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Uncommon 'too-big-to-fail' market utility label possible for Fannie, Freddie

A Senate committee has jump-started a push to add Fannie Mae and Freddie Mac to the "too big to fail" framework as regulators work to end the mortgage giants' decadelong conservatorship.

The Senate Banking Committee held a hearing to consider options for a new regulatory regime for the mortgage buyers. Regulators and lawmakers are aggressively pursuing housing finance reform in 2019 after years of failed attempts to strengthen the government-sponsored enterprises and bring them out from under the Treasury Department's wing.

Debate among members and expert witnesses centered around whether Fannie and Freddie should be considered a market utility, like the clearinghouses that underpin much of the financial system, or as systemically important financial institutions, or SIFIs, like the largest banks, two possible regulatory structures afforded by the Dodd-Frank Act.

Title I of the law gives a group of the nation's top financial regulators, known as the Financial Stability Oversight Council, or FSOC, the authority to name any company a SIFI, which generally subjects them to stress testing, increased capital requirements and enhanced regulator supervision.

Title VIII of the law also allows FSOC to designate a company as a systemically important financial market utility, which would require companies to comply with risk-management standards and subject them to examinations and enforcement actions but not capital or liquidity requirements.

In 2012, FSOC designated eight financial market utilities as systemically important. Most are clearing companies such as Depository Trust & Clearing Corp. and The Clearing House Interbank Payments Company LLC, in addition to Chicago Mercantile Exchange Inc., the exchange operated by CME Group Inc.

Two experts on the panel argued the GSEs should be regulated in the same way as the nation's largest banks, with stress testing and heightened capital and liquidity requirements.

"Fannie and Freddie continue to represent giant moral hazard, as they always have," Alex Pollock, a senior fellow at the Washington think tank R Street Institute, said in an opening statement. "Since they now have virtually zero capital, they are even more dependent on the Treasury's credit support and its implicit guarantee than they were before."

The two companies have paid their excess net worth to Treasury in the form of a preferred dividend since 2012, and only recently were they allowed to retain some capital as a buffer against losses.

But another expert, Susan Wachter, a real estate finance professor at the University of Pennsylvania, argued that Fannie and Freddie should be named systemically important financial market utilities, or SIFMUs, instead. She said the GSEs are unique financial institutions that do not function like banks.

Wachter made the case that the Federal Housing Finance Agency's regulatory structure over the companies already requires enhanced oversight and prudential capital standards, due to their conservatorship status. Naming the GSEs as SIFMUs is more appropriate to monitor their systemic risk, Wachter said.

"The SIFMU designation can support macro stability while enabling the GSEs to provide access to sustainable mortgage credit over the long term," Wachter said.

New FHFA Director Mark Calabria characterized the GSEs as "too big to fail" and as "systemically important" during a May 15 policy speech. Calabria's solution to dilute the risk posed by the Fannie and Freddie duopoly is to "charter" new guarantors to compete in the space.

But during the hearing, Wachter pushed back on the multi-guarantor model, arguing that dozens of guarantors would be necessary to effectively spread the risk of the GSEs' massive portfolios.

"If you had a few, that's not a problem, but if you had five, six ... that doesn't get you competition," Wachter said. "What gets you the competition is more like 30 or 100. How would we regulate 30 or 100 entities for standard-setting and for rate-setting?"

Members on the panel expressed an openness to the market utility model proposed by Wachter, but they also entertained the idea of a dual SIFI and SIFMU designation, to be sure adequate oversight is in place should the GSEs be removed from conservatorship.

"I'm not really sure what the harm would be of the dual designation," Sen. Mark Warner, D-Va., said. "These are extraordinarily significant enterprises and need all the appropriate capital and oversight."