mr. DeMarco. Mm-hmm.
Senator Reed. ----and let me suggest that your individual
activity is absolutely critical, but there are many other
factors here--what the State Attorney Generals do with respect
to their activities. But Fannie and Freddie have such a
dominant position, particularly with, literally, the collapse
of all the private label folks who were eating their lunch in
2005 and now they are no longer there, leaving Fannie striving
to keep the housing markets moving forward.
But I think we all have to be much more creative, and I
think you have to be much more demanding in terms of those
types of performance ends you expect and also the innovative
ways in which your management, or the management of these two
companies, carry out their responsibilities, because
ultimately, the only way we can justify these types of
compensation arrangements is discernible progress that is
recognized not just here, but across the country. And you have
a difficult job and I think you are obviously putting a great
deal of effort in, but we all have to do much better.
Mr. DeMarco. Well, I accept that, Senator, and as I tried
to say in my written statement, I am committed to looking at
these scorecards and how we go about doing that and taking some
further steps in the coming year in the direction that you have
outlined.
Senator Reed. And if I may, one final point. The overall
health of the housing market, its sort of stabilizing and then
beginning to slowly appreciate, is ultimately what will make
the balance sheets of Fannie and Freddie look much, much, much,
much better. Do you agree?
Mr. DeMarco. Yes. No, I think that is right, Senator.
Senator Reed. Thank you.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Mr. DeMarco, I want to pick up where Senator Reed just left
off. Earlier this past month, former Treasury Secretary Larry
Summers published an op-ed piece in the Washington Post that
pretty much, I think conveys the sentiments that I have, which
is that the FHFA has taken a narrow view of the public interest
and that it has neglected its conservatorship mandate to ensure
that the GSEs help stabilize the nation's housing market. It
has taken no account for the reality that the GSEs' health
depends on a national housing recovery. And instead, you know,
it seems to me that you all have been focused on reversing
previous policies, heedless of the changes in the environment,
and treating mortgage finance as a morality play.
The question for me, I have never seen the Nation move into
an economic recovery without housing being one of the drivers,
and in terms of ensuring the best results for the taxpayers,
having a housing market that is on the move and thriving again
is going to be critical to that. So it seems to me that you
have a narrow and cramped view of the public interest that is
hurting the housing market's recovery. What is your response to
that?
Mr. DeMarco. Well, Senator, I have had the honor of working
with Mr. Summers. I have a great deal of respect for him. But
on this, I do disagree, and I would not say that I have a
cramped view. I think I have a view that is following the law
as I understand it has been written by Congress. I do not
believe that the Congress of the United States has authorized
me to expend taxpayer funds for the general support and uplift
of the housing market.
I believe that the funds that the Congress gave to the
Treasury Department to purchase securities of Fannie Mae and
Freddie Mac were designed to support the operations of this
conservatorship, and as conservator, Congress has given me a
statutory obligation to conserve and preserve the property and
assets of these companies, and that does not extend to
providing general support. If general support is what lawmakers
believe is what is going to help the country's economy and
housing sector recover, I believe that that needs to be
appropriated for that purpose by Congress.
Senator Menendez. How do you define conserve and preserve?
Give me your definition of that.
Mr. DeMarco. I believe that it means that we are not
supposed to dissipate assets. We are supposed to work to
mitigate the losses that are there so that there is--we are
maximizing what is left for the owners of the company. In this
case, with the Treasury Department essentially having these
warrants in the company that give it an 80 percent ownership
interest, that goes to minimizing losses for the taxpayer. But
that is the view and interpretation that the agency has taken
as it has studied the statute.
Senator Menendez. So if you want to minimize the loss of
the taxpayer, one of the things you want to do is make sure
that, for example, my understanding is that GSEs lose about
$65,000 per property per foreclosure. Is that a fair estimate?
Mr. DeMarco. It could be. I am sorry, Senator. I do not
know----
Senator Menendez. So it seems to me that if we were looking
at how do we deal with mitigation if we were looking at a more
aggressive borrower outreach and response, which we have
written letters to you about and which Freddie Mac has not been
responsive to, that maybe we would be avoiding on behalf of the
taxpayers a loss of $65,000 per foreclosed property. Is Freddie
Mac going to be in the midst of implementing a similar borrower
outreach program that Fannie has begun?
Mr. DeMarco. Honestly, Senator, I am not sure which
particular outreach effort that Freddie Mac is not doing that
you are talking about. But, look, both companies have been
working on outreach efforts and working with mortgage servicers
to contact troubled borrowers rapidly.
There is no disagreement with you, Senator. You are
absolutely correct that the best thing we can do to minimize
losses on these troubled mortgages is to contact borrowers
early and to try to find foreclosure alternatives for them,
ideally where the homeowner stays in their home. And I believe
we put a great deal of effort into that. We have had 1.6
million successful foreclosure alternative transactions done
that have resulted in the borrower staying in their home. But
we do need to continue to do more and I do believe that we have
taken some important steps, Fannie and Freddie together with us
this year, to improve the instruction to servicers to contact
borrowers and work with them in an aggressive way from the
moment they first become delinquent on their mortgage.
Senator Menendez. Well----
Mr. DeMarco. Because you are quite right, Senator. This is
very costly, especially when the mortgage goes to foreclosure.
Senator Menendez. Well, Fannie is headed in the right
direction. Freddie Mac has a dismal record. I would commend it
to your attention and like to see your response to it.
Second, under the Emergency Economic Stabilization Act of
2008, you have a statutory responsibility to, quote,
``implement a plan that seeks to maximize assistance for
homeowners''--maximize assistance for homeowners--``and use its
authority to encourage the servicers of the underlying
mortgages in considering net present values to the taxpayer to
take advantage of available programs to minimize
foreclosures.'' Is that not an equal responsibility that you
have?
Mr. DeMarco. It is, Senator, and I believe it is one that
we have been working very hard on since Congress enacted it,
and we send a monthly report to the Senate Banking Committee
outlining--updating the Committee on the actions that have
taken place in the last month and running a--we have a running
tally of what are all the different things that have been done
and how many homeowners have been assisted by that, and that is
provided monthly, and that is where that 1.6 million figure
that I mentioned a moment ago is reported at.
Senator Menendez. But if that answer you gave Senator Reed,
that a robust housing market is ultimately going to place the
taxpayers in a better position, why is it that you view so
narrowly the ability to think a little bit outside of the box
and help to achieve a housing market that is more robust?
Mr. DeMarco. Well, that is fair, Senator, but the statutory
provision that you read includes in that a consideration of the
net present value to the taxpayer, which I believe is
consistent with the HERA mandate that we have as conservator to
preserve and conserve the assets of the Enterprise. And so we
look at all these various programs, HAMP, HARP, and other
proprietary loan modification programs that Fannie and Freddie
do, but we do it with a consideration of will this foreclosure
alternative transaction reduce the cost to the taxpayer
relative to foreclosure? If the answer to that question is yes,
by all means, Senator, we want that transaction to be executed,
whether it is a loan modification, a forbearance plan, a short
sale, depending on the facts and circumstances.
If that transaction is going to lower costs relative to
foreclosure, we are very committed to wanting to see that done
because we believe it is consistent with the EESA mandate, and
that is how we are interpreting the EESA mandate, to maximize
assistance, and we think it is in harmony with our HERA mandate
to conserve and preserve the assets of the----
Senator Menendez. Well, finally, Mr. Chairman, as someone
who supported and voted for the legislation, it seems to me
that I have a different vision, and I think many of us share
that vision, of what your mandate is. At the end of the day,
the biggest holders of these mortgages is all of us as U.S.
taxpayers through the GSEs. We want to maximize the opportunity
for people to be able to mitigate our losses, and in part, that
means a robust housing market.
Let me ask you one last question with the indulgence of the
Chair. Do you not agree--this issue of loan limits was raised,
something that I and Senator Isakson have been pursuing and
that 60 members of the Senate supported--CBO says keeping the
loan limits at the higher rate that had expired will not cost
taxpayers one dime. Do you agree with that statement?
Mr. DeMarco. I have not seen the CBO statement, but the
loan limits themselves, I am not sure how I would say that it
would add or subtract from the taxpayer. The mortgages would
certainly have to be underwritten properly and priced properly
and that is what we have been doing.
Senator Menendez. Well, the CBO says keeping the limits
would not cost taxpayers one dime because the cost of the
defaults are paid by the premium loan fee of 15 basis points
per year from the loans that benefit from this. And in a
housing market that certainly we might think that this is not
appropriate 2 years from now, but in a housing market right
now, certainly along the coasts it would be pretty devastating,
not only because of the higher limits, but 125 median ratio,
and that would dramatically affect housing across the country.
So I just hope that we are adopting policies that give us
long-term growth in the housing market, which is going to be
part of our solution, versus just whittle ourselves down to a
set of circumstances in which we may be viewing that we are
saving the taxpayers from a greater liability instead of
growing and mitigating more effectively. I hope that you will
consider that as part of your deliberations moving forward.
Mr. DeMarco. Well, thank you, Senator. We will. Obviously,
the conforming loan limit is a matter that has been for
Congress to set and adjust.
The one thing about the bill of yours that you mentioned,
of course, is that this added fee does not go to Fannie and
Freddie to offset their credit risk directly. It is going to
the Treasury Department and then would need to be appropriated
back. I do not entirely follow the connections there in how
that would--so that might affect the answer in terms of how
this loss would affect the taxpayer versus how it would show up
on Fannie and Freddie if the fee was going away from them.
Senator Menendez. Clearly, the fee is meant to ensure that
the borrower is the one who bears the burden, not the entities,
and so I am sure that issue can be easily resolved.
Thank you, Mr. Chairman, for your indulgence.
Chairman Johnson. Mr. DeMarco, thank you for your testimony
and being here with us today.
Oversight of FHFA is and will continue to be an extremely
high priority of the Committee. With the housing market still
in flux, a robust and proactive FHFA is essential.
This hearing is adjourned.
[Whereupon, at 11:27 a.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
I would like to thank Mr. DeMarco for being here today. As I
mentioned at our hearing on November 3, we have been planning to hold
an FHFA oversight hearing, and I am pleased it was able to come
together so quickly.
As Ranking Member Shelby, and others, so accurately noted during
consideration of the Housing and Economic Recovery Act in 2008, one of
the most important aspects of the bill was the establishment of the
Federal Housing Finance Agency as an independent regulator. This
ensures that it can operate without undue political interference and
that the appropriations process cannot be used to hold the regulator
hostage.
With this independence, the Banking Committee must exercise
Congressional oversight to ensure that the agency is balancing its
attention among the entities it regulates and the role as conservator
of Fannie Mae and Freddie Mac.
To give the Committee and the public greater confidence in the new
regulator, HERA also established the FHFA Office of the Inspector
General to investigate potential concerns and ensure transparency of
the regulator's operations. I plan to invite Inspector General Linick
before the Committee at a date to be determined. It is only appropriate
that we should hear from him as well. The Inspector General's role is
even more important while FHFA is acting as both conservator and
regulator.
It is important for this Committee to understand how FHFA evaluates
new opportunities and programs at Fannie Mae and Freddie Mac during
conservatorship, including the decision to allow them to participate in
certain Making Home Affordable programs and the decision not to
participate in or initiate other programs.
The internal operations at FHFA are also important, as staffing of
the regulator will affect its oversight of the GSEs. Oversight of
executive compensation structures and evaluations of executive
performance goals both require the regulator's attention. FHFA must
have proper management of operational risks, as well as secure and
updated information systems and privacy policies. I am concerned about
recent reports that show problems in each of these areas, and that FHFA
does not have adequate certified staff to perform examinations of the
entities under its supervision.
FHFA is tasked with regulating two of the largest entities in the
mortgage market, Fannie Mae and Freddie Mac, which together backstop
approximately $5 trillion in mortgages and help support the nearly $11
trillion U.S. mortgage market. Unfortunately, that market is now
supported by $170 billion in assistance from the taxpayers. As we've
heard from other witnesses before this Committee, the mortgage market
would be even worse-off than it is today if they had not been placed
into conservatorship during the Bush Administration.
But as we have said over and over again, we need to find ways to
end the need for future support without destabilizing the housing
market further.
Finding a path out of conservatorship is a task for both the FHFA
and this Committee. I would like to thank Senator Shelby and his staff
for working so closely with me and my staff in laying out the hearings
the Committee has held so far this year. I hope we can continue to work
together to do our homework and create a sustainable system for the
housing market going forward that can protect taxpayers and spur
economic growth.
An adequately staffed and engaged regulator is a key component to a
stable housing market. Mr. DeMarco, I look forward to hearing about the
steps you have taken as Acting Director of FHFA since the last time you
were before the Committee.
______
PREPARED STATEMENT OF EDWARD J. DeMARCO
Acting Director, Federal Housing Finance Agency
November 15, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I am pleased to be invited here today to discuss the Federal
Housing Finance Agency's (FHFA) oversight of our regulated entities
(Fannie Mae and Freddie Mac, together the Enterprises) and the Federal
Home Loan Banks (FHLBanks).
The main focus of my testimony will be on key topics related to
FHFA's role as the Enterprises' conservator and regulator. I will
update you on the financial condition of the Enterprises in
conservatorship. Then I will review FHFA's approach to preparing for
increased private market participation in housing finance and describe
significant activities that FHFA has undertaken during the past year to
further our conservatorship goals. I will then briefly report on
several Federal Home Loan Bank (FHLBank) issues and, as requested, on
recent reports issued by the FHFA Office of Inspector General.
I will conclude with a review of FHFA's oversight of the executive
compensation structure for Fannie Mae and Freddie Mac. I will explain
how the Enterprises' executive compensation program supports the
statutory mandates of the Enterprises in conservatorship, how it was
developed, and how it is structured.
Introduction
As it has been more than 2 years since I appeared before this
Committee at a general oversight hearing, it may be useful for me to
begin with a brief overview of what it means for Fannie Mae and Freddie
Mac to be in conservatorship and what legal responsibilities FHFA
operates under as conservator.
The determination to place Fannie Mae and Freddie Mac, or the
Enterprises as I will refer to them, in conservatorship, was made as
the financial crisis of the autumn of 2008 was taking shape. At that
time, the private mortgage securitization market had already vanished,
house prices were declining rapidly, and the Enterprises' eroding
financial condition and inability to access capital markets threatened
a collapse of the country's housing finance system. FHFA, with
financial support from and substantial consultation with the Treasury
Department, placed the Enterprises into conservatorship on September 6,
2008.
Conservatorship, along with financial support from Treasury,
permitted the Government to take greater management control of the
Enterprises and give investors in the Enterprises' debt and mortgage-
backed securities confidence that the Enterprises would have the
financial capacity to honor their financial obligations. The
alternative, receivership, was rejected at the time, in part because
such action would have placed greater limits on the timing and approach
for the Congress and the incoming Administration to analyze and respond
to the problems confronted by the Enterprises and the country's housing
finance system. At the time, Treasury Secretary Paulson referred to
conservatorship as a ``time-out'' to allow markets to continue to
function while policymakers considered and acted on a permanent
resolution. More than 3 years later, we are still waiting for that
resolution.
As conservator, FHFA stands in the place of each company's
shareholders, boards, and management, with the responsibility to
``preserve and conserve the assets and property'' of the companies. The
statute also charges the conservator with the responsibility to place
the companies in ``a sound and solvent condition.'' At the time the
conservatorships were established, FHFA was less than 6 weeks old as an
agency, and had fewer than 400 employees. To accomplish these
responsibilities, FHFA made the practical judgment that the most
effective means to carry out these functions was to replace the boards
and senior management, and then delegate to new boards and management
day-to-day responsibility. Since then, reconstituted boards of
directors have worked with FHFA to define the operational goals in
conservatorship and to support FHFA in its work to guide and oversee
management in fulfilling these goals. Likewise, the new CEOs and
executive officers have worked with FHFA to these same ends.
As conservator and regulator, FHFA has three principal mandates set
forth in law that direct and motivate FHFA's activities and decisions
involving the Enterprises.
First, as I have noted, FHFA has a statutory responsibility as
conservator of the Enterprises to ``take such action as may be:
necessary to put the regulated entity in a sound and solvent condition;
and appropriate to carry on the business of the regulated entity and
preserve and conserve the assets and property of the regulated
entity.'' As FHFA has stated on numerous occasions, with taxpayers
providing the capital supporting the Enterprises' operations, this
``preserve and conserve'' mandate directs us to minimize losses on
behalf of taxpayers.
Second, even though the Enterprises are in conservatorship, without
further statutory changes they have the same mission and obligations as
they did prior to being placed into conservatorship. FHFA has a
statutory responsibility to ensure the Enterprises ``operate in a safe
and sound manner'' and that ``the operations and activities of each
regulated entity foster liquid, efficient, competitive, and resilient
national housing finance markets.'' We typically refer to this
requirement as ``supporting a stable and liquid mortgage market.''
Third, under the Emergency Economic Stabilization Act of 2008, FHFA
has a statutory responsibility to ``implement a plan that seeks to
maximize assistance for homeowners and use its authority to encourage
the servicers of the underlying mortgages, and considering net present
value to the taxpayer to take advantage of . . . available programs to
minimize foreclosures.''
These three mandates form the basis for how FHFA views its
responsibilities as conservator of the Enterprises. In view of the
critical and substantial resource requirements of conserving assets and
restoring financial health, combined with a recognition that the
Enterprises operate today only with the support of taxpayers, FHFA has
focused the Enterprises on their existing core business, including
minimizing credit losses. This means that FHFA is not permitting the
Enterprises to offer new products or enter new lines of business. Their
operations are focused on their core business activities and loss
mitigation. This type of limitation on new business activities is
consistent with the standard regulatory approach for addressing
companies that are financially troubled. And it is even more pertinent
for the Enterprises given their uncertain future and reliance on
taxpayer funds.
As a final introductory comment, the Enterprises' equity holders
retain an economic claim on the companies but that claim is subordinate
to taxpayer claims. As a practical matter, taxpayers are not likely to
be repaid in full, so Enterprise stock lower in priority is not likely
to have any value. Prior to conservatorship, much executive
compensation, and indeed some staff compensation, was in the form of
company stock, so the value of such compensation has essentially
vanished. Finally, the company leaders most responsible for the
business decisions that led to the Enterprises ending up in
conservatorship had either left the company before conservatorship, at
the time of the conservatorship, or shortly thereafter. The boards of
directors were also replaced.
Thus, the leadership working at the Enterprises today is not the
same as those chiefly responsible for the business decisions that led
to conservatorship and that continue to drive the financial results.
Moreover, they are there to further the goals of conservatorship and
ensure the country has a functioning secondary mortgage market while
lawmakers deliberate the future structure for housing finance. The
boards, executives, and staff have been and are working with FHFA in
its efforts to minimize taxpayer losses, provide stability and
liquidity to the market, and maximize assistance to homeowners to avoid
foreclosure. They do so knowing that the long-term outlook is that
neither Enterprise will continue to exist, at least in its current
form, in the future.
Third Quarter 2011 Financial Performance and Condition of the
Enterprises
Providing Liquidity to the Market
Since conservatorship, Fannie Mae and Freddie Mac have been the
largest issuers of mortgage-related securities in the secondary market,
guaranteeing roughly three-quarters of single-family mortgage-backed
securities (MBS) issued.
Capital
Combined Treasury support as a result of financial performance in
the third quarter of 2011 was $13.8 billion. The Single-Family Credit
Guarantee segment continued to drive losses as credit-related expenses
remained high. Additionally, the Investments segment results turned
negative in the third quarter of 2011, due primarily to a significant
decrease in interest rates and a widening of credit spreads on
nonagency securities. This was partially offset by a 2 percent increase
in net interest income. Four point one billion dollars of the $13.8
billion draw is to pay interest to the Treasury on previous draws.
Credit Quality of New Single-Family Book of Business
The quality of new business remained high in the third quarter of
2011. The percentage of new business volume with FICO scores below 620
remained below 2 percent and the average loan-to-value ratio (LTV) for
new business was roughly 70 percent for both Enterprises, reflecting in
part the high degree of refinance activity.
Loss Mitigation Activity
Loan modifications are on pace to be below 2010 levels. Total home
retention actions as of August, 2011, were approximately 375,000
compared with 832,000 for all of 2010. Significantly, loans modified
since late 2009 continue to perform substantially better than loans
modified before then.
Since conservatorship, the Enterprises have completed 1.9 million
foreclosure prevention transactions, of which nearly 1 million have
been permanent loan modifications and another 650,000 have been other
forms of assistance that have allowed homeowners to retain home
ownership. Separately, another 260,000 transactions have resulted in
households leaving their homes but without going through foreclosure.
Most of these actions have been short sales.
Projections of Financial Performance
To provide additional information on future Enterprise financial
performance, beginning in October, 2010, FHFA published financial
projections of the Enterprises' financial performance across different
house price scenarios. Those initial projections were updated a few
weeks ago, and the projected combined cumulative Treasury draws (which
includes 10 percent dividend payments to Treasury) through the end of
2014 range between $220 and $311 billion. In general, these financial
projections show that under less stressful house price scenarios, the
cumulative draws from Treasury would stabilize in the next year or so,
with the Enterprises earning enough income to cover dividend payments
to Treasury.
FHFA Initiatives
Recent Congressional efforts to begin serious discussion of a
gradual transition to greater private capital participation in housing
finance and greater distribution of risk to participants other than the
Government are important. FHFA has already begun taking actions in
support of these objectives. Since conservatorship, underwriting
standards have been strengthened and several price increases have been
initiated to better align pricing with risk. Additionally, we have had
several guarantee fee price increases and we will continue to gradually
increase guarantee fee pricing to better reflect that which would be
anticipated in a private, competitive market. Also, we will soon be
exploring more private sector risk-sharing opportunities. Such steps
are consistent with actions already taken in conservatorship and we are
examining further options along these lines in support of a stable
transition over time.
While debate over the future of the housing finance system
progresses, FHFA has and will continue to focus on meeting the goals of
the conservatorships through a series of initiatives aimed at retaining
value in the business operations of Fannie Mae and Freddie Mac,
maintaining their support for the housing market, and mitigating losses
to taxpayers.
Recovering Certain Losses
Consistent with FHFA's mission to preserve and conserve the
Enterprises' assets on behalf of taxpayers, this year we filed lawsuits
against 18 financial institutions to recover certain losses suffered by
Freddie Mac and Fannie Mae that we believe are the legal responsibility
of others. We believe that the loans in these private-label mortgage-
backed securities had different and more risky characteristics than the
descriptions contained in the marketing and sales materials provided to
the Enterprises for those securities.
Real Estate-Owned Request for Information
In August, FHFA in conjunction with the Department of Housing and
Urban Development (HUD) and the Treasury Department, issued a Request
for Information (RFI) seeking input on new options for selling single-
family real estate owned (REO) held by Freddie Mac, Fannie Mae, and
FHA. We are looking for approaches to reduce the REO portfolios of the
Enterprises in a cost-effective manner, as well as to reduce the losses
on individual distressed properties. We are seeking alternatives that
will maximize value to taxpayers and increase private investments in
the housing market, including approaches that support rental and
affordable housing needs. We are not trying to develop a single,
national program for REO disposition. We are most interested in
proposals tailored to the needs and economic conditions of local
communities. Based on the input of RFI responders we understand the
magnitude of the task at hand. FHFA is proceeding prudently, but with a
sense of urgency, to lay the groundwork for the development of good
initial pilot transactions.
Uniform Mortgage Data Program
In May, 2010, FHFA directed the Enterprises to develop uniform
standards for data reporting on mortgage loans and appraisals. This
Uniform Mortgage Data Program is designed to improve the consistency,
quality, and uniformity of data that are collected at the front end of
the mortgage process. By identifying potential defects at the front end
of the mortgage process, the Enterprises will improve the quality of
mortgage purchases, which should reduce repurchase risk for
originators. This initiative will be phased in over the rest of this
year and next.
Loan Level Disclosures
Earlier this year I announced that FHFA is considering ways to
enhance loan-level disclosures on Enterprise MBS, both at the time of
origination and throughout a security's life. I believe that improving
Enterprise MBS disclosures over time will help establish consistency
and quality of such data. Moreover, it will contribute to an
environment in which private capital has the information needed to
efficiently measure and price mortgage credit risk, thereby
facilitating the shifting of this risk away from the Government and
back into the private sector.
Servicing Alignment Initiative
Our Servicing Alignment Initiative (SAI), which we announced last
April, responded to concerns about how delinquent mortgages were being
serviced. SAI meets the conservatorship objectives of minimizing losses
and assisting homeowners with alternatives to foreclosure. FHFA
instructed Freddie Mac and Fannie Mae to establish a single, consistent
set of procedures for servicing Enterprise mortgages, from the time
they first become delinquent. The updated framework, which went into
effect on October 1, prioritizes early borrower outreach, streamlines
documentation requirements, simplifies mortgage modification terms and
requirements, and establishes a schedule of performance-based incentive
payments and penalties aimed at ensuring that servicers review
foreclosure alternatives in a timely manner. We are also working to
align and improve Fannie Mae and Freddie Mac policies regarding
unemployment forbearance to reflect the realities of the current job
market.
Foreclosure Attorney Networks
Last month, as an adjunct to SAI, FHFA directed Freddie Mac and
Fannie Mae to change the way foreclosure attorneys are selected in an
effort to produce uniform foreclosure processing standards to assist
servicers, homeowners, and lenders. Under current practice, in certain
States each Enterprise designates law firms eligible under the
Enterprise's criteria to undertake foreclosure work and mortgage
servicers then select and work with these firms. FHFA instructed Fannie
Mae and Freddie Mac to transition away from current foreclosure
attorney network programs and move to a system where mortgage servicers
select qualified law firms that meet certain minimum, uniform criteria.
These efforts will lead to greater transparency and benefit delinquent
borrowers who become subject to the foreclosure process. FHFA is now
working with other regulators and industry stakeholders to create
uniform qualifications and oversight of foreclosure attorneys.
I am hopeful that these new directives, which create uniform
procedures for servicing delinquent loans and processing foreclosures,
will gain acceptance beyond the Enterprises and become ``best
practices'' throughout the industry.
Home Affordable Refinance Program
On October 24, we announced a series of changes to the Home
Affordable Refinance Program (HARP). These changes should make HARP
refinances accessible to more households with mortgages owned or
guaranteed by the Enterprises. Changes to the program include:
eliminating or reducing certain risk-based fees; removing the current
125 percent LTV ceiling; waiving certain representations and
warranties; eliminating the need for certain property appraisals;
improving the process for carrying over mortgage insurance coverage;
and extending the end date for HARP to December 31, 2013.
Importantly, such refinances should also reduce the Enterprises'
credit risk, and thus losses to taxpayers. HARP, even with the new
enhancements, is not a mass refinancing program; it was designed to
help a defined set of borrowers with Fannie Mae and Freddie Mac
mortgages that are underwater or nearly underwater.
It is impossible to project accurately how many homeowners will
benefit from the enhancements to HARP because of unknowable factors,
such as future interest rate fluctuations and the desire of borrowers
to enter into a refinance transaction. Since HARP was introduced in
2009, more than 900,000 homeowners have refinanced through the HARP
program. We believe the announced changes may double the number of
homeowners helped through HARP. The Enterprises plan to issue guidance
with operational details about the HARP changes to mortgage lenders and
servicers today. Since industry participation in HARP is not mandatory,
implementation schedules will vary as individual lenders, mortgage
insurers and other market participants modify their processes.
Separately, the Enterprises have refinanced approximately 9 million
mortgages since 2009.
Servicing Compensation Initiative
The last initiative I will discuss today, the Joint Servicing
Compensation Initiative, made up of FHFA, Fannie Mae, Freddie Mac, and
HUD, is one of the initiatives we have directed the Enterprises to
undertake that are designed to broadly consider changes that will lead
to improvements in the operations of the Enterprises and the overall
mortgage market. The goals of the Joint Initiative are to improve
service for borrowers, reduce financial risk to servicers, and provide
flexibility for guarantors to better manage nonperforming loans, while
promoting continued liquidity in the To Be Announced mortgage
securities market. In addition to those specific goals, the Joint
Initiative seeks broader options for mortgage servicing compensation
that lead to enhanced competition in mortgage servicing and
origination, and that can be replicated across multiple future states
of housing finance.
At the end of September, the Joint Initiative released a discussion
document seeking comments on two alternative servicing compensation
structures for servicing single-family mortgages. One proposal would
establish a reserve account within the current servicing compensation
structure. The other proposal would create a new fee-for-service
compensation structure that would replace today's fixed fee approach.
We requested that comments be submitted by late December, after which
they will be considered and evaluated by the Joint Initiative.
Federal Home Loan Bank Supervision
Third Quarter 2011 Performance and Condition of the FHLBanks
Total assets of the FHLBanks declined by $31 billion in the third
quarter of 2011 and by $100 billion during the first three quarters of
the year. From a peak in 2008 of $1.4 trillion, combined assets have
nearly halved to $778 billion at September 30, 2011. Advances
(collateralized loans to members) are driving the decline, as balances
have fallen from a 2008 high of $1.0 trillion to just $415 billion, or
about the level of advances last seen in the first quarter of 2000.
More recently, advances declined $13 billion in the third quarter of
2011, and $63 billion year-to-date through September. The decline, in
part, reflects high levels of liquidity at member banks with a
consequent decline in the demand for advances. At September 30, 2011,
advances comprised 53 percent of assets, non-MBS investments were 19
percent, agency and Federal MBS were 15 percent, mortgage loans were 7
percent, and private-label mortgage-backed securities (PLMBS) were 4
percent. Though PLMBS assets are relatively small, their distribution
among FHLBanks is uneven, leading to pockets of concentration at some
FHLBanks.
The FHLBanks principally fund themselves by issuing consolidated
obligations in the capital markets. Market access remains excellent,
and spreads to comparable Treasury securities are narrow. Total
regulatory capital at September 30, 2011, was $55.4 billion or 6.5
percent of assets.
Net income is declining at the FHLBanks as fewer earning assets
generate less net interest income, and as lower interest rates reduce
the return on the FHLBanks' invested capital. Offsetting these factors
is a decline in credit-related other-than-temporary impairment (OTTI)
on PLMBS, though this remains a potentially volatile item, with the
possibility to increase should collateral performance or the broader
housing market deteriorate further. On a year-to-date basis through
September 30, 2011, all FHLBanks were profitable, though some did have
quarterly net losses. Combined net income was $475 million for the
third quarter of 2011 and $1.1 billion year-to-date. This is down from
comparable periods in 2010, when net income was $680 million in the
third quarter and $1.3 billion year-to-date through September 2011. A
significant factor in the lower quarterly net income was mark-to-market
losses on derivatives. These derivatives are part of a prudent risk-
management strategy, and the losses should reverse as the derivatives
approach maturity. Credit OTTI charges were lower in 2011 relative to
2010--credit OTTI totaled $775 million in the first three quarters of
2011, down from $905 million for the same period in 2011. To-date, the
FHLBanks have reported a total of $4.4 billion in credit-OTTI charges
on PLMBS, which amounts to about 5 percent of the peak balance of this
asset category. PLMBS remain a supervisory concern.
Resolution Funding Corporation
In 2011, the FHLBanks satisfied their collective obligation to make
payments related to the Resolution Funding Corporation (REFCORP), a
funding mechanism used during the savings and loan crisis. Related to
this accomplishment, the FHLBanks collectively entered into a Joint
Capital Enhancement Agreement, which requires each FHLBank to allocate
20 percent of its net income to a restricted retained earnings account,
from which it cannot pay dividends and which serves to enhance the
joint-and-several liability features inherent in FHLBank consolidated
obligations.
FHLBank of Chicago
On September 31, 2011, FHFA approved the capital plan of the
FHLBank of Chicago, a requirement of the 2007 Consent Order with that
FHLBank. Implementation is expected on January 1, 2012. Until then, the
FHLBank of Chicago remains the only FHLBank still operating under a
pre- Gramm-Leach-Bliley Act capital structure.
FHLBank of Seattle
The FHLBank of Seattle faces a declining advance franchise, a
problematic PLMBS portfolio, and insufficient retained earnings.
Although the FHLBank has capital equal to 6.8 percent of assets, FHFA
has exercised its discretion to classify the FHLBank as
``undercapitalized.'' The FHLBank of Seattle has operated under a
Consent Order to resolve outstanding capital and supervisory matters
since October 2010.
Office of Inspector General Reports
Mr. Chairman, you asked me to comment on the recent reports issued
by FHFA's Office of Inspector General (OIG). In response, I offer four
observations.
First, my staff has heard from me repeatedly that I believe
Inspectors General are in place to help make Federal agencies better,
to see what we sometimes cannot see for ourselves, or see things in a
different way from those who are up close to an issue. Since FHFA is
committed to continually improving itself, I look forward to input from
the Office of Inspector General to assist us in that objective.
Second, FHFA has agreed to carry out all of the formal
recommendations made by the Office of Inspector General in each of
these reports. I believe it reflects a good-faith partnering with the
OIG to be complete and timely in responding to the various
recommendations and we are doing so.
Third, while we are implementing all the recommendations in these
recent reports, I do not agree with some of the statements, inferences,
and conclusions drawn in some of these reports. Where we do have
disagreements, I believe they reflect a new office and staff getting to
learn the FHFA's statutory responsibilities, safety and soundness
regulation, and the business of the regulated entities. By the same
token, FHFA is learning how to work with an OIG. I expect such
disagreements to decline with time.
Finally, it appears from these reports that the OIG's view is that
FHFA should be a larger organization than it is today. A recurring
conclusion in the OIG reports to-date is that FHFA is understaffed and
that it should be more directly engaged day-to-day in the Enterprises'
business activities, independently repeating and validating numerous
business decisions and calculations. This could involve a costly build-
up of staff at FHFA with an uncertain long-term future for this work if
Congress legislates away the conservatorships. It would also result in
greater taxpayer draws to fund this build-up through assessments on
Fannie Mae and Freddie Mac. It also raises questions as to the purpose
of Enterprise management and boards if FHFA reviews and repeats so much
of their work. As I noted earlier in my statement, conservatorship has
been predicated on a delegated authority for the Enterprises to run
their day-to-day business. This approach is aimed at achieving
operational savings and reducing operational risks. I believe changes
to this approach would need to demonstrate benefits that outweigh the
costs.
In any event, FHFA is already undergoing considerable growth,
albeit not at the pace and ultimate size that may be contemplated by
the OIG. From the fewer than 400 people composing FHFA at the outset 3
years ago, we now have more than 520 staff and have budgeted for growth
to a level slightly above 600. Furthermore, the OIG itself is growing
rapidly to a scale unprecedented for an agency OIG. The OIG's budget
request for FY2012, which Congress has not yet acted on, would provide
the OIG with a budget of $48 million and a staffing level of 150. This
would give the OIG one staff member for every four at FHFA, to my
knowledge an unprecedented ratio. The ratio of our respective budgets
would be of similar magnitude. Since both FHFA and OIG are funded by
assessments on FHFA's regulated entities, the growth at FHFA and OIG is
adding costs to the conservatorships and to the FHLBanks.
Executive Compensation
You have asked me to address executive compensation for Fannie Mae
and Freddie Mac executives. At the outset let me state that the best
way to address concerns with executive compensation is action by
Congress to restructure the nation's housing finance system and
dissolve the conservatorships. In the absence of that resolution, FHFA
will continue to evaluate the appropriateness of executive compensation
at the Enterprises given their ongoing activities.
Before getting into the details, I would like to begin by sharing
my own frustration with compensation issues in conservatorship. Nothing
like this has been done before--placing two of the largest private
financial institutions in the world into Government conservatorship and
then overseeing their operations in that State for multiple years.
Determining appropriate compensation in this situation is vexing. As a
career-long Federal employee, I, too, perceive the compensation
agreements as large. I also share the frustration of many that past
leaders of these companies received enormous compensation pre-
conservatorship. Yet, while frustration with the past business
decisions of Fannie Mae and Freddie Mac leadership, past policy
failures, and the resulting enormous taxpayer costs is understandable--
and I share it--it cannot distract us from the task at hand.
As conservator, I need to ensure that the companies have people
with the skills needed to manage the credit and interest rate risks of
$5 trillion worth of mortgage assets and $1 trillion of annual new
business that the American taxpayer is supporting. I have concluded
that it would be irresponsible of me to risk this enormous contingent
taxpayer liability with a rapid turnover of management and staff,
replaced with people lacking the institutional, technical, operational,
and risk management knowledge requisite to the running of corporations
with thousands of employees and more than $2 trillion in financial
obligations each. That conclusion is further buttressed by the
realization that, from an Enterprise executive's or staff's point of
view, continued employment at an Enterprise risks substantial job and
career uncertainty. The public scrutiny and criticism is often harsh,
and almost everyone expects the Enterprises to cease to exist, at least
in their current form, in the future. At the same time, the taxpayer is
backing Enterprise financial commitments that have 30-year lives, and
we will need expert management of those guarantees for years to come.
Given the amount of money at risk here, small mistakes can easily be
amplified to losses far greater than the compensation paid to
Enterprise executives.
In short, as Congress considers executive compensation at the
Enterprises, the basic fact is that despite the large amounts of
Government support provided to the Enterprises they remain private
companies with uncertain futures, not Government agencies. They employ
thousands of people. We cannot maintain operational effectiveness while
suddenly treating them as ongoing Government agencies--something they
are not. Major changes to compensation, for executives or staff, cannot
be done safely and soundly in a short period of time and attempting to
do so would pose substantial risk to the mortgage market and a greater
risk of loss to taxpayers.
In the next section, I will review the history of how FHFA
established the executive compensation program operating today, and
describe the details of that program and how it has been working. I
will then conclude with a few thoughts on the program going forward and
the role Congress might play to bring this difficult matter to an end.
Initial Conservatorship Decisions
During FHFA's intense preparations for placing the Enterprises into
conservatorship, we received some valuable insights from discussions we
had with the Federal Deposit Insurance Corporation (FDIC). The FDIC's
experience in bank failure resolutions, including conservatorships,
supported our view that achieving the goals of conservatorship depended
on retaining capable and knowledgeable staff. At the same time we
sought to no longer employ those executives most responsible for the
conditions leading to our action. As a part of our planning process, we
hired Hay Group, a well-respected executive compensation consultant, to
help us design a plan to encourage the best employees to stay, while
not rewarding poor performance.
In placing the Enterprises into conservatorship, our foremost
concern was that their troubled condition was leading them to withdraw
their services from housing finance markets at a time when they were
greatly needed. Their combined market share in 2008 was more than
double what it had been 2 years earlier, as most other participants
went out of business or sought to avoid new risk exposure to the
mortgage market. For the sake of our country's economy and especially
its housing sector, it was and remains essential that the Enterprises
continue to bring liquidity, stability, and affordability to the
mortgage market. Furthermore, the Enterprises' enormous size, including
more than $5 trillion of mortgage credit risk, and taxpayer exposure to
that risk in the face of rapidly deteriorating housing markets, made it
imperative that the Enterprises strengthen their management in the
areas of risk control and loss mitigation. In addition, it was and
remains imperative that the Enterprises attract and retain the
particular and specialized skills needed to manage these activities.
To address these concerns, FHFA discussed our retention approach in
some detail with both new Chief Executive Officers (CEOs) on the day
before their new jobs officially began. Both CEOs agreed with our view
of the importance of such a plan, and over the next few weeks worked
with us, Treasury, and Hay Group to customize plans for their
respective institutions. Payments under the plans were virtually the
only nonsalary compensation for Enterprise employees for the 2008
performance year, as no bonuses were paid for that year at either
Enterprise.
At the inception of the conservatorships, we also announced that
the incumbent CEOs would be leaving after a brief transition period.
They received no severance payments. In prohibiting such payments, we
relied in large part on the golden parachute provisions in the Housing
and Recovery Act of 2008 (HERA). In addition, because most of their
remuneration had been in the form of Enterprise stock, roughly two-
thirds of their previously reported pay during their tenures as CEOs
vanished with the collapse in the market prices of their shares. The
golden parachute provisions were also helpful in other cases, as
ultimately, five of the six Fannie Mae executives that were highest
paid before the conservatorships and the top four Freddie Mac
executives left in one fashion or another during the first months of
conservatorship, but none of them received severance or other golden
parachute payments. They also saw a substantial reduction in the value
of their past compensation due to the collapse in their company's stock
price. While I know all the attention today is on executive pay, I'd
like to add that many of the more than 11,000 rank and file employees
at the Enterprises also had large portions of their life savings in
Enterprise stock and suffered accordingly.
New Compensation Structure
FHFA's development of a new compensation structure for senior
Enterprise executives for 2009 and beyond was delayed, first by our
appointment of new boards of directors at the Enterprises, with new
compensation committees, then by the departure of the CEOs hired at the
start of the conservatorships.
Additionally, FHFA had agreed, under the Senior Preferred Stock
Purchase Agreements that control financial support to the Enterprises,
to consult with Treasury about new compensation arrangements with
executive officers at the Enterprises. We wanted to consider fully the
approach being developed at the Treasury for institutions receiving
exceptional assistance from the Troubled Assets Relief Program (TARP).
After Kenneth Feinberg was appointed Special Master for TARP Executive
Compensation, Treasury asked us to consult with him, and we began to
discuss how we could adapt to the Enterprises the approach he was
developing for TARP institutions.
In making that adaptation, a major consideration was that
compensating Enterprise executives with company stock would be
ineffective because of the questionable value of such stock. Further,
large grants of low-priced stock could provide substantial incentives
for executives to seek and take large risks. Accordingly, all
components of executive compensation at the Enterprises are in cash.
Another consideration was and remains the uncertain future of the
Enterprises as continuing entities, which is in the hands of Congress
and beyond the control of Enterprise executives. It is generally best
to focus management's incentives toward its institution's performance
over the long-run rather than just the near-term. In the case of the
Enterprises, that is nearly impossible. Therefore, compensation for
current work does not depend on results more than 2 years out. To
encourage talent to stay put, FHFA made deferred payments generally
dependent on an executive's continued employment at the Enterprise. We
also made half of the deferred pay subject to adjustment based on
corporate performance to partially simulate the effect of corporate
performance on the corporate shares paid to executives at TARP firms
for their deferred pay. That allows for reductions in deferred salary
if the Enterprise's goals, as set by the Board with increasing input
from FHFA, are not met. As I will explain further below, corporate
performance in this context is tied to the goals of conservatorship.
FHFA also looked to existing practice elsewhere to determine the
appropriate levels of total target compensation for the most senior
positions. We considered data from consultants to both Enterprises,
data received earlier from our own consultant, and the reported plans
of TARP-assisted firms. It was important to set pay at levels
sufficient to compete for quality talent because the Enterprises had
many key vacancies to fill, potential departures to avoid, and pay has
been a significant issue in some cases. That need was, as it must be,
balanced by our efforts to keep the cost to taxpayers as low as we
possibly could.
Based on review of past compensation, the market comparables
identified by outside pay consultants, discussions with each board of
directors, recent experience in recruiting CEOs, and consultation with
the Treasury Department, FHFA settled on a target of $6 million a year
for each CEO, $3.5 million for the Chief Financial Officers (CFOs), and
less than $3 million for Executive Vice Presidents and below. That
amount rolls back Enterprise CEO pay to pre-2000 levels. It is less
than half of target pay for Enterprise CEOs before the
conservatorships. For all executive officers, Fannie Mae and Freddie
Mac have reduced target pay by an average of 40 percent.
The basic compensation structure for senior executives at both
Enterprises, as at institutions receiving exceptional TARP assistance,
comprises three elements: base salary, a performance-based incentive
opportunity, and deferred salary. Salary scales have been sharply
reduced from pre-conservatorship levels at both Enterprises. As at the
TARP-assisted firms, base salaries generally are capped at $500,000
with a few exceptions. Before the conservatorships, the two Enterprises
had 16 officers earning base salaries higher than that amount, now
there are only four.
Both Enterprises' charter acts, which remain operational in
conservatorship, require that ``a significant portion'' of executive
compensation be tied to corporate performance. Consistent with that
requirement, while also following the approach taken for TARP-assisted
firms, target incentive pay for the Enterprises is limited to a third
of overall compensation. Payment is based on Enterprise performance, as
measured by scorecards developed by each Enterprise subject to FHFA
approval, and individual performance. In reviewing scorecards, we are
particularly sensitive to ensuring that executives are not given
incentives to take inappropriate risks. Our special examinations of
accounting failures at each Enterprise in 2003-2006 revealed that badly
constructed compensation incentives contributed significantly to
excessive focus on near-term earnings reports to the serious detriment
of the Enterprises.
Accordingly, FHFA has required a much broader focus that emphasizes
remediation of operational and risk management weaknesses, loss
mitigation, and mission achievement. For 2009, I approved for each
Enterprise funding of incentive payment pools at 90 percent of
aggregate targets. For 2010, I again approved Fannie Mae funding of its
pool at 90 percent, and I approved funding of Freddie Mac's pool at 95
percent. Individual executives could receive more or less, as long as
the aggregate did not exceed the pool amount. Both Enterprises made
substantial progress in loss mitigation and risk management, while
meeting the challenges of implementing Treasury's Making Home
Affordable Programs. However, the boards of both Enterprises, with my
encouragement, recognized that those successes needed to be tempered by
consideration of the sizable contributions of taxpayers needed to
offset Enterprise losses, which occurred despite the generally strong
efforts of the executives. Next year's goals will emphasize not only
loss mitigation and progress on REO disposition, but improvements that
will benefit mortgage market functioning, whatever new structure
Congress may ultimately decide on, such as improved servicing
standards, improved securities disclosures, the Uniform Mortgage Data
Program, and development of risk-sharing pilots.
The remaining portion of compensation is deferred salary, which is
paid with a 1-year lag to executives still working for their Enterprise
at that time. For the highest paid executives, deferred salary is the
largest component of their compensation. As noted earlier, deferred
salary motivates retention. An executive that voluntarily departs
forfeits their deferred but not-yet-paid salary. Any exceptions require
FHFA approval, in consultation with the Treasury. Starting with
payments made in 2011, the amounts are adjusted up or down, based on
each Enterprise's performance on its deferred salary scorecard. I
approved a 10-percent deduction for Fannie Mae and a 12-percent
deduction for Freddie Mac.
The revised compensation structure was designed to align pay with
taxpayer interests. Deferred salary and incentive pay for all executive
officers are subject to claw backs by the Enterprises in the event of
gross misconduct, gross negligence, conviction of a felony, or
erroneous performance metrics. The structure also adopts and in some
respects expands on reforms advanced by the Special Master for firms
receiving exceptional TARP assistance. This structure, established in
2009, and the annual targeted compensation amounts for executive
officers remain in place today. Whenever Congress acts to direct how
and when the conservatorships end and to decide the ultimate resolution
of the companies, these executive positions, and the compensation
program, are subject to change or elimination.
News reports have described $12.8 million of 2010 pay as
``bonuses.'' That number is the sum of $7.5 million in deferred salary
and $5.3 million in target incentive opportunity payments.
Turnover and Compensation Under the Program
Both Enterprises have experienced some increase in turnover.
Freddie Mac's voluntary turnover rate over the past two quarters has
averaged more than 13 percent compared to its 5-year average of 8\1/2\
percent. Fannie Mae's has risen to about an 11 percent annual rate so
far this year after averaging a bit above 6 percent over the preceding
3 years. Among officers at Fannie Mae, more than 11 percent have left
so far this year. Five of Freddie Mac's 16 executive officers have left
voluntarily since the beginning of the year. Both Enterprises have
experienced some difficulty filling vacancies from outside, as
candidates have expressed concern about the Enterprises' future and the
lack of any remuneration in the form of equity.
Compensation in the Near-Term
At the present, my plan for executive compensation is to continue
to seek opportunities for gradual reductions, particularly when
executives leave. This approach is consistent with the Administration's
notion of a gradual wind down. I also believe it important for FHFA to
continue to assess the corporate scorecards used to improve the
alignment between the scorecards and the goals of conservatorship.
Earlier in this prepared statement I described positive steps FHFA
has undertaken to prepare the mortgage market for the future, with or
without the Enterprises. I have recently spoken publicly of my goal to
bring greater private capital participation into the Enterprises'
mortgage purchases so that the taxpayer is not the sole source of
support. And I have spoken of my goal to continue a gradual program of
guarantee fee increases by the Enterprises so that their pricing better
reflects that one would expect from a purely private company operating
with its own capital at risk. I believe the executive compensation
program in place today would be enhanced by more tightly aligning
corporate goals with the successful achievement of these recently
established conservatorship goals. Likewise, I believe we should be
striving to simplify and shrink the operations at each Enterprise, and
should award successful steps toward those ends.
Executive Compensation--Concluding Thoughts
I recognize that this Committee, or the full Senate, may soon
consider legislating changes to the executive compensation program I
have just described. The House Financial Services Committee is
scheduled to consider legislation today that would put Enterprise
employees on the Federal Government's GS-pay scale. I have already
testified before that body why I do not think that would be a good
idea.
I am grateful for this opportunity to explain the program that is
in place today, its rationale and its features. I hope that this
explanation has cleared up some misunderstandings and placed the matter
in a different light. I would like to close with a few final thoughts,
respectfully submitted for your consideration.
I believe that commitments already made by the Government through
the compensation already awarded by FHFA should be respected, whether
lawmakers completely agree with the judgments FHFA made or not.
Changing compensation going forward, thereby allowing Enterprise
employees to make an informed choice about their continued employment,
is fair. Changing what has already been promised and earned is not.
Some have suggested that we should have no trouble maintaining
adequate staffing at far smaller pay levels, pointing to outstanding
cabinet members who serve or have served with distinction on Government
pay scales. I have serious doubts about taking this approach to the
management of the Enterprises. People come to work for the Government
for a variety of reasons. The opportunity to serve our country is
important for many of us. Some especially desire the relative job
security of the career service, others the policymaking roles and the
stature that comes with temporarily filling high-ranking jobs. If you
want to influence the determination of our nation's financial and
economic policies, a job in the Government may well be what you want,
despite better pay offers elsewhere. But if you are working at an
Enterprise in conservatorship, you have less say in the direction or
outcome of your company than in normal businesses. And one of our first
rules of conservatorship is that company employees may not lobby or
participate in the policymaking process to decide the future of housing
finance. At the same time, by working at Fannie Mae or Freddie Mac your
work comes under a much higher degree of scrutiny and criticism, and
with a lot less job security than comes with working for any other
private firm engaged in housing finance. Executives who have spent a
career developing their reputations risk tarnish to those reputations
under the highly charged environment in which these companies operate
today, regardless of how well they perform their duties or how great a
financial sacrifice they make forsaking other private sector
opportunities to assist the country's housing finance system.
I do not question that, despite these drawbacks, some might be
willing to sign up at Fannie Mae or Freddie Mac for relatively little
pay, and I am committed to finding capable people willing to do so. But
I have not seen, even in this marketplace, that people with the right
skills to run these two companies, as they exist today with all the
uncertainty involved and the negative atmosphere, are easy to find.
But even if it could be done, and I think it might be possible if
the missions and operations of the Enterprises were sufficiently
streamlined, it would require a careful transition over time. The
people who are there now did not choose Government jobs. A sudden and
sharp change in pay would certainly risk a substantial exodus of
talent, the best leaving first in many instances. The Enterprises
likely would suffer a rapidly growing vacancy list and replacements
with lesser skills and no experience in their specific jobs. A
significant increase in safety and soundness risks and in costly
operational failures would, in my opinion, be highly likely. Thus,
sharp and sudden pay cuts should not be expected to lower taxpayer
costs, but rather to raise them. Because of the huge size of these
institutions, the potential consequences of any increases in risk are
magnified. Additional losses amounting to just one basis point on their
$5 trillion of assets and liabilities would translate to $500 million,
nearly 40 times the ``bonuses'' that have received so much attention.
Should the risks I fear materialize, FHFA might well be forced to
limit the Enterprises' business activities. Such cut backs likely would
drive much larger business volumes to FHA and Ginnie Mae, potentially
straining their capacities. Some of the business the Enterprises would
be unable to undertake might simply not occur, with potential
disruption in housing markets and the economy.
No one wants that. Whether you prefer that the secondary mortgage
market be a purely governmental or a predominately private sector
activity, we need to have an orderly transition, not a sudden shock.
The best way to accomplish that is for lawmakers and the Administration
to decide on the future structure of housing finance, especially as it
regards the secondary mortgage market. Then we could have a final
resolution of Fannie Mae and Freddie Mac in conservatorship, which
would resolve the compensation issue once and for all.
Mr. Chairman, thank you again for this opportunity. I have tried to
provide the Committee with a clear overview of key aspects of our
current activities and oversight goals as we await direction on the
future of the housing finance markets. I look forward to responding to
the Committee's questions.
OVERSIGHT OF THE FEDERAL HOUSING FINANCE AGENCY--PART II
----------
TUESDAY, DECEMBER 13, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:03 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. Good morning. I would like to call this
hearing to order. I would like to welcome the first Inspector
General of the FHFA, Steve Linick, before the Committee today.
As we wrap up the hearings for this year, I am pleased that
the Ranking Member and I were able to agree to a plan for the
hearings that the Committee held on housing finance reform this
year and hope that we will be able to continue that bipartisan
approach next year.
The 12 housing finance-related hearings we held this year
have highlighted some general principles I believe we hold in
common that will guide us going forward. Small institutions
that maintained sound underwriting standards during the boom
should still have access to any secondary market that is
created in the future. This is important for maintaining
strong, responsible home ownership opportunities in rural and
underserved areas. Fully documented underwriting should be the
standard practice in any system going forward. Clear rules of
the road are essential for providing stability to the market,
but the transition must be a gradual one, given the current
fragile state of the market.
The Committee's exploration of these specific topics has
helped inform members and build a record on which the Committee
can evaluate legislative efforts. Looking ahead to next year,
there are some topics that still need to be explored, but I am
hopeful that Senator Shelby and I can continue moving forward
on housing finance reform in the same bipartisan way that we
have conducted hearings and markups this year.
In nearly every hearing this year, the current state of the
economy and strategies for improving the housing market were
topics of discussion. The need to reform our housing finance
system and the need to improve the housing market go hand in
hand. The Federal Housing Finance Agency, as the conservator of
Fannie Mae and Freddie Mac, could play a significant role in
improving the housing market, but based on reports from the
Inspector General's office, there are deficiencies at the
agency that are holding back those efforts.
I am concerned that the reports produced by the Inspector
General's office show several negative trends in FHFA's
oversight of operations at Fannie Mae and Freddie Mac. First,
the regulator defers to the GSEs on major decisions without
independently verifying the benefits to the conservatorship or
the taxpayers. Second, the FHFA appears to allocate staffing
resources in a manner that limits its ability to enforce
directives and adequately oversee operations at the GSEs. These
two trends appear to restrict the FHFA's ability to help
stabilize the housing market and protect taxpayer dollars while
also continuing the problematic relationship that Fannie Mae
and Freddie Mac had with their previous regulator.
Despite its independent status, which was granted on a
bipartisan basis in 2008 as a single director with
congressional appropriations and expanded powers as
conservator, FHFA could be doing more to prevent losses and
enforce required changes at Fannie Mae and Freddie Mac. As the
regulator of two of the largest entities in the housing market,
it is essential that FHFA prioritize oversight as one of the
strategies necessary to stabilize our housing market. This
would benefit the taxpayers both by strengthening the current
state of the GSEs and also providing guidance and consistency
to a large sector of the housing market to further create
stability for homeowners and potential homebuyers.
I look forward to hearing your recommendations for
improvements and the possible reasons for the trends that you
continue to see, Inspector General Linick.
With that, I turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
Today, as the Chairman has mentioned, the Committee will
hear the testimony of the Inspector General of the Federal
Housing Finance Agency, Mr. Steve Linick. This will be his
first appearance before us.
The Office of the Inspector General oversees the Federal
Housing Finance Agency's regulation of Fannie Mae, Freddie Mac,
and the Federal home loan banks. I look forward to hearing the
testimony today from the Inspector General about the status of
Fannie, Freddie, and the Federal Housing Finance Agency, as
well as how he plans to carry out his duties. I am interested
to hear how his office can help FHFA, the Federal Housing
Finance Agency, oversee the conservatorship of Fannie and
Freddie.
Unfortunately, before Mr. Linick was confirmed, the post of
the Federal Housing Finance Inspector General was vacant for 2
years, a period when the need for oversight I believe was
critical. During that time Fannie and Freddie were placed into
conservatorship, and taxpayers began paying for their losses.
So far, Fannie and Freddie have cost almost $183 billion and
counting.
Despite their financial problems, Fannie and Freddie's
dominant role in the housing market persists as they currently
back 71 percent--71 percent--of new mortgage-backed securities.
The delay in filling the IG post means that Mr. Linick has a
lot of important work, I believe, to catch up on.
First and foremost, I believe we must provide oversight of
the Federal Housing Finance Agency's conservatorship of Fannie
and Freddie to ensure that the taxpayers' dollars are spent
wisely. During its short existence, the Office of the Inspector
General here has already identified several ways in which the
Federal Housing Finance Agency can do a better job of
protecting taxpayers. For example, in its semiannual report,
the Inspector General noted that the FHFA did not effectively
oversee Fannie and Freddie's negotiations with Treasury on the
administration's Home Affordable Modification Program that we
call ``HAMP.''
According to the report, this contributed to the GSEs'
entering into a poorly drafted agreement. As a result, there
have been significant disputes between the Federal Housing
Finance Agency and the Treasury about how the GSEs should run
HAMP.
The report also notes that HAMP has undermined the ability
of the GSEs to perform their core functions. Indeed, FHFA
Acting Director Ed DeMarco concluded in a letter, and I will
quote. He said, ``HAMP created operational risk with the
enterprises and diverted staff and resources from other
critical priorities.'' This report recommends that the Federal
Housing Finance Agency better engage with Treasury and the GSEs
to clarify certain aspects of the HAMP agreements, including
establishing a dispute resolution mechanism.
Another issue that the IG mentions in his semiannual report
is FHFA's lack of analysis or compensation for Fannie and
Freddie executives here. According to the Office of the
Inspector General, and I quote again, ``FHFA had not considered
factors that might have resulted in reduced executive
compensation costs.''
To improve FHFA's framework for making executive pay
decisions, the Office of Inspector General recommended that
FHFA use performance data and independent verification of
compensation levels. Taxpayers I believe should never be put in
the position of paying millions to executives of any company.
Yet as long as we have had the GSEs, this has been the case.
The OIG recommendations are intended to ensure that taxpayers
spend only what is required, what is necessary.
The OIG's work also shines a light on the larger issue of
the costs arising from the administration's failure to propose
a detailed plan to end the conservatorship of Fannie and
Freddie. It has been 3 years and 98 days since the
conservatorship began. The conservatorship was never intended
to last this long. Nor was FHFA designed to handle the
``conservatorship to nowhere'' that we face today.
It should not be surprising that the OIG has found
significant shortfalls in the FHFA's examination program,
including having too few examiners overall to ensure the
efficiency and effectiveness of FHFA's oversight of the GSEs.
This is no small finding since examination is the primary
means by which the FHFA supervises and regulates the GSEs. This
serious problem here exists in large measure because the
perceived short-term nature of the conservatorship makes it
difficult for FHFA to hire enough qualified examiners. This is
just one of many problems created by the GSEs' prolonged
conservatorship, and the longer we wait to reform our housing
finance system, the larger these problems will grow, and the
solutions will become more expensive for the taxpayer.
Nevertheless, the majority decided not to tackle housing
finance reform in Dodd-Frank, as many people on this Committee
recommended. At some point, however, the majority is going to
find that it can no longer kick the can down the road. We need
to work together on this.
Thank you.
Chairman Johnson. Thank you, Senator Shelby.
[Whereupon, at 10:15 a.m., the Committee proceeded to other
business and reconvened at 10:22 a.m.]
Chairman Johnson. Returning from Executive Sessions, are
there any other Members who wish to make a brief opening
statement?
[No response.]
Chairman Johnson. Thank you all. I want to remind my
colleagues that the record will be open for the next 7 days for
opening statements and other materials you would like to
submit.
Now, I would like to briefly introduce our witness here
today. The Honorable Steve A. Linick is Inspector General of
the Federal Housing Finance Agency. Mr. Linick has served in
this capacity since October 2010, having previously served in
various senior positions at the Department of Justice. We
welcome you here today Mr. Linick and ask you for your time.
Mr. Linick, you may proceed with your testimony.
STATEMENT OF STEVE A. LINICK, INSPECTOR GENERAL, FEDERAL
HOUSING FINANCE AGENCY
Mr. Linick. Thank you, Chairman Johnson, Ranking Member
Shelby, and Members of the Committee, for inviting me to
testify today. I will provide an assessment of our emerging
trends based on the work we have conducted to date and describe
our operations.
I am the Agency's first Inspector General. My office began
operations after I was sworn in in October of 2010. Over the
past 14 months, we have hired a professional staff and have
gotten the office up and running. To date, we have published 10
audits and evaluations. We have commenced multiple criminal and
civil investigations. We have issued our second semi-annual
report to Congress just 2 weeks ago.
I want to tell you about emerging trends we have seen in a
number of our reports, to which Chairman Johnson has alluded.
Let me begin with some of the positives for which FHFA deserves
credit.
For example, FHFA has eliminated golden parachute
compensation awards to terminated Fannie Mae and Freddie Mac
executives. In addition, FHFA has accepted our recommendations
to improve its effectiveness and efficiency and to reduce its
vulnerability to fraud, waste, and abuse.
On the other hand, however, our reports have also
identified deficiencies reflecting two significant and related
emerging trends. First, FHFA often relied on determinations of
the Enterprises without independently testing and validating
them, thereby giving undue deference to Enterprise decision
making. Second, FHFA's decisions about how it allocated its
resources may have affected its ability to oversee the GSEs.
Let me start with the first emerging trend. FHFA has not
independently tested and validated Enterprise decision making.
In brief, we believe FHFA has displayed undue deference to the
Enterprises in a number of areas. The Agency's actions appear
to reflect its approach as conservator to delegate most
business decisions to the Enterprises. In four of our reports,
we identified instances in which the Agency relied upon review
and corporate governance processes already in place at the
Enterprises. However, we believe there are some matters that
are sufficiently important to warrant greater involvement and
scrutiny by the Agency. Here are illustrations from two of the
four reports.
First, I will discuss FHFA-OIG's report on the review and
approval of the Freddie Mac settlement of repurchase claims
with Bank of America. At the end of 2010, FHFA approved a $1.35
billion settlement of mortgage repurchase claims between
Freddie Mac and Bank of America. In approving the settlement,
FHFA relied on Freddie Mac's analysis of the settlement
benefits. But there was reason to question the settlement based
on a significant flaw identified in the Freddie Mac loan review
process. Before the settlement came up, an FHFA senior examiner
questioned whether Freddie Mac's process accounted for housing
boom loans. Freddie Mac's internal auditors raised similar
questions at the end of 2010 and in the middle of 2011.
Nonetheless, FHFA did not independently test the assumptions
underlying Freddie Mac's settlement. According to the senior
FHFA examiner, he believed the flaw he identified could be
costing Freddie Mac a significant amount of money.
In the wake of our report, FHFA has suspended approvals of
additional repurchase settlements, agreed to improvements in
its internal management process, and has initiated further
study of the issue.
Second, I will discuss another example involving FHFA's
review and approval of executive compensation. In another
report, we found that for 2009 and 2010, Fannie Mae and Freddie
Mac paid their top six executives over $35 million in salaries
and benefits over those 2 years. FHFA reviewed and approved
those payments based on recommendations made by Fannie Mae and
Freddie Mac. But FHFA did not independently test or validate
the recommendations. And given the amounts involved, we
concluded that FHFA should have done more, for instance, by
including a wider range of salaries for pay comparison purposes
and a review of performance metrics used to judge the
executives' compensation levels.
Let me now turn to the second emerging trend. FHFA's
resource allocations may have affected its ability to oversee
the GSEs and enforce its directives. Again, in brief, we
identified in four reports situations in which FHFA was not
proactive in its oversight and enforcement. Inadequate resource
allocations may explain these failings. Here are two
illustrations.
First, I will discuss a report involving FHFA's oversight
of foreclosure process abuses. News reports about foreclosure
abuses in the foreclosure process by law firms and their agents
began to surface in a big way starting in the summer of 2010.
But only after the news surfaced did FHFA begin to schedule
comprehensive examination coverage of foreclosure issues.
Before that time, FHFA had not considered the risks associated
with foreclosure processing to be significant. However, our
report identified multiple indications of foreclosure abuse
issues prior to mid-2010 that could have led FHFA to foresee
the heightened risk in foreclosure processing abuses. FHFA had
not acted on the issue before mid-2010 because neither the
Agency nor its predecessor agency considered the matter to be a
priority.
The second illustration involves a report addressing FHFA
examination capacity. As noted in this report, FHFA believes it
has too few examiners monitoring the operations of Fannie Mae,
Freddie Mac, and the Federal Home Loan Banks. Moreover, about
only a third of FHFA line examiners are accredited. Our report
concluded that this examination shortage may have contributed
to FHFA's lack of oversight in significant areas, such as real
estate owned property.
I would now like to provide a brief overview of my office's
operations. Broadly, our plans for audits and evaluations
include reviews of the following Agency activities: Management
of the Enterprise conservatorship, including servicing and real
estate owned property; oversight of the Federal Home Loan
Banks; and FHFA internal operations.
We also operate a separate Office of Investigations. It,
too, has made significant contributions to a range of mortgage-
related investigations. For example, we recently participated
in the investigation, prosecutions, and convictions associated
with the Taylor, Bean & Whitaker case. In that case, the
defendants perpetrated a $2.9 billion fraud that has been
described as among the largest in history. Freddie Mac reported
losses in that case alone of $1.8 billion.
The Office of Investigations also operates the FHFA-OIG
Hotline, which allows for confidential reporting of fraud,
waste, or abuse, and that hotline can be reached at 1-800-793-
7724.
In closing, we look forward to continuing to work with the
Committee to provide independent, relevant, and objective
assessments of FHFA's operations and programs. FHFA continues
to face significant challenges based on the continuing
fragility of the Nation's housing market and the continuing key
roles still played by Fannie Mae, Freddie Mac, and the Federal
Home Loan Banks, and I hope the work by my office will be of
assistance in meeting those challenges.
Thank you, and I am happy to answer your questions.
Chairman Johnson. Thank you very much for your testimony.
As we begin questions, I will ask the Clerk to put 5
minutes on the clock for each Member.
Mr. Linick, according to your semi-annual report, FHFA and
its predecessor have failed to enforce requirements that Fannie
Mae implement an operational risk program. Does this lack of
follow-through pose an operational risk to the conservatorship
and taxpayer dollars, in your opinion? What is providing the
Agency, especially now as conservator, from taking further
actions to force compliance?
Mr. Linick. Senator, operational risk involves identifying
losses caused by people, processes, and external events, such
as foreclosure abuses. Operational risk is critical to
corporate governance. Good operational risk programs would
require the Enterprise to self-identify, report, and correct
risks as they emerge.
What we found in our report on operational risk is that for
5 years, between 2006 and 2011, FHFA and its predecessor
agency, OFHEO, had repeatedly cited Fannie for not implementing
an effective operational risk program. In 2009, FHFA said it
was a critical concern and issued numerous citations. Yet
despite these findings, Fannie Mae has not implemented an
operational risk program and FHFA has not required it to, and
that is of concern to us.
It is of concern to us because FHFA's own examination
shortages cause concerns, and if FHFA is weak as a regulator or
as a conservator, it is important that Fannie's and Freddie's
operational risk programs be strong because they go hand-in-
hand. So that is why operational risk is a critical element to
oversight and accountability.
In terms of what is preventing the Agency from enforcing
this and requiring Fannie Mae to develop an operational risk
program, I do not know why. It is rather shocking, since they
have been telling Fannie Mae for 5 years that they need an
operational risk program. FHFA has broad authorities as
conservator. They can fire people. And as regulator, they
certainly can issue cease and desist orders and the like.
They have promised that they will implement an effective
operational risk program by 2012 and we are monitoring it.
Chairman Johnson. Can you give examples of areas where
staff and resources are not being allocated to prioritize
oversight and how this could impact FHFA's ability to limit
taxpayer losses.
Mr. Linick. We have issued a report on examination capacity
at the Agency, and this report reflected what the Agency told
us about staffing shortages resulting in limited transaction
testing, scaled back examination, and delays in examination. We
heard that from the Agency. In part, it involved the HAMP
program. Transfer of risk examiners to the HAMP program early
on caused stressors on the examination program.
The examination program is absolutely critical to assessing
risk management at the Enterprises, and we have noticed that as
a result of these shortages, there have not been targeted
examinations of real estate owned property until every
recently. There have not been examinations of critical business
lines, such as multifamily housing. And there have been
insufficient examinations at the Federal Home Loan Banks.
Clearly, if FHFA does not have the capacity to examine
critical programs at the GSEs, there is a risk of loss to
taxpayers and it is very important that the Agency takes steps
to mitigate these shortfalls, which it is doing.
Chairman Johnson. Does the FHFA have the resources and
staff to provide proper oversight and examinations of a $5
trillion mortgage portfolio and entities responsible for
supporting the majority of the $11 trillion mortgage market?
Mr. Linick. The staffing issue is a complicated issue
because there is no doubt that the Agency, in our view, could
do a better job prioritizing and allocating resources. But we
have not done an across-the-board human capital assessment to
determine whether, overall, the Agency needs to staff up to
address the conservatorship.
We have looked at staffing in one area, examination
capacity, and we concur with the Agency that they need more
examiners. We are also concerned because their Office of
Conservatorship Operations has six individuals in it, and we
are looking at that issue now to determine whether or not that
is sufficient.
But staffing also relies on other considerations. Bigger is
not necessarily better for an organization. So, for example, it
is possible that the Agency can beef up its conservatorship
operations if their examination operations are not strong, or
vice-versa.
The Agency can also ensure through operational risk
programs, that Fannie and Freddie and the Federal Home Loan
Banks have their house in order to compensate for examination
shortfalls.
So, clearly, more can be done to improve. We have
recommended that the Agency study this issue to determine how
it can mitigate these examination shortfalls. Ultimately, Mr.
DeMarco is going to have to find the optimal point of how to
staff the Agency in a way in which resources are allocated
appropriately and strategically.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Mr. Linick, in addition to managing a brand new Inspector
General's office, you lead a very unique office here. The
conservatorship of Fannie Mae and Freddie Mac have now lasted
for over 3 years, as I mentioned in my opening statement, at a
cost of $183 billion, I understand, and growing. In your
position, you provide oversight of the Federal Housing Finance
Agency not only in its traditional role as a regulator, but
also now as a conservator.
During your tenure, and I know you have not been there that
long, what will be your priorities, number one, and what issues
do you intend to focus on specifically? I know there will be
some that will pop up to you, but on the overall substantive
issues. And how will you implement your agenda going forward as
an independent Inspector General at the Federal Housing Finance
Agency?
Mr. Linick. Senator, as you mentioned, our role is unique
given we have a conservatorship and a regulator all wrapped in
one.
In terms of our priorities, our number one priority is
looking at conservatorship management and Enterprise oversight.
We are looking at every stage of the mortgage loan process,
from underwriting all the way to deficiency judgments. We are
looking at various stages of servicing, from the beginning of
servicing to the end of servicing. And we have already issued
reports on default-related legal services, how attorneys relate
to the servicing process and foreclosure processing abuses, and
we have issued an operational risk report.
We are also looking at risk management. The operational
risk report addresses that and we are looking at other types of
risk management and Enterprise board governance. We are also
looking at how the $183 billion is being spent, just to name a
few.
We are also looking at the Federal Home Loan Banks----
Senator Shelby. Good.
Mr. Linick. ----and there are a number of issues associated
with management of the Federal Home Loan Banks as well as FHFA
capacity and internal operations.
Senator Shelby. And also the Federal Home Loan Banks' risk
to the taxpayer?
Mr. Linick. Absolutely. Regarding the Federal Home Loan
Banks, there are a number of issues we are looking at. In fact,
we have a couple of reports which are in progress now,
including one on the four troubled banks. We are also looking
at advance and collateral management and we are looking at
capital management, as well.
We also have a robust Investigations Division which we
would like to hold people accountable and institutions
accountable for defrauding the GSEs and defrauding individuals
holding GSE loans. So our investigations section, combined with
our audit and evaluation section, is how we plan to attack the
issues facing the Agency.
Senator Shelby. OK. In your testimony, you also mentioned
that the Federal Housing Finance Agency views operational
risk--you alluded to it earlier--as an important safety and
soundness challenge to all of us facing, of course, Fannie and
Freddie. Yet, during the past 5 years, Fannie has consistently
failed to manage operational risk. Although the Federal Housing
Finance Agency has the authority to discipline the GSEs for
such failures, including removing personnel, FHFA so far has
not chosen to exercise this authority. That does not mean you
will not in the future. I understand that.
In your view, should the Federal Housing Finance Agency
take stronger action to discipline the GSEs for their failure
to manage operational risk, and why has FHFA not taken stronger
remedial action, and does the perceived temporary nature of
FHFA's role as a conservator create challenges to managing
these significant and ongoing risks, $5 trillion, I believe the
Chairman mentioned.
Mr. Linick. Senator, let me start with the question of
enforcement. The operational risk report is just one report we
have done on the issue of enforcement. But enforcement, in our
view, is critical to ensuring that losses are mitigated and
that there is proper oversight. Enforcement not only in
ensuring the operational risk program is implemented, but also
enforcement in servicing, in foreclosure processing abuses.
We are in the middle of a servicing report now, but
standards alone are not sufficient. There is an initiative
currently proposed by FHFA, a servicing alignment initiative,
and we are monitoring that, and that is a good step forward.
However, what we want to see is not just standards but
compliance with those standards and enforcement by FHFA.
Senator Shelby. What additional challenges have been
created by the--for, not by, but for the Federal Housing
Finance Agency--by the uncertain nature of the ongoing
conservatorship of the GSEs? In other words, you do not know
what the future is going to be.
Mr. Linick. Senator, uncertainty is always a bad thing, and
the uncertainty factor has created difficulties for the Agency
in recruiting qualified personnel to the Agency. It has
affected their ability to plan, how to staff resources, such
as, whether they should staff the conservatorship operations or
the regulatory operations. And I think it has had an effect on
oversight, as well, because one of the factors that Mr. DeMarco
has cited as the reason for employing a delegated approach to
conservatorship is the prospect of a wind-down.
Senator Shelby. Sure. FHFA was created to be an agency
independent of executive branch influence, whoever the party
was in power. There have been multiple reports of executive
branch officials attempting to pressure the Federal Housing
Finance Agency and the GSEs into implementing programs with
political benefits to the Administration.
Do you believe that it is important for the Federal Housing
Finance Agency to continue to operate free from executive
branch influence, as is mandated by the statute that created
the Federal Housing Finance Agency? And two, how can your
office most effectively ensure that your independence is not
compromised by the executive branch? And third, do you believe
that increased transparency requirements are needed for FHFA
and the GSEs regarding their interactions with the executive
branch?
Mr. Linick. Senator----
Senator Shelby. I know that is a lot, but I just had a
little time.
Mr. Linick. Let me answer the third question.
Senator Shelby. OK.
Mr. Linick. Transparency is always a good thing. Our role
is to promote transparency----
Senator Shelby. Right.
Mr. Linick. ----in Government operations, and we have
recommended that the Agency be transparent in a number of
different areas, from executive compensation to operational
risk, whatever it is.
One of the reports we issued is the Treasury Making Home
Affordable report, in which we looked at the independence of
the Agency. We do believe that it is absolutely essential for
the Agency to be independent and to act independently, and we
found in that particular report that with respect to FHFA's
role negotiating the financial agency agreements for HAMP that
its independence was not undermined. The problem in that
particular review was the lack of engagement by FHFA in
participating in those negotiations and----
Senator Shelby. And what brought that about?
Mr. Linick. Well, FHFA decided to leave those negotiations
up to the Enterprises and Treasury, and----
Senator Shelby. But that is not always a good idea, is it?
Mr. Linick. It is not a good idea. These involve 5-year
commitments by the Enterprises to administer efforts to
potentially modify millions of mortgages, and there were
significant financial obligations. The Enterprises were in
conservatorship at the time. We recommended that FHFA be more
engaged. This was another example of a situation where the
Agency deferred too much to the Enterprises----
Senator Shelby. But would that not have been at a cost to
FHFA, perhaps, to allow that modification, or those
modifications?
Mr. Linick. I am sorry, a cost to FHFA?
Senator Shelby. I said, a lot of the modifications that we
are talking about, somebody has to pay for that. Was FHFA going
to have to absorb some of that?
Mr. Linick. Well, one of the issues that we looked at is
whether or not the Treasury was going to be paying for the
administrative efforts----
Senator Shelby. Mm-hmm.
Mr. Linick. ----of the Enterprises, and that was a point of
contention that was never ironed out in the agreement.
Senator Shelby. OK. Well, we wish you well in your job.
Mr. Linick. Thank you, Senator.
Chairman Johnson. Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman, and
thank you, Mr. Linick, and your staff for your efforts.
You are very clear in your September 23 evaluation that the
FHFA has too few examiners, which goes to the very basic
ability to conduct their operations. Just can you confirm that
is, in fact, your conclusion? And second, what can they do to
increase the examiners? Otherwise, they are under-resourced and
noneffective.
Mr. Linick. Well, the FHFA told us that they have too few
examiners and we concur with that assertion. We have
recommended a number of things that they undertake to remedy
that.
Number one, we asked them to study the issue because, as I
mentioned earlier, shortfalls in examination capacity may be
mitigated by strengthening operational risk or strengthening
conservatorship. So we asked them to study that.
The Agency has taken a number of actions to mitigate that
and we have recommended that they train, examiners to increase
the number of accredited examiners, potentially hire detailees
and contractors from other agencies, and finally, to be
transparent about these examination shortfalls because Congress
and the American public need to understand their ability to
regulate Fannie and Freddie.
Senator Reed. Are they moving aggressively to fulfill your
recommendations and to correct this, and do they have the
resources to do it?
Mr. Linick. Well, I believe that they are moving
aggressively in this area. I know that they have reorganized
the Agency and made examination a priority. But it has been
very difficult, from what I understand, based on my
conversations with Mr. DeMarco, to attract examiners. It is
already difficult when you are not in a conservatorship--when
you are not in a financial crisis. It is very difficult when
you are. I do think that examiners are reluctant to come to the
Agency because they do not know where their future lies.
This has been a very difficult area. I know the Agency has
been putting out notices and advertisements. I am confident
that they are trying as best as they can. From what I have
heard, however, they are having trouble meeting their goals,
and we are continuing to monitor and work on this and we will
certainly brief you and the Committee----
Senator Reed. I think you will have to, because you have
identified this key fault line in the Agency.
Let me just shift gears slightly, but I think we have all
been talking around this topic. The essence of the
conservatorship is to maintain as best you can the value of the
assets of the Enterprises. At least, that is my view point. And
there is a constant debate whether that is done simply by sort
of the status, maintaining the status quo, or it is done by
engaging in modifications of some of the mortgages. All of that
is at the heart of these discussions about HAMP and its
successor programs.
Have you taken your office's perspective on how well they
are doing managing or maintaining the value of the Enterprises,
and have you evaluated whether alternative approaches, like
mortgage modifications, et cetera, would yield more value over
time?
Mr. Linick. Senator, let me respond in two parts to your
question. I think, first, this issue about monitoring the sale
of assets and the modifications issue sort of underscores the
tension that we have seen between the housing mission and
safety and soundness mission. We are looking at how the
Director is balancing those missions as he promulgates policies
and so forth. So transparency is absolutely critical. We are
trying to take a look at the rationale, the analysis that is
being done, and trying to ensure that independent judgment is
exercised and not undue deference on the Enterprises.
Let me see. The second question--can you just repeat the
second question? I am sorry. I have lost my train of thought.
Senator Reed. You assume my train is running better than
your train.
[Laughter.]
Senator Reed. What I----
Mr. Linick. I had two parts.
Senator Reed. You had two parts.
Mr. Linick. I got the second part.
Senator Reed. You had two parts. But I think, basically,
the remaining question rests on this whole topic of how well
they are doing maintaining the value as a conservator, and let
me just--you have given me the opportunity to elaborate just a
bit, and very quickly. One part of this is all about where the
housing market is moving. If the housing market starts
appreciating, then guess what. They will look like geniuses
because they have held on to these assets, or they have had
Fannie and Freddie hold on. If the market keeps deteriorating,
then I think you could make the argument they should have
disposed of the assets, modified the mortgages, done all sorts
of things, and they have not done that. So there is uncertainty
based on market movements.
But the other complicating factor, frankly, is because of
the sheer size of Fannie and Freddie, what Fannie and Freddie
each does, influences the market. So it is a very complicated,
volatile situation, and again, from your perspective, are you
trying to evaluate how well they are doing maximizing or
maintaining--I guess maintaining would be better--the value of
Fannie and Freddie, given that the market's future is uncertain
and the fact that Fannie and Freddie influence the market? This
is--it is almost like particle physics. It is pretty
complicated, so----
Mr. Linick. Got it.
Senator Reed. Thank you, sir.
Mr. Linick. Senator, we are looking at this issue from a
number of different angles. Our Repurchase Claims Report is one
way we have addressed this, looking at how well they are doing
in recovering taxpayer monies through the repurchase process.
There are a lot of different ways to slice this.
The other way we have started looking at this is the real
estate-owned property. Holding that property or selling it
quickly is a very important and tricky balance that needs to be
made. If you hold that, obviously you have carrying costs and
you have potential blight issues and so forth. If you sell it
too quickly, it could affect the housing prices. We have an
ongoing audit in that area, but we are looking at loss
mitigation from a number of different angles.
Senator Reed. Right. Well, I appreciate that, and I think
that is absolutely critical, because you are--we do not want to
compromise the independence of FHFA, but we do not want an
agency that is paralyzed because of the complexity of the
issues they face, and the uncertainty. And your office can help
direct them, and I think you put your finger on the right
terminology that I have been struggling with, which is minimize
losses, either through a creative REO, renting it out, selling
it quickly, modifications, et cetera. To take all those off the
table and just sit pat I think is not the way to minimize
losses going forward, unless you are very lucky and the market
comes back on its own.
Thank you.
Chairman Johnson. Senator Tester.
Senator Tester. Thank you, Mr. Chairman, and thank you for
being here, Mr. Linick.
You addressed the $35 million FHFA-approved compensation
package in the March 30th report for the enterprises' top six
officers. You referenced the fact that FHFA failed to identify
or acknowledge the benefits of Federal assistance in enabling
senior executives meet corporate and other performance goals.
You also found that FHFA lacked the processes and controls
necessary to monitor the GSEs' compensation decisions and that
the FHFA failed to provide necessary transparency. You talked
about it in your opening remarks.
You made a number of recommendations, and they agreed with
some and they disagreed with others. Can you explain to me why
FHFA disagreed with your recommendation to take a look at
disparities between executive compensation at Fannie Mae and
Freddie Mac and other Federal housing agencies, and a second
recommendation that the FHFA test and independently verify the
GSEs' individual salary recommendations? Can you give me any
insight into their thought process on this?
Mr. Linick. Senator, I think they actually have changed
their tune on the comparability, and they are actually
undertaking that analysis.
Senator Tester. So to test and independently verify, or the
first one you are talking about?
Mr. Linick. I believe they have actually agreed to all of
the recommendations.
Senator Tester. Really?
Mr. Linick. And they are actively engaged in looking at
that.
Senator Tester. OK. And so what are they doing looking at
it? I mean, are they--OK. You can take a lot of heat off
yourself and say, ``Yes, well, I agree with the recommendation
now, and we are going to look at it.'' But what is the outcome
of that?
Mr. Linick. This is an area that concerns us because we are
in compensation season right now when they are developing
bonuses and so forth. And the way it works is essentially there
is a base salary and then there is a performance base, and that
performance piece is influenced by individual and corporate
goals. Those corporate goals are developed and blessed, if you
will, by the FHFA at the very beginning of the process, and
those corporate goals influence what grade those executives
get.
Senator Tester. Right.
Mr. Linick. We found in our report that there was not a lot
of vetting being done of those goals. For example, one of the
goals required the enterprises to increase market share. I
think they were required to sell 37 percent of mortgage issue,
37 percent of----
Senator Tester. So where you are going with this, what you
are saying is next year it is going to be different.
Mr. Linick. Well, what I am saying is I am concerned that
we are going to be in the same exact spot next year as we are
at this year.
Senator Tester. Even though they agreed with the
recommendation and said they are going to look at----
Mr. Linick. Well, I believe that they are going to do it.
The problem is whether they are going to do it in time for the
next cycle. That is what concerns me, and I have alerted Mr.
DeMarco to this particular concern, that they need to get
procedures in place so they can evaluate these goals to make
sure these goals are in sync with the conservatorship.
Senator Tester. Did he seem to be open that it would make a
difference next time around?
Mr. Linick. He acknowledged the need to do that. I do not
know what the status--I know that it is supposed to be done by
the end of the year. The problem is all of this occurs right
now and in November.
Senator Tester. OK. Have you had an opportunity--taking our
eyes off the six top folks, have you had an opportunity to look
at the compensation of the other senior-level employees which
we have heard bonuses are significant there?
Mr. Linick. We have not issued a report on that topic.
Senator Tester. Are you going to take a peek at it maybe?
Mr. Linick. We have actually asked for documents reflecting
what those salaries are.
Senator Tester. Oh, good. So you have already started.
Mr. Linick. We are looking at it, but we do not have a
report, and I have no findings or conclusions in that regard.
Senator Tester. OK. Well, we look forward to that, too,
because that will also have an indication of how serious they
are to deal with the problem that you pointed out that they
disagreed with and then they agreed with, with the six top
employees, in my opinion.
A previous questioner asked about reports, he had read
reports of the administration's pressure on FHFA. I have not
read that report, and sometimes you wonder about what you read
about back here anyway. But your perspective is more important
than any report I might read, anyway, except if it is your
report. And that is, have you seen any examples of the
administration applying pressure to the FHFA?
Mr. Linick. No. Well, we have only looked at one sliver of
the variety of relationships. The one relationship we looked at
is the relationship between Treasury and negotiating the
financial agency agreements, and we did not find that FHFA's
independence was compromised in that arena.
Senator Tester. All right. Well, thank you very much. That
is probably about it. I could ask about solvency since the
conservator took over, but I do not know that you can answer
that question. Since FHFA has taken over, how has their
portfolio looked from that time forward? Or have you had a
chance to take a look at that?
Mr. Linick. I do not have any independent findings on that,
so I would rather defer to Mr. DeMarco and others.
Senator Tester. Super. Thank you very much.
Thank you, Mr. Chairman.
Chairman Johnson. Mr. Linick, your work only strengthens my
view that we need a permanent Director at FHFA. Unfortunately,
the President's first nominee, Joe Smith, was blocked from
confirmation despite a bipartisan vote of support in this
Committee. Because of the importance of FHFA's mission, I urged
the President to send to the Senate a new nominee as soon as
possible.
Mr. Linick, I thank you for your testimony and for being
here with us today. This Committee takes their oversight of
FHFA very seriously, and your role as Inspector General serves
as a valuable resource that we appreciate. FHFA continues to
play a key role in the stabilization of the housing market, and
a robust Inspector General will only assist them in this
process.
This hearing is adjourned.
[Whereupon, at 11:02 a.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
I would like to welcome the first Inspector General of the FHFA,
Steve Linick, before the Committee today.
As we wrap up the hearings for this year, I am pleased that the
Ranking Member and I were able to agree to a plan for the hearings the
Committee held on housing finance reform this year, and hope that we
will be able to continue that bipartisan approach next year.
The 12 housing finance related hearings we held this year have
highlighted some general principles I believe we hold in common that
will guide us going forward. Small institutions that maintained sound
underwriting standards during the boom should still have access to any
secondary market that is created in the future. This is important for
maintaining strong, responsible home ownership opportunities in rural
and underserved areas. Fully documented underwriting should be the
standard practice in any system going forward. Clear rules of the road
are essential for providing stability to the market, but the transition
must be a gradual one given the current, fragile state of the market.
The Committee's exploration of these specific topics has helped
inform Members and build a record on which the Committee can evaluate
legislative efforts. Looking ahead to next year, there are some topics
that still need to be explored, but I am hopeful that Senator Shelby
and I can continue moving forward on housing finance reform in the same
bipartisan way that we have conducted hearings and markups this year.
In nearly every hearing this year, the current state of the economy
and strategies for improving the housing market were topics of
discussion. The need to reform our housing finance system and the need
to improve the housing market go hand in hand. The Federal Housing
Finance Agency, as conservator of Fannie Mae and Freddie Mac, could
play a significant role in improving the housing market, but based on
reports from the Inspector General's office, there are deficiencies at
the agency that are holding back those efforts.
I am concerned that the reports produced by the Inspector General's
office show several negative trends in FHFA's oversight of operations
at Fannie Mae and Freddie Mac. First, the regulator defers to the GSEs
on major decisions without independently verifying the benefits to the
conservatorship or the taxpayers. Second, the FHFA appears to allocate
staffing resources in a manner that limits its ability to enforce
directives and adequately oversee operations at the GSEs. These two
trends appear to restrict the FHFA's ability to help stabilize the
housing market and protect taxpayer dollars while also continuing the
problematic relationship that Fannie Mae and Freddie Mac had with their
previous regulator.
Despite its independent status, which was granted on a bipartisan
basis in 2008 as a single director with Congressional appropriations,
and expanded powers as conservator, FHFA could be doing more to prevent
losses and enforce required changes at Fannie Mae and Freddie Mac. As
the regulator of two of the largest entities in the housing market, it
is essential that FHFA prioritize oversight as one of the strategies
necessary to stabilize our housing market. This would benefit the
taxpayers both by strengthening the current state of the GSEs and also
providing guidance and consistency to a large sector of the housing
market to further create stability for homeowners and potential
homebuyers.
I look forward to hearing your recommendations for improvements and
the possible reasons for the trends that you continue to see, Inspector
General Linick.
______
PREPARED STATEMENT OF STEVE A. LINICK
Inspector General, Federal Housing Finance Agency
December 13, 2011
Thank you, Chairman Johnson and Ranking Member Shelby, for inviting
me to testify before the Senate Banking Committee. I appreciate the
opportunity to summarize the work and findings of the Federal Housing
Finance Agency Office of Inspector General (FHFA-OIG) to date.
I am the Agency's first Inspector General, and my office began
operations following my swearing in on October 12, 2010, in the midst
of a housing crisis of historic proportions. Over the past fourteen
months, we have made great strides in hiring a professional staff and
getting the organization up and running. We have published 10 audits
and evaluations and have commenced numerous criminal and civil
investigations. We also issued our second Semiannual Report to Congress
2 weeks ago. \1\ Today, I will provide an assessment of emerging trends
based on the work we have conducted to date, describe our operations,
and answer the Committee's questions.
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\1\ Available at http://www.fhfaoig.gov/Content/Files/
second%20semiannual%20report.pdf.
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FHFA-OIG oversees FHFA's operations and programs. This oversight
includes the Agency's regulation of the housing Government-sponsored
enterprises (GSEs)--Fannie Mae, Freddie Mac, and the 12 Federal Home
Loan Banks; the GSEs' approximately 12,000 employees; as well as the
conservatorships of Fannie Mae and Freddie Mac. Fannie Mae and Freddie
Mac currently own or guarantee home mortgages worth over $5 trillion
and account for 70 percent of the Nation's secondary mortgage market.
To date, they have received $183 billion in taxpayer money in order to
ensure their continuing solvency.
FHFA-OIG's mission is to promote the economy, efficiency, and
effectiveness of FHFA's programs and operations. To carry out its
mission, FHFA-OIG conducts, supervises, and coordinates audits of
FHFA's programs and operations. FHFA-OIG also works to prevent and
detect fraud, waste, and abuse in those programs and operations through
investigations involving FHFA, Fannie Mae, Freddie Mac, and the Federal
Home Loan Banks. Important features of FHFA-OIG's work are the
promotion of transparency in FHFA programs and GSE oversight, as well
as public understanding of matters affecting FHFA, the GSEs, and
housing policy.
Emerging Trends
Our reports have revealed a number of emerging trends. These
reports credit FHFA's work in several areas, both as regulator of the
GSEs and conservator of Fannie Mae and Freddie Mac (the Enterprises).
For example, FHFA-OIG has found:
FHFA has eliminated golden parachute compensation awards to
terminated Fannie Mae and Freddie Mac executives;
FHFA has taken steps to mitigate its shortage of qualified
examiners;
FHFA has increased underwriting standards and raised
guarantee fees;
FHFA has taken steps that may improve Enterprise repurchase
claims recoveries, thereby reducing Enterprise losses; and
FHFA has positively responded to FHFA-OIG's recommendations
to improve FHFA's effectiveness and efficiency and to reduce
its vulnerability to fraud, waste, and abuse.
On the other hand, FHFA-OIG reports also have identified
deficiencies in FHFA operations, and these deficiencies appear to
reflect two significant and related trends. First, FHFA often relied on
determinations of the Enterprises without independently testing and
validating them, thereby giving undue deference to Enterprise decision
making. Second, FHFA was not proactive in oversight and enforcement,
and accordingly, resource allocations may have affected its ability to
oversee the GSEs and enforce its directives. Both trends have emerged
in a number of our reports.
I. FHFA Has Not Independently Tested and Validated Enterprise Decision
Making
In four reports, FHFA-OIG identified significant instances in which
FHFA has displayed undue deference to Enterprise decision-making.
Without adequately testing or validating data, FHFA has deferred to the
Enterprises regarding: (1) Freddie Mac's assessment of mortgage
repurchase claim issues involving Bank of America; (2) the Enterprises'
participation in the Making Home Affordable programs (MHA); (3) the
Enterprises' decisions regarding executive compensation; and (4)
numerous Enterprise transactions.
The Agency's actions in each case reflect its approach as
conservator to delegate most business decisions to the Enterprises. In
each case, it relied upon review and corporate governance processes
already in place at the Enterprises. However, FHFA-OIG concluded that
some matters are sufficiently important to warrant greater involvement
and scrutiny by the Agency.
a. FHFA Deferred to Freddie Mac's Analysis of Repurchase Claim Exposure
At the end of 2010, FHFA approved a $1.35 billion settlement of
mortgage repurchase claims that Freddie Mac asserted against Bank of
America. In approving the settlement, FHFA relied on Freddie Mac's
analysis of the settlement without testing the assumptions underlying
the Enterprise's existing loan review process. An FHFA-OIG report found
that FHFA did not act timely or test concerns raised by an FHFA senior
examiner months prior to the settlement about limitations in Freddie
Mac's existing loan review process for mortgage repurchase claims. The
senior examiner was concerned that the loan review process Freddie Mac
used for repurchase claims failed to account adequately for changes in
foreclosure patterns among loans originated during the housing boom.
According to the senior examiner, this could potentially cost the
Enterprise a considerable amount of money. \2\ Freddie Mac's internal
auditors independently identified concerns about the process and in
June 2011, recommended that the issue be studied further. Following
initiation of FHFA-OIG's report, FHFA suspended future Enterprise
mortgage repurchase settlements premised on the Freddie Mac loan review
process and set in motion activities to test the assumptions underlying
the loan review process.
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\2\ Available at http://www.fhfaoig.gov/Content/Files/EVL-2011-
006.pdf.
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b. FHFA Provided Limited Oversight of the Enterprises' Administration
of the Home Affordable Modification Program
In early 2009, the Department of the Treasury initiated the Making
Home Affordable (MHA) programs. A key initiative of MHA is the Home
Affordable Modification Program (HAMP), which involves servicers
agreeing to modify mortgages for borrowers facing default or
foreclosure. In early 2009, the Enterprises began participating in
HAMP. They started modifying mortgages in their portfolios and entered
into 5-year agreements with Treasury to manage the program and oversee
participants' compliance with program requirements. An FHFA-OIG report
found that FHFA largely removed itself from overseeing the negotiations
of the 5-year agreements. FHFA believed its appropriate role was to
ensure the Enterprises were legally authorized to administer HAMP, not
to participate actively in negotiations between the Enterprises and
Treasury. In other words, FHFA did not engage in any formal substantive
review to evaluate the agreements' feasibility, risks, or the
suitability of the Enterprises to serve as Treasury's financial agents.
This lack of engagement may have contributed to the agreements'
omission of significant details concerning payments to the Enterprises,
the scope of their responsibilities, and processes to resolve
differences. As a consequence of the omissions, significant problems
developed in these areas almost from the beginning, requiring FHFA and
the Enterprises to devote substantial time and resources to resolve
ambiguities. \3\
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\3\ Available at http://www.fhfaoig.gov/Content/Files/EVL-2011-
003.pdf.
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c. FHFA Did Not Fully Analyze Factors Related to Executive Compensation
at Fannie Mae and Freddie Mac
For 2009 and 2010, the Enterprises awarded their top six officers a
cumulative total of over $35 million in compensation. FHFA reviewed and
approved these compensation awards based on the Enterprises'
determinations and recommendations. However, an FHFA-OIG report found
that FHFA did not independently test or validate the means by which the
Enterprises calculated their recommended compensation levels and did
not consider factors that might have resulted in reduced executive
compensation costs. These factors included the lower compensation
levels paid to senior officials at Federal agencies supporting the
housing market and the extent to which Federal support for the
Enterprises may facilitate the ability of Enterprise officers to meet
individual and corporate performance targets. \4\
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\4\ Available at http://www.fhfaoig.gov/Content/Files/
Exec%20Comp%20DrRpt%2003302011%20final,%20signed.pdf.
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d. FHFA Does Not Perform Sufficient Transaction Testing of Enterprise
Activities
Transaction testing is the method employed by financial institution
examiners to make independent judgments about the financial and
operational conditions of an institution, as well as its compliance
with applicable laws and regulations. An example of transaction testing
would be reviewing a regulated entity's loan files to test the veracity
of statements concerning loan underwriting and performance. During an
evaluation of FHFA's capacity to examine the GSEs, a senior FHFA
manager acknowledged to FHFA-OIG that examiners too often accept
assertions made by Enterprise managers rather than independently
validate such assertions through appropriate transaction testing. \5\
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\5\ Available at http://www.fhfaoig.gov/Content/Files/EVL-2011-
005.pdf.
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II. FHFA's Resource Allocations May Have Affected Its Ability To
Oversee the GSEs and Enforce Its Directives
In four reports, FHFA-OIG identified instances in which FHFA was
not proactive in oversight and enforcement, and accordingly, resource
allocations may have affected its ability to oversee the GSEs and
enforce its directives. For example, FHFA did not assign sufficient
priority and resources to handle consumer complaints. Additionally,
FHFA-OIG found that FHFA (along with its predecessor agency, the Office
of Federal Housing Enterprise Oversight (OFHEO)) has permitted Fannie
Mae to delay for 5 years the directives to implement an effective
operational risk management program. Further, FHFA may not have
allocated resources to or prioritized addressing new and emerging risks
that may impact the GSEs. Finally, FHFA reported that it may have too
few examiners to meet its oversight responsibilities. Some of FHFA's
lack of oversight may have resulted from a lack of examination
capacity, while other shortfalls may stem from a misallocation of
resources.
a. FHFA Did Not Allocate Sufficient Resources To Handle Consumer
Complaints
Due in part to deteriorating financial conditions in the housing
market, FHFA and OFHEO experienced a substantial increase in consumer
complaints about the Enterprises. A number of these complaints
contained important information about alleged foreclosure processing
abuses and fraud. However, an FHFA-OIG report found that FHFA did not
adequately process consumer complaints. For example, the Agency did
not: develop and maintain a consolidated system for receiving or
processing complaints; consistently follow up on complaints referred to
the Enterprises; prioritize complaints or assess the timeliness of
responses to complaints; refer complaints to law enforcement for
evaluation or possible investigation; or perform substantive analyses
to identify overall trends in complaints. These deficiencies occurred
because FHFA did not establish adequate internal controls and did not
assign sufficient priority and resources to complaint processing. FHFA-
OIG found that FHFA assigned only two employees--on a part-time basis--
to handle consumer complaints. \6\ FHFA's lack of oversight and
prioritization in this area stemmed from its view that, among other
things, addressing consumer complaints was not its role.
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\6\ Available at http://www.fhfaoig.gov/Content/Files/AUD-2011-
001.pdf.
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b. FHFA Has Not Enforced Directives Regarding Fannie Mae's Operational
Risk Program
In 2006, OFHEO issued a Consent Order requiring Fannie Mae to
establish an operational risk management program. FHFA views
operational risk management as an important financial safety and
soundness challenge facing the Enterprises. The Agency defines
operational risk as the risk of loss resulting from failures in people,
processes, systems, or from external events (such as foreclosure
abuses). Between 2006 and 2011, FHFA and OFHEO repeatedly found that
Fannie Mae had failed to establish an acceptable and effective program
despite outstanding requirements to do so. As Fannie Mae's conservator
and regulator, FHFA's authority over the Enterprise is broad and
includes the ability to discipline or remove Enterprise personnel to
ensure compliance with Agency mandates. However, an FHFA-OIG report
found that FHFA has not exercised this or other authorities to compel
Fannie Mae's compliance with the operational risk requirement. \7\
Fannie Mae's lack of an acceptable and effective operational risk
management program may have resulted in missed opportunities to
strengthen oversight of law firms with which it contracts to process
foreclosures.
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\7\ Available at http://www.fhfaoig.gov/Content/Files/EVL-2011-
004.pdf.
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c. FHFA Did Not Identify and Address New and Emerging Risks Potentially
Impacting the GSEs
Only after news of foreclosure abuses surfaced in mid-2010 did FHFA
begin to schedule comprehensive examination coverage of foreclosure
issues, including allegations of abuse by its default-related legal
services vendors. FHFA had not previously considered risks associated
with foreclosure processing to be significant. However, an FHFA-OIG
report found that there were multiple indications of foreclosure issues
prior to mid-2010 that could have led FHFA to foresee the heightened
risk in foreclosure processing abuses. These indications included
significant increases in the volume of foreclosures (which accompanied
the collapse of the housing market), rising consumer complaints
alleging improper foreclosures, contemporaneous media reports about
foreclosure abuses by the Enterprises' law firms, and public court
filings highlighting such abuses. \8\
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\8\ Available at http://www.fhfaoig.gov/Content/Files/AUD-2011-
004.pdf.
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d. FHFA May Not Have Enough Examiners To Meet Its Regulatory and
Conservatorship Oversight Responsibilities
FHFA has critical regulatory responsibilities with respect to the
GSEs and conservator responsibilities regarding the Enterprises. To
satisfy these responsibilities, Congress provided FHFA significant
budget and hiring authority. Nonetheless, an FHFA-OIG report noted that
FHFA had found shortfalls in the Agency's examination coverage.
Internal Agency reviews also corroborated that FHFA believes it has too
few examiners to ensure the efficiency and effectiveness of its
examination program. Additionally, only 34 percent of the Agency's line
examiners are accredited Federal financial examiners. FHFA has taken
steps to mitigate its shortage of qualified examiners, but it needs to
move quickly and aggressively in this area. Last winter, for example,
the Acting Director announced and implemented a substantial
restructuring of FHFA's supervision units and reassigned numerous
staff. These steps, which also include plans to add examination staff
and implement an examiner accreditation program, are designed to
enhance FHFA's supervision program. Further, although FHFA's near-term
plans include hiring up to 44 additional staff in the supervision
divisions, FHFA believes there is substantial uncertainty as to whether
this number of additional examiners will enable FHFA to overcome its
examination capacity shortfalls and ensure the success of the Agency's
2011 reorganization of its examination structure. \9\ Insufficient
examination capacity contributed to FHFA's lack of oversight by leaving
key areas unchecked. For example, until recently there had been no
targeted examinations involving the real estate owned (REO) area.
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\9\ Available at http://www.fhfaoig.gov/Content/Files/EVL-2011-
005.pdf.
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OIG Audits and Evaluations
In addition to monitoring and reporting on FHFA's progress in
implementing report recommendations, FHFA-OIG will continue to release
new audits and evaluations covering key areas. FHFA-OIG maintains a
detailed Audit, Evaluation, and Survey Plan that focuses strategically
on the areas of FHFA's operations posing the greatest risks and
providing the greatest potential benefits to FHFA, Congress, and the
public. Originally developed with input from an independent, third-
party risk assessment, the Audit, Evaluation, and Survey Plan reflects
continuous feedback from FHFA-OIG's reviews of current events and
comments from FHFA officials, members of Congress, and others. Broadly,
FHFA-OIG's audit and evaluation strategies include reviews of the
following FHFA activities:
Regulatory efforts and its management of the Enterprise
conservatorships. This is a particularly high-risk area because
Treasury has to date invested $183 billion of taxpayer funds in
the Enterprises. As conservator, FHFA must regulate and oversee
the Enterprises in an efficient, effective, and transparent
manner so as to minimize taxpayer costs, conserve Enterprise
resources, and meet all statutory mandates.
Oversight of the Federal Home Loan Banks and their
associated risks, including investment portfolio management and
concentrations, credit underwriting, and administration.
Internal operations, such as privacy and allegations of
fraud, waste, or abuse.
The Audit, Evaluation, and Survey Plan identifies a number of other
ongoing and planned reviews of specific FHFA programs.
Given the Committee's interest, I want to highlight two projects
currently underway. First, we are assessing whether FHFA has an
effective supervisory control structure and sufficient examination
coverage to adequately and timely identify and mitigate mortgage
servicing risks. We are also assessing FHFA's oversight of Enterprise
controls over real estate owned (REO) operations, including management
and sales activities and contractor performance. Given the breadth and
importance of issues relating to servicing and REO, no doubt we will
continue to examine them from various angles for some time to come. We
look forward to working with you on these matters and reporting our
findings and recommendations to the Committee.
Investigations
As a further part of our mission to combat fraud, waste, and abuse,
FHFA-OIG operates an active Office of Investigations that has made
significant contributions to a range of mortgage-related
investigations. While many remain confidential, FHFA-OIG and its law
enforcement partners, which include Federal agencies, U.S. Attorneys'
Offices, and State and local agencies nationwide, have released details
about several high-profile mortgage fraud investigations involving
Colonial Bank and Taylor, Bean & Whitaker Mortgage Corporation,
Marshall Home and Margaret Broderick, and Home Owners Protection
Economics, Inc.
FHFA-OIG's Office of Investigations currently has numerous open
criminal and civil investigations involving a wide variety of
allegations of wrongdoing. The Office of Investigations focuses on FHFA
and the GSEs, both internally and externally, concentrating on those
individuals and organizations that have victimized either FHFA or the
GSEs or borrowers with GSE loans. While I cannot comment on specific
open cases, I can describe the trends we are seeing in fraud. The types
of cases that we are actively investigating generally fall into the
following six categories:
Fraud involving mortgage-backed securities
Mortgage origination related frauds
Short sale and other mortgage modification frauds
Fraud involving REO transactions
Fraud involving mortgage servicing
FHFA or GSE employee misconduct
Fraud Involving Mortgage-Backed Securities is a key area of focus.
During the precrisis housing boom, the GSEs purchased and guaranteed
hundreds of billions of dollars of residential mortgage-backed
securities that have since declined precipitously in value due to the
sharp deterioration in the value of those assets. The GSEs may have
been victims of fraud in instances where the quality and value of the
underlying assets they purchased or guaranteed was misrepresented to
them.
Mortgage Origination related frauds include cases where the GSEs
have been defrauded as the loan was being underwritten and sold to a
GSE. These are the most commonly known frauds and could include schemes
such as loan officers funding mortgages for otherwise ineligible
borrowers. For example, one recent allegation reviewed by my office
involved a borrower whose loan was funded despite the fact that the
borrower was deceased. We have also seen schemes involving appraisers
inflating the value of the property and straw buyers.
Short Sale frauds can include allegations of a non-arm's length
transaction in which financial institutions are deceived into allowing
a short sale through a straw buyer for a significantly lower price.
Once the price decline is captured, the property is sold at the lower
price to a relative or friend of the seller, with the owners ultimately
staying in the property at a considerable loss to the GSE. In one of
our cases, the average transaction loss to the GSE was approximately
$150,000.
Mortgage Modification frauds are a particularly insidious fraud.
This type of fraud targets financially distressed homeowners who are
underwater or have fallen behind on their mortgage payments. Some
frauds involve advance fee schemes that require the homeowner to pay a
fee for participating in supposedly ``official'' programs that are in
fact completely fictitious or improperly imply participation in a U.S.
Government housing relief program. Besides scamming vulnerable
homeowners out of money they can ill afford to lose, these schemes are
particularly harmful because by the time borrowers recognize the scam,
they may have been foreclosed upon and have little recourse. Other
scams are designed to force a distressed homeowner into default sooner
than would otherwise be the case.
REO Related frauds may involve individuals connected to the
foreclosure and subsequent resale of a property. This situation
provides multiple opportunities for fraud. For example, the GSEs
contract with so-called asset managers to maintain and prepare the
property for sale. These asset managers may subcontract work to
gardening companies to cut the grass, but the grass isn't cut; or they
may contract with electricians for ``required'' maintenance that was
neither required nor done, but still subsequently billed to a GSE. REO
fraud can also involve realtors who collude with investors or other
realtors and appraisers to drive down the price of properties they are
selling on behalf of the GSEs. Over the past year, the Department of
Justice's Anti-Trust Division has announced a number of convictions of
real estate investors involved in such bid-rigging schemes designed to
deflate property auction prices.
Fraud Involving Mortgage Servicing can include allegations that the
mortgage servicer is not acting in the best interest of the GSE or the
investor. For example, a mortgage servicer may make decisions regarding
modifications or loan foreclosures with its own personal benefit in
mind and contrary to GSE guidelines.
FHFA or GSE Employee Misconduct is another type of fraud. These are
cases in which specific allegations are made involving administrative
or criminal misconduct by FHFA or GSE employees or contractors.
Finally, I want to mention that the Office of Investigations
operates the FHFA-OIG Hotline, which allows concerned parties to report
information directly and in confidence regarding possible fraud, waste,
or abuse related to FHFA or the GSEs. In the past year it has handled
many allegations of wrongdoing or fraud. FHFA-OIG honors all applicable
whistleblower protections. Should you or your constituents wish to
report any allegations of fraud, waste, or abuse, the Hotline can be
reached at 1-800-793-7724, by fax at 202-408-2972, or through our Web
site at www.fhfaoig.gov.
My staff and I look forward to continuing to work with the Banking
Committee to provide independent, relevant, and objective assessments
of FHFA's operations and programs. The continuing fragility of our
Nation's housing market remains a significant source of ongoing
concern. Further, Fannie Mae, Freddie Mac, and the Federal Home Loan
Banks continue to be key market participants, and FHFA continues to
face significant challenges. We are hopeful that our work will be of
assistance in meeting those challenges.