In prepared remarks to present to the Senate Banking Committee on Thursday, Alfred M. Pollard, General Counsel of the Federal Housing Finance Agency (FHFA) explained the regulatory powers available to his agency and told the Senators both how they differ from those available to its predecessor and what additional authorities are and will be needed.  Pollard had been called before the committee specifically to address regulatory authority issues in relationship to the legislation proposed in Senate bill S. 1217.  

FHFA was established by the Housing and Economic Recovery Act of 2008 (HERA) to replace the Office of Federal Housing Enterprise Oversight (OFHEO), former regulator of the government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae.  FHFA was also given supervisory authority over the 12 Federal Home Loan Banks (FHLBanks).

OFHEO did not have a full range of powers to regulate the GSEs, Pollard said.  It could not set capital requirements, undertake supervisory actions comparable to those of other financial regulators, lacked receivership authority and relied on appropriations, subjecting it to potential congressional budgetary disruptions. In addition, much had to be done with implied rather than explicit authorities.  HERA corrected most of these deficiencies in creating FHFA, but by the time the law was passed, Pollard said, it was too late to implement them prior to invoking conservatorship.

Pollard outlined a few of the basic regulatory tools FHFA has today.

• A full array of supervisory tools. FHFA has implemented these tools through two divisions, the Division of Enterprise Regulation (GSEs) and the Division of Bank Regulation (FHLBanks) and the Office of Finance. Both Divisions conduct examinations and carry forward prudential standards according to regulations to ensure safety and soundness and compliance with laws and regulations.

In conservatorship FHFA maintains a permanent on-site presence at the GSEs to conduct examinations and monitor business activities, key risks and compliance. FHFA typically carries out three on-site examinations per quarter of FHLBanks so that all twelve are examined on-site once per year in addition to an ongoing program of off-site monitoring.

FHFA has established comprehensive examination manuals as guides for examination efforts, issues Advisory Bulletins regarding key matters such as credit risk management and model risk governance, and is the only financial regulator required to provide an annual report to Congress on its examination results.

As the conservatorships have lasted far longer than originally anticipated, FHFA has responded by developing an Office of Conservatorship Operations and an Office of Strategic Initiatives to coordinate and collaborate with the other divisions to help FHFA ensure the regulated entities operate in a safe and sound manner.

• Enforcement. FHFA is empowered by statute to take a broad range of enforcement actions including cease and desist orders, civil money penalties, debarment of officials, and the ability to act against institution-affiliated parties. Additionally, the Agency has created a process for suspending individual or corporate counterparties found guilty of criminal law violations.

• Emergency Tools. While FHFA does not have a fund such as Deposit Insurance Fund to cover losses it does maintain a working capital fund and has the ability to impose special assessments on the GSEs and FHLBanks to address any shortfalls in its resources in order to respond to emergency situations.

Several court decisions have rounded out FHFA authorities, Pollard said.  Significantly in a case in the Southern District of New York, the Court found not only that FHFA had examination privilege, but also shared similar authorities to banking regulators.  This both solidified the examination privilege and made clear that FHFA supervisory actions find support in long-standing bank regulatory powers.  

Pollard said that in sum, the agency is equipped to meet the mission Congress has set for it and he turned to address the regulatory structure set forth in S. 1217, and what areas exist for improvement in terms of regulatory structure and powers. The bill would establish a new model for the secondary mortgage market and a new supervisory agency, the Federal Mortgage Insurance Corporation (FMIC).  This would represent a move from traditional examination- and enforcement-based supervision to a multi-faceted construct covering availability and transparency of information, standard-setting to enter and participate in the market, supervision of participants, access to credit and the secondary mortgage market, insurance of securities and establishment and operation of databases including a mortgage data repository.  

Implementation of the bill's varied elements will require careful thought and appropriate transitional steps over a five-year period and, Pollard said, as we learned during the financial crisis  even with adequate powers, regulators will not always get it right.  If taxpayers are going to be at risk of loss, there must be sufficient private capital out front.

The bill provides FMIC with limited explicit regulatory authority, though additional tools may be implied and, importantly, an "incidental powers" provision is set forth.  But clear and explicit regulator authority including to establish prudential standards, set capital requirements and take enforcement actions would enhance market stability and provide a higher degree of confidence to all market participants, limit litigation, and better insure consistent outcomes.  Reliance on implied authority, Pollard explained, also makes it difficult to say what is missing. 

FMIC needs full authorities including the authority to set capital standards, request reports from and examine market participants, establish enforceable prudential standards, require participants to undertake remedial actions where appropriate and impose penalties for bad behavior and bad actors.  He outlined for the committee examples from FHFA on how the language of S. 1217 regarding powers could be made clearer and more explicit. He also advocated for greater sharing of supervisory information and greater cooperation among regulators.

There are two important questions about the way S. 1217 sets a new direction for the housing finance market; does the legislation get the right structural pieces in place for the new market to function well?  Does it provide for an effective transition from the current to the new system?  Pollard said FHFA has identified areas where these questions could be better answered.

For example, S. 1217 authorizes consultation and coordination with other agencies that may already be supervising likely participants in the new market, but more could be done to ensure that other regulators share information with FMIC and that exams are coordinated.  FMIC and FHFA's roles in the Financial Stability Oversight Council should be clarified to ensure that during market transition appropriate representation remains in place and FMIC should have an appropriate and defined role in the Federal Financial Institutions Examination Council.

There may also be gaps to be filled such as a possible omission of non-bank mortgage servicers from supervision.  Assigning regulatory oversight to FMIC with the ability to set and enforce prudential requirements could help fill this gap.  Additionally, FHFA has seen certain state and local laws that may impair efficient operation of a national secondary mortgage market.

FMIC is designed to be funded exclusively by insurance fees on mortgage-backed securities. Relying exclusively on fees, particularly as the new market is developing, may present certain challenges and at its inception, FMIC should be insured adequate resources.   In addition, Funding FMIC and growing the insurance reserve could require rather large insurance fees in the early years and in times of market distress revenues could drop substantially.  Perhaps FMIC's sources of funding could be expanded to include other fees and assessments such as creating application fees and restoring assessments on the FHLBanks for their supervision.

The transition will involve a simultaneous wind-down of the GSEs, the transfer of functions and employees from FHFA to FMIC, and the hiring of additional staff at the new agency. S. 1217 establishes a two-step transition that would have FHFA and FMIC co-exist for five years, which could be confusing and inefficient for both market participants and agency employees.  FHFA's experience from the transition from OFHEO would argue in favor of immediately transferring all FHFA personnel and responsibilities to FMIC and maintaining the congressional direction to wind down Fannie Mae and Freddie Mac.  

In particular, moving all employees to the new agency - or, possibly, renaming and empowering FHFA as FMIC -avoids issues of dispersion of resources and expertise.  Also guidance would be helpful on the legal authority of FMIC's Director to act before the Board is fully constituted.  Funding in transition may be critical to assure that a smooth start for FMIC occurs with a solid capitalized reserve fund, systems and technology in place and providing resources to address challenges not anticipated at this time.

While work continues on the Common Securitization Platform and moves to develop more fully the National Mortgage Database, Pollard suggests that it may be beneficial to also look at a national note repository which could bring benefits to homeowners, lenders, the state foreclosure process and efforts of groups such as the Uniform Law Commission to make more uniform state foreclosure laws.