On July 7, a bipartisan group of six (out of twenty-two) members of the Senate Banking Committee wrote a letter to Federal Housing Finance Agency (FHFA) Director Mel Watt, encouraging him to “avoid taking any steps that may facilitate the release of the government sponsored enterprises, Fannie Mae and Freddie Mac, out of conservatorship without comprehensive reform.” The letter writers counseled Watt that “changes…to the existing structure…should come from housing reform legislation, not unilateral action by this or any future administration.”

The July 7 letter was the third policy-oriented communication Watt had received in less than a month. On June 8, five Washington D.C. trade associations—the American Bankers Association (ABA), the Mortgage Bankers Association (MBA), the National Association of Homebuilders (NAHB), the National Association of Realtors® (NAR) and the National Housing Conference (NHC)—wrote “to share our view that comprehensive reform to the secondary housing finance system must come through Congress.” Sandwiched in between this and the July 7 letter was one sent to Watt on June 22 by a group of 25 housing and community organizations—including the ABA, MBA, NAHB, NAR and NHC—requesting FHFA to direct Fannie and Freddie to lower their guaranty fees through the “reduction or elimination of loan-level price adjustments (LLPAs) charged by [the companies]”.

The pair of letters signed by the ABA, the NHC and the three lobbying powerhouses for the housing industry—the NAR, MBA and NAHB—had a notable inconsistency. On June 8 these organizations told Watt that, “policymakers and stakeholders need to continue to work together on important efforts to advance housing finance reform through a legislative solution.” Yet two weeks later the same organizations joined 20 others in urging Watt to unilaterally require Fannie and Freddie to lower their guaranty fees, without Congressional action on reform. The letter from the six Banking Committee senators (Republicans Corker, Crapo and Heller, and Democrats Warner, Tester and Heitkamp) also was curious; it went beyond the scope of the June 8 trade group letter not just to ask Watt to leave comprehensive mortgage reform to Congress but further to request him to take no steps that might hurt prospects for reform legislation. Conspicuously absent from the letter, however, was any hint of what steps the authors were concerned Watt might be considering, or how or why those steps might make it harder for Congress to act.

In my view there is a simple explanation for both the sudden flurry and perplexing content of this correspondence with FHFA. Recent developments in the court cases have led participants in the reform debate to realize that a status quo they had taken for granted and hoped would continue indefinitely—Treasury’s dominance of FHFA, and FHFA’s consequent management of Fannie and Freddie not to conserve their assets but to prepare them ultimately to be wound down—may not be sustainable, and the letter writers believe it is prudent to begin to try to influence a “potentially independent” Director to take actions that still would advance their interests.

An objective analysis of the transcript and motions in the appeal of the Perry Capital case does not bode well for the possibility that the appellate panel will uphold Judge Lamberth’s lower court ruling that the law permits FHFA and Treasury to do as they please with Fannie and Freddie in conservatorship, irrespective of the language in HERA. And if FHFA and Treasury do not prevail on the law, the facts will not support them either, as evidenced by the documents produced in discovery for the Federal Court of Claims cases and released from their protective orders by Judge Sweeney.

FHFA thus finds itself in a very awkward position. The stance its counsel has taken, and continues to take, in the court cases—that FHFA and Treasury are right on the law and right on the facts—constrains its ability to act independently of Treasury at the moment. Yet the Director and officials of FHFA must know that the odds of their legal stance prevailing are not high. They also know there is no ambiguity at all in the language governing FHFA’s independence as a conservator. Section 1145 (a) of HERA amended the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 to read: “AGENCY NOT SUBJECT TO ANY OTHER FEDERAL AGENCY. —When acting as conservator or receiver, the Agency shall not be subject to the direction or supervision of any other agency of the United States or any State in the exercise of the rights, powers, and privileges of the Agency.” HERA does not prohibit Treasury from telling FHFA what to do, but it does prohibit FHFA from doing it.

When viewed as being sent to, and read by, an FHFA Director aware that at some point in the not too distant future he may have to act independently of Treasury and in accordance with his duties and responsibilities as conservator of Fannie and Freddie, the purpose and content of the recent letters become more understandable. The sections below discuss the main requests made of the Director in that context.

Allow Congress to determine the fate of Fannie and Freddie. Taken at face value, this request by the six members of the Senate Banking Committee in their July 7 letter and the five large trade groups (ABA, MBA, NAHB, NAR and NHC) in their June 8 letter is easy for FHFA to accommodate, by not opposing Congressional efforts at reform. But that’s not what the authors really are asking; they want FHFA to make legislative action easier by managing Fannie and Freddie in ways that make the companies less competitive, or (as discussed shortly) by keeping their guaranty fees artificially high. There is one sensible and straightforward way for Watt to react to this entreaty: by allowing Fannie and Freddie to manage themselves as efficiently and effectively as they can, and if Congress can come up with a secondary market mechanism that works better for all stakeholders, that should be the new system.

 Avoid taking steps that hurt prospects for reform. There can be little doubt that the primary unnamed “step” the Senate Banking Committee authors are worried FHFA might take is allowing, or requiring, Fannie and Freddie to build up capital buffers large enough to accommodate the quarterly volatility in their GAAP net income that results from their compulsory use of market value accounting for derivatives and other items on their balance sheets. The Third Amendment to the Senior Preferred Stock Agreement states that Treasury shall receive dividends under the net worth sweep “ratably, when, as and if declared by the Board of Directors, in its sole discretion….” Acting as a true conservator, FHFA would have little reason to decline to allow the boards of Fannie and Freddie to withhold net worth sweep payments to Treasury until they can accumulate capital cushions sufficient to absorb the amount of quarterly net income volatility each expects to experience.

It’s a poorly kept secret that Treasury deliberately engineered the terms of the net worth sweep to reduce the companies’ capital buffers to zero at the end of 2017, in order to make it likely that at some point quarterly accounting volatility at one or both will force a draw from Treasury, and that this in turn would allow Fannie and Freddie’s critics to orchestrate cries for Congressional action to legislate their “failed business model” out of existence. Yet because it is difficult for the Senate letter writers to come out and say they oppose allowing the companies to have a capital buffer—to most people that would be an entirely reasonable thing to permit—they are left with having to make vague references to “steps” harmful to future reform efforts. The disadvantage of vagueness, however, is that it is easy to ignore, and in this instance FHFA should do precisely that.

 Lower Fannie and Freddie’s guaranty fees. To me, this request of FHFA made by the same five large advocacy groups that earlier asked it to let Congress determine the course of housing reform epitomizes the current muddled state of the reform debate. The only plausible explanation for these contradictory pleadings is that the five groups equate “mortgage reform” with “eliminating Fannie and Freddie”—not with capital requirements, credit guaranty mechanisms, or the consequences of both for guaranty fees and affordability—and further that they don’t recognize, or have elected to ignore, that choices made on mortgage reform will be the overwhelmingly dominant factors that determine how guaranty fees are set in the future (whether by Fannie and Freddie or whatever mechanism is picked to replace them).

The basic premise of the letter on guaranty fees is one I agree with: that “the framework used to set [guaranty] fees and LLPAs should be transparent,” and “provide access to credit for a broad range of borrowers, and promote a ‘liquid and efficient housing market,’ while maintaining the safety and solvency of [Fannie and Freddie].” And while the letter writers’ focus on the LLPAs is misplaced—what’s important is the total guaranty fee, irrespective of whether it’s expressed as an annual amount or an up-front premium—they are correct that FHFA has given little justification for why Fannie and Freddie’s guaranty fees are set where they are.

In their letter, the authors note that the companies’ average charged fee on new business rose “from 22 basis points to 58 basis points between 2009 and 2014, while at the same time credit quality increased and regulations took effect that limits [sic] the risk to [Fannie and Freddie].” They might have added that the majority of the fee increases occurred in 2012 in two 10-basis point increments, both driven by external considerations. The first, in April 2012, was required to implement the Temporary Payroll Tax Cut Continuation Act passed by Congress in 2011 (with proceeds going to Treasury). Then, quoting FHFA, “Later in 2012, FHFA again directed the Enterprises to increase their guarantee fees by 10 basis points on average. This increase was intended to encourage more private sector participation, reduce the Enterprises’ market share, and more fully compensate taxpayers for bearing mortgage credit risk.” FHFA’s acting Director, Ed DeMarco, had been explicit about his intention to use guaranty fee increases to “crowd in” private capital, and by the time Watt became FHFA Director in the first quarter of 2014 Fannie’s average charged fee on new business was 63 basis points and Freddie’s was 56 basis points (both had been around 28 basis points in 2011).

Guaranty fees have changed little in the past two and a half years. Keeping fees at levels designed to make Fannie and Freddie less competitive with other sources of funding—in the hope this might make it easier for Congress to come up with a way to replace the companies—may be consistent with Treasury’s objectives, but it’s not appropriate or defensible behavior for an independent conservator that also is a regulator. The 25 housing and community organizations are right to ask FHFA for more transparency on how Fannie and Freddie’s guaranty fees are set. FHFA should comply with their request, laying out in specific and understandable detail the methodologies the companies use to determine guaranty fees by risk category—including stress levels of loss and other relevant parameters and assumptions—for examination and comment by key stakeholders and policymakers.

These same organizations and others, however, also need to be much more responsible and informed in their public and private statements on housing finance reform. What are their true priorities? Are they as simple as getting rid of Fannie and Freddie, or is it more important to them to achieve consensus on a secondary market financing mechanism that makes the greatest amount of fixed-rate mortgages available to the widest variety of borrowers at the lowest possible cost? What if the former conflicts with the latter? Stakeholders must educate themselves about the real choices in mortgage reform, and not fall victim to the temptation to endorse courses of action advanced for undisclosed reasons by others, without fully understanding their implications or consequences.