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Watt Insists 3% Down Payment Loans Are Not Riskier

Federal Housing Finance Director (FHFA) Mel Watt, testifying before the House Financial Services Committee, which he once sat on as a Democratic U.S. Representative for North Carolina, insisted that mortgage loans with a 3 percent down payment backed by GSEs are no more riskier than those with a loan-to-value (LTV) ratio of lower than 80 percent.

Watt was testifying before Congress for the second time since becoming director of FHFA a year ago, this time to give an update on the government's conservatorship of Fannie Mae and Freddie Mac.

Committee Chairman Jeb Hensarling (R-Texas), who has been a vocal critic of Watt's housing policies during the last year, began his five-minute questioning period by stating, "I fear, Director Watt, that you have reversed policies of your predecessor which will make it more difficult to have a sustainable finance system," and told the director that not only was the 3 percent down payment loan backed by GSEs bad for taxpayers, but it was "putting people into homes they can't afford to keep."

"If (homebuyers) can only afford 3 percent down, do you believe that 3 percent down is riskier to the home purchaser than 1o percent down?" Hensarling said.

"Again, the same consideration would apply to the borrower as would apply to the lender," Watt said in response. "If you carefully look at other considerations and take them into account in deciding whether to extend that credit, or in Fannie and Freddie's case, whether to back that credit, you can ensure that a 3 percent loan is just as safe as a 10 percent down payment loan."

Hensarling presented data from the FHFA which showed mortgage loans to have a "precipitous rise in default rates" among mortgage loans with an LTV ratio higher than 90 percent – particularly among those with higher than 95 percent, while the performance was "noticeably better" among those mortgage loans with an LTV ratio of less than 80 percent.

"With all due respect, I understand what you're saying," Hensarling said with regard to Watt's assertion that the 97 percent LTV loans were safe. "But I fear what you're doing is again, repeating the exact same mistakes that brought us here in the first place and now you're in a contest with FHA to see who can be the nation's largest subprime lender. I fear we are going in the complete wrong direction with your policy."

Later, while being praised for instituting the lower down payment loans by Representative and Committee Minority Ranking Member Maxine Waters (D-California), Watt reaffirmed his stance that those loans are safe.

"We have no interest in going back to irresponsible lending, and it's part of our statutory mandate to make sure that doesn't happen," Watt said. "We are going to not sanction loans backed by Fannie and Freddie and the taxpayers that are not reliably expected to be paid."

Regarding the issue of a proposed rule to tighten membership requirements in the Federal Home Loan Banks, Watt responded to questions from Representative Frank Lucas (R-Oklahoma), who said that he hopes the Committee would "be very sensitive about doing anything to a model that has worked really well and is working well," for the FHLBanks.

"We have no agenda other than making sure that members of the Federal Home Loan Banks meet the criteria that Congress has established for membership," Watt said. "I know this is a controversial issue, because we put out the rule and we got 1,300 comments. That's almost unprecedented. We're going to go through every one of those comments and evaluate every single one of them. Most of them, I would say 90 percent of them, appear to be against the proposed rule. Obviously, we touched a nerve. But we are going to apply the statute and try not to have the adverse impact that people are contemplating might be a result."

As expected, Watt faced some tough questioning from Republicans on the panel regarding his decision to lift the suspension of allocation of Fannie Mae and Freddie Mac funds into the Housing Trust Fund and the Capital Magnet Fund. Representative Ed Royce (R-California), a senior member of the HFS Committee, told Watt that "(w)e find the FHFA today engaged in this race with Fannie and Freddie to see who can more swiftly crowd up the private sector, who can assume more risk on behalf of the American taxpayer" and, after citing statistics that show the GSEs are undercapitalized and overleveraged, said it is "difficult to see how you can argue that as it is required by law, the GSEs are financially stable enough to begin the transfer of money to housing groups," referring to the GSEs' funding of the Housing Trust Fund and Capital Magnet Fund.

"We've put in place prudential stops if circumstances go back in the other direction," Watt said. "If we ever have a draw on the Treasury, that would automatically stop funding of the Housing Trust Fund. When Fannie and Freddie were put into conservatorship, and the preferred stock agreements were entered into with Treasury, that suspended the capital of Fannie and Freddie. Now, if we were building up capital, I understand exactly what you're saying. But those two criteria don't apply anymore because they are in conservatorship. Every dime is going to the taxpayers if there is a profit."

Royce concluded his five-minute questioning period by stating that he and other Republican colleagues were introducing the Pay Back the Taxpayers Act of 2015, which prohibits the GSEs from diverting funds into housing groups.

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