DeMarco Defends FHFA, Preps Agency for Next Chapter

WASHINGTON — Edward DeMarco, the acting director of the Federal Housing Finance Agency, has one of the toughest jobs in town.

Fannie Mae and Freddie Mac have now been held in conservatorship for more than three years with no end in sight, and the cost to the taxpayer continues to soar. There's been growing public criticism of the agency for awarding exorbitant multimillion-dollar compensation packages to senior executives and failing to intervene earlier to stop servicer abuses like robo-signing.

Still, in a sit-down interview with American Banker earlier this month, DeMarco defended the agency's actions as he looked ahead to how to prepare the FHFA for whatever decision Congress makes regarding the future of Fannie and Freddie. Following is an edited transcript:

Q: Recently, you've gone beyond telling Congress that keeping Fannie and Freddie in conservatorship is "unsustainable," and instead have impressed upon the need to stop skirting the issue. What does the future of the housing market look like to you if Fannie Mae and Freddie Mac are not unwound in five, 10 years?

DeMarco: Private capital that might otherwise invest in infrastructure and risk management of mortgage assets remains on the sidelines. Until we give market participants certainty regarding the future infrastructure and legal framework for the mortgage market it's hard for private capital to know what to develop, where to deploy, where its business opportunities may be because there's no answer to the Fannie and Freddie question.

Q: Putting aside the issue of uncertainty that's often talked about, what do you then see as the immediate roadblocks to allowing the private sector to enter back into the market?

DeMarco: The private sector doesn't know what the role of government is going to be. Is the government going to be the ultimate guarantor on $1 trillion of mortgage business in the future? $2 trillion? $5 trillion? It's an $11 trillion market. Where's that dial going to get set? That's the threshold question that is so challenging for lawmakers and the administration — is where to set that dial and then how to define a transition path to get there. We know the direction we want to go, but we don't know how far and we don't know how fast.

Q: Well, what's the magic number?

DeMarco: There is no magic number. What are the public policy goals and to what extent is government's involvement necessary in order to accomplish those goals? How much are investors willing to take on and at what price? My personal belief is that private capital can support a broad portion of this market and they're going to charge an appropriate price for the credit risk and the market risk for doing so.

Q: Was there ever a real expectation that Fannie and Freddie would have been out of conservatorship by now?

DeMarco: No one thought three years ago when we put them into conservatorship that more than three years later we would still be waiting for some semblance of a plan for how long conservatorship might go and what a transition would look like. The goal was to make sure that Monday morning the market actually opened, that Fannie and Freddie opened, that we didn't have a collapse of housing finance, and that we were conserving this trying to keep it in place as it was for lawmakers to come in and give some direction. But now as it turns out that's not come about as fast as we had anticipated and it's requiring us to make more and more strategic decisions, longer-term decisions about what direction Fannie and Freddie ought to be going.

Q: As you've said, still acting as conservator you've had to make long-term strategic decisions that in some cases, like executive compensation, have gotten the FHFA in some hot water. Explain to me how you operate in between that fine line of government entity and public firm.

DeMarco:You've got companies operating here only because they have government support, but they remain private companies with employees whether they are senior executives or rank-and-file staff that are saying, "I'm working at this company but I don't know how long this company is going to be around." We've got to offer them an attractive enough opportunity for them to want to stay.

I realize this looks like a lot of money. We're all career officials. It looks like a lot of money to us. But not withstanding this we've seen a substantial amount of turnover in the executive suites at both companies, so we must not be overpaying relative to the market because we've got plenty of people still leaving.

Q: Republicans have had sharp words for the executive compensation programs, but at some point do you become concerned the enterprises are at risk in terms of operating efficiently and effectively because of such senior-level turnover?

DeMarco: Yes, I am concerned about that as a risk. It's expensive to recruit executive talent. It takes time. I'm an economist, so I think a lot about opportunity cost. The more time we spend needing to go out and recruit new talent to fill the voids, that's effort not being spent on foreclosure prevention, servicing the market today and building for the market of tomorrow.

Q: There were several inspector general reports recently which have not been favorable to the FHFA. I want you to talk about the report which referenced the foreclosure abuse practices, which found the agency hadn't taken steps to address this issue until there were media reports. How do you explain how that happened?

DeMarco: The IG report makes a lot of an internal study that Fannie Mae had done in 2006, and says if Fannie Mae and the regulator had thought about that report, they could have predicted that these other foreclosure processing problems would have occurred. It's a tougher connection in my mind between what the subject of that review was and what happened four years later. If one wants to say, "FHFA did not early enough in 2010 identify foreclosure processing problems" that may be true, then one has to recognize that FHFA oversees Fannie and Freddie, it doesn't oversee the servicers, so this gets into the servicers themselves failing to have good control systems in place. Worrying about or thinking about the process by which foreclosure affidavits were being signed and notarized was not viewed as a high-risk issue; and wasn't on anyone's particular radar. Whether it should have been or not, it wasn't.

Q: Talk a little bit of the challenges or how frustrated you've been at times as the overseer of Fannie and Freddie. Have there been missed opportunities?

DeMarco: I don't want to say that I'm frustrated about anything. I will admit this is an incredibly challenging environment and the workload has been and remains extraordinary. The housing environment, the economic environment remains really stressed and everyone's concerned with the number of citizens that are losing their homes to foreclosure; that are struggling with their mortgage payments, and the solutions here aren't easy.

And no, we don't always get it right. No institution or company does, but we strive to learn from what we see not working and to make changes.

Q: Let's talk about the Federal Home Loan banks. Obviously, their advance business is not what it once was, and you've mentioned this year your concern about their surge in investment portfolios. How are the banks doing today in your view?

DeMarco: Very recently there's been a stabilization in their advances. But clearly in 2011, taken as a year, has been marked by continual, gradual decline in advances. Long-term, what we are trying to articulate to the bank system is the goal needs to be that you're asset portfolio should be dominated by advances. It's hard to make dramatic changes to the investment book. But we expect over time that the banks are hearing our message and will be adjusting their balance sheets accordingly over time.

Q: The FHFA recently released guidance and procedures of how to perform a voluntary merger within the Federal Home Loan Bank System. Can you shed some light on what circumstances a voluntary merger would occur?

DeMarco: This is designed for bank boards to make a judgment about how best to ensure that the members of their district, their states have the best opportunity to have stable, reliable access to the system; and to get them the most value out of the capital that they have to invest in the system. So, that's going to be for them to decide.

Q: Do you foresee some consolidation among the 12 banks?

DeMarco: I certainly think it's possible. These banks with these boundaries have been in existence for decades. Certainly, if we were starting from scratch today and we were told to go draw up 12 district boundaries, we wouldn't draw them the way they are. I'm not predicting a change or saying it is necessary, but I'm also saying that the boards of directors are really being given an opportunity to determine what's in the best interest of the membership.

Q: Do you think as acting director you're hands have been tied?

DeMarco: I've got all the authorities and responsibilities that a permanent confirmed director would have. I'm not sitting here being cautious awaiting some confirmation hearing. I'm going ahead and doing this the way I think the law frames it. It's just a very difficult environment in which to be working and a lot of balancing going on when you're in this highly unusual long-term conservatorship.

Q: Would you like to be able to continue on in this position for an extended period?

DeMarco: I've been honored to be the acting director and I'm fully intent on continuing in this role till such time there's a confirmed director.

Q: Anything specific you want to accomplish next year?

DeMarco: I'd like to continue down the road and provide some greater sense of strategic direction that will serve any path that Congress and the administration ultimately decide to take with respect to housing finance reform. So, if you think about the Treasury's white paper; we are building towards something that would be resilient to whichever one of those paths elected officials decide to go, but this is the sort of stuff that needs to be built for it to work.