Tag Archives: conservatorship

Watt’s Happening with Fannie and Freddie?

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FHFA Director Watt

Federal Housing Finance Agency Director Watt testified before the House Committee on Financial Services today and gave a good overview of the decade-long conservatorship of Fannie and Freddie.  He also gave some sense of the urgency of coming up with at least a stopgap measure before the two companies’ capital buffer drops to zero at the end of the year pursuant to the terms of the Senior Preferred Stock Purchase Agreements (PSPAs) that govern the two companies’ relationship with the Treasury. He stated that it would

be a serious misconception for members of this Committee, or for anyone else, to consider any actions FHFA may take as conservator to avoid additional draws of taxpayer support either as interference with the prerogatives of Congress, as an effort to influence the outcome of housing finance reform, or as a step toward recap and release. FHFA’s actions would be taken solely to avoid a draw during conservatorship.

This signifies to me that he is planning on doing something other than reducing the capital buffer to $0.  As far as I can tell, Watt is playing a game of chicken with Congress — if you do not act, I will.

It is not clear to me clear how much authority Watt has or thinks he has to change the rules relating to the capital buffer. Does he think that he could act inconsistent with the PSPAa and withhold capital?  I have not seen a legal argument that says he could.  Is he willing to do it and be sued by Treasury?  These are speculative questions, but I do think that he has laid the groundwork for taking action if Congress and Treasury do not.

It does not seem to me that he was much wiggle room according to the terms of the PSPAs themselves, except perhaps to delay making the net worth sweep at the end of this year by converting it to an annual sweep or by some other mechanism.  That will be a short-term fix.

Given his strong language — “FHFA’s actions would be taken solely to avoid a draw during conservatorship” — I think he might be prepared to take an action that is inconsistent with the plain language of the PSPAs in order to act in a way that he thinks is consistent with his duty as the conservator.  This is less risky than it sounds because the only party that would seem to have standing to sue would be the Treasury, the counter-party to the PSPAs.  One could imagine that the Treasury would prefer to negotiate a response with the FHFA or await Watt’s departure rather than to have a judge decide the issue.  One could also imagine that Treasury would go along with the FHFA without explicitly condoning its actions, particularly if its actions soothed a turbulent market for Fannie and Freddie mortgage-backed securities.

Watt has consistently signaled that he will act if no other responsible party does and he emphasized that again today.

Time Is Ripe For GSE Reform

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photo by Valerie Everett

Banker and Tradesman quoted me in Time Is Ripe For GSE Reform (behind a paywall). It opens,

Federal Housing Finance Agency (FHFA) Director Melvin L. Watt told the U.S. Senate Committee on Banking, Housing and Urban Affairs last month that “Congress urgently needs to act on housing finance reform” and bring Fannie Mae and Freddie Mac out of conservatorship after almost nine years.

Conservatorship is temporary by its very nature. There is universal agreement that it can’t go on forever, but there is widespread disagreement about what the government-sponsored entities (GSEs) should look like after coming out of conservatorship – and how to get there.

“Only a legislative solution can provide political legitimacy and long term market certainty for the housing finance system,” according to a recent Mortgage Bankers Association (MBA) white paper on GSE reform. MBA President and CEO Dave Stevens said now is the time for Congress to tackle the changes that will maintain liquidity, but protect taxpayers and homebuyers.

“The last recession destroyed many communities throughout the country,” he said. “The GSEs played a large role in that. They fueled a lot of the capital that allowed all varieties of lenders to make risky loans and then received the single-largest bailout in the history of this nation. They are not innocent.”

Connecticut Mortgage Bankers Association President Kevin Moran said his organization supports the positions of the MBA.

“There’s going to be change no matter what,” Stevens said. “We’re stuck with this problem. It’s technical and complicated and needs to be done. They can’t stay in conservatorship forever.”

Taxpayers Need Protection

Professor David Reiss at Brooklyn Law School said that future delays are not out of the question.

“Change is coming, but the Treasury and FHFA can amend the PSPA [agreement] again,” Reiss said. “It’s been amended three times already. There’s a little bit of political theatre going on here. It’s incredibly important for the economy. You really hope that the broad middle of the government can come to a compromise. If there isn’t the political will to move forward, they can simply kick the can down the road.”

Reiss said the fact that Fannie Mae and Freddie Mac are both going to run out of money by January 2018 is a factor in why reform is needed soon, but the GSEs aren’t in danger of imminent collapse.

“They are literally going to run out of money,” Reiss said. “But keep in mind they will continue to have a $2.5 billion line of credit. It’s partially political. They’re trying to get the public conscious of this. I don’t think anyone in the broad middle of the political establishment thinks it’s good that they’ve been in limbo for nine years.”
The MBA’s proposal to reform Fannie Mae and Freddie Mac aims to ensure that crashes like the one in 2007-2008 never happen again, in part by raising the minimum capital balance GSEs have to maintain to a level at least as high as banks and other lenders.

“They have a capital standard that is absurd,” Stevens said. “Pre-conservatorship they had to have less than 0.5 percent capital. Banks are required to maintain 4 percent of their loan value against mortgages. That’s a regulated standard. Fannie and Freddie are not as diversified as banks are. Our view is to make sure they are sustainable; they should at least a 4 to 5 percent buffer to protect them against failure.”

To put that into context, a 3.5 percent buffer would have been just large enough for the GSEs to weather the last housing crash without the need for a taxpayer-funded bailout. Stevens said the MBA would go even further.

“They should also pay a fee for every loan that goes into an insurance fund in the event all else fails,” he said. “In the event of a catastrophic failure, that would be the last barrier before having to rely on taxpayers. Keep in mind: for years, shareholders made billions and when they failed taxpayers took 100 percent of the losses.”

Stevens said the MBA would like to see more competition in the secondary market, and that the current duopoly isn’t much better than a monopoly.

“There should be more competitors,” he said. “If either one [Fannie or Freddie] fails, you almost have to bail them out. Our goal is to have a highly regulated industry to support the American finance system without using the portfolio to make bets on the marketplace.”

A Bipartisan Issue

While some conservatives like Chairman of the House Financial Services Committee Rep. Jeb Hensarling (R-Texas) have called for getting the government out of the mortgage business altogether, Stevens said that would likely mean the end of the 30-year, fixed-rate mortgage.

Furthermore, GSEs are required to serve underserved communities. Private companies would be more likely to back the most profitable loans.

“The GSEs play a really important role in counter-cyclical markets,” Stevens said. “When credit conditions shift, private money disappears. We saw that in 2007. It put extraordinary demands on Fannie Mae, Freddie Mac and Ginnie Mae. You need a continuous flow of capital. You can put controls in place so it can expand and contract when needed.”

Reiss said getting the government out of the mortgage business would certainly mean some big changes.

“I think there is some evidence that some 30-year, fixed-rate mortgages could still exist,” Reiss said. “It would dramatically change their availability, though. Interest rates would go up somewhere between one-half and 1 percent. Some people might like that because it reflects the actual risk of a residential mortgage, but it would also make housing more expensive.”

Framing Bipartisan Housing Finance Reform

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photo by Jan Tik

The Bipartisan Policy Center has issued A Framework for Improving Access and Affordability in a Reformed Housing Finance System. The brief was written by Michael Stegman who had served as the Obama Administration’s top advisor on housing policy. It opens,

With policymakers gearing up to reform the housing finance system, it is worth revisiting one of the issues that stymied negotiators in the reform effort of 2014: how to ensure adequate access to credit in the new system. The political landscape has changed substantially since 2014. For those who are focused on financing affordable housing and promoting access to mortgage credit, the status quo—the continued conservatorship of Fannie Mae and Freddie Mac—may no longer be as appealing as it was during those negotiations. This brief draws upon the lessons learned from that experience to outline a framework for bipartisan consensus in this transformed political environment.

The “middle-way” approach described here is not dependent upon any one structure or future role for the government-sponsored enterprises (GSEs), though it does assume the continuation of a government guarantee of qualified mortgage-backed securities (MBS). It is this guarantee that forms the basis of the obligation to ensure that the benefits flowing from the government backstop are as broadly available as possible, consistent with safety and soundness and taxpayer protection.

In recent months, at least three such proposals have been developed that preserve a federal backstop (see Mortgage Bankers Association, Bright and DeMarco, and Parrott et al. proposals). Should the administration and Congress pursue a strict privatization approach to reform, lacking a guarantee, it’s unlikely that any affordable housing obligations would be imposed in the reformed system. (cover page, footnotes omitted)

Stegman goes on to describe “The Affordable Housing Triad:”

Over the years, Congress has made it clear that the GSEs’ public purpose includes supporting the financing of affordable housing and promoting access to mortgage credit “throughout the nation, including central cities, rural areas, and underserved areas,” even if doing so involves earning “a reasonable economic return that may be less than the return earned on other activities.” As part of this mandate, policymakers have created a triad of affordable housing and credit access requirements:

  1. Meeting annual affordable-mortgage purchase goals set by the regulator;
  2. Paying an assessment on each dollar of new business to help capitalize two different affordable housing funds; and
  3. Developing and executing targeted duty-to-serve strategies, the purpose of which is to increase liquidity in market segments underserved by primary lenders and the GSEs, defined by both geography and housing types. (1, footnote omitted)

The paper outlines three bipartisan options that would not

compromise the obligation to provide liquidity to all corners of the market at the least possible cost, consistent with taxpayer protection and safety and soundness. Each option attempts to ensure that the system as a whole provides access and affordability at least as much as the existing system; includes an explicit and transparent fee on the outstanding balance of guaranteed MBS; and includes a duty to serve the broadest possible market. (3)

The paper is intended to spark further conversation about housing finance reform while advocating for the needs of low- and moderate-income households. I hope it succeeds in pushing Congress to focus on the details of what could be a bipartisan exit strategy from the endless GSE conservatorships.

 

GSE Investors Propose Reform Blueprint

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Moelis & Company, financial advisors to some of Fannie and Freddie investors including Paulson & Co. and Blackstone GSO Capital Partners, has release a Blueprint for Restoring Safety and Soundness to the GSEs. The blueprint is a version of a “recap and release” plan that greatly favors the interests of Fannie and Freddie’s private shareholders over the public interest. The blueprint contains the following elements:

1. Protects Taxpayers from Future Bailouts. This Blueprint protects taxpayers by restoring safety and soundness to two of the largest insurance companies in the United States, Fannie Mae and Freddie Mac. This is achieved by (a) rebuilding a substantial amount of first-loss private capital, (b) imposing rigorous new risk and leverage-based capital standards, (c) facilitating the government’s exit from ownership in both companies, and (d) providing a mechanism to substantially reduce the government’s explicit backstop commitment facility over time.

2. Promotes Homeownership and Preserves the 30-Year Mortgage. This Blueprint ensures that adequate mortgage market liquidity is maintained, the GSE debt markets continue to function without interruption, and the affordable 30-year fixed-rate conventional mortgage remains widely accessible for every eligible American.

3. Repositions the GSEs as Single-Purpose Insurers. Given the substantial reforms implemented by the Federal Housing Finance Agency (“FHFA”) since 2008, the GSEs can now be repositioned and safely operated as single-purpose insurers, bearing mortgage credit risk in exchange for guarantee fees with limited retained investment portfolios beyond that necessary for securitization “inventory” and loan purchases.

4. Enables Rebuild of Equity Capital while Winding Down the Government Backstop. The Net Worth Sweep served the purpose of dramatically accelerating the payback of Treasury’s investment in both companies. The focus must now turn to protecting taxpayers by rebuilding Fannie Mae’s and Freddie Mac’s equity capital and winding down the government’s backstop.

5. Repays the Government in Full for its Investment during the Great Recession. Treasury has retained all funds received to date during the conservatorships. The government has recouped the entire $187.5 billion that it originally invested, plus an additional $78.3 billion in profit, for total proceeds of $265.8 billion. Treasury’s profits to date on its investment in the GSEs are five times greater than the combined profit on all other investments initiated by Treasury during the financial crisis.

6. Produces an Additional $75 to $100 Billion of Profits for Taxpayers. Treasury can realize an estimated $75 to $100 billion in additional cash profits by exercising its warrants for 79.9% of each company’s common stock and subsequently selling those shares through secondary offerings. This monetization process, which follows the proven path of Treasury’s AIG and Ally Bank (GMAC) stock dispositions, could bring total government profits to $150 to $175 billion, the largest single U.S. government financial investment return in history.

7. Implements Reform Under Existing Authority. This Blueprint articulates a feasible path to achieving the Administration’s GSE reform objectives with the least amount of execution risk. It can be fully implemented during the current presidential term by FHFA in collaboration with Treasury utilizing their existing legal authorities. Congress could build on these reforms to develop an integrated national housing finance policy that accounts for the Federal Housing Administration, the Department of Veterans Affairs, and Rural Housing Service, and emphasizes (i) affordable housing, (ii) safety and soundness, and (iii) universal and fair access to mortgage credit for all Americans. (1)

As can be seen from the last paragraph, GSE investors are trying to use the logjam in the Capitol to their own advantage. They are arguing that because Congress has not been able to get real reform bill passed, it makes sense to implement a reform plan administratively. There is nothing wrong with such an approach, but this plan would benefit investors more than the public.

My takeaway from this blueprint is that the longer Fannie and Freddie remain in limbo, the more likely it is that special interests will win the day and the public interest will fall by the wayside.

This Is What GSE Reform Looks Like

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Scene from Young Frankenstein

The Federal Housing Finance Agency’s Division of Conservatorship release an Update on Implementation of the Single Security and the Common Securitization Platform. As I had discussed last week, housing finance reform is proceeding apace from within the FHFA notwithstanding assertions by members of Congress that they will take the lead on this. The Update provides some background for the uninitiated:

The Federal Housing Finance Agency’s (FHFA) 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac includes the strategic goal of developing a new securitization infrastructure for Fannie Mae and Freddie Mac (the Enterprises) for mortgage loans backed by 1- to 4-unit (single-family) properties. To achieve that strategic goal, the Enterprises, under FHFA’s direction and guidance, have formed a joint venture, Common Securitization Solutions (CSS). CSS’s mandate is to develop and operate a Common Securitization Platform (CSP or platform) that will support the Enterprises’ single-family mortgage securitization activities, including the issuance by both Enterprises of a common single mortgage-backed security (to be called the Uniform Mortgage-Backed Security or UMBS). These securities will finance the same types of fixed-rate mortgages that currently back Enterprise-guaranteed securities eligible for delivery into the “To-Be-Announced” (TBA) market. CSS is also mandated to develop the platform in a way that will allow for the integration of additional market participants in the future.

The development of and transition to the new UMBS constitute the Single Security Initiative. FHFA has two principal objectives in undertaking this initiative. The first objective is to establish a single, liquid market for the mortgage-backed securities issued by both Enterprises that are backed by fixed-rate loans. The second objective is to maintain the liquidity of this market over time. Achievement of these objectives would further FHFA’s statutory obligation and the Enterprises’ charter obligations to ensure the liquidity of the nation’s housing finance markets. The Single Security Initiative should also reduce the cost to Freddie Mac and taxpayers that has resulted from the historical difference in the liquidity of Fannie Mae’s Mortgage-Backed Securities (MBS) and Freddie Mac’s Participation Certificates (PCs). (1, footnote omitted)

This administratively-led reform of Fannie and Freddie is not necessarily a bad thing, particularly because the executive and legislative branches have not taken up reform in any serious way since the two companies entered conservatorship in 2008. While Congress could certainly step up to the plate now, it is worth understanding just how far along the FHFA is in its transformation of the two companies:

Upon the implementation of Release 2, CSS will be responsible for bond administration of approximately 900,000 securities, which are backed by almost 26 million home loans having a principal balance of over $4 trillion. CSS’S responsibilities related to security issuance, security settlement, bond administration and disclosures were described in the September 2015 Update on the Common Securitization Platform. The Enterprises and investors, along with home owners and taxpayers, will rely on the operational integrity and resiliency of the CSP to ensure the smooth functioning of the U.S. housing mortgage market. (8)

That is, upon the implementation of Release 2, the merger of Fannie and Freddie into Frannie will be complete.

GSE Investors’ Hidden Win

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Judge Brown

The big news yesterday was that the US Court of Appeals for the DC Circuit ruled in the main for the federal government in Perry Capital v. Mnuchin, one of the major cases that investors brought against the federal government over the terms of the Fannie and Freddie conservatorships.

In a measured and carefully reasoned opinion, the court rejected most but not all of the investors’ claims.  The reasoning was consistent with my own reading of the broad conservatorship provisions of the Housing and Economic Recover Act of 2008 (HERA).

Judge Brown’s dissent, however, reveals that the investors have crafted an alternative narrative that at least one judge finds compelling. This means that there is going to be some serious drama when this case ultimately wends its way to the Supreme Court. And there is some reason to believe that a Justice Gorsuch might be sympathetic to this narrative of government overreach.

Judge Brown’s opinion indicts many aspects of federal housing finance policy, broadly condemning it in the opening paragraph:

One critic has called it “wrecking-ball benevolence,” James Bovard, Editorial, Nothing Down: The Bush Administration’s Wrecking-Ball Benevolence, BARRON’S, Aug. 23, 2004, https://tinyurl.com/Barrons-Bovard; while another, dismissing the compassionate rhetoric, dubs it “crony capitalism,” Gerald P. O’Driscoll, Jr., Commentary, Fannie/Freddie Bailout Baloney, CATO INST., https://tinyurl.com/Cato-O-Driscoll (last visited Feb. 13, 2017). But whether the road was paved with good intentions or greased by greed and indifference, affordable housing turned out to be the path to perdition for the U.S. mortgage market. And, because of the dominance of two so-called Government Sponsored Entities (“GSE”s)—the Federal National Mortgage Association (“Fannie Mae” or “Fannie”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “Freddie,” collectively with Fannie Mae, the “Companies”)—the trouble that began in the subprime mortgage market metastasized until it began to affect most debt markets, both domestic and international. (dissent at 1)

While acknowledging that the Fannie/Freddie crisis might justify “extraordinary actions by Congress,” Judge Brown states that

even in a time of exigency, a nation governed by the rule of law cannot transfer broad and unreviewable power to a government entity to do whatsoever it wishes with the assets of these Companies. Moreover, to remain within constitutional parameters, even a less-sweeping delegation of authority would require an explicit and comprehensive framework. See Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 468 (2001) (“Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.”) Here, Congress did not endow FHFA with unlimited authority to pursue its own ends; rather, it seized upon the statutory text that had governed the FDIC for decades and adapted it ever so slightly to confront the new challenge posed by Fannie and Freddie.

*     *     *

[Congress] chose a well-understood and clearly-defined statutory framework—one that drew upon the common law to clearly delineate the outer boundaries of the Agency’s conservator or, alternatively, receiver powers. FHFA pole vaulted over those boundaries, disregarding the plain text of its authorizing statute and engaging in ultra vires conduct. Even now, FHFA continues to insist its authority is entirely without limit and argues for a complete ouster of federal courts’ power to grant injunctive relief to redress any action it takes while purporting to serve in the conservator role. See FHFA Br. 21  (2-3)

What amazes me about this dissent is how it adopts the decidedly non-mainstream history of the financial crisis that has been promoted by the American Enterprise Institute’s Peter Wallison.  It also takes its legislative history from an unpublished Cato Institute paper by Vice-President Pence’s newly selected chief economist, Mark Calabria and a co-author.  There is nothing wrong with a judge giving some context to an opinion, but it is of note when it seems as one-sided as this. The bottom line though is that this narrative clearly has some legs so we should not think that this case has played itself out, just because of this decision.

Muddled Future for Fannie & Freddie

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poster_of_alexander_crystal_seer

The United States Government Accountability Office released a report, Objectives Needed for the Future of Fannie Mae and Freddie Mac After Conservatorships.  The GAO’s findings read a bit like a “dog bites man” story — stating, as it does, the obvious:  “Congress should consider legislation that would establish clear objectives and a transition plan to a reformed housing finance system that enables the enterprises to exit conservatorship. FHFA agreed with our overall findings.” (GAO Highlights page) I think everyone agrees with that, except unfortunately, Congress.  Congress has let the two companies languish in the limbo of conservatorship for over eight years now.

Richard Shelby, the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, asked the GAO to prepare this report in order to

examine FHFA’s actions as conservator. This report addresses (1) the extent to which FHFA’s goals for the conservatorships have changed and (2) the implications of FHFA’s actions for the future of the enterprises and the broader secondary mortgage market. GAO analyzed and reviewed FHFA’s actions as conservator and supporting documents; legislative proposals for housing finance reform; the enterprises’ senior preferred stock agreements with Treasury; and GAO, Congressional Budget Office, and FHFA inspector general reports. GAO also interviewed FHFA and Treasury officials and industry stakeholders (Id.)

The GAO’s findings are pretty technical, but still very important for housing analysts:

In the absence of congressional direction, FHFA’s shift in priorities has altered market participants’ perceptions and expectations about the enterprises’ ongoing role and added to uncertainty about the future structure of the housing finance system. In particular, FHFA halted several actions aimed at reducing the scope of enterprise activities and is seeking to maintain the enterprises in their current state. However, other actions (such as reducing their capital bases to $0 by January 2018) are written into agreements for capital support with the Department of the Treasury (Treasury) and continue to be implemented.

In addition, the change in scope for the technology platform for securitization puts less emphasis on reducing barriers facing private entities than previously envisioned, and new initiatives to expand mortgage availability could crowd out market participants.

Furthermore, some actions, such as transferring credit risk to private investors, could decrease the likelihood of drawing on Treasury’s funding commitment, but others, such as reducing minimum down payments, could increase it.

GAO has identified setting clear objectives as a key principle for providing government assistance to private market participants. Because Congress has not established objectives for the future of the enterprises after conservatorships or the federal role in housing finance, FHFA’s ability to shift priorities may continue to contribute to market uncertainty. (Id.)

One finding seems particularly spot on to me. As I wrote yesterday, it appears as if the FHFA is not focusing sufficiently on building the infrastructure to serve secondary mortgage markets other than Fannie and Freddie.  It seems to me that a broader and deeper bench of secondary mortgage market players will benefit the housing market in the long run.