[Continued from yesterday's Part 1]. 

Yesterday’s post dismantled a slightly fear-mongering Wall Street Journal suggesting that FHA’s net worth would fall below the statutorily mandated 2%, and if so, that FHA would need a ‘bailout.’  In fact it does seem that FHA’s portfolio is under stress, with delinquencies up from 5.4% to 7.8%, and that this will bring its net worth, last year a little over 3% of portfolio, down to or just under the target.

Steering between the capital-reserve pylons

Even though that under-capitalization will be no more than an accounting entry – unlimited credit does have its little advantages, does it not? – it signals a larger challenge, and one that needs addressing:

Critics have said the FHA, which has never had a chief risk officer, isn’t able to manage such a large portfolio in an unstable market.

With the FHA’s entire balance sheet – loans plus insurance commitments – at risk, the portfolio’s health is of critical interest to the nation.  Against that, FHA’s information systems and its risk-management policies have been archaic.  Add this to the list of major initiatives to be undertaken soonest – but in the meantime, keep lending on the successful programs, and shut down the risky or rotten ones – some of them foisted upon it by Congress.

Policymakers have used the FHA to stabilize the housing market by pushing it to offer credit with far easier terms than that offered by most private lenders. For example, it will back loans with down payments as low as 3.5%.

Last year, the agency ended a program [Nehemiah – Ed.] that allowed sellers to fund down payments.

That is fantastic news; I’m chagrined to have missed it.  As I wrote two years ago, in 3% altruistic, it was little more than a transparent scam: 

No, I’m truly substantial 

 Do the non-profits act as surrogates for the buyer, making sure prices are held down?

Sellers have tried to recover the cost of the fee they pay nonprofits by raising the price of the house an average of 3%, a 2005 study [text version here -- Ed.] by Congress’s nonpartisan Government Accountability Office found [also referenced here -- Ed.].   

So let’s keep score here:

·         Buyers use FHA-insured financing for 97% of the purchase price.

·         Even though there is a 3% down payment, buyers do not pay it themselves.  Independent non-profits give them the money.

·         Non-profits get the money from property sellers.

·         Sellers also pay the non-profits a processing fee.

·         Property sellers raise prices by 3%.

In a cruder world, what these particular non-profits are doing might be called ‘procuring.’  In such a procurement, two entities get screwed:

What happens to those receiving a procurement

1.             The buyers get screwed.

The higher prices contribute to the increase in foreclosures by buyers who have no equity in the homes, the GAO found. 

2.             The Federal government (that’s us taxpayers) gets screwed.

The programs are “a contributing factor of increased risk in our portfolio’ of loans, HUD spokesman Lemar Wooley said in an e-mail.  

More than 100,000 low- and moderate-income consumers bought homes using such programs last year. The percentage of foreclosures on these homes is more than double that on other loans sponsored by the Federal Housing Administration, according to agency audits.

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You’ve got to try harder

In the aftermath of the subprime meltdown, fingers are being pointed every which way, among them at the appraisal community, which led to a systemic change brought about by new York’s aggressive Attorney General, Andrew Cuomo, who pressured the GSEs into an agreement about which I recently posted:

[The Home Valuation Code of Conduct (HVCC), which applies to mortgages placed via Fannie Mae and Freddie Mac, bars loan officers, mortgage brokers or real-estate agents from any role in selecting appraisers.]

This has encouraged lenders to outsource the selection to appraisal-management companies, or AMCs, which take a sizable cut of the appraisal fee.

This is value-chain re-engineering. If the link between commissioner and appraiser is too cozy, then it’s necessary to add a link. Adding a link adds costs. The first-order systemic response is simple:

As a result, appraisers are under pressure to “do it faster, do it cheaper,” said Bill Garber, a spokesman for the Appraisal Institute, a trade group.

It takes all the cycle-time shrinking you can do just to stay ahead of the workload

Faster, cheaper leads to an easy second prediction:

With costs cut, we have the second-order reaction – adverse selection by quality. Premium providers are pushed out of the business.

Now, to judge by this Banker & Tradesman article, that prediction is already coming true:

Mortgage brokers and appraisers predicted headaches and worse with the advent of the new appraisal rules that hit the mortgage business on May 1, and now they say that’s just what they’ve found – with a few extra aggravations thrown in.

As if you haven’t got enough to worry about

Appraisers say it’s just as they feared:

Under the new Home Valuation Code of Conduct:

[1] They’re making less for each job

[2] Consumers are paying more

[3] For an inferior appraisal.

Outcome 1 was self-evident; outcome 2 was the inevitable corollary.

Appraisers are also complaining appraisal management companies take a chunk out of their fees as payment for arranging the assignment.

What about the third, inferior quality? Two weeks ago I extracted this risible quote:

Funny, by George

Jeff Schurman, executive director of the Title/Appraisal Vendor Management Association, said AMCs typically take about 40% of the fees and appraisers get the rest.

Two-fifths isn’t exorbitant, but it’s not minuscule either.

Mr. Schurman said he has seen no evidence that AMCs’ practices lead to lower quality.

At that I laughed out loud. “The head of an association that takes 40% of another’s fees said he has seen no evidence that cutting what’s paid for actual work leads to lower quality.”

A four-year-old child could make it out!
Quick, get me a four-year-old child, I can’t make head or tail of it

More significant for consumers are these disruptions in the value chain:

Don’t break the value chain; use the Force

Meanwhile, brokers can’t easily make good on locked-in interest rates because new rules gum up the application process, said David Black, president of First New England Mortgage in Newton.

Also, brokers now often struggle to transfer appraisals between lenders, leaving them unable to easily transfer the application to a more favorable lender.

“We could keep banks honest,” he said. “If we can’t get our job done, we’ll disappear.”

This argument is intriguing. Mortgage brokers can shop for different lenders, and if they can take a single appraisal to multiple lenders, they can get better apples-to-apples price comparison.

When mortgage brokers ordered the appraisals, they could take those numbers to a variety of lenders, ideally shopping around for the best terms on behalf of the borrower.

This leaves unanswered the challenging question of who the mortgage broker actually works for, about which readers may be forgiven for being skeptical.

The National Association of Mortgage Brokers, which tried to prevent the rules from taking effect, is now urging brokers to direct their uproar toward The Federal Housing Finance Agency and other organizations.

No namby-pamby lobbyists these!

NAMB has also succeeded in persuading two representatives to introduce HR 3044, legislation proposing an 18-month moratorium on HVCC.

But that fight truly began last year, when FHFA announced that Fannie Mae and Freddie Mac would not back mortgages in which brokers had contact with appraisers, and issued the new code to prevent that.

As I posted previously, contact between an interested and a disinterested party isn’t necessarily improper; it may be the lifeblood of accuracy.

Avoid impermissible contact, okay?

At my for-profit company, we do valuations of complex structured interests. After making our initial data request, which includes a comprehensive checklist of information we think relevant, we also invite our customers to provide any information they think worthwhile for us to know. Unless the circumstances are unusual, we also give our customers a chance to look at and comment upon our draft, and to provide additional evidence. This creates an intellectual argumentation, where the client is advocate for its view of the right value, and we are judge and jury of what we think is the right value.

Such contact also allows influence to be brought to bear:

Make up your own mind

Previously, brokers order the appraisal before submitting the loan application to the lender – and often, critics say, those brokers would pressure appraisers to come back with higher valuations.

Get it?

Naturally that pressure will be applied, and the expert has to be intellectually and morally tough:

For this tension to yield improved (more accurate, more thoughtful) results, we as valuation experts have to be strong enough to repel improper suggestions and to resist flimsy or unsubstantiated argumentation.

Evidently, many appraisers were suspected of being weaklings.

And proud of it!

Now the appraisal comes through the lender, and critics say if consumers want to shop around, they’ll have to order a new appraisal for each lender they try out.

Ironically, the cozy relationship of in-house commissioned appraisals – being proposed as a reform – is among the sins of which Countrywide’s Angelo Mozilo was accused.

“There’s a real competitive issue here,’ said Stephen Sousa, executive vice president of the Massachusetts Board of Real Estate Appraisers.

Hoping to put your financial house in order

The lender who ordered the first appraisal has to certify it in order to pass it along to another lender, Sousa said, and it’s doubtful lenders will want to shoulder the liability – with no potential reward – that comes with certifying an appraisal for a loan they’re not going to make.

Absolutely right. Why should I take a risk that helps you make money I’m not going to?

“On top of that, other lenders don’t want to accept the other guy’s appraisal anyway, and will request another – at hundreds of dollars of cost to the consumer.”

“That was one competitive advantage [for brokers]: We could take the loan to a new lender,” Black said. “Now we can’t do that.”

A valid point.

Another in the list of complaints: The new code prevents brokers from successfully locking in borrowers at lower rates, says Richard Shapiro, principal of Asset Mortgage Group in Natick.

Because the appraisal is completely out of the mortgage brokers’ hands and another layer of management is inserted in the process, everything just takes longer and 30-day lock-ins are likely to expire before the application is complete.

This, by contrast, strikes me as simply growing pains. Give the system time and it’ll get faster.

Longer lock-ins are possible, but are more expensive to the consumer.

Any growing value chain is inherently less efficient until it achieves stabilization and scale.

Many appraisers were upset that their work was being shuttled through appraisal management companies because the new system broke professional ties they’d established with brokers, who would refer them to jobs in their area. Now management companies just cast around for whoever will do the job cheaply and quickly, they say.

What’s quality worth? Does it compensate for cozy relationships?

We’re not cozy, it just looks that way

Sousa said his organization sent out a survey on the new code that – so far – has 55% of appraisers saying the number of assignments they’ve received has declined, and 39% said their assignments have decreased more than 10% since HVCC kicked in on May 1.

Foolish statistic; all appraisals are probably down.

What is the future of these regulations? The HVCC is a set of guidelines laid out by Fannie and Freddie, not legislation; David Bunton, president of Appraisal Institute, speculates the HVCC is merely “placeholder” rules that will be swept away in the spate of new regulations coming out of Washington.

We saw above that the NAMB got legislation introduced requesting an 18-month delay – but that’s a long, long way from it becoming law.

Others aren’t as optimistic.

“The longer it’s in place, the more it becomes entrenched,” Sousa said.

Think you can shoot down that legislation, boys?

He’s right; HVCC is here to stay.

Lenders are spending time and money to engineer the new processes, and would kick up a fuss if someone suggested change. Chris Kelley, sales manager at First New England Mortgage, noted that the mortgage brokers’ Washington lobby can’t match the powerful banking machine in place.

And with all due quivering respect to the mighty banking machine versus the plucky mortgage broker machine, the case for repealing HVCC is far from proven. Certainly the value-chain problems cited above are relevant, but they sound transitional, and by the time Congress gets around to considering whether to suspend the HVCC, the system will probably be operating more efficiently.

Still, the brokers keep hoping:

Shapiro theorized that they’d need a politician or well-connected lobbyist to get fired up on their behalf: “I’m just hoping that the right big shot gets their loan all screwed up because of this and says, ‘Why are we even doing it?’”

It’s more fun than being depressed

E-mail: lschreier@thewarrengroup.com

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[Continued from yesterday's Part 1.]

Yesterday we began our two-part blog post providing unsolicited advice to Freddie Mac’s board as they search for a successor to now-resigned chief executive David Moffett.  As reported in last week’s Washington Post (red text) and Wall Street Journal (dark blue), the search will be difficult.

Going to the ends of the earth to find a CEO

So far we’ve covered the resume/ CV questions; now for the individual.  What will make a great CEO?

B.        Attributes and abilities

Whoever becomes the new chief executive will be the organization’s most important leader in its history – a statement that surprised me even as my fingers typed it, but that is nonetheless true.  Freddie Mac and Fannie Mae stand at a crossroads, where a choice must be made and from which there is no turning back.

“When you come to a fork in the road, take it.”

B1.       Is comfortable with shaping and executing any of the possible end states

No one knows what end state awaits Freddie Mac and Fannie Mae:

David M. Moffett’s resignation comes amid growing losses at the McLean mortgage-finance company and unresolved questions about whether it should follow the path of a private firm trying to make its way back to profitability or that of a government agency whose overriding goal is carrying out public policy.

There are at least four possibilities:

Four for the fiends?

1. Re-privatized under tighter regulation (perhaps with a strong oversight body as proposed four years ago).

2. Merged with Fannie Mae and then the conglomerate re-privatized.

3. Converted into a national housing finance agency – government owned, privately operated for public benefit.

4. Converted into something like FHA, government owned, governmentally operated.

Any of those could be the right answer.  Any of them could be what the Administration and the Congress decide.  The new CEO had better be able to guide Freddie Mac toward all four of them, keeping the options open, and then when the choice is made, execute to an effective organization consistent with that strategic vision.

I have the vision to find our future with my eyes closed

B2.       Commands the President’s personal respect to the point where he/ she can demand and get necessary space to do the job.

I almost put this first – and with the benefit of hindsight, doubtless Mr. Moffett would have put it first.  He was selected by a private board mere days before a Bush-presidency Treasury secretary took over both GSEs.

Associates described Moffett as never gaining the kind of independence he wanted as chief executive and never feeling fully invested in the company’s activities.

Mr. Moffett was blindsided – he had no idea he’d have to negotiate for autonomy, because he thought he was going to be running a bank!

Didn’t see that coming, did you?

His successor will be forewarned, and must have the President’s respect, otherwise he or she will be nibbled to death by ducks.  You cannot run a vast organization if your every decision is undercut by the swarm of administrators (see Wolfowitz, Paul). 

Sandbagged by my own staff – I never should have insulted them so much

B3.       Is fearless and principled

The new CEO must be someone who can bet his job and his credibility on what he thinks is right.  And there’s only one proof of that – he or she must be someone who did it once before. 

The new Freddie Mac CEO must have a strong belief in what is right and wrong, and must act on that belief, fully prepared to lose his or her job at a moment’s notice, but never to shrink from doing what is right because of that fear.

A man who put principle first: Archibald Cox

B4.       Can express a coherent vision of the need and mission of Freddie Mac in the changing environment. 

Freddie and Fannie will need friends in high places – on Capitol Hill, in the White House, and around the world.  It’s critical that the world continue to buy GSE paper and that the GSEs’ customers, counterparties, and employees all have something to believe in and invest in. 

To do that, they need a vision, articulated by someone who believes it and can express it.

A man with a vision: Cato the Elder

Carthago delenda est: Carthage must be destroyed

            B5.       Can inspire and motivate the staff

I know a fair number of people at the headquarters of both Fannie Mae and Freddie Mac, and more who used to work at either institution.  Without exception, the people I’ve encountered have been smart, hard-working, dedicated, knowledgeable, and mortified at what has happened to their organizations and how it could have come to be.

Moffett’s view of his tenure at Freddie Mac appeared to change with time. A few days after starting at the firm, Moffett was asked at a town-hall meeting of employees whether he planned to live in the Washington area, a sensitive question because his predecessor had often commuted from his home in Massachusetts.

We happy few

The employees are also demoralized, and they need rallying.

Moffett said he planned to move, and the employees thundered in applause.

To McLean!

B6.       Speaks and writes clearly and persuasively

To articulate the vision, to rally the troops, communication is essential.  For that, the CEO needs to speak and write clearly and persuasively.

‘If you cannot say what you mean, your majesty, you will never mean what you say and a gentleman should always mean what he says.”

Without artifice.

He so loved plain speech that he invented its opposite: Newspeak

C.        Things he/ she will demonstrate in the search process

The ideal new CEO will have the background and credentials; he or she will have the vision and the ability to express it.  But who will this paragon be?  What will define his or her character?

“History is made at night!  Character is what you are in the dark!”

C1.       Works for $1 a year

Mr. Moffett thought he was taking a high-powered banking job with lots of authority and, we can deduce, meaningful pay:

Pay also may have been an issue. In November, Freddie disclosed that the regulator hadn’t yet determined Mr. Moffett’s compensation plan but that in the interim his base salary was $900,000 a year. At U.S. Bancorp he received total compensation of nearly $5 million in 2006.

By now it’s clear that whoever is CEO of Freddie Mac needs to adopt the mindset of the current Fannie Mae CEO:

Fannie’s government-appointed CEO, Herbert Allison, who has described his job as “public service,” received no salary or bonus for 2008 but was reimbursed for certain expenses.  Fannie says the regulator hasn’t determined his compensation for 2009.

Making it part of his public service

Indeed, Mr. Alllison’s background is just what we prescribed earlier:

Mr. Allison worked for Merrill Lynch for almost 30 years, rising to the positions of president and chief operating officer.

A long career in investment banking – check.

Later, he [snip] became the chairman and chief executive of TIAA-CREF, the big money management company.

Mr. Allison began his career at Merrill Lynch in 1971, after graduating with a degree in philosophy from Yale, serving in the Navy and earning a master’s degree in business administration from Stanford.

While at Merrill Lynch, he lived in London, Paris and Tehran, where he met his wife. He returned to the United States and a series of senior jobs at the brokerage. In 1997, he sought to succeed Daniel P. Tully as the head of the firm, but lost out when David H. Komansky was named chief executive.

Mr. Allison was named president, but the partnership did not last long. In 1998, after a tumultuous period in the markets, Mr. Allison oversaw large layoffs at Merrill.

Willing to make tough decisions – check.

The next year, he resigned after being told he would not succeed Mr. Komansky, said a person involved in the discussions. He left long before Merrill became mired in the current mortgage crisis.

Great reputation, not tarnished by recent problems – check.

C2.       Intends this to be the end of career

Somebody willing to throw himself upon the pyre of public service for a dollar a year must necessarily be someone who sees this as a logical capstone to his career.

The only potential candidates for such posts are retired or unemployed executives with little recent crisis experience and “a burning desire to make sure that these great financial institutions come out of this,” said Barrett J. Stephens, a managing director of RSR Partners in Greenwich, Conn., an executive-search firm that also recruits board members.

You sure this is good for career-building?

C3.       Has no personal ego; ego is in the mission/ job

It’s all about the job, not about your personal glorification.

Sorry, Donald, despite your bankruptcy experience, you’re fired

C4.       Takes the job on a time-limited basis

The CEO should state right up front that he or she is in the job for a short interval, such as two years, solely to guide the organization through its current crisis and to its period of stability.  Once it has stabilized into a suitable new form (see B1 above), and we are out of the current economic difficulties, it will be time to hand over to a new leader for the future, preferably one promoted from within.

Run hard for two years, then hand over the job

(When the time comes, the President can always ask for longer service.)

            C5.       Negotiates and wins a longer leash

To judge by this Post report, Mr. Moffett tenure was doomed from early on:

As Moffett worked to present a 2009 business plan that would steer Freddie Mac back to being a profitable company, the FHFA second-guessed many of his decisions, people familiar with the matter said. He sometimes had to wait weeks for government feedback on issues such as employee compensation, spending on computer equipment and evaluating the risk of extending credit to borrowers, the people said.

You can’t run a business that way.  Nor can you inspire and articulate a vision when you’re procedurally gagged:

The company also had to get approval from its regulator for employees to speak on panels or attend conferences.

To be an executive, you have to be able to make decisions fast, and have those decisions executed by your leadership.  So the incoming CEO, during his or her recruitment process, must simply lay out conditions of contest, and get them in writing, so that he or she has a clear charter. 

Directors have [only] one function: they can and must judge the chief executive officer, and throw him out when the times comes.  (Since this task is painful, it is rarely performed even when all the directors know it is long overdue.)  The manager of a … company must come to these terms: he must make it clear from the outset that he accepts without question the right of the directors to assemble whenever they want and decide to replace him, in effect signing a resignation datable at their pleasure.

 – Robert H. Townsend, Up The Organization, 1971.

The new CEO can be fired at any time, but short of that, the CEO should say politely, ‘Mr. President, Mr. Treasury Secretary, get out of my face.’

Finding a successor could be a challenge, some recruiters said.  “The problem is there are very few people like that out there.”

Let’s hope they succeed

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“Why did you resign?”  “That – would be telling.”

As the Washington Post reported it (in red text; text from a contemporaneous Wall Street Journal article is in dark blue):

The government-appointed chief executive of Freddie Mac announced yesterday that he is stepping down just six months into the job because, associates said, he was frustrated with the intense scrutiny by federal regulators and the short leash they keep the company on.

Feeling hobbled?

His resignation is effective Friday the Thirteenth:

Moffett will step down by March 13.

Have a nice rest of your conservatorship

Now Mr. Moffett has reversed the short leash, giving the board a very short window to find his successor:

The board expects to name an interim chief executive by then. People familiar with the situation said Chairman John A. Koskinen or another board member is likely to fill in temporarily. Freddie Mac has had a temporary chief financial officer since September.

Who should the Board choose?  There’s no shortage of plausible role models:

Dangerous job, Kemo Sabe

Rob from the rich and give to the delinquent?

Here I am, to fund your loans!

Your hobe: gib it do me

“How can anyone solve this recapitalization mystery, Holmes?”

“Elementary, my dear Watson”

While there’s no shortage of fictional candidates, in the world of real this will be a tough position to fill.

The resignation signals the challenges the Obama administration will face in finding highly experienced bankers to head financial institutions and do the government’s bidding without huge pay packages.

For whom are we looking?

Here’s my list, and the reasons why:

Where is “able to work miracles’ on the list?

A.        Experience and curriculum vitae

Say what you will about past leadership of Fannie Mae and Freddie Mac – and we have – there is no question both enterprises are enormously large, complex mission entrepreneurial entities that are integral to the US housing financial ecosystem.   This is not a job for amateurs.

You need a professional

The first scan, therefore, must be for experience and sectoral knowledge, which manifests itself in six attributes:

A1.       Strategist but with a deep knowledge of housing finance

This is not the job for a neophyte or a generalist.  Affordable housing program design is hard, the market is in turmoil little short of tumult, credit is scarce, and the GSEs pumping of liquidity is as akin to a beating heat in the body financial.

Keep that liquidity flowing

Fixing the GSEs is heart surgery and brain surgery combined.  Get the best, get the surgeon.

            A2.       Impeccable policy credentials

From the Wall Street Journal article, Mr. Moffett was, if not sandbagged, at least unpleasantly surprised by his new employer:

In mid-August of last year, Mr. Moffett received a phone call at his home on Amelia Island, Fla., from a senior U.S. Treasury official asking him whether he might be interested in running a major financial institution that was about to be taken over by regulators.

 He thought they meant ‘bank,’ a job for which Mr. Moffett, as the former CEO of US Bank, was well qualified.

Mr. Moffett said in a recent interview that he didn’t know he would be running Freddie until a day or two before that was announced in early September.

Mr. Moffett was not prepared to run an entity that had the dual mission of a GSE, which has always been a Mission Entrepreneurial Entity, defined as:

It all began with a crash, didn’t it?

Fannie Mae’s past leadership has been especially reviled – and with considerable reason – although Freddie Mac’s has not escaped criticism. 

A person briefed on the decision said Mr. Moffett saw conflicts between government policy mandates and his efforts to turn around the company. In his prior banking career, Mr. Moffett dealt with shareholders, community representatives and rating firms, as well as regulators, but he found the Freddie job “one-dimensional: It’s just policy,” this person said. Another person close to the situation said Mr. Moffett’s decision was partly due to frustration with a job offering little freedom to maneuver. “He’s a private-sector guy,” this person said.

 To rebuild that trust in both the private and public sectors, we have to bring in a CEO whose integrity and commitment to affordable housing are unquestioned.

I’ll take my oath you’re not the right fellow: Angelo Mozilo

            A3.       Demonstrated ability to straddle economics and policy

Whatever their future end state may be – for discussion, see Part B below – Freddie Mac and Fannie Mae will continue to have a dual role of both fiscal soundness and maximizing affordability. 

When Moffett considered adjusting prices on certain types of mortgages to reflect the declining economy, Lockhart intervened and urged the firm to keep mortgages as cheap as possible, people familiar with the matter said.

 The double bottom line isn’t a flaw in their design, it’s an intrinsic element; the design flaw, if flaw there was, is in how you put in place governance to manage the inherent tension.

One foot on each shore

The McLean, Va., company gave no explanation for the resignation, effective March 13, but said Mr. Moffett “indicated that he wants to return to a role in the financial-services sector.”

 An appalling statement, that – if Mr. Moffett thinks that Freddie Mac isn’t in the financial-services sector, then he had no business staying.

When reconstituted – and even Hank Paulson’s swan song reluctantly acknowledges that they will be reconstituted as some form of ongoing enterprise – the enterprises will continue to straddle the twin objectives of policy and economics, so their emergent leader must be someone who’s demonstrated he can balance both, bestriding the ongoing tension.

Tension?  What tension?   Sam Zell

            A4.       Has run a large organization with very smart people at its apex

 Just as a person cannot escape the imperatives of his or her body, an organization’s character is strongly influenced by its size – how many people, how far-flung – and its product sophistication – the average intellectual input required at each stage of the company’s value chain.  Big organizations are not run like small ones – it’s a different tempo and style of direction, a different mix of skills.

Though Mr. Moffett’s title is CEO, his job is more like that of a chief operating officer. The FHFA runs Freddie under a legal procedure known as conservatorship, under which the regulator assumes the powers of the board and shareholders and seeks to restore the company to financial health. Freddie’s main rival, Fannie Mae, also is under conservatorship.

For many reasons, Jack Welch is the wrong man for this job, but someone who’s had the pedigree of leadership in large organizations.

And we could call it, The Manhattan Project, couldn’t we?

A5.       Not political; either bipartisan or apolitical

Freddie Mac, like Fannie Mae, is intended to be a national utility, so its CEO’s position is not an advocacy or partisan slot.  Partisanship will kill it.

Remember, it’s the bipartisanship, stupid

A6.       Not recently associated with a failed or even questionably risky venture

 If the leader is to command respect, he or she needs to be someone not recently associated with horrible failure or foolish dismissal of risks.  Unfortunately for us, virtually every major bank around the world has had its share of problems.

Available but associated with a recently-struggling institution: Bob Rubin

So much for experience and the CV.  What about attributes, abilities, and character?

 [Continued tomorrow in Part 2.]

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After two long posts focusing on outgoing Treasury Secretary Hank Paulson’s Remarks on the Role of GSEs in Supporting the Housing Recovery, we’ve seen that the Secretary:

1. Has concluded, with audible reluctance, that privately-run GSEs are likely essential.

2. Correctly restates the inescapable dynamic tension between social and economic goals.

Tell me something I don’t already know

He offers a menu of four possible futures:

The future’s up in the air

Depending on the degree of subsidy policymakers choose, there are a variety of options for structures to replace the GSEs, including:

(1) Expanded FHA/ Ginnie Mae. Some advocate that beyond the current credit crisis the U.S. government’s long-term policy should make the implicit, explicit. Explicitly guaranteeing Fannie and Freddie’s obligations would essentially nationalize this significant portion of the U.S. housing finance market.  Under this model, the GSEs could become a government entity, or their functions could be absorbed by FHA/Ginnie Mae.

Along with RHS, the oldest Federal housing agency, established 1934

FHA is an arm of the Federal government; Ginnie Mae is a private corporation wholly-owned by the Federal government.

Once upon a time, the peer of Fannie Mae

In either case, the GSEs would no longer have private shareholders. The size of the eligible population of homebuyers would determine how large a share of mortgage credit exposure the government would own.

I view the permanent nationalization of the GSEs, essentially expanding the role of FHA and Ginnie Mae, as a less-than optimal model.  

Me too.

The blogger agrees with me?

While it offers the perceived advantage of explicit government support, it eliminates the necessary private sector evaluations of credit risk and the private market stimulus to innovation.

That’s the big defect of a purely governmental model.  FHA’s last innovative product was over a decade ago, and its ability to grow its business is constantly at the whim of Congress, which doles out credit subsidy.  A banker shouldn’t be politically controlled, and a banker should have financial incentive to innovate.

Next victim!

(2) Partial Guarantee. A hybrid of this would be to create a Ginnie Mae-like entity for non-FHA mortgages, structured as a partial guarantee mechanism. The new entity could operate on a similar basis as Ginnie Mae, but provide only partial guarantees for MBS.  Investors would then have a floor under potential MBS losses, but would still evaluate the credit risk associated with individual issuers.

In effect, this model would make the GSEs into a last-loss insurer, taking risk greater than some negotiated levels.

That be us

The devil, of course, is in the details; if you’re taking some of the losses, then you have to negotiate how much loss you take in each issue or asset class.  Pre-conservatorship Fannie Mae solved this problem very effectively with its massively successful and clever Delegated Underwriting and Servicing (DUS, rhymes with ‘muss’) program – a program, we should note, whereby Fannie Mae acquired and resold huge volumes of loan pools, without experiencing the systemic risk or balance-sheet turbocharging that got the GSEs, Fannie in particular, in their current impasse.

While such a hybrid program would clearly define the extent of the government’s guarantee, developing risk sharing parameters compatible with profit incentives would be as problematic, and potentially as inefficient, as in the current GSE structure.

The Secretary’s arguing that if the GSEs are going to have to balance the tensions between risk/ profit and subsidy/ affordability, they might as well own all of it, not just some of it, and they might as well be in the program space themselves, rather than adding a layer of principal-agent risk in working with and through independent mortgage originators, who sometimes go bad and make bad loans.

I don’t care what a blogger says, I still don’t like it

(3) Privatization. A third alternative would be to remove all direct or indirect government support, completely privatizing these companies while breaking them up to minimize systemic risk.

What we might call the AEI solution, because solons like Alex Pollack have long advocated this, and claimed it can be done at the stroke of a pen.  It could, if we had an autocracy, but in a democracy, the government OODA loop of creating legislation is so slow the forces of incumbency would likely rally.

Curiously, with the conservatorship, we theoretically could completely privatize the GSEs – but we need the eggs:

As appealing as this alternative sounds, it is difficult to envision a sound, practical, private sector mortgage insurance business of any significant size that does not require large amounts of capital, and consequently generates only a modest return on capital.

“If it were privatized, it would need tons of capital that it hasn’t got.”

The recent problems encountered by monoline insurers, which ventured into guaranteeing mortgage product, as well as the experience of the GSEs, underscores this point.

Good point.

Moreover, a break up scenario does not look particularly promising, as reverse economies of scale would take hold.

Having built it, don’t unbuild it.

It is also worth noting that a regional mortgage insurer would lack diversity as a risk mitigant.

Right.  Capital is national if not global.

Perhaps a consortium of banks would find it advantageous to own a national mortgage insurer to wrap their product, or some other good private sector business model may emerge.

Perhaps they wouldn’t.

Anybody out there want to own a national mortgage insurer?  No?

But I am skeptical that the “break it up and privatize it” option will prove to be a robust or even viable model of any substantial scale, without some sort of government support or protection.

And I’m not the only skeptic

However, should policymakers choose to scale back public policy bias toward homeownership, we will eventually find out what business model the free market would support.

Elsewhere in this speech the Secretary makes a long philosophic discursion into the economically rational but politically incendiary territory of suggesting we should get rid of the mortgage interest deduction – but that third rail of politics is best left for another post or posts.

Wanna not get re-elected?  Touch the mortgage interest deduction

Finally, in the manner of good salesmen everywhere, the Secretary finishes with the option he favors:

(4) Housing Utility. Finally, given traditional U.S. public policy support for marshalling private capital to expand homeownership, establishing a public utility-like mortgage credit guarantor could be the best way to resolve the inherent conflict between public purpose and private gain.

Turning on and off the spigot of liquidity?

Under a utility model, Congress would replace Fannie Mae and Freddie Mac with one or two private sector entities. The entities would purchase and securitize mortgages with a credit guarantee backed by the federal government, and would not have investment portfolios.

These are the GSEs pre-Jim-Johnson era, with no balance-sheet turbocharging.  But the Secretary wants a further shackle:

Where did those pesky GSEs go?

These entities would be privately-owned, but governed by a rate setting commission that would establish a targeted rate of return, thereby addressing the inherent conflicts between private ownership and public purpose that are unresolved in the current GSE structure.

Alternatively, the ‘rate commission’ could instead set ongoing capital requirements, and periodically require capital to be redeployed into new products.  State HFA’s operate something along these lines.

This commission would also approve mortgage product and underwriting innovations to continually improve the availability of mortgage finance for a population to be defined by the Congress.

A noble ambition.  Much harder than it sounds.  If the rates of return are set, where’s the pressure to innovate?

In this model, continued safety and soundness regulation would be essential.

Actually, in any model they’re essential.

So Secretary Paulson plumps for a public-utility concept – which is by no means nonsensical – but just at the point the hard questions would need answering, he punts.

Next Administration!

Maybe that’s right – the decisions will belong to his successors – but it’s disappointing.

Not boldly going anywhere

In all the Secretary’s many words, there are some whose absence was deafening:

He didn’t say we needed two.

Didn’t I?

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