After his successful Valentine’s Day hearing at the Senate Banking Committee, it looks like Mark Calabria is on his way to becoming director of the Federal Housing Finance Agency (FHFA). In that capacity, he will oversee more than $6 trillion in mortgage-related assets—in very round numbers, more than $3 trillion for Fannie Mae, $2 trillion for Freddie Mac and $1 trillion for the combined Federal Home Loan Banks.

For the $5 trillion of Fannie and Freddie, the FHFA director is more than a regulator. He is the conservator, who has the combined powers of CEO, board of directors and regulator, for as long as Fannie and Freddie are in conservatorship. As is well-known, but seems unbelievable, that has been more than 10 years so far, for a supposedly temporary status. When might it end?

Mr. Calabria rightly told the senators that the fundamental design of housing finance must be determined by Congress. But it doesn’t require Congress to end the conservatorship and the intertwined bailout deal (the Senior Preferred Stock Purchase Agreements) with the U.S. Treasury Department. That could be done by the FHFA and Treasury, working together, just as they did to implement the conservatorship and bailout agreements in the first place.

Should they do that?  Only if Fannie and Freddie get serious, much higher capital requirements as an essential part of the arrangement. That is the first of four key requirements. As the American Banker reported: “Calabria said he supported the GSEs [Fannie and Freddie] having significantly more capital.” The absolutely right position. The report continues, “but he added that the FHFA director cannot unilaterally require an increase in the capital reserves under the current terms of the preferred stock purchase agreements.” Also right—it takes agreement with the Treasury, which on behalf of the taxpayers, currently takes all the risk of Fannie and Freddie.

How much more capital should Fannie and Freddie be required to have?  A lot more. Using them to escalate the leverage and the risk of the giant housing finance system should be eliminated. For details, see “Changes to capital rules should be part of GSE overhaul.”

In addition to capital, there are three other requirements if Fannie and Freddie are to be successfully taken out of conservatorship:

  1. They need to pay a meaningful fee to the Treasury for the government credit support they will continue to have, since they are and will continue to be Far Too Big To Fail (not just TBTF, but FTBTF!). This fee should be at the same rate the Federal Deposit Insurance Corp. would charge a bank of equivalent riskiness for government deposit insurance, for which the Treasury is also on the hook.
  2. Their enormous systemic risk must be regulated, in addition to their micro risks. This means they should be formally designated as the systemically important financial institutions (SIFIs) they so obviously are. This can be done administratively by the FSOC (Financial Stability Oversight Council), which is chaired by the secretary of the Treasury.
  3. Finally, the Treasury should exercise the warrants it holds to acquire, at a fraction of a cent per share, 79.9 percent of the common stock of Fannie and Freddie. This is part of the return to the taxpayers, through the Treasury, for having first saved Fannie and Freddie and then made their continuing existence possible. They could not exist even for a minute without Treasury’s credit support.

Could a sounder and better Fannie and Freddie emerge without legislation?  Yup.