Sunday, May 18, 2008

OFHEO`s Lockhart Promotes Increased Regulatory Power, Friday, May 16, 2008 4:01:26 PM

The Office of Federal Housing Enterprise Oversight`s managing director James Lockhart discussed the lessons that housing GSEs Fannie Mae (FNM) and Freddie Mac (FRE) `must learn` from the current market turmoil, expressing his support for legislation what would allow for the OFHEO to increase its regulatory powers.

Lockhart spoke Friday at the Chicago Federal Reserve`s 44th annual Banking Structure Conference.

Fannie Mae and Freddie Mac have performed their role of supporting the loan market `reasonably well` throughout the financial turmoil, Lockhart said. However, he added that the GSEs have `many` lessons to learn, some which admittedly `should have been learned already.` Specifically, Lockhart acknowledged that Fannie and Freddie ignored the lesson learned from previous bubbles, `what goes up to far goes down too far.`

`The lack of transparency all along the long chain of mortgage financing is, in retrospect, mystifying,` Lockhart said.

He added that `complicated, risky mortgages` shouldn`t be marketed to people who don`t understand them, a lesson that `unfortunately` was not learned in the mortgage industry.

Fannie and Freddie `have continued to be a point of vulnerability for the financial system` due to the fact that they are highly leveraged compared to their risks, Lockhart noted.

`Such leverage has also limited the ability of Fannie Mae and Freddie Mac to fulfill their mission of supporting secondary mortgage market stability and liquidity in good times and bad,` he said.

The OFHEO has taken a series of actions in order to better balance the ability of Fannie and Freddie to be a lender of last resort, and to limit the risk that these GSEs pose to both taxpayers and the financial system, Lockhart said. In March, the OFHEO removed regulatory caps on the two GSEs, and a few weeks later it lowered their minimum capital requirements by 10 percent. Last week, the OFHEO lifted its consent order with Fannie Mae, although it has not yet done so for Freddie Mac.

Fannie and Freddie`s `very high leverage made striking that balance quite a challenge,` Lockhart said. However, he noted that the actions related to the two GSEs along with the rescue of Bear Stearns and the Fed`s use of the term auction facility other liquidity aids `had the desired effect of quickly reducing MBS-to-Treasury spreads,` although he added that they are still higher than market spreads prior to the crisis by 100 basis points.

Lockhart was critical of the risk-based capital requirement that Fannie and Freddie are required to have, saying it is `pretty much a joke at this point,` because it is set by law and is therefore inflexible.

He cautioned that a recent effort by Fannie and Freddie to alleviate recent losses by tightening their underwriting standards `could tend to be pro-cyclical and exacerbate the current weakness in housing and mortgage markets, if taken to extremes.`

Lockhart concluded his remarks by voicing his support for current legislation in Congress that would expand the OFHEO`s regulatory powers.

`The legislation that is working its way through Congress would give the new GSE regulator broader powers and increased flexibility to ensure the safety and soundness of Fannie Mae and Freddie Mac and to apply the lessons I have enumerated,` Lockhart said, `Especially efforts to encourage the Enterprises` mission to support mortgage and housing markets throughout the credit cycle.`

The Senate is scheduled to vote on the legislation on Tuesday.

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