Tag Archives: Basel III

Fannie, Freddie & The Affordable Housing Feint

Posted on by
ShapiroPhoto

Robert J. Shapiro

kamarck_mm_duo

Elaine C. Kamarck

 

 

 

 

 

Robert J. Shapiro and Elaine C. Kamarck have posted A Strategy to Promote Affordable Housing for All Americans By Recapitalizing Fannie Mae and Freddie Mac. While it presents as a plan to fund affordable housing, the biggest winners would be speculators who bought up shares of Fannie and Freddie stock and who may end up with nothing if a plan like this is not adopted.  The Executive Summary states that

This study presents a strategy for ending the current conservatorship and majority government ownership of Fannie and Freddie in a way that will enable them, once again, to effectively promote greater homeownership by average Americans and greater access to affordable housing by low-income households. This strategy includes regulation of both enterprises to prevent a recurrence of their effective insolvency in 2008 and the associated bailouts, including 4.0% capital reserves, regular financial monitoring, examinations and risk assessments by the Federal Housing Finance Agency (FHFA), as dictated by HERA. Notably, an internal Treasury analysis in 2011 recommended capital requirements, consistent with the Basel III accords, of 3.0% to 4.0%. In addition, the President should name a substantial share of the boards of both enterprises, to act as public interest directors. The strategy has four basic elements to ensure that Fannie and Freddie can rebuild the capital required to responsibly carry out their basic missions, absorb losses from future housing downturns, and expand their efforts to support access to affordable housing for all households:

  • In recognition of Fannie and Freddie’s repayments to the Treasury of $239 billion, some $50 billion more than they received in bailout payments, the Treasury would write off any remaining balance owed by the enterprises under the “Preferred Stock Purchase Agreements” (PSPAs).
  • The Treasury also would end its quarterly claim or “sweep” of the profits earned by Fannie and Freddie, so their future retained earnings can be used to build their capital reserves.
  • Fannie and Freddie also should raise roughly $100 billion in additional capital through several rounds of new common stock sales into the market.
  • The Treasury should transfer its warrants for 79.9% of Fannie and Freddie’s current common shares to the HTF [Housing Trust Fund] and the CMF [Capital Magnet Fund], which could sell the shares in a series of secondary stock offerings and use the proceeds, estimated at $100 billion, to endow their efforts to expand access to affordable housing for even very low-income households.

Under this strategy, Fannie and Freddie could once again ensure the liquidity and stability of U.S. housing markets, under prudent financial constraints and less exposure to the risks of mortgage defaults. The strategy would dilute the common shares holdings of current private investors from 20% to 10%, while increasing their value as Fannie and Freddie restore and claim their profitability. Finally, the strategy would establish very substantial support through the HTF and CPM for state programs that increase access to affordable rental housing by very low-income American and affordable home ownership by low-to-moderate income households.

Wow — there is a lot that is very bad about this plan.  Where to begin? First, we would return to the same public/private hybrid model for Fannie and Freddie that got us into so much trouble to begin with.

Second, it would it would reward speculators in Fannie and Freddie stock. That is not terrible in itself, but the question would be — why would you want to? The reason given here would be to put a massive amount of money into affordable housing. That seems like a good rationale, until you realize that that money would just be an accounting move from one federal government account to another. It does not expand the pie, it just makes one slice bigger and one slice smaller. This is a good way to get buy-in from some constituencies in the housing industry, but from a broader public policy perspective, it is just a shuffling around of resources.

There’s more to say, but this blog post has gone on long enough. Fannie and Freddie need to be reformed, but this is not the way to do it.

 

Banks Should Know Their Investment Risks

Posted on by

Nathaniel Zumbach

The latest issue of the Federal Deposit Insurance Corporation’s Supervisory Insights (Devoted to Advancing the Practice of Bank Supervision) has an esoteric, but important article on Bank Investment in Securitizations: The New Regulatory Landscape in Brief (starting on page 13). The article opens,

The recent financial crisis provided a reminder of the risks that can be embedded in securitizations and other complex investment instruments. Many investment grade securitizations previously believed by many to be among the lowest risk investment alternatives suffered significant losses during the crisis. Prior to the crisis, the marketplace provided hints about the embedded risks in these securitizations, but many of these hints were ignored. For example, highly rated securitization tranches were yielding significantly greater returns than similarly rated non-securitization investments. Investors found highly rated, high yielding securitization structures to be “too good to pass up,” and many investors, including community banks, invested heavily in these instruments. Unfortunately, when the financial crisis hit, the credit ratings of these investments proved “too good to be true;” credit downgrades and financial losses ensued.

In the aftermath of the financial crisis, interest rates have remained at historic lows, and the allure of highly rated, high-yielding securitization structures remains. Much has been done to mitigate the problems experienced during the financial crisis with respect to securitizations. Congress responded with the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and regulators developed and issued regulations and other guidance designed to increase investment management standards and capital requirements.

The gist of these new requirements is simple: banks should understand the risks associated with the securities they buy and should have reasonable assurance of receiving scheduled payments of principal and interest. This article summarizes the most pertinent of these requirements and provides practical advice on how the investment decision process can be structured so the bank complies with the requirements.

The guidance and regulations applicable to bank investment activities reviewed in this article are: „

  • Office of the Comptroller of the Currency (OCC): 12 CFR, Parts 1, 5, 16, 28, 60; Alternatives to the Use of External Credit Ratings in the Regulations of the OCC;
  • OCC: Guidance on Due Diligence Requirements to determine eligibility of an investment (OCC Guidance);
  • Federal Deposit Insurance Corporation (FDIC): 12 CFR Part 362, Permissible Investments for Federal and State Savings Associations: Corporate Debt Securities;
  • FDIC: 12 CFR Part 324, Regulatory Capital Rules; Implementation of Basel III (Basel III); and  „
  • FDIC: 12 CFR Part 351, Prohibitions on certain investments (The Volcker Rule).

As financial institutions move into an investment world where relying on credit ratings from third party providers is not longer sufficient, the advice in this article is welcome. One wonders though what the consequences will be, if any, for those who do not follow it.