Since being seized by the government during the financial crisis, Fannie Mae and Freddie Mac haven't been businesses so much as government-owned mortgage utilities. That status was supposed to be temporary, but three years later, lawmakers have shown little appetite for changing it.

Now Ed DeMarco, head of the government-sponsored enterprises' primary regulator, is increasingly agitating for Congress to get a move on. Conservatorship is creating "real risks" for Fannie and Freddie's ability to function as businesses in the future, DeMarco, acting director of the Federal Housing Finance Agency, told industry members in a recent speech.

The longer Fannie and Freddie remain in limbo, the more they risk their ability to function as stand-alone businesses and to fulfill their foundational role in the U.S. housing mortgage market.

The resulting uncertainty affects that entire market. The two mortgage giants, along with the Federal Housing Administration, guarantee about 90% of new mortgages in the U.S.

DeMarco tells ASR's sister publication American Banker government conservatorship has made it more difficult for Fannie and Freddie to recruit and retain staff with institutional expertise in the housing market, which could eventually degrade the companies' underwriting standards.

But DeMarco also has to be careful with those warnings. As the GSEs' primary regulator, his task is complicated by a desire to avoid further spooking Fannie and Freddie's employees or undercutting the perception of the GSEs within the industry. He said in an interview that he is "trying to responsibly inform lawmakers and the public that this is not an easy or normal situation in which the companies are operating, and we are appropriately responding to this challenge."

Conservatorship "attenuates the normal processes and functions of making determinations about investing in business processes and investing in human capital," he says. "I have a responsibility to simply report that challenge."

DeMarco has made his message clear in speeches and testimony over the past year: While Congress drags its heels on making a decision about the future of the mortgage market, the uncertain status of the GSEs becomes increasingly dangerous.

That uncertainty has complicated even routine tasks, like recruiting qualified employees or making decisions about updating systems. Some prospective employees have declined job offers at the GSEs, citing uncertainty about the companies' future, he tells American Banker.

On the whole, DeMarco says he is "rather pleased with the success we have had at retaining the staff at the two companies, and attracting new staff. But it hasn't been easy."

Beyond personnel, "we have tried to identify our risk areas, whether in terms of business operations or human capital, and focus our attention on managing those risks," DeMarco says. "Three years in, I am pleased overall with the results we have to show and the fact that we haven't had major blowups or difficulties."

Of course, when success is defined by the absence of disasters, it becomes increasingly clear the current course is unsustainable.

"Without direction on the future of the enterprises, as the length of the conservatorships extend, real risks exist beyond the normal business risks associated with guaranteeing new mortgages," DeMarco said in a speech in September to the American Mortgage Conference. "Previously, I have characterized these risks as the problem of how to preserve and conserve the enterprises' intangible assets … while operating in conservatorship with the general policy position of the administration and many in Congress that market reliance on the enterprises for mortgage finance should be greatly reduced or eliminated over time."

DeMarco is not alone in predicting dire consequences for the GSEs if their situation doesn't change. "I think it's quite plausible that the extended period as a ward of the government has hurt the GSEs as businesses," says longtime GSE critic Peter Wallison, a veteran of the Reagan administration's Treasury Department and the Arthur F. Burns Fellow in financial policy studies at the American Enterprise Institute.

Fannie and Freddie's conservatorship "certainly would impair their ability to retain good employees, although in the current housing economy it can be argued that there aren't attractive alternatives even for high quality personnel," Wallison says.

But he cites a bigger challenge for the GSEs when it comes to attracting talent: support on both sides of the aisle for a conflicting mess of proposals that would replace the GSEs with market-based alternatives, a direct government backstop, or any number of alternate public-private hybrids. Prospective employees would be naturally reluctant to join firms that many in Congress have marked for a revamp or outright elimination, he says.

Wallison, a proponent of killing off the GSEs, argues that they may be already so far gone to make the question about their health as businesses moot. "They are not businesses anymore," Wallison says. "They are public utilities carrying on a necessary function that will be terminated as soon as the political system forms a majority for how they will be replaced."

Winding down Fannie and Freddie would at least resolve the uncertainty surrounding their future. But the political system appears to be in no hurry to decide one way or another.

Through more than a dozen hearings over the past several years, legislators have introduced very few bills aimed at reforming the housing market. A bill to merge Fannie and Freddie is languishing in subcommittees, but even that is a stopgap plan, not a real stab at reform.

The companies themselves are, to a great degree, handcuffed by conservatorship and must be extremely careful about how they characterize its impact on their business. "As our conservator has stated, retaining human capital in the face of an uncertain future is a challenge," says Freddie Mac spokesman Doug Duvall. "We support the goal of attracting more private capital to the market and are managing the company to maximize our assets and provide support to the housing market, an effort that could support any future structure of America's housing finance system," he says.

Fannie spokeswoman Amy Bonitatibus declined to comment.

For the time being, the GSEs have at least one major advantage that many stand-alone businesses would like: when it comes to guaranteeing home mortgages, they are pretty much the only game in town. "They may not have a lot of positive things going for them but they are being force fed a lot of volume," says Bert Ely, a banking consultant in Alexandria, Va. "They have a lot of business coming in the front door, regardless of what is happening internally in terms of morale. Whether that's healthy for the long term, well, that's a hell of a good question."

As long as the GSEs remain in conservatorship, some argue the resulting staff turnover and loss of institutional knowledge will lead to poor underwriting of loans.

Ely, another GSE critic of long standing, says "we're not going to know for a few years whether this operating environment has hurt underwriting."

Whatever happens to Fannie and Freddie, industry members are not expecting it to happen quickly. Wallison says he does not expect Congress to do anything to resolve the GSEs' status before the presidential election in 2012.

"No matter who takes office in January 2013, it is likely that there will be a concerted effort to develop an alternative housing finance system that does not include the GSEs," he says. "Whether it will include continuing government support is the issue, and that will have to be resolved by the election."

Of course, the 113th Congress isn't likely to arrive in Washington with a fully formed plan for reforming the housing market that is ready for a vote on day one. So realistically, if lawmakers wait until the next Congress to act, Fannie and Freddie will be approaching five full years in conservatorship before anything significant happens.

While he declined to discuss exactly how long he believes the GSEs can continue to function well under current conditions, DeMarco makes it plain that the FHFA is "looking to lawmakers to give direction on where this finally goes" and that legislative action would be welcome in the near term.

"Can we keep this operation going for a period of time to come? Yes, we certainly can," DeMarco says.

"The larger message here is that that job gets harder over time. So I would look to lawmakers and policymakers to be moving toward final resolution of the conservatorship and focusing on developing a framework for the future of the country's housing finance system sooner rather than later."

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