The merger of two government-sponsored enterprise regulators to form the Federal Housing Finance Agency — a year ago this month — offers a cautionary tale as policymakers consider combining banking agencies and creating a new consumer protection supervisor.

Though the new agency was billed as the creation of a "world-class regulator," critics say it is little more than a sum of its parts, and new authorities it was given were granted too late to stave off the collapse of its principal institutions — Fannie Mae and Freddie Mac.

While some worry a similar fate could befall a proposed merger Office of the Comptroller of the Currency and Office of Thrift Supervision, they also raise concerns that the Obama restructuring plan is at odds with what most consider a right move in the creation of the Finance Agency: combining mission and safety and soundness oversight.

Under the Obama plan, bank regulators would be stripped of consumer protection authority and have it handed to a new agency. But a separation of such responsibilities among GSE regulators helped cause their downfall, said Finance Agency Director James Lockhart.

"You can't really separate that," he said in an interview this week. "Some of the problems we have today may have been the result of excessive requirements on affordable housing goals. With better coordination, maybe that wouldn't have happened."

Until last year, Fannie and Freddie were subject to affordable housing goals from the Department of Housing and Urban Development while being regulated for safety and soundness by the Office of Federal Housing Enterprise Oversight. Lockhart said that disconnect between OFHEO and HUD did not make sense, and putting them together in his agency has worked well.

"We have a better understanding now of the safety and soundness related to mission goals," he said. "In retrospect, I would say they were too high and they kept accelerating and that did cause some problems."

Yet policymakers appear headed in the opposite diyrection when it comes to banks. Currently, consumer protection and safety and soundness are both handled by the federal banking regulators.

Under the Obama plan, consumer protection, which is akin to mission oversight, would fall to a new consumer protection agency — an idea opposed by the industry but popular with Democrats.

While some observers worry that Congress is poised to repeat the same mistakes it made with Fannie and Freddie, others said the new Consumer Financial Protection Agency would be significantly stronger than HUD.

"It's a good comparison in terms of the split responsibilities, but I think the difference … was that HUD had the affordable housing goals but not a lot of power to execute them, and whatever power it had was never used," said Karen Shaw Petrou, the managing director of Federal Financial Analytics. "The CFPA, as proposed by the administration, would be extremely empowered."

But much of the focus remains on whether the creation of the Finance Agency really strengthened GSE oversight, or whether the combination of two agencies is largely window dressing.

Sources complain that even a year later, tensions between the former staff of OFHEO and the Federal Housing Finance Board, which oversaw the Federal Home Loan banks, is still high.

"There are still inherent problems between OFHEO people and Finance Board people," said one source close to the agency, who requested anonymity because of the sensitive nature of the discussion. "There's a culture clash, and the OFHEO people still feel like they were the stronger agency in the deal."

The same problems could beset the OCC and OTS if they were merged, as Obama has proposed, into the National Bank Supervisor, observers said. That could especially be the case if lawmakers do not eliminate the thrift charter.

Part of the friction between former OFHEO and Finance Board staff may turn on a Congressional mandate that the Home Loan banks be treated differently from Fannie and Freddie, making it hard for the two arms of the agency to fully blend. "Maybe they expected us all to be put in a juicer," said Alfred DelliBovi, the chief executive of the Federal Home Loan Bank of New York. "But that's not what the legislation called for."

There were also tensions in how standards for two GSEs were applied to 12 others. Several sources said that former accountants at OFHEO frequently clash with former supervisors from the Finance Board. Still scarred by earnings manipulation at Fannie and Freddie, the accountants have taken an aggressive view of other-than-temporary impairment charges on private-label mortgage holdings at the Home Loan banks. The result has been a wave of writedowns at the Home Loan banks, undermining faith in the system.

"There were some big issues for the Federal Home Loan banks when we arrived," Lockhart said. "There are always a few growing pains."

Paul Leonard, the vice president of government affairs at the Financial Services Roundtable's housing policy council, said he expects a new National Bank Supervisor to be structured like the Finance Agency, with one division for commercial banks and another for thrifts. (The Obama administration has recommended doing away with the thrift charter, but that provision faces an uphill battle on Capitol Hill.) "We would recommend that those who have a thrift charter are grandfathered," Leonard said. "They could look at how they did the FHLBs and the GSEs when thinking of how to combine the OCC and OTS."

Perhaps the most important lesson that can be learned from the Finance Agency is that any legislation — no matter how substantial — might be worthless if it is passed too late. Though the housing legislation finally gave Lockhart power he spent years stumping for, he was forced to place Fannie and Freddie into conservatorship less than two months later.

"The GSE reform effort was done too late," said Brian Gardner, an analyst with KBW Inc. "They were given the right powers … but Congress acted too late."

Steve Blumenthal, a former deputy director at OFHEO, agreed.

"Congress passed a substantial piece of legislation that did in fact create an agency with world-class authority," he said. "Unfortunately, the conservatorship was appointed almost immediately."
The big question facing the GSEs is what will happen to them once they emerge from conservatorship, something Lockhart said could happen within a year and a half. That would also have implications for the Finance Agency itself. "If Fannie and Freddie were turned into a government agency…, you wouldn't need a third-party regulator," Petrou said.

In the end, Lockhart finds himself in a much more difficult place from a year ago, when he praised the housing legislation for creating a "world-class, empowered regulator."

He now backs away from that language. "We're creating a much stronger regulatory format," he said this week.

Dick Swanson, the chief executive of the Federal Home Loan Bank of Des Moines, said everyone in the industry is adjusting to a more realistic definition of world-class.

"After the year or two that the banking and financial markets have been through," he said, "I think everyone has been humbled by what it means to be a world-class regulator."

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