Congress Overhauls Regulatory Regime for Fannie Mae and Freddie Mac; SEC Has Role
Acting on a broad consensus that government sponsored enterprises need a strong well-funded and independent federal regulator, Congress has overhauled the regulatory oversight of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The Housing and Economic Recovery Act (HR 3221) creates an independent and unified regulator of the GSEs with broad powers analogous to federal banking regulators, and with a free hand to set appropriate capital standards, and a clear and credible process sanctioned by Congress for placing a GSE in receivership. The Act also holds the GSEs to SEC reporting requirements comparable to other large, complex public companies. The Senate passed the bill today and cleared it for the President, who is expected to quickly sign it.
Overview of Reform Legislation
The new federal regulator for the GSEs will have enhanced authority to raise capital standards, set strict prudential standards, including internal controls, and enforce these new standards and promptly take corrective action. The new regulator will oversee, and can directly restrict, executive compensation at Fannie Mae and Freddie Mac.
The Act establishes the Federal Housing Finance Agency (FHFA), an independent agency, to oversee Fannie Mae, Freddie Mac and the Federal Home Loan Banks. FHFA is empowered with broad regulatory powers over the operations, activities, corporate governance, safety and soundness, and mission of the GSEs. The measure provides new and more flexible authority to establish minimum and risk-based capital requirements.
The Act also increases Treasury’s authority under existing lines of credit to Freddie Mac, Fannie Mae, and the Federal Home Loan Banks for the next 18 months, giving Treasury standby authority to buy stock or debt in those companies. To use the authority, the Secretary must make an emergency determination that use of the authority is necessary to stabilize markets, prevent disruptions in mortgage availability, and protect the taxpayer.
The authority also provides enhanced oversight of the enterprises while the standby facility is in place, with the Federal Reserve consulting with the new regulator on the safety and soundness of and risks posed by the GSEs.
As part of the enhanced oversight, the new regulator must specifically approve, disapprove or modify executive compensation at all of the GSEs. A regulated entity may be required to withhold compensation from an executive officer during a review of the reasonableness and comparability of compensation, and may take into consideration any wrongdoing by the officer
New authority is also provided to establish critical capital levels and capital classifications, and specify supervisory actions to be taken regarding undercapitalized, significantly undercapitalized, and critically undercapitalized regulated entities. There will be an expanded conservatorship and receivership authority similar to that of federal bank regulators.
FHFA is given clear enforcement authority, including cease and desist, removal, subpoena and civil money penalty authority
The Act also includes provisions transferring supervisory and regulatory authority to oversee the Federal Home Loan Bank System to the FHFA, and requires the FHFA, in regulating the these banks to recognize the distinctions between the enterprises and the banks. The Act also clarifies the ability of the Federal Home Loan Banks to voluntarily merge, and provides clear regulatory authority regarding the liquidation or reorganization of a bank.
Federal Housing Finance Agency
The Federal Housing Finance Agency would be headed by a Director, appointed by the President and confirmed by the Senate for a 5-year term. The Director can be removed for cause by the President.
The Director must have a demonstrated understanding of financial management or oversight, and have a demonstrated understanding of capital markets, including the mortgage-backed securities markets and housing finance. There is a three-year look back provision under which a person who has served as an executive officer or director of any regulated entity or entity-affiliated party at any time during the preceding 3-year period cannot serve as the FHFA Director. The Director must also be a US citizen.
On a transitional basis, the Act names the current regulator of the GSEs, the Director of the Office of Federal Housing Enterprise Oversight, as the Director of the new agency until a Director is appointed by the President and confirmed by the Senate.
The Act creates an oversight board to advise the Director on strategy and policy with regard to carrying out his or her statutory duties. The board may not exercise any executive authority and the Director may not delegate to the board any of his or her powers or duties
The measure mandates a board of four members composed of the Director, the Treasury Secretary, the HUD Secretary and the SEC Chair. Any member of the board may require a special meeting of the board. Otherwise, the board will meet quarterly. The board must testify annually before Congress on a number of matters involving the GSEs, including their safety and soundness and any material deficiencies in their operation. The testimony must also include an evaluation of the performance of the regulated entities in carrying out their respective missions, as well as a discussion of their overall operational status.
With regard to Fannie Mae and Freddie Mac, the Act establishes an independent regulator and make the GSEs function more like private corporations. The new regulator will review and set portfolio limits, establish minimum capital requirements, and review new programs and products. More broadly, the Act authorizes the new regulator to supervise the GSE portfolios for safety and soundness. Any new financial products developed by the GSEs must be approved by the Director, after a finding that the product is in the public interest and consistent with the safety and soundness of the GSE.
FHFA would issue and enforce prudential management and operations standards for the regulated entities, including credit, interest rate, and market risks, internal controls, liquidity, and investments. The agency may also require a regulated entity to withhold compensation from an executive officer during a review of the reasonableness and comparability of compensation, and may take into consideration any wrongdoing by the officer.
The Act also empowers FHFA to adjust minimum and risk based capital levels. The agency may increase the minimum capital level through regulation or, if there is a serious safety and soundness concern, temporarily through an order. The agency may also establish capital or reserve requirements with respect to particular programs or activities as the agency considers appropriate. The measure also authorizes the regulator to adjust the portfolio holdings of the GSEs. This could be done for either the purpose of increasing safety and soundness of the enterprise or fulfilling the housing mission.
The Act requires the GSEs to register at least one class of capital stock with the SEC under Exchange Act reporting requirements. Also, the GSEs will be subject to SEC proxy and insider reporting provisions. Thus, their directors and policymaking officers will have to comply with the reporting requirements of Section 16(a).