2014 Financial Markets Conference

April 2014

An interview with Edward DeMarco, senior deputy director, Federal Housing Finance Agency

Dennis Lockhart: I'm Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, and we're here in Atlanta at the Atlanta Fed's annual Financial Markets Conference. I'm with Ed DeMarco who is the senior deputy director of the FHFA, the Federal Housing Finance Agency, and we're going to have an interesting conversation on housing and mortgage markets. So, Ed, welcome to Atlanta.

Ed DeMarco: Thank you.

Lockhart: Ed, let me start with some big-picture questions. You've been in an extremely responsible position overseeing the GSEs [government-sponsored enterprises] and, in effect, the housing and mortgage markets of the country. What are the accomplishments that you think about of the agency over the last few years?

DeMarco: Well, the first thing is that the conservatorships themselves accomplished job one, which was to bring some stability to the company so that there would be some stability in housing finance; that people in late 2008 during the financial crisis could continue to get mortgages. Since that time we have been working very hard on borrower assistance to try to help homeowners in trouble avoid foreclosure, and we've also tried to repair both the risk management problems at Fannie Mae and Freddie Mac, the pricing problems in the market, and started to bring some real change and improvement to how the housing finance system works. And so there's been an awful lot of activity the last few years on that and progress is being made.

Lockhart: I know it's your view that regulators too often focus on institutions and not enough on the workings of markets. Could you give us your sense of how the country's mortgage markets are working today?

DeMarco: Well, the mortgage markets are certainly working pretty well, actually. People can get mortgages, mortgage rates have been low, but the real reason behind that is the enormous role played by the American taxpayer and by the American government. The American taxpayer is providing the credit guarantee on well over 90 percent of the mortgages being written in this country, whether it's through mortgages sold to Fannie Mae and Freddie Mac or mortgages financed through FHA [Federal Housing Administration]. And the Federal Reserve System through its purchases of mortgages has taken tremendous steps to keep mortgage rates low. But this degree of government involvement is really quite unprecedented, and I think everyone agrees it needs to be reduced over time. Those steps need to take place.

Lockhart: You've presided over the conservatorship, which by most accounts has been enormously successful. Could you just reflect back on that experience and what it's meant to the country?

DeMarco: Well, this is totally unprecedented. The size and the duration of these conservatorships (it's been five and a half years now), this is totally unprecedented, and it does need to come to an end, but as I said it has been successful in that it has brought some stability to the housing market, it's allowed mortgage lending to continue, and that has all been a part of the success. But now the country has a real challenge ahead of it.

The conservatorships must be brought to an end. We need legislation from Congress that will define the path forward for the country's housing finance system, including what is the proper role for the government and what are the limits on that governmental role going forward.

Lockhart: I understand that you're an advocate of bringing more private capital into the mortgage markets. Over the last year or so, I understand that Fannie and Freddie have issued credit-linked notes that then effectively raised private capital. Can you comment on that particular innovation and where will that lead over time?

DeMarco: As a basic matter, the way Fannie Mae and Freddie Mac create mortgage-backed securities is they issue a security that is backed by a pool of mortgages, and they provide a 100 percent guarantee to the investor that if any of those borrowers default that Fannie Mae or Freddie Mac will make good on those payments. Well, today the capital for that guarantee is coming from the American taxpayer.

And so what we wanted to do with these credit-linked notes and some other types of transactions we've done is to say, "You know, the market can actually price and bear some of this credit risk. We need to start moving it off the backs of the American taxpayer." So the credit-link note is a transaction where we use a reference pool of mortgages and we get investors to buy nonguaranteed securities, and the actual repayment to them is going to be a function of how well these mortgages in the reference pool actually perform. In that fashion what we've done is we've sold off some of this credit risk, moved it away from the American taxpayer and into the hands of private investors.

Lockhart: You and I are both regulators, in a manner of speaking, and my job involves regulating banks. I often get the question or even the accusation when I'm talking to members of the public that regardless of the rules, banks just are far more conservative at the moment in underwriting or originating mortgages. And therefore, first-time homebuyers and sometimes people with good credit histories still have difficulty getting mortgages. We're both in this business, but what's your perspective on that question?

DeMarco: I think the mortgage market is functioning; mortgage credit is available. But there has been such tremendous change in the last few years, including a tremendous amount of change regarding government rules and government oversight. And there are institutions that make mortgage loans that are still very much recovering from their losses and from the problems that they've had—they're trying to improve their own internal management, their own approach to risk management, risk assessment. They're trying to understand the implications of all these government changes. And so, yes, as part of a cycle of recovery the credit standards today are not what they were in 2006 and 2007. I don't think any of us want to go back to that. The question is, where is this pendulum and where are we in terms of approaching a more equilibrium point with regard to mortgage credit?

Lockhart: I'll ask one final question—a looking-forward question. What do you think the major challenges are in the evolution of our mortgage finance system in the country, and that's an indirect way of asking the question what is going to be on the plate of Congressman Mel Watt when he is fully in charge (I guess he is now)...

DeMarco: He is fully in charge.

Lockhart: ...what's on his plate for the next few years to get our mortgage finance system where it needs to be?

DeMarco: So a couple of years ago, we issued a conservatorship strategic plan where we talked about building for the future, gradually contracting Fannie and Freddie's footprint in the mortgage market, maintaining a focus on market liquidity, and assisting troubled borrowers. And so his challenge is to take that "plan," assess it, see where we are now that it has been in place for over two years, and make some determinations about both directionally and with regard to prioritization how he wants to proceed from here. But it is a big challenge overseeing such enormous conservatorships. As I said earlier, this is really quite unprecedented and I wish him all the very best with it.

Lockhart: Well, Ed DeMarco, thank you very much for coming to Atlanta, particularly when you only have a few more days in office. Thank you for a very interesting interview.

DeMarco: Very good. Thanks for having me, Dennis. It's a pleasure to be here.