Four Takeaways from Watt's Grueling Return to Capitol Hill

WASHINGTON — Federal Housing Finance Agency Director Mel Watt didn't receive quite the homecoming he may have hoped for when he appeared before the House Financial Services Committee on Tuesday.

Though they at times joked with their former colleague, GOP lawmakers hammered Watt over his recent decisions to allow Fannie Mae and Freddie Mac to buy loans with lower down payments and provide money to two affordable housing trust funds during a grueling four-hour hearing. It was Watt's first time in front of the committee since leaving Congress to head the FHFA last year.

Below are four crucial takeaways from his lengthy appearance before Congress.

The GOP is clearly frustrated with the 3%-down-payment plan.

Republican lawmakers were perhaps toughest on Watt's recent decision to reduce down-payment requirements for loans backed by the government-sponsored enterprises to 3% from 5%, which they argued could increase risky lending and push the country back toward another financial crisis.

"We're concerned where taxpayer dollars are potentially going to be as we turn to these very loose underwriting standards," said Rep. Scott Garrett, R-N.J.

Rep. Jeb Hensarling, R-Texas, chairman of the panel, added that the decision amounts to a "race to the bottom" for the agency.

"As history repeats itself, historically prudent underwriting standards are yet again being thrown out the window," he said. "The data is overwhelming that there is a direct correlation between delinquencies and foreclosures on the one hand and low down payments on the other."

But Watt defended the decision, noting that the proposal calls for taking into account other factors about a potential borrower's financial position that can help offset the risks associated with a lower down payment.

"If you carefully look at other considerations and take them into account in deciding whether to extend that credit — or in Fannie and Freddie's case, whether to back that credit — then you can ensure that a 3% loan is just as safe as a 10%-down-payment loan," he said.

Republicans are also angry about the housing trust funds.

Watt faced more pushback from Republicans for his decision last month to turn on GSE contributions to the Housing Trust Fund and the Capital Magnet Fund. The two trust funds were established by a 2008 housing law, but never funded because Fannie and Freddie were quickly put into conservatorship after the law was enacted.

GOP lawmakers argued that the decision to divert some GSE profits to the housing trust funds violates language in the 2008 law.

"How can the enterprises be in this state, with these leverage ratios, and not be deemed both financial unstable and undercapitalized?" said Rep. Ed Royce, R-Calif., who reintroduced a bill Tuesday that would block the FHFA from funding the trust funds as long as the GSEs are in conservatorship or receivership.

But Watt argued that while he believes his predecessor Edward DeMarco acted appropriately in turning off contributions to the funds, "circumstances have changed" around the condition of the GSEs, given their profitability. Moreover, he said, concerns about capital at the GSEs are no longer relevant now that the government doesn't allow Fannie and Freddie to build up capital reserves.

"Basically, when Fannie and Freddie were put into conservatorship, and the preferred stock agreements were entered into with Treasury, that suspended the capital of Fannie and Freddie," Watt added.

The FHFA director also said that the decision includes backstops for suspending the funds again, should the GSEs slip financially.

"We put in place prudential stops if circumstances go back in the other direction, if we ever have another draw on the Treasury, that would automatically stop the funding of the housing trust funds," he said.

Democrats, meanwhile, continued to praise the decision, arguing that the funds will help needy renters who don't currently have access to affordable housing options.

"These critical new funds will not only add to the supply of affordable rental housing, but will also help to address homelessness and poverty across the country," said Rep. Maxine Waters, D-Calif., ranking member on the panel.

Lawmakers from both parties dislike the FHFA's proposal regarding the Home Loan banks.

Several lawmakers also voiced concerns about a controversial FHFA plan that would impose ongoing membership requirements on institutions that belong to the Federal Home Loan Bank System.

The proposal would require banks and credit unions with less than $1 billion in assets to hold at least 1% of their assets as mortgages, and bigger institutions to hold at least 10% of their assets as mortgages to remain in the system.

Regulators, bankers and others have criticized the plan, arguing that it could push out smaller institutions from a stable source of funding.

"Is this an effort to try, through the rule process, to determine how these resources can be used and, in effect, to put the institutions that are part of the Home Loan Bank System on a rather short leash?" said Rep. Frank Lucas, R-Okla.

Watt conceded that the agency has "touched a nerve" with the plan, but argued that the agency estimates just 50 to 100 of the roughly 7,500 institutions in the system would be pushed out by the new requirements.

The FHFA has yet to make a decision on G-fees or principal reductions.

Watt reiterated earlier comments that he hopes the agency will announce a decision on mortgage guarantee fees by the end of March, though he warned that it "may slip" later into the spring.

The mortgage industry has long been awaiting a response from Watt on the issue of G-fees, after the FHFA director postponed an earlier decision to increase the fees under DeMarco.

"We're still in the process of evaluating the input we got in response to a request for input from the public on this issue," Watt said, declining to provide any specifics on which way the agency might be leaning.

He also indicated that the agency will continue to look at ways to offer principal reductions that are helpful to consumers without being costly to the GSEs. Some Democrats, including several on the Senate Banking Committee, have pushed Watt to find ways to modify existing mortgages through principal reductions, arguing it could still help millions of Americans affected by the financial crisis.

"What we're trying to do on principal reduction is find a place where it is beneficial to borrowers and not negatively net present value to Fannie and Freddie — there are some instances in which that is the case," said Watt. "When we find that niche, that's when we're going to make a decision about this."