Risk Sharing, Or Not

On February 11, Fannie Mae priced its tenth Connecticut Avenue Securities (CAS) risk-sharing transaction. Since the program’s inception in 2013, Fannie has issued $13.4 billion in these notes, covering about $470 billion in newly originated single-family mortgages and obligating the company to pay about $7 billion over the next ten years in premiums and hedging costs (assuming it’s hedging the notes’ short-term interest rate risk, as it should be).

In the initial CAS deals, Fannie took the risk on the first 30 basis points of credit losses (technically “credit events,” but we’ll try to keep this understandable) on a specified pool of mortgages, and issued securities totaling 2.57 percent of this pool that paid investors floating rates of around 3.50 percent over 1-month LIBOR, before hedging costs, for taking 95 percent of the next 270 basis points of losses.

Even these first deals had excessive amounts of coverage and extremely generous pricing to investors, but the terms on the two most recent CAS issues have been so unfavorable to Fannie—committing the company to pay sharply higher interest rates for still greater amounts of unneeded coverage, while requiring it to take more losses itself before the insurance kicks in—as to merit being called giveaways. In the October 2015 CAS transaction, Fannie took the first 50 basis points of loss, while paying investors 1-month LIBOR plus 455 basis points (before hedging costs) to take 95 percent of the next 350 basis points of losses. Then, in the CAS deal done last month, Fannie paid one group of investors LIBOR plus 1175 points (that’s not a misprint) to split the first 100 basis points of losses, and paid two other groups of investors an average of LIBOR plus 500 basis points for coverage against 95 percent of losses over 100 and up to 400 basis points.

The terms and pricing on the recent CAS deals have worsened for three reasons. Most importantly, they are being done not because they make economic sense, but because they’ve been mandated by FHFA, which in turn has been told to do them by Treasury. Second, there is a very limited and highly specialized investor base for CAS transactions (the Urban Institute says 59 percent of the more junior risk-sharing tranche in the October 2015 CAS deal was purchased by hedge funds), so as more deals are pushed on the market the terms for absorbing them deteriorate. And third, the very structure of the CAS securities, by grossly over-insuring the underlying collateral, inadvertently signals to investors that the risk-bearing tranches of these deals contain far more potential for loss than they actually do.

There is more than a little irony in this last point. The standard of protection for CAS transactions—insuring against losses of up to 4 percent of the original balance of the loans in the pool—is derived from losses experienced between 2009 and 2012 on mortgages originated between 2005 and 2008. But these loans, and their losses, come from a highly anomalous period in mortgage lending history, in which control over underwriting and financing shifted to the same Wall Street firms and their supporters, including Treasury, who now insist that Fannie (and Freddie) must insure against an environment that will not, and indeed now cannot, repeat itself.

The huge jumps in the riskiness of mortgages made by all lenders, including Fannie and Freddie, during the 2005-2008 period—and the consequent mammoth losses these loans suffered in subsequent years—were the results of the lethal interaction of two factors: (a) the rise to dominance in 2004 of a financing mechanism, private-label securitization, that placed few limits on mortgage credit risk anywhere along the financing chain, and (b) a deliberate policy choice by banking regulators not to prohibit any of the irresponsible lending practices that took hold in the primary market during this period, including “liar loans,” interest-only ARMs with deep teaser rates, and excessive risk layering. The combination of a very powerful but indiscriminate financing mechanism and no substantive regulation of either the products or the borrowers it served produced four years of undisciplined mortgage lending on a massive scale, culminating in a boom and bust cycle for the mortgage and housing markets whose impact lingers even today.

We clearly learned our lesson from this disaster. The private-label market now is moribund (and unlikely to return as a major financing source for a very long time, if ever), while the Consumer Financial Protection Board has prohibited the types of toxic loans responsible for the large majority of the 2009-2012 credit losses. With neither of their causative factors any longer present, the credit losses on Fannie or Freddie’s 2005-2008 books of business are not relevant benchmarks for the loans the companies are making today.

A much more fitting reference point for gauging the riskiness of these loans is the comparable set of mortgages Fannie purchased or guaranteed from 2000 to 2003 (before lending standards began deteriorating in 2004). The credit quality of the 2000-2003 and 2014-2015 loans is similar, with the more recent arguably being better. The average loan-to-value ratio of Fannie’s 2014-2015 loans is only somewhat higher than its 2000-2003 loans (76% versus 73%), but the average credit score—746 versus 714—is considerably higher. Over 12 years of performance data now exist for the 2000-2003 loans, and they have an ever-to-date default rate of 1.5%, an average loss severity of 34%, and a credit loss rate of 51 basis points.

I was CFO at Fannie during 2000-2003. We were shown risk-sharing deals by Wall Street firms that had much more favorable parameters and pricing than the ones Fannie is doing today, and we did not do any of them (Freddie did a few) because our analysis found their risk-adjusted costs to be too high. We would have rejected the most recent CAS deals out of hand. A simple illustration using the October 2015 CAS transaction—which had better terms than last month’s deal—shows why. Had Fannie insured the same categories of its new 2000-2003 single-family loans as it is insuring now (for the 2000-2003 books, just under half the total) using the structure and pricing of the October 2015 CAS deal, it would have paid at least 7 percent per year (before hedging costs) on an average balance of about $31.5 billion in risk-sharing securities, for total premiums of at least $22 billion for the minimum 10 years the securities would have been outstanding. Based on the performance of all loans in the 2000-2003 books, the CAS-insured loans would have suffered no more than about $5.5 billion in cumulative credit losses, virtually all of which would have fallen under the 50 basis point threshold for risk-sharing, and thus been absorbed by the company. After-tax, the $22 billion in premiums Fannie would have paid to insure against a further 350 basis points in losses (an absurd amount of coverage to begin with) would have cost it over $14 billion in foregone capital, and returned at most a few hundred million dollars in loss reimbursements.

There is no reason to expect the results of Fannie’s more recent CAS transactions on even better books of business to be very different: virtually all of the risks on the loans are likely to end up as losses for the issuer (Fannie), while virtually all of the premiums are likely to end up as income for the investor (principally hedge funds).

Although it is FHFA that has mandated Fannie to “transfer credit risk on at least 90 percent of the unpaid principal balance of newly acquired single-family mortgages in [targeted] loan categories” this year, Treasury is behind this requirement, and it cares not one whit about whether the risk-sharing transactions make economic sense for the company. Treasury’s support for the CAS program stems from its goal of winding down Fannie and Freddie and replacing them with “private market” alternatives. With private-label securitization inoperative, securitized risk sharing is the one remaining tool Treasury has for accomplishing its objective of transferring secondary mortgage risk management (and revenue) from Fannie and Freddie to Wall Street and its customers.

Here, however, is one more heavy irony. Treasury reflexively terms Fannie and Freddie a “failed business model”—even though they dramatically outperformed all other sources of mortgage finance prior to the crisis—yet the credit risk-sharing transactions it is requiring them to do on a massive scale have serious flaws that even the technique’s supporters acknowledge. Those flaws make securitized risk sharing unsuitable for anything other than supplementary credit enhancement when their economics make them competitive.

Opponents of Fannie and Freddie are loath to admit it, but the companies’ method of managing mortgage credit risk is simple, proven, and unequalled. It relies on capital and loss reserves to absorb losses up to some defined level of stress (with that amount now under review in the wake of the financial crisis). Credit risk is diversified by product type, loan characteristic, geography and, importantly, over time. The housing and mortgage markets always have been cyclical: the lifetime loss rates for some origination years are low (or very low), for others they are medium, and for some they are high (or very high). The key to diversification across time is to “bank” the excess returns from the good years, either as loss reserves (to the extent the FASB allows you to do so) or as surplus capital, then draw on that excess capital or reserves to absorb spikes in losses from the bad and very bad years.

This diversification of risk across time is precisely where the risk-sharing model breaks down. Investors are eager to do risk sharing when times are good and risks seem low (although even then the transactions can be prohibitively costly), but risk-sharing investors are less plentiful in times of uncertainty and disappear entirely in times of turbulence. And this fact leads to a second, even more serious, flaw: risk sharing in good times takes what should be future capital out of the mortgage finance system, and gives it to investors who do not re-inject it in bad times, when it is essential and generally either very expensive or not available at all.

The fundamental weaknesses of the risk-sharing model aren’t going to change no matter how many CAS deals Treasury forces Fannie to do. And today’s deals are an extraordinarily wasteful means of making an ideological statement. Fannie is giving away huge chunks of its guaranty fees that otherwise would go to the government as profits if the net worth sweep is upheld, or be returned to the company as capital if the net worth sweep is overturned. Certainly it can’t be Treasury’s objective to transfer revenues from the government to hedge funds, and I hope it is not so cynical as to deliberately be draining Fannie’s revenues, expecting to lose the net worth sweep cases and wanting to make it harder for the company to recapitalize itself.

Irrespective of Treasury’s motivations, however, the CAS transactions give FHFA Director Watt a perfect opportunity to exert his independence as conservator, either by changing their structures so that they no longer dissipate Fannie’s assets or, if that’s not possible (and I suspect it may not be), stopping them altogether.

In remarks to the Bipartisan Policy Center last month, Watt said, “FHFA expects Freddie Mac and Fannie Mae to determine their pricing as though they were holding capital and seeking an appropriate economic return on this capital.” A corollary of this stance is that, as steward of Fannie’s capital, FHFA should not allow Treasury to waste it. With the 50 basis points Fannie currently charges lenders to guarantee their (high quality) single-family loans, it has ample resources to self-insure against unexpected losses, and to devote any excess guaranty fees to the build-up of its capital base if and when the net worth sweep is invalidated. The credit risk management approach Fannie has used for decades—prudent underwriting, and the diversification of risk across product, loan characteristic, geography and time—has proven to work, and FHFA must not permit Treasury to force Fannie to supplant it with a true “failed business model”: programmatic securitized risk sharing.


102 thoughts on “Risk Sharing, Or Not

  1. Good read, very informative! Always looking to follow people who are willing to share their perspective and info freely! Again, enjoyed the read and look forward to your next post.


  2. Mr. Howard,

    Thank you endlessly for your unselfish sharing of decades of expertise. Whomever our next president is, they would be wise to enlist your wisdom. I would also like to thank you for helping me to understand so much of this situation, connecting the various pieces, making sense.

    I recently ran across some articles on Warren Buffett’s investing history pertaining to Fannie and Freddie. I found the timing [so important in multiple instances it seems] to be somewhat interesting. Almost like he received some inside advance warning of what was to come soon after he sold his holdings in Fannie and Freddie. And those holdings were quite large. He is quoted below in an article at the link below.

    Did Warren Buffett ever drop by Fannie Mae when you were there to your knowledge?

    “At it’s core Berkshire Hathaway is an insurer”

    “I don’t see any role for Berkshire in Fannie or Freddie. There could be some in some housing arrangement that gets worked out in the future.”

    [cough cough, CSS, cough cough]



    1. The article you cite talks about Buffet’s experience with Freddie Mac in 1999. But a decade earlier, he did come to Fannie Mae to see David Maxwell, when I was there, and I mention that episode in my book (pages 29 and 30). Buffet started buying Fannie stock, but got nervous when the price went up. In what he subsequently called “the biggest mistake I ever made,” he not only stopped buying Fannie shares, he sold the ones he’d acquired. Sixteen later, Frank Raines and I flew to Omaha in December 2004 to ask him if he would be willing to make a multi-billion dollar investment in Fannie Mae preferred stock (which I also discuss int he book). He agreed to do so, but the terms he wanted weren’t acceptable to Fannie’s regulator, and the deal did not go through.


  3. Good Evening Tim
    Did you have a chance to read the paper that proposes the merger of FnF under a government owned corporation? Do you have an opinion yet?


    1. Sue: I did read it. As I think we’ll all see shortly, there will be a number of proposals for housing finance reform being made public (in some form), since an institution in Washington DC has asked several people–me included– to prepare short papers on the subject. The “More Promising Road to GSE Reform” piece isn’t short, but it was done in response to the same request for ideas that will elicit the other papers. I’ve already submitted mine, and it will be the subject of my next post, which I hope to do very soon. Once my proposal is out, I’ll be in a better position to give my reaction not only to the “Promising Road” piece, but also to the other proposals that are made.

      Sorry to be cryptic, but I’d really rather get something positive out first, then do critiques based on that. I can at least give a preview, though: you might imagine that after what I wrote in “Risk Sharing, Or Not,” I’m not likely to give very high marks to a proposal that makes programmatic securitized risk-sharing the basis for ALL (or virtually all) financing done in the secondary market.

      Liked by 1 person

      1. Looking forward to reading your proposal. Can you at least share which DC institution requested papers and why?
        I see that the Zandi, et al. paper was hosted at Moody’s Analytics… is that merely because Mark works there?


        Liked by 1 person

        1. I’ll let the “DC institution” make its own announcement– which I understand it’s planning to do early next week–but the purpose of the project as I understand it is to get a number of what they call “housing reform thinkers” to put their ideas for reform on paper, so that a wider audience can review, compare and contrast them. I think that’s a laudable and worthwhile initiative, and am happy to participate in it. They’ve asked me to hold off putting my proposal on my site until they can put it up on theirs, and I’d like to comply with that request. They have mine scheduled to go up next Thursday, so I’ll post it here the same day.

          Technically, the “Promising Road” piece by Zandi et al isn’t part of this initiative, but I suspect he (or one of the other authors) will do a 2000-word version to go along with the rest of the submissions. I’m not sure why he and his co-authors decided to release their version earlier than the rest of us (and in a longer version), or why Moody’s is hosting it.

          Liked by 1 person

          1. Perhaps I am too cynical, but, the Zandi proposal calls for risk sharing structures similar to CAS/STACRs. Moody’s makes money on rating those structures. Eliminate risk sharing and you eliminate those fees.

            A model (such as F/F taking the credit risk through debt/equity structures) will not generate fees for Moody’s

            Liked by 1 person

          2. That did not escape my notice. I’m going to try to get a short post up tomorrow commenting on the reliance of the “Promising Road” proposal on securitized risk sharing. I’ll put my own proposal for reform up towards the end of next week– currently targeting Thursday the 31st (it’s already “in the can,” as they say).

            Liked by 1 person

          3. Tim I can’t wait to read your proposal ! I have been expecting it for long time-remember when we talk about building blocks- I am sure it will be the best for the country because you are putting together Experience+Honesty+Common sense. Three things that are not very common among these so called “housing advisers ” that are shielded under “institutes” or “thinking tanks”

            Liked by 1 person

  4. The early call on the latest CAS is that spread on the riskiest class is over LIBOR + 1200 — worse than even the previous one


    1. I may be missing something on these “first loss” tranches, but I don’t think so. The investors in them split the first 100 basis points of losses with Fannie Mae, pari passu. Let’s say it’s a $10 billion pool. The size of the first-loss risk-sharing tranche (owned by the investor) would be $50 million. It would have a minimum maturity of ten years, and because the tranche gets paid down only as principal amortizes (it is unaffected by unscheduled repayments or prepayments), its average outstanding balance would be about $44.8 billion. If Fannie is paying 1-month LIBOR (currently about 45 basis points, before hedging costs) plus 1175 basis points, it will make at least in $54.7 million in interest payments over the life of the risk-sharing tranche. If Fannie took all the risk on the loans itself, the most it could lose would be $50 million (half the first 100 basis points of losses), and it could lose considerably less than that if the total losses on the pool in the first ten years are under 100 basis points.

      I can see why a hedge fund would want to do a deal like this: even if they price to the worst credit outcome, they’ll still make money, and they’ll make a great deal of money in what I think would be the expected loss case. What I can’t understand is why Fannie would do the same deal, and I doubt it’s doing so on its own volition. (And, yes, paying 1200 basis over LIBOR instead of 1175 doesn’t improve the deal from Fannie’s perspective…)

      Liked by 1 person

      1. If there are catastrophic losses in the first few years (and if defaults occur, they will happen in the first five years), Fannie Mae will be better off with this structure. Say all $50 million losses occur in year 1, Fannie Mae has passed all the losses to the hedge funds and paid only $6.2 million (LIBOR +1200 on $50 million).

        A rational loss protection policy would take these factors into consideration. The first loss protection should only exist for the first five years of a mortgage.


        1. Barry: You’re right; I DID miss something: losses (obviously) pay down the balance of the first-loss risk-sharing securities, and thus reduce the total amount of interest paid. But all the losses won’t occur in year one. Let’s look at two scenarios, each assuming a typical loss curve, with about two-thirds of the losses coming between years 4 and 8. In the first scenario, there are 100 basis points of loss by year 10. In this case, the risk-sharing partner puts up $50 million but only gets about $30 million in interest payments before losses wipe out its principal. Fannie is $20 million to the good. In the second scenario, there are 50 basis points of loss through year 10. In this case, the investor puts up $50 million, gets about $65 million in interest payments, loses $25 million, and gets $25 million in principal repayments (annual amortization and the final payment). Here Fannie clearly is the loser: it pays $65 million to get $25 million of loss absorption, so is out $40 million.

          The break-even point on this structure looks to be at around 80 basis points of loss by year 10. I’d be very surprised if Fannie’s most recent books of business get close to even half that amount of losses by that time.

          Liked by 1 person

  5. J.P. Morgan announced issuance of a private sector version of the GSE Risk Sharing Structures (Chase Trust 2016). The securitization consists mainly (75%) of conforming loans — loans that could have been sold to Fannie Mae.

    JPM is retaining the senior tranches (which mostly have interest rate risk) and selling the credit risk tranches — JPM is acting as a GSE.

    It will be interesting to see where JPM can sell the credit risk tranches. If the tranches can be placed at lower spreads than CAS/STACRs — it proves the GSEs (i.e., taxpayers) are acting against their best interests.

    Regardless, this is the first of many attempts by Wall Street to bypass the GSEs — who have no idea what is happening.


    1. I have no problem with banks or other originators using Wall Street to help them manage the credit risks (or interest rate risks) on their own mortgages. Selling loans to Fannie or Freddie– or swapping them for guaranteed Fannie or Freddie securities– should be a choice lenders have, if the economics work for them. Mel Watt says that Fannie and Freddie are pricing their credit guarantees according to their best estimates of the risk of the loans they’re guaranteeing, and if they’re truly doing that, they’ll get the business if they offer the best execution, and lose the business if they don’t.

      I’ll also be interested to see where JP Morgan prices their risk-sharing deal (and to see how the collateral of their deal differs, if it does, from the loans Fannie has been insuring).


    2. from moody’s rating of chase deal:

      “Chase, as the mortgage loan seller, has provided clear representations and warranties (R&Ws) including an unqualified fraud R&W. There is a provision for binding arbitration in the event of dispute between investors and the R&W provider concerning R&W breaches.”

      maybe institutional investors wont care, but arbitrating R&W breaches strikes me as a huge benefit for the issuer


  6. FHFA Director is not immune from law suits as FHFA regulator (Regular role).

    FHFA Director is immune from law suits only as long FHFA Director is exercising authority as conservator.

    Since FHFA Conservator role is sub-ordinate to FHFA Regulator role (Regular role),
    Can not shareholder as ordinary citizens file case against FHFA regulator for dereliction of duty and complicity to destroy FnF (BTW all citizens are stakeholders of FnF)?


    1. Certainly a shareholder could do so. But I’m now coming to feel that there probably are enough cases litigating FHFA’s behavior, and that additional suits are more likely to slow or complicate resolution of the most important or promising cases– as we saw last week with FHFA’s motion to consolidate the Jacobs-Hindes case filed in the U.S. District Court in Delaware with three other cases filed in the D.C. District Court. The Jacobs-Hindes case deals with a straightforward point of law, and consolidating it with three more complex cases, in a different venue, would slow its progress markedly. That’s clearly what the government wants, but not what supporters of Fannie and Freddie should wish for.

      Liked by 1 person

      1. Tim,

        Regarding number of cases filed and FHFA request for consolidations, there are two ways to look at it.

        If there were only 1 or 2 cases then, Gov/FHFA will say, these are only few greedy rich hedge funds that are suing the Gov and rest of the country is ok with unlawful ways of FHFA.

        If there are numerous cases then it proves that it is not only just few hedge funds, but diverse group of aggrieved ordinary investors that are opposed to the unlawful ways of FHFA conservatorship.

        It is better to have as many as lawsuits as possible from diverse aggrieved investors so that all know how unlawful behavior of FHFA is affecting countless citizens.

        There is strength in numbers. Judges will be careful not to dismiss the cases considering the number of cases pending in other courts. If Judge Lamberth were to know the strength of diverse FnF shareholders he would not have dismissed the case so easily.


  7. Click to access 15-00047-0076.pdf


    “This case presents important issues of national significance and threatens to impact
    the FHFA’s ongoing efforts to carry out its statutory duties as Conservator of Fannie Mae and Freddie Mac.”

    Did not defendant open the doors for plaintiffs to challenge on whether defendant is “carrying out its statutory duties as Conservator of Fannie Mae and Freddie Mac” considering “this case presents important issues of national significance”?


    1. This is the issue in almost all of the suits. There is little doubt that most of the actions taken by FHFA as conservator of Fannie and Freddie have not been in the best interest of the companies (or their shareholders). FHFA has shown no signs of changing its posture, even though, as an independent conservator, it clearly could. So it appears that stakeholders of Fannie and Freddie are going to have to wait for some judicial resolution of the question: does FHFA, in fact, have a statutory right as conservator to run the companies for the benefit of the federal government, rather than their shareholders?


  8. Hi Tim
    Are you planning to warn Congress and media about the risk of the CAS trades taken by hedge funds?
    It seems that you are the only one that is seeing this tremendous danger !!!.

    Plus you have the skill to put in writing everything clearly and easy to understand. One example is the Amicus presented in Delaware suit . For me it is a piece of art that should be mailed to every Congressman and published everywhere.

    I encourage you to write a piece stating this risk and warning what may happen. Maybe the shareholders should file a complaint opposing this action taken by the conservator as it is not in the best interest of the companies.
    It sounds very scary the fact that the counterparts are ” leveraged hedge funds”


    1. There are three areas where the fates of Fannie and Freddie might be determined: Congress, the administration, and the courts. Of the three, Congress is the least likely to do anything in the next year. In addition to the pieces on my website, I’ve been working to get better facts into the judicial proceedings (principally through the amicus briefs, but also through direct contacts with some of the law firms and investment funds behind the suits) as well as to people in a position to influence decision makers within the administration. It’s a slow process, though, and one in which you can’t push too much new (or complex) material through too quickly, or it becomes overwhelming to people for whom this is not familiar ground.

      But I do agree with you that more attention needs to be paid to the shortcomings and dangers of securitized risk-sharing, and it’s a theme I intend to keep after.

      Finally, the suit filed by Tim Pagliara for access to the books and records of Fannie and Freddie does address the CAS transactions, as well as the funds being spent by the companies on the common securitization platform. Should this action turn into a suit against the companies’ directors, it might be opportune to file an amicus addressing the problems of the risk-sharing transactions in more depth.


    1. Ed: The transaction you cite is the latest in Fannie Mae’s Credit Insurance Risk Transfer (or CIRT) program, which is different from the Connecticut Avenue Securities (or CAS) program I discussed in my post. Both have Fannie taking the initial losses on a pool of mortgages (in the case of the most recent CIRT deals, 50 basis points), with the company paying a third party or parties to take a defined percentage of the subsequent losses. There are at least three differences between the CIRT and CAS programs: (a) the former is much smaller–$66 billion in insured loans to date under CIRT, versus seven times that amount ($470 billion) to date in CAS deals; (b) CIRT deals are done directly with insurers or reinsurers, whereas CAS deals are done with whichever institutions purchase the securities, and (c) while Fannie discloses the spreads over LIBOR on the risk-bearing tranches of its CAS transactions, it does not disclose the premium rates it pays on CIRT deals. Despite the lack of disclosure on the terms of the CIRT transactions, I suspect they are better than Fannie is getting on the CAS deals. Neither, however, make economic sense for the company at the present time.

      As to whether the CIRT or CAS transactions might make sense for the company going forward, I would answer differently by program. Both CIRT and CAS only should be done when the economics are favorable for Fannie (which is not the case currently), but there is an important difference between CIRT and CAS that makes the former much more reliable for possible future use. The counterparties in CIRT are insurance companies, which are reasonably well capitalized and in the mortgage insurance business for the long haul. The counterparties in CAS transactions are mainly hedge funds, who don’t bring actual capital to the table, and view these deals as a trade, not a business. Hedge funds use debt to buy their CAS tranches– they borrow at “LIBOR plus a little” and invest in CAS deals at “LIBOR plus a lot.” (The claim that they bring ‘private capital’ to the mortgage market is pure fiction; they bring more leverage.) Hedge funds only will do that trade for as long as it is profitable to them. Worse, if and when bad times come and some of them come under pressure, they very likely will sell their CAS holdings, because of their relative liquidity, to raise money for redemptions or other needs, and that will create havoc in the credit risk reinsurance market. I never have understood why any sensible analyst thinks it’s a good idea to base the mortgage finance system of the future on risk-sharing deals done with hedge funds.

      Liked by 1 person

      1. Tim, Are the below points valid?

        Looks like FHFA conservator and Gov bureaucrats are preparing FnF for grand failure.

        Other private FIs try to stay ahead of the curve to make profits as well protect against risks.

        But FHFA conservator and Gov bureaucrats always try to stay behind the curve to be safe.
        Staying behind the curve will make FnF less profitable as well highly vulnerable to risks.

        All these risks sharing schemes are designed by the same WS elites to make easy money without risks. These transactions burden FnF with more risks without the appropriate ROI for these risks.

        FHFA conservator needs to answer these questions?

        Q1. If FnF were to take first large initial loss then how taxpayers or FnF are protected?

        Q2. Does the historical actuarial data support the risk and ROI objectives with these transactions?

        Q3. Is conservator trying to do what the failed FnF wind down bills in congress were trying to do?

        Q4. Do these transactions mean “FnF losses, WS gains”?


  9. Tim,

    Some previous and current Gov officials seem to be claiming that
    FHFA can act as conservators and receiver at the same time to rehabilitate and at the same time bankrupt/liquidate FnF.

    Are such surrealistic laws made with such surrealistic intentions valid or
    such a surrealistic interpretation valid?

    Are not such laws, first steps to anarchy?


      1. My reading of HERA is that conservatorship and receivership are two very different activities that can’t be conflated. I also think judge Lamberth’s interpretation of HERA–that it gives FHFA full discretion to manage the conservatorship in any way it deems fit, immune from judicial challenge–sets such a broad and dangerous precedent that it is highly unlikely to be upheld in the higher courts.

        As to your broader concern, my experience is that politicians and regulators have a very long history of treating Fannie and Freddie differently, and much worse, than other financial institutions, without in any way being restrained by such an obvious double standard. I doubt, however, that members of the judicial branch will either wish or be able to justify judging Fannie and Freddie with principles or criteria that apply only to them.

        Liked by 1 person

  10. Tim,

    1. One of the worn out talking points of FnF detractors is,
    FnF have unfair advantages over other private FIs because FnF can raise funds at lowers costs because of Gov implicit guarantees.

    2. However during years leading up to 2008 crisis, other private FIs were beating FnF hand down, in loan volume.

    How can point-2 be possible if point-1 is true?


    1. The alleged “funding advantage” Fannie and Freddie have is in their portfolio businesses; other financial institutions “beating FnF hands down, in loan volume” in years leading up to the 2008 crisis occurred in the credit guaranty business.

      The reason I call Fannie and Freddie’s portfolio funding advantage “alleged” is that it is only true for long-term senior debt, which the companies use to finance their holdings of long-term fixed-rate mortgages. For short-term debt–which is used to finance ARMs– banks’ government-guaranteed deposits have a much lower cost than any short-term debt Fannie or Freddie can raise. (And banks’ government-guaranteed short-term deposits are one reason their senior debt costs are higher– bank senior debt is subordinate to a long line of insured depositors; Fannie and Freddie senior debt-holders have first claim on the companies’ assets.) So both Fannie/Freddie and banks have what some call “unfair funding advantages”– they’re just at different places along the yield curve.

      But what happened leading up to the 2008 crisis had nothing to do with funding advantages. Once private-label securities (PLS) reached a critical mass of issuance–due in large part to the innovation of the collateralized debt obligation, which magically transformed lower-rated PLS tranches into new tranched securities, 80% of which got rated AAA and found a ready market of eager buyers–lending standards plunged, since virtually any type of loan could get PLS financing. It was the classic “competing on credit.” Fannie and Freddie resisted the temptation to chase PLS execution for market share for a while–which is why they got “beaten hands down”– but they ultimately gave into it, at least to a degree.


      1. Tim,
        Thanks for clarifying the doubt.
        Now we can use this explanation to counter the unfair advantage allegations.


      2. Tim,

        The yield curve advantage explanation looks all legitimate.
        FnF had specific advantage in long term borrowings with questionable Gov implicit guarantees while
        Banks had specific advantage in short term borrowings with Gov real explicit guarantees.

        But non-FDIC FIs did not have Gov explicit guarantees like FnF.
        Many non-FDIC FIs used below scheme to make big profits and caused 2008 crisis.

        Many private FIs used fraudulent packaging of low quality loans into high quality securities to lower borrowing costs and make big money. Each step in the process involved fraudulent misrepresentation and serious violation of laws.

        1. issue high yielding short term sub prime or ninja mortgage loans
        2. use crafty securitization scheme to hide the low quality of loans
        3. get (or buy) AAA ratings for these securities from complicit of rating agencies
        4. buy hollow insurance guarantees for these AAA securities
        5. sell these AAA securities to gullible investors
        6. short the same securities


    1. The common securitization platform, or CSP, was a project conceived of and initiated by people who were in favor of “winding down” Fannie and Freddie, but who wished to use their expertise (and money) to build a securitization platform that could be adapted to whatever secondary market financing mechanism ultimately succeeded them. More recently, it was given a second justification, which was as a means of allowing Freddie Mac to overcome a structural deficiency that has existed in its securitization program for decades (related to the fact that Freddie PCs make payments to investors sooner than Fannie MBS, but investors don’t value or pay full theoretical price for those payments) that has caused Freddie’s securitization market share to fall well behind Fannie’s.

      The CSP is one of many examples of the companies’ “conservator” acting in a manner inconsistent with the statutory duties of a conservator, and using Fannie and Freddie to further its own policy objectives. There is no sensible reason for Fannie and Freddie to be spending their own money to build a securitization platform that will be open to other potential credit guarantors, nor does it make sense for Fannie to be paying to build a system that will remove a traditional competitive advantage it has had over Freddie (although it would make sense for Freddie to be doing that).

      As you might imagine, I’m not a fan of the CSP, and am pleased to see that Tim Pagliara has it in his “gun sights” as part of his suit for access to Fannie’s and Freddie’s books and records.

      Liked by 1 person

  11. Morning Gentlemen.
    Tim if you don’t mind I want ask here a question for our lawyers:
    Yesterday government presented a motion to consolidate the pending cases in DE, Iowa, KY, IL
    all in one at the District Court in DC. I think that it is not a good thing for shareholders, is it?
    Can the parties oppose firmly to this consolidation ?


  12. Tim, do you have any idea on the following comments:
    “During the 2008 mortgage collapse, the main contributor was the sub prime. ALT loans that were issued by TBTF and bought as secondary mortgage by PLMBS( private label mortgage back securities. Estimate value of PLMBS is around $2.1T. What happened to that? No forensic accounting available, but one thing for sure HARP program was initiated to help those deliquent mortgages or under water mortgages and if one traces who took care of HARP, it is the FNF. So the question again is, FNF help saved those underwater mortgages for refi and what cost to FNF and shareholders?
    Can this be a part of Paglaria’s suit to open the books of FNF and see what happened to $2.1T PLMBS and how FNF was used?”


    1. One of your premises is incorrect. HARP was a targeted refinance program, but only borrowers whose loans were owned or guaranteed by Fannie or Freddie were eligible for it. People who had subprime loans financed by private-label securities could not refinance out of them into a Fannie or Freddie loan using HARP.

      To the extent HARP had a cost to Fannie or Freddie, it would have been to their portfolio businesses, by causing higher coupon loans held in portfolio to refinance into lower-coupon loans that otherwise might not have. The offset to that, however, is that absent a program like HARP some of the higher-rate mortgages that couldn’t refinance because of credit concerns or very high LTVs (including over 100 percent)–both in portfolio and guaranteed as mortgage-backed securities– may have defaulted. On net, therefore, it’s hard to say what the overall impact of HARP on the companies has been.

      So, no, I don’t think concerns about HARP are an element of Pagliara’s desire to get access to the books and records of Fannie and Freddie.


      1. Tim thanks for the clarification.
        I came across the following info on HAMP borrowers. I would assume that HAMP borrowers are those covered by PLMBS and it looks like these HAMP ” borrower who has applied for or received a loan modification is eligible to refinance under DU Refi Plus” (this is Fannie’s name for the HARP program)”. Anyway I agree with you it is not an element of Paglaria’s desire to get access to the books of FNF but I was just hoping that there could be answer on what happened to those $ 2.1T PLMBS.

        “HAMP borrowers can also refinance if there is a clear benefit
        However, we also uncovered this language which specifies when a HAMP borrower can also be approved for a HARP refinance (https://www.efanniemae.com/sf/guides/ssg/sg/pdf/sel051512.pdf):

        Part B, Origination Through Closing

        Subpart 5, Unique Eligibility and Underwriting Considerations

        Chapter 5, Community Seconds, Community Land Trusts, DU Refi Plus™ and Refi Plus™, and Loans with Resale Restrictions, DU Refi Plus and Refi Plus Mortgage Loans, Page 787

        “A borrower who has applied for or received a loan modification is eligible to refinance under DU Refi Plus” (this is Fannie’s name for the HARP program).

        “The borrower benefit provision (described above) must be met. The terms of the modified loan (trial or permanent) must be used for this comparison. If the borrower was previously in a trial period plan, but denied a permanent modification, the current terms of the loan must be used for this purpose.”

        The “borrower benefit” (mentioned above) means that the new loan must provide:

        A reduced monthly mortgage principal and interest payment
        A more stable mortgage product
        A reduction in the interest rate
        A reduction in the amortization termks,


  13. ‘(2) SUBJECT TO SUIT.—Except as otherwise provided by
    law, the Director shall be subject to suit (other than suits
    on claims for money damages) by a regulated entity with respect
    to any matter under this title or any other applicable provision
    of law, rule, order, or regulation under this title, in the United
    States district court for the judicial district in which the regulated
    entity has its principal place of business, or in the United
    States District Court for the District of Columbia, and the
    Director may be served with process in the manner prescribed
    by the Federal Rules of Civil Procedure.’’.
    Above provision is under HERA. Can Director Watt be sued for negligence because one of his duty is to see to it that FNF under FHFA regulation maintains adequate capital?


    1. I’m the wrong person to answer this one, unfortunately. Although I do try to keep up with and understand what’s going on in the court cases, my expertise is in mortgage finance (and Fannie Mae), not the law. And I don’t like to”practice without a license.”


  14. Hi Tim
    What is your opinion about the new loans with only 3% down? Is FHFA lowering the standards of the GSEs and buying dangerous mortgages?


    1. Not necessarily. It is possible to do very low downpayment lending responsibly. When I was at Fannie, we introduced a 3% downpayment loan we called the “Fannie 97.” To qualify for it, lenders needed to put a borrower’s credit information into our automated underwriting tool, Desktop Underwriter, which required “compensating factors”–elements of the borrower’s financial characteristics or credit history that were strong enough to at least partially offset the risk of such a small downpayment, and thus make the loan acceptable to us. In addition, we started the Fannie 97 program on a very small scale, and tracked the loans it brought in meticulously. As with all of our specialized “affordability products,” if we found the actual performance falling short of our expectations or our standards in general, we either would modify the terms of the program or end it entirely. And we would try to do that early on in the program’s life cycle, so that even the products that didn’t work out did insignificant damage to our risk profile or bottom line, given the enormous scale of our mainstream business.

      Fannie could be doing its 3% downpayment program in a similar manner. I certainly hope so. But this raises an important point. The longer Fannie remains in indefinite conservatorship–with the Director of FHFA saying they’re not running the company for the benefit of its shareholders– the harder it will be for Fannie’s staff to maintain the risk-management discipline we had as an executive team with significant stock-based compensation and a strong financial incentive to make decisions in the long-term best interests of the company, its owners and, yes, the taxpayer as well. Not having any direct connection to the consequences of credit (or other) decisions is one of the many dangers of having Fannie run as a quasi-nationalized entity, and it does concern me.


  15. The fact that the 9th Circuit Court ruled, FNMA is a private shareholder company, Tim Pagliara from Investor Unite, filed suit to inspect the company’s records If Mr. Pagliara is successful, do you believe it opens up a can of worms? What is your thoughts?

    Thank you for your insight.

    Below link is Pagliara’s filing.

    Click to access 12105-0001.pdf


    1. I’m glad Pagliara is raising these issues in his lawsuit. Both FHFA and Fannie Mae’s board of directors effectively have turned Fannie over to the Treasury Department to run as it pleases. Pagliara is challenging the Fannie Mae board’s contention that under HERA and post-conservatorship, it owes its duties not to the company’s shareholders but to FHFA. I hope the judge agrees with Pagliara, and gives him access to the company’s books and records, which then should allow him to challenge the board’s post-conservatorship actions (or inaction). If that happens, I don’t see it as opening a can of worms; I think it’s all for the good. The more legal challenges there are, the better the chances that at some point fairly soon FHFA will start acting like a real conservator, and Fannie’s directors will start acting like a real board.

      Liked by 1 person

      1. There is a clear conflict of interest in federal courts when US Gov is a party in the case. That is why most of such cases are decided in favor of US Gov. As long as politicians appoint judges from their own ranks, this is not going to change.

        This case is in state court, so outcomes may be different.


      2. Thank you very much.

        In case you didn’t get the notice, Pagliara is hosting a teleconference on March 14, 2016. Joining Pagliara for the teleconference will be Barr Flinn, who is representing him in Delaware in the complaint against Fannie Mae, and Tom Connally, who is representing him in Virginia in the complaint against Freddie Mac.

        To join the teleconference, you’ll need to RSVP to media@investorsunite.org.


        Tim Pagliara, Investors Unite Executive Director, CapWealth Advisors Chairman and CEO

        Barr Flinn, Partner, Young Conway Stargatt & Taylor LLP

        Tom Connally, Partner, Hogan Lovells US LLP

        WHEN: Tuesday, March 14; 2:00pm EST

        DIAL: Toll Free: (800) 230-1093

        NOTE: Please RSVP to media@investorsunite.org


  16. Hey Tim,

    Bethany has written a new (very long) piece for Washington Monthly. There’s a lot of content, but I wanted to single out something she said.

    “They were told to come to Washington for a meeting at five p.m. on September 5th at the regulator’s offices. They had no idea what was coming until they walked into the fourth-floor conference room, where they had all been many times before, and saw not just Lockhart but also Paulson on his left and then Federal Reserve chairman Ben Bernanke on his right. There was a provision in the law that if the directors agreed to conservatorship, they were immune from legal action by shareholders or creditors, making it difficult for them to do anything but agree. The management teams were told to go, and both Fannie and Freddie had to immediately fire all their lobbyists. Paulson later called the decision to take over Fannie and Freddie the “most impactful and the gutsiest thing we did.” ”

    She claims that Fannie and Freddie’s lobbying was killed when they were put into conservatorship. In a previous comment though you said that lobbying was killed back during the accounting scandals in 2004. Am I misinterpreting something here, or is there an error?

    If lobbying was truly completely forbidden as far back as 2004, that helps a lot to explain the companies demise in my mind, so that comment really stood out to me.


    1. Trevor: It’s my understanding that after Frank Raines and I left Fannie at the end of 2004, OFHEO Director Armando Falcon told non-executive chairman Steve Ashley and acting CEO Dan Mudd to cease Fannie’s lobbying efforts, and they complied. My source for that information was Fannie’s former head of government relations, Bill Maloni. I’ll check with him to confirm, and if what I told you is not correct I’ll put an addendum on this comment.


  17. Have you ever written in Op-Ed piece for the NY Times? If not please consider it as its readers would appreciate your knowledge and insight.


    1. BT: I’ve not submitted an op-ed recently. In late 2013 and in the first half of 2014 I sent three op-eds to the Washington Post (using channels that put them in front of the right people on the editorial staff) and two to the NY Times, but none were accepted. I thought all of the op-eds were well done (if I do say so myself!), and believed at the time that they probably were turned down because nobody else in the mortgage finance world was saying the things I was saying. (A less charitable view would be that both editorial boards had fallen for what now is being called “the big lie,” and preferred not to highlight that fact by having me call attention to it on their pages.) But it’s possible that with the lawsuits, and more people saying that there are two sides to this story, the editorial climate at the Times is now different (I’m dubious about the Post). So it might be time to take another stab at an op-ed. Thanks for the suggestion.


      1. Tim,

        Please send this article (Risk Sharing, Or Not) to major financial and law publications.
        You need to do this in the greater interest of public as well FnF.


  18. Tim,

    In case of FnF, there are many distinct independent roles mandated by laws.

    1. FHFA as an independent FnF conservator
    FHFA as a independent FnF conservator is obligated by laws to work in the best interest of conservatees. FHFA as a FnF conservator does not owe any duties to Gov or taxpayers. FHFA as a FnF conservator assumes the roles of FnF/CEO/shareholders. So FnF conservator is governed by the same corporate laws that Govern the FnF/CEO/shareholders.

    2. FHFA as an independent regulator
    FHFA as an independent regulator has regulatory duties.

    3. Tsy as a creditor/investor of FnF
    Tsy as a creditor/investor of FnF is obligated to work to protect the interests of Gov.

    4. FnF BOD/CEO
    FnF BOD/CEO have the duty to work in the best interest of FnF and also governed by same corporate laws that apply to conservator.

    These roles are supposed to work on the basis of separation of powers so as to avoid conflict of interest and at the same time protect and serve the interests of all participating entities. Because of previous zealous FHFA directors and self serving political appointees acting on behalf of competing WS business interests have violated laws, democratic traditions and expectations. The above independent entities have become members of the same tsy interest group and this tsy interest group is using FnF conservator as a proxy to serve the interests of known as well as unknown private entities. In this process the interests of FnF have been harmed irreparably.

    Should not courts be looking at these independent entities and hold them responsible for dereliction of the duties and violation of laws.?


    1. You’ve correctly outlined the roles, responsibilities and legal obligations of the various parties. Problems have arisen with Fannie and Freddie because none of the parties seem to be acting in accordance with those roles, responsibilities or obligations. Plaintiffs in a multitude of lawsuits have in my view done an excellent job identifying and documenting how, where and why they have fallen short (or missed entirely), and now it’s up to the courts to rule on their allegations.

      Supporters of or investors in Fannie and Freddie are frustrated that what seem to them to be obvious violations of law or regulation have not been found to be so more quickly. But that’s not how our judicial system works. I have first-hand experience with this. I was caught up in an earlier episode in the fight to control the U.S. mortgage market, and for all of the lawsuits against me to finally be resolved (in my favor) took nearly eight years. I don’t believe the conservatorship lawsuits will last anywhere near that long, but unfortunately for judicial processes to fully run their course takes much more time than most of us would wish.


      1. Tim,
        Thanks, you are one great first hand authentic and well balanced source for any information related to FnF. It is no surprise that defendants do not want to involve you in helping the courts.


      2. Tim,

        Thanks. The obvious issue is complicity of previous FHFA Directors with political appointees to mix up roles of conservator and regulator to serve the interest of political appointee and their private business interests.

        Acting as the proxy for TSY (political appointees) interest group, FHFA wants to have it both ways and no way for FnF investors.

        Courts should recognize this political corruption and conflict of interest affecting the private shareholder companies. FnF were created for public policy purposes. So public have as much rights in knowing real facts about FnF as private shareholders. If Courts can lift the veil of secrecy and the veil of “protecting taxpayers” then all can see the real reasons for conservatorship, SPAPA and profit sweep.

        Is it so difficult for courts to verify whether it is national security matter or cover up of wrong doing?
        FnF shareholders’ main interest is their investment in FnF and they are no way interested in affecting national security matters.


  19. Hi Tim
    In your past article, ” The Takeover and The Terms”, you said that plaintiff in Washington Federal was “asking for a status conference to discuss contracting the timetable for the related cases pending there.” Now it seems that they agree to the general schedule proposed by Fairholme and others. Why they would do that? I think that it is because they expect good results from discovery. May it be the reason? But my question is what is the period that discovery demands documents to be produced by government? Is it since 2008, showing the decision making process previous to C-ship? Or is it only from 2012 previous to NWS?


    1. Eric: Unfortunately, I can’t give a good answer to either of your questions. On the first, I would guess that counsel for Washington Fed was convinced by counsel for the other plaintiffs to stick with the schedule proposed by Fairholme, but I don’t know what reasons were advanced for that. As to the scope of discovery, that IS knowable, but I don’t have the information at hand. My specialities are the financial and factual aspects of the cases; there are many others who track and analyze the legal and procedural aspects.


  20. Good evening Tim
    I think that you are one the persons that have in mind the biggest picture of the past and possible future of the GSEs.
    How do you envision the GSEs five years from now?


    1. Sue: There still are too many uncertainties and unknowns for me to feel comfortable about describing what Fannie and Freddie might look like in five years. However, I do feel confident they will be around and functioning as shareholder-owned companies then. It would take an act of congress to eliminate them, but only an act of common sense to bring them out of conservatorship.

      Liked by 2 people

      1. Thanks Tim,

        You have given FnF shareholders a Great Quote:

        “It would take an act of congress to eliminate them, but only an act of common sense to bring them out of conservatorship.”


    1. I’ve read the Deloitte complaint, but not the most recent one against PWC (which I believe is substantially similar). I would stand by the statements I made in the comment section of my previous post: I think plaintiffs in the auditing suits have very strong arguments on the audit of the deferred tax asset reserve and strong arguments on the audit of the loan repurchases, but may face tougher going on their challenge to the audit of the loss reserves and the valuation of the companies’ holdings of private-label securities (not because of any lack of merit in their allegations, but because the companies and their auditors have substantial latitude in these areas). I also believe that both Deloitte and PWC are vulnerable to the charge that they should have withdrawn their opinions of the companies’ 2008-2011 financial statements after so many of the book losses taken in those years were reversed in 2012 and 2013.


  21. I don’t think treasury hates fannie and freddie as much as the federal reserve banks particularly the nyfrb. I believe treasury is scapegoating for nyfrb. The white paper they put out a while ago affirms their hatred of the gse’s more so than treasury. With the federal reserve buying up the mbs portfolios while simultaneously having treasury sweep up their net worth is the de facto wind down.


    1. I haven’t read the white paper you refer to, but I don’t share your view of the New York Fed as “bad guys.” Unless things have changed dramatically there since I left Fannie (it’s been over ten years now), the staff at the NY Fed is much more professional and focused on market realities than than the staff at the Fed’s Board of Governors in Washington, which at least when it came to Fannie and Freddie I found to be theoretical, ideological and biased. There was, and still is, an institutional opposition to Fannie and Freddie at both the Board of Governors and Treasury that doesn’t (or didn’t) exist at the NY Fed. One quick example of this, from the last year I was at Fannie, 2004. The Wall Street Journal’s editorial page was pounding us about our use of derivatives to manage interest rate risk. (By 2004 we had tightened our risk tolerances for the mismatch we would permit in the portfolio–which we called the “duration gap”–mainly through the increased use of derivatives.) No matter what we told them about this derivative use, whether relating to the types of derivatives we used (only the most simple and transparent ones) or the disclosures we made about them in our annual 10Ks (which were “best in class”) the Journal would find something else to criticize. Finally they claimed that the fact that we managed our derivatives positions actively during periods of interest rate volatility–to keep our duration gap within our specified tolerance–caused dealers to have to make trades and hedges the caused instability in the overall financial markets. The NY Fed said it would look into this. I and a few other senior Fannie risk managers went up there to explain to them what we did with derivatives and how we were doing it (among the people at the first of these meetings was Tim Geithner.) When the NY Fed did their paper, they agreed that our transactions did not pose broader systemic risks to the market. The Board of Governors in Washington, under Alan Greenspan, did not release that paper publicly. Shortly afterwards, in a speech, Greenspan cited the study, but then added his own (contradictory) conclusion about it– which was that Fannie’s derivative risk DID pose a risk to the market.


      1. FRBs are 100% privately owned and controlled by the WS banks.

        Does it surprise anyone why FRBs want to wind down FnF?

        Many think that FRBs are the giant tails that wag the dog.


      2. I believe Anonymous was referring to “The Rescue of Fannie Mae and Freddie Mac” written in March 2015 by NY Fed staff where in conclusion they state:

        “Although there appears to be broad consensus that Fannie Mae and Freddie Mac should be replaced by a private system—perhaps augmented by public reinsurance against extreme tail outcomes—substantial disagreement remains about how to implement such a system.”

        The NY Fed piece refers heavily to the 2011 Treasury/FHFA report to Congress “Reforming America’s Housing Finance Market” where it states:

        “The Administration will work with the Federal Housing Finance Agency (“FHFA”) to develop a plan to responsibly reduce the role of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) in the mortgage market and, ultimately, wind down both institutions.”

        Click to access sr719.pdf

        Click to access Reforming%20America’s%20Housing%20Finance%20Market.pdf


  22. Tim, thank you for providing this blog and your insight. Is it possible that Treasury is concerned about the needs of financing our ballooning national debt and would like to crowd out the MBS offerings by Fannie and Freddie, that are considered near government quality? I am a shareholder and I am very disappointed by the clear takings and lack of respect for the, at the minimum, clear 20.1% common ownership. I’m attempting to find any logic in the Treasury actions and continued unlawful position. I think it could be the concern for financing the national debt today and what it will be in the future. Can you share any thoughts on that hypothesis?


    1. The risk-sharing transactions don’t “crowd out” Fannie and Freddie MBS. The MBS already are outstanding, so the CAS securities (in Fannie’s case) are an addition to those MBS, putting even more securities in the market (although not a large amount– the most recent CAS deal totaled 3.33% of the size of the MBS it was insuring). I do think the most likely explanation for very poor economics of these deals is that Treasury really hasn’t focused much on them and doesn’t actually care about them– it’s just committed (whether ideologically, politically, or competitively) to some form of secondary market financing other than Fannie and Freddie, and these deals are the best alternative it’s got.


  23. Excellent blog. Great post.

    You mentioned the possibility that the Treasury could now be using this ‘scheme’ (my word, not your word) to intentionally drain Fannie Mae’s revenues as perhaps a last ditch effort– perhaps as they see the possibility that they may lose their lawsuits, have their beloved and profitable sweep overturned, and thus be worried about their worst case scenario– a recapitalized FNMA returning from the ashes.

    Could another explanation be that the Treasury is now throwing an incentive to the Hedge Funds, possibly to get them to call off or dial back their lawsuits and instead incentivize them to keep a system in place that may now benefit them too? In other words, could the Treasury and the Wall Street banks that have seemingly been behind this economic ‘coup d’etat’ (once again, my words not yours) now be capitulating to the hedge funds by letting them in on the spoils of their theft?

    To be more direct– would Pershing Square Capital benefit from this new set-up? Is there any evidence that they could now be in on it? If a hedge fund like Pershing Square Capital now gets invited to the club, how much incentive would they have to prosecute their lawsuit?

    Of course, this is all my speculation (in the form of questions), but your post had me wondering if perhaps there wasn’t something else going on. I could be way off, of course.


    1. I should make clear that I really don’t know what Treasury’s motivation is for insisting that Fannie do CAS deals that don’t make economic sense from the company’s perspective. As far back as the Reagan administration– and perhaps even before that– Treasury has opposed Fannie and Freddie, and looked for ways to curtail or eliminate them. Now that it has effective control of the companies, it does not want to see them emerge from conservatorship. But Treasury needs an alternative to them– otherwise we don’t have a functioning secondary mortgage market– and in the absence of legislative reform the only one they can come up with is these securitized risk transfers, so that’s what they’re making Fannie (and Freddie) do. It’s entirely possible that Treasury doesn’t know how bad the economics of the CAS deals are for Fannie, but I think even if it did know it wouldn’t care. It would insist on Fannie doing them anyway.

      I don’t see any connection with hedge funds as investors in the junior risk tranches of CAS deals and the position of the investment funds (some are not hedge funds) in the lawsuits. Hedge funds in general are in these deals because they can do them on a leveraged basis (i.e., borrowing short-term money and investing it at very attractive spreads over LIBOR). The specific investment funds that are backing the lawsuits are doing so because they’ve made investments in the companies’ common or preferred equity, and believe those investments will do very well if they as plaintiffs prevail in the lawsuits.


  24. Tim,

    After 2008, Gov spent $16T to bailout mostly on BIG WS companies who caused 2008 crisis.

    Gov bailout for FnF was $132B and that is less than 1% of total bailout on punitive terms.

    Gov bailout for other companies were more than $14.76T and were mostly subsidized by taxpayers. But these companies were not harshly treated like FnF are being currently treated. Investors in these companies are enjoying stock appreciations and dividends.

    Is $16T bailout amount correct?

    Then why people make big deal of $132B bailout of FnF that too on mafia loan terms.


    Click to access HLL110_crop.pdf

    Page 418 Part I. INTRODUCTION

    In an effort to stabilize the collapsing economy, the federal government spent an estimated $16 trillion to “bail out” hundreds of large private institutions—ranging from banks, to auto manufacturers, to insurance companies *2.

    131 (2011).

    Liked by 1 person

    1. The $16 trillion and $132 billion numbers are measures (or estimates) of different things. My understanding is that the $16 trillion number is an estimate of the total dollar amount of all of the individual loans made by the Fed or the Treasury to financial institutions in distress, without regard to maturity (i.e., counting a 1-week loan of $1 billion rolled over ten times as $10 billion) during the crisis. The $132 billion “bailout” figure for Fannie and Freddie is somebody’s estimate of what Treasury gave the companies to keep their collective net worth from falling below zero. (I can’t validate that figure; the number I use is $151 billion, which is their $187 billion in draws of senior preferred stock, less the $36 billion that was made necessary because of dividends owed on the $151 billion.)

      Apart from the numbers– which aren’t really comparable– I agree with your general point, which is that the Federal Reserve and Treasury treated Fannie and Freddie much differently (and much more punitively) than they treated other financial institutions during the financial crisis. Even before Lehman Brothers failed, the Fed and Treasury went to extraordinary lengths to keep a tremendous number of financial institutions afloat (that’s where the $16 trillion number comes from), with few conditions attached. They did the exact opposite with Fannie and Freddie: declining to make collateralized loans to them and choosing instead to take them over, after which their “conservator” ran up huge amounts of non-cash losses to force them to take senior preferred stock they didn’t need, to the benefit of Treasury which could collect a perpetual string dividends on that stock.

      Liked by 1 person

      1. Tim,

        Thanks for fair and balanced opinion on this question.

        FnF are Gov creations for public policy purposes, and highly regulated by Gov unlike other financial institutions. Gov burdens FnF with expensive social mandates and regulations.

        Despite this, political/ws powers in Gov chose to protect and help other financial institutions directly and indirectly with very favorable terms and also by scapegoating FnF investors.


      2. The monumental hypocrisy is, these “protectors of taxpayers” mention $187B as to why they are bankrupting FnF, and completely silent on $15.87T subisidized bailout to favored ones.

        How is that nobody is demanding accountability from Administration, Fed, FHFA and Congress?


      3. My 2 cents: the imbalance of treatment, WS vs GSEs, is all politics. The politicians didn’t like the power the GSE’s had and with the swinging door issue needed to preserve future job opportunities with large payouts…


        1. Politicians know very well that they can not afford to have opinion of their own.

          It is the WS that did not like the power of FnF that promoted the affordable housing goals and controlled 20% of the economy.

          WS controls 100% of everything, WS does not like competition.


  25. Since member banks receive a fixed dividend from the FED and UST receives the balance, I’ve pointed out that UST is essentially the single common shareholder of the FED. When the UST forced FnF to reduce their MBS portfolio and the FED was buying at a rate of $40B/m, this created a long term income for UST at the expense of FnF.

    I’ve argued that this was a taking.


    Liked by 2 people

    1. As you note, the Federal Reserve began buying Fannie and Freddie MBS at the same time as Treasury mandated that the companies shrink their portfolios of MBS and whole loans. The income from these purchases gets added to the rest of the Fed’s investment income, which, after the Fed’s expenses, is turned over to Treasury and added to the government’s general revenues.

      Personally, I think labeling that a taking would be a stretch. For one thing, it’s two separate actions. The first is Treasury limiting the size of Fannie’s and Freddie’s portfolios, which it had wanted to do for a very long time, but only got the opportunity to after it forced the companies into conservatorship and got FHFA to agree to the PSPAs, which had portfolio shrinkage as one component. Perhaps related, but also perhaps independently, the Fed decided to start buying Fannie and Freddie MBS to help support the market at around the same time. The Fed always had the power to buy Fannie and Freddie MBS had it wished.

      And I recall when the Fed first started buying agency MBS wondering what Alan Greenspan must have thought about that. He always insisted that Fannie and Freddie’s holdings of mortgages and MBS in portfolio had no effect whatsoever on either the supply or the price of mortgages. Apparently portfolio holdings are of no value to the market when they’re Fannie’s or Freddie’s, but matter greatly if it’s the Fed doing the buying and holding.

      Liked by 2 people

  26. i honestly believe there is no one in govt who understands this like you do. if they do. then this is a big sham. great article.

    ot, it seems like fnma is doing more multifamily lending lately. is fnma holding these loans or securitizing and guaranteeing them. this seems like a nice business as long as it can achieve geo diversity

    Liked by 1 person

    1. It’s possible that many of the people inside Treasury don’t know how one-sided these deals are. They may just be following the playbook that says, “Fannie risk-taking is bad; private market securitization of risk is good,” without having much understanding of the mortgage side of the business and how hugely overinsured Fannie’s loans are, given their credit quality and the irrelevance of assessing the riskiness of those loans against post-crash loss rates on the types of loans made during the bubble. I also doubt that people at FHFA are aware of the economics of the deals, either. But I suspect there are many people inside Fannie who know they’re giveaways, but think they can’t do anything about it.

      I actually haven’t looked into Fannie’s multifamily business recently, and I should. When I was there it was a terrific business, built around a form of lender risk-sharing, called Delegated Underwriting and Servicing, that worked exceptionally well.

      Liked by 2 people

  27. Tim, I wish you get to enlighten the attorneys for the plaintiffs on this which is all the reason that the courts address and judge the cases sooner than later before the slow death of the GSEs.

    Liked by 2 people

    1. Bill: I honestly don’t know what Treasury is trying to do; I just know that these deals make no economic sense for the companies, nor can they be justified as “experiments” or a “proof of concept,” since we already know how this movie will turn out.

      Liked by 2 people

  28. Tim you said before that you prefer to launch ideas or building blocks for a possible future legislation and once those ideas are accepted it will be easier to push through Congress. I agree. You want Congress to be self-persuaded, but on the other hand they need desperately a good, irrefutable and ready made piece to align themselves with it. They don’t have the resource, nor the knowledge.
    That is why this issue is sleeping there and unfortunately only the enemies of the GSEs are given some ideas to Corker and Co. As soon as you put a good piece in the hands of some Congressmen they will have plenty of followers.

    Liked by 1 person

  29. Thanks Tim. As a small retail investor in FNMA I try to read everything I can, but I have never read anything so deep and detailed regarding CAS. While I still don’t understand it entirely, your expertise shows through. Thank you for doing this.

    Liked by 1 person

    1. Jeff: Unfortunately, very few people understand the CAS deals, which I believe is why more objections have not been raised about them.

      I knew that doing this post would be tricky: I felt I needed to explain the structure and weaknesses of the CAS transactions in enough detail to be convincing to the initiated, but still try to make the piece understandable to the general reader. Hopefully I came close to a balance on those tasks (and if not, perhaps during the course of the comment period I can do a better job of explaining things).

      Liked by 1 person

  30. In one word FnF are forced to buy expensive insurance from Wall St. The question is whether FnF will increase the G fees to offset the cost of the premiums or not , right?
    What is your opinion?

    Liked by 1 person

    1. No, I don’t believe there will be any need for Fannie to increase its guaranty fees because of the CAS transactions. There still are ample fees both for the risk-sharing deals and for Fannie to make an acceptable risk-adjusted return on the company’s (hypothetical) capital. But the CAS deals are wasteful, and without them Fannie would be able to either (a) recapitalize itself faster if and when the net worth sweep is ruled invalid, and Fannie’s profits are again retained by the company, or (b) lower guaranty fees to be more in line with the actual riskiness of the loans that are being insured.

      Liked by 2 people

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s