Fixing What Works

Serious proposals for housing finance reform must have clearly defined objectives against which they can be evaluated, and must be derived from a clear-eyed analysis of the causes of the previous crisis so that by addressing and fixing those causes we minimize the chance of a similar crisis happening again.

My proposed reform objective is the following: to create a capital markets-based secondary market mechanism capable of financing at least $1 trillion of 30-year fixed-rate mortgages annually throughout the business cycle, at the lowest cost to homebuyers consistent with an agreed-upon standard of taxpayer protection. The emphasis on homebuyer cost is deliberate. Low-, moderate-, and medium-income homebuyers suffered the most during the 2008 crisis, and received no significant relief from the government. These same families have seen little growth in their incomes during the recovery, so it should be a policy priority to provide them with the greatest possible access to mortgage credit at the lowest possible cost.

Fixing the correct problem is the second essential element of mortgage reform. Immediately after the crisis Fannie Mae and Freddie Mac were singled out as its primary cause. Based on indisputable data, however, we now know that this was not true. To the contrary, Fannie and Freddie were the most disciplined sources of mortgage finance in the years leading up to the crisis. During the summer of 2008 the serious delinquency rate on the single-family loans owned or guaranteed by the companies was about one-third the serious delinquency rate of other prime lenders, and less than one-tenth that of subprime lenders. The subsequent performance of Fannie’s and Freddie’s loans was equally superior: the loss rates on their single-family loans from 2008 to 2015 averaged less than 50 basis points per year—about one-third the average loss rate on comparable mortgages held by banks and less than one-fifth the loss rates on loans financed with private-label securities.

We also now understand why Fannie and Freddie had to take $187 billion in senior preferred stock from the Treasury Department. It was not because of operating losses. Through 2011, the companies’ business revenues—net interest income, guaranty fees, and other income—exceeded their combined credit losses and administrative costs. Their draws of senior preferred stock were made necessary by $151 billion in noncash expenses (plus $36 billion in dividend payments) booked by their conservator, the Federal Housing Finance Agency (FHFA), based on highly pessimistic estimates of future losses. The large majority of those losses did not materialize, and as a consequence Fannie and Freddie had enough income to pay Treasury $158 billion—more than all of the $151 billion in non-cash expenses taken earlier—in just 18 months, beginning in the fourth quarter of 2012. The companies never needed the $187 billion “bailout” they received from the government.

When invented narrative is replaced with verifiable fact, Fannie and Freddie cease to be a “failed business model” that must be wound down and replaced; they instead become valuable resources that must be built upon and improved. My proposal—outlined below—does that. It makes fundamental changes to Fannie and Freddie in three key areas: relationship with the government, capital, and regulation. It also preserves the companies’ ability to support affordable housing, and can be implemented administratively.

Relationship with the government. Experts generally agree that the role of the government in the charters of Fannie and Freddie is too ambiguous, and that the balance of benefits tilts too far in the direction of the companies. Moving to a “utility model,” with limited returns and a more focused business purpose, addresses both issues. In the model I propose, Fannie and Freddie would remain shareholder-owned but would agree to accept (1) a cap on the average return they could target in their guaranty fee pricing (I suggest 10 percent after-tax), (2) restrictions on the size and use of their portfolios (limited to 10 percent of outstanding credit guarantees, and to purposes ancillary to the guaranty business), and (3) standards for minimum and risk-based capital determined by administration policymakers with percentages set and imposed by FHFA. In an “exchange for consideration,” the government would commit to provide temporary support to the companies should their capital ever prove insufficient (which by design would be highly unlikely).

Homeowners and the government each would benefit from this arrangement. The government backstop would produce the lowest possible yield on the companies’ mortgage-backed securities, benefiting homeowners, while the government would limit its risk—and control moral hazard—thorough rigorous capital standards, close regulation and supervision of Fannie and Freddie, and caps on their returns.

There are many advantages to the government’s supporting utility-like companies rather than the companies’ securities. Individual pools of securitized mortgages have limited diversification, and can experience much higher loss rates than the companies that issue them. Even in normal times guarantees on securities will require the government to make unrecoverable payments to investors. Worse, if the government guarantees only securities but not the issuing companies, in a crisis there may be no surviving entities to issue new securities and keep the system from collapsing. Having the government stand behind companies keeps the system intact, and allows the government to recover any outlays after the crisis has passed.

Capital. With strict limits on their portfolios, Fannie and Freddie will be taking one type of risk (credit) on one high-quality asset (residential mortgages) in one country and one currency. Proposals for Fannie and Freddie to adopt the Basel III bank capital standards therefore contradict the principle that capital must be related to risk. Large multinational banks can take many types of risks on many types of assets (including very risky ones) in countries and currencies around the world. Giving Fannie and Freddie bank-like capital requirements without bank-like asset powers would doom them to failure.

Fortunately, there is a proven way to set capital standards for a company that deals in a single, homogenous asset type: require that company to hold enough capital to withstand a defined, worst-case stress scenario. In my proposal, administration policymakers would pick that scenario. I recommend that they require Fannie and Freddie to hold sufficient capital to survive a 25 percent nationwide decline in home prices over five years. Even though such a price decline did happen between 2006 and 2011, both major factors that precipitated it—very risky mortgage types like no-documentation loans or interest-only ARMs with teaser rates now prohibited by the Consumer Financial Protection Bureau (CFPB) and the dominance of a financing method, private-label securitization, that placed few limits on the risks of the mortgages it accepted—will be absent in the future, making the chance of a repeat of the previous episode vanishingly small.

Fannie’s prior experience suggests how it would have to capitalize against a future 25 percent home price decline. With the loans it had in 2008, and using its guaranty fees (but none of its portfolio or other income) to help absorb credit losses, Fannie would have needed less than 2 percent capital to survive the previous crisis. And if we remove from the data the loan types no longer permitted by CFPB regulations—which accounted for roughly half the company’s post-crisis credit losses—it could have survived with only about 50 basis points of capital.

If FHFA confirms these results, it should set Fannie and Freddie’s minimum capital ratio at 2 percent, then specify a supplemental risk-based standard that imposes capital requirements by product type and risk category (defined at a minimum by paired combinations of loan-to-value ratios and credit scores). FHFA would grade the companies’ business as it comes in, and require them to hold the greater of the risk-based or minimum capital amounts. All of the companies’ capital would have to be retained earnings or common or preferred stock.

Fannie and Freddie could make their minimum standard binding by holding down the risk of the mix of business they acquire. With 2 percent capital and a 10 percent target return, Fannie and Freddie’s average charged single-family guaranty fee would be about 40 basis points, which—after the 4.2 basis point affordable housing fee and the 10 basis point payroll tax fee (through October 2021)—would be a little over 50 basis points to the borrower. At this level the companies could use cross-subsidization effectively to attract a broad range of business, including affordable housing loans. Should the risk mix of the companies’ business rise, their risk-based standard would cause their capital and average guaranty fees to rise as well.

Regulation. After a stress standard for the companies has been chosen, FHFA will need to analyze Fannie and Freddie’s credit performance during the prior housing market collapse to determine the percentage of minimum capital—for the types and characteristics of loans the companies are permitted to acquire today—that would allow them to comfortably withstand that stress. FHFA would use that same data to determine the stress capital percentages by product type and risk category used to calculate required risk-based capital.

Once the minimum standard and the risk-based requirements are in place, Fannie and Freddie would be permitted to price their business as they saw fit—including using cross-subsidization—as long as their guaranty fees in the aggregate were consistent with no more than a 10 percent return on capital. FHFA would monitor the companies’ pricing, and if it found their average fees to be too high it could take whatever remedial action it deemed appropriate. FHFA would track each company’s business and calculate its required risk-based capital on a quarterly basis, with adjustments as warranted for any risk-sharing transactions they do.

 Affordable housing. Fannie and Freddie’s role in supporting affordable housing is limited by the fact that they only can purchase or guarantee the loans lenders originate. Despite this, FHFA should set affordable housing goals for the companies. FHFA also should have the power to impose penalties for failing to meet those goals, but only if the percentage of affordable business Fannie or Freddie does falls short of the percentage originated by lenders that year.

FHFA should not increase the amount it requires Fannie and Freddie to contribute to affording housing funds beyond the 4.2 basis points mandated by legislation. Fees for affordable housing imposed only on the companies are an excise tax on the secondary market. Should Congress wish to increase support for affordable housing through additional fees, it should levy them on all mortgages. This would raise more money—or raise the same amount at a lower fee rate—and not favor primary market over secondary market financing.

 Implementation. The above changes could be effectuated through administrative action, as were the 2008 Preferred Stock Purchase Agreement and its amendments. With the written consent of the boards of directors of Fannie and Freddie, FHFA as conservator would make binding commitments on behalf of the companies, and Treasury and FHFA would make binding commitments on behalf of the government.

Before these reforms could take effect, the government would need to settle all of the lawsuits against it for its treatment of Fannie and Freddie before and during the conservatorships. It likely will take rulings adverse to the government’s current position to trigger that settlement. Assuming such rulings are forthcoming, Treasury should cancel the warrants it holds for 79.9 percent of the companies’ common stock, allow them to use proceeds from the reversal of the net worth sweep to repay their senior preferred stock, and retroactively replace the 10 percent dividend on that stock with a more reasonable 1 percent markup over the cost of the funds Treasury borrowed to give the companies the $187 billion they did not need.

Treasury is prohibited by the “Jumpstart GSE” legislation from liquidating Fannie and Freddie’s senior preferred stock before January 2018. Until then, FHFA should stop paying dividends on it, and notionally credit the companies with the amount of capital they will have when the stock is repaid, to assist them in planning for their recapitalization.


146 thoughts on “Fixing What Works

  1. New urban institute piece of GSE credit risk sharing deals:

    notice that goodman and parrott are co-authors, and goodman is sponsoring the GSE incubator on GSE reform on urban institute site, to which tim contributed his utility proposal, and parrott is a co-author of zandi’s proposal.

    not the way to run an objective incubator imo


    1. I saw (and read) that piece by Goodman and Parrot in February. I also read the Urban Institute piece titled “Delivering on the Promise of Risk-Sharing” by Goodman, Parrott and Zandi in December 2015, and the Urban Institute piece titled “Charting the Course to a Single Security” by Goodman and Ranieri in September 2014. But I noticed that the “Promising Road” paper was NOT hosted by the Urban Institute, but by Moody’s. I’m not sure what that signifies, but it’s worth pointing out.

      Liked by 1 person

      1. zandi’s piece on urban institute incubator is a synopsis of the proposal that parrott coauthored with zandi and 3 others on moodys. you are being fair tim, but i am calling a spade; if i were running a public policy site and put out a call for proposals, i would not accept a proposal that was a synopsis of one co-authored by a senior advisor (parrott) to my site w/o identifying it as such. just a call for standards on my part, though in today’s world, how quaint


  2. judge sweeney releases from confidential seal documents and depositions indicating that fhfa and treasury lied when they justified the NWS on the theory that the GSEs were in a “death spiral”


    1. I was very pleased to see that. I’ve known for quite some time what Treasury (and FHFA) did, but the great majority of the public did not and still does not. This is the first crack in the dam. The logical progression of this revelation will be, “well, if what Treasury has been telling us about the net worth sweep (and the original takeover) is not true, then what IS true?” Once that question is asked, the facts about the “rescue,” the non-cash losses, the unneeded “bailout,” and Treasury’s plans for replacing Fannie and Freddie with a bank-centric secondary market system will become much more understandable, and should be more widely recognized and acknowledged.

      Liked by 12 people

        1. i apologize Tim for hijacking your site for this message, but I would urge all of your readers to take Tim’s comment and everything else you’ve seen and read today about the Sweeney decision and share it with as many media people and public officials as you can.

          Also because some of them may not be as bright as you give them credit for, spell out what the depositions suggest, as Tim did in his response above.

          It’s not easy or natural for people to comprehend that their government has lied, big time.

          Liked by 3 people

          1. Bill,

            Picking up on what you said, I find it a bit passing strange that when l paint the scenario to folks they aren’t moved in the least. I think until Fox reports on it, it ain’t news worthy to some. Or just maybe corruption has become too common place.


      1. I am grateful that Judge Sweeney acted with courage and righteousness in releasing the documents and upholding the rule of law and so did Ms. McFarland in standing up against the corruptible and the powerful. Hope this momentum continues…

        Liked by 1 person

        1. when i heard sweeney granted motion in part and denied in part, i thought she permitted reference to sealed discovery in perry appeal oral arguments, a half loaf. in fact she permitted unsealing, the full loaf, and her denying in part was superfluous.

          this increases my confidence that she will grant Ps motion to compel documents withheld under claim of executive privilege, which is still under consideration. that will be the next big event, after the actual perry appeal being argued 4/15.

          Liked by 1 person

          1. From the Whitehouse website:

            “Transparency and Open Government

            Memorandum for the Heads of Executive Departments and Agencies

            SUBJECT: Transparency and Open Government

            My Administration is committed to creating an unprecedented level of openness in Government. We will work together to ensure the public trust and establish a system of transparency, public participation, and collaboration. Openness will strengthen our democracy and promote efficiency and effectiveness in Government.

            Government should be transparent. Transparency promotes accountability and provides information for citizens about what their Government is doing. Information maintained by the Federal Government is a national asset. My Administration will take appropriate action, consistent with law and policy, to disclose information rapidly in forms that the public can readily find and use. Executive departments and agencies should harness new technologies to put information about their operations and decisions online and readily available to the public. Executive departments and agencies should also solicit public feedback to identify information of greatest use to the public.”

            Hope the judges will note and hold the executive branch to honor.


  3. AH Ha! Finally! Thanks, Tim, for identifying the problem I have searching for the last 8 years. Can you provide more details how this happened? You wrote: “The problems that caused the 2008 crisis were the successful efforts, supported by Treasury and the Federal Reserve, to set up a parallel secondary market system– private-label securities financing toxic mortgages from a primary-market origination process the Fed declined to regulate–to compete with Fannie and Freddie, which ultimately supplanted the companies as the gatekeepers of mortgage creditworthiness in 2005. From that point a cascade of high risk loans inflated the housing bubble to the point that the only possible outcome was a spectacular bust.”

    I thought your book “The Mortgage Wars” was the second best book I have read in my life. Can’t wait for the movie.


    1. Thanks. Since you have the book, you might want to quickly reread Part Three–“The Fight for the Mortgage Market.” The details you’re asking about are in that section.


  4. Tim,

    I have read your plan several times and still am not sure how it addresses the problems that caused the 2008 crisis:

    1) You say that the securities issued by Fannie / Freddie would not carry federal guarantees but that Fannie / Freddie would have some kind of guarantee. This kind of ambiguity is what led to the crisis. Though the every prospectus since 1981 said that Fannie debt did not have any federal guarantee, investors felt that there was some kind of ‘wink/nod’ arrangement where the Treasury would not allow the securities to default. This created a moral hazard that should not be allowed to again happen.

    2) My view is that unless there is an explicit guarantee, there will be little demand for Fannie / Freddie MBS. Even today, the FRB is the largest buyer. It is not clear who replaces the FRB. Recall that between 1981 and 2008, Fannie / Freddie were the largest buyers of their own securities. They are currently prohibited from such purchases.

    3) The minimum capital is entirely based on market perception. In the summer of 2008, markets perceived that the losses being seen in private label securitization would spread to agency MBS. That those perceptions were, in hindsight, wrong is not relevant. If investors flee agency MBS at the first hint of losses in other markets (as happened in 2008), does the Treasury again advance capital? What if the market wants 5% capital to feel comfortable with MBS. Does the Treasury advance over $100 billion to the GSEs?

    4) You are, in effect, describing a GSE structure that resembles the ‘super senior tranche’ of a CDO. In this tranche, an investor puts up some capital (e.g., 2.00%) to cover the tail credit risk on a CDO. The investor receives a fee (e.g., 25 basis points) on the full amount of the CDO giving the investor a 12.5% yield. However, if defaults uptick, the investor has to put up additional capital. In your proposal, the GSEs take on, not tail credit risk, but the full credit risk. And the source of the additional capital is the Treasury (i.e, the taxpayer).

    5) If you truly believe the risk of any loss is low, then why not just expand GNMA to handle all conforming mortgages? It would take legislation, but it could be done with 1/10 the staff and no need for quarterly multi-billion dollar derivatives losses.

    Liked by 1 person

        1. Barry: The problems that caused the 2008 crisis were the successful efforts, supported by Treasury and the Federal Reserve, to set up a parallel secondary market system– private-label securities financing toxic mortgages from a primary-market origination process the Fed declined to regulate–to compete with Fannie and Freddie, which ultimately supplanted the companies as the gatekeepers of mortgage creditworthiness in 2005. From that point a cascade of high risk loans inflated the housing bubble to the point that the only possible outcome was a spectacular bust.

          My proposal would restore Fannie and Freddie to their historical roles as shareholder-owned entities at the center of the secondary market. In that proposal, the government would agree– in exchange for Fannie and Freddie accepting capped returns and limits on their portfolio business– to support them in the unlikely event their (agreed-upon) percentage of capital turned out to be inadequate at any point. I believe the market would view that commitment of support as an explicit guaranty. Should that not be the case, I would support payment of a modest annual fee to the government to remove any doubt about the backstop. (The reason the fee was not in my original proposal is that it would just be passed on to homebuyers, and I think it is better policy to keep secondary market guaranty fees as low as possible, consistent with a designated level of safety.)

          You’re confusing spread widening in the MBS market with weakness in the financial position of the guarantor companies. If the companies are strong–and in my proposal they would be– that should limit any degree of spread widening that occurs on their MBS during a crisis (particularly with a government backstop).

          Finally, my proposal is in no way analogous to the “super senior tranche of a CDO”. It’s an improvement on a structure that worked for seventy years, and would have continued to work had the government not decided to allow entities with no skin in the game to use “private market incentives” to determine which loans should be made and how they should be financed. Many now wish to try a version of this approach again; I emphatically do not.

          Liked by 1 person

          1. I appreciate your giving me a chance to present by points and apologize if I appear overly critical:

            1) From 1981 onwards, every Fannie Mae prospectus explicitly stated (often in 24 point RED LETTERS) that the obligations were NOT guaranteed by the USA (you were CFO of record on many of those documents). In your proposal what will be on the prospectus? If they are obligations of the USA, then those obligations will (and should) count towards the national debt.

            2) LBJ created Fannie Mae specifically to avoid having its debt be added to the national debt. The housing market cannot be held hostage to fights over increases in the debt ceiling.

            3) The historical role of Fannie Mae is misunderstood. Issuing MBS was never an intended role. Fannie Mae did not issue a single MBS until 1981.

            4) Spreads widened in 2008 because markets perceived the financial weakness of Fannie and Freddie. That the markets were proven, in hindsight, to be wrong is irrelevant. What do you think would happen to MBS spreads if the Treasury were to withdraw its $185 billion explicit guarantee to the GSEs? I doubt that they would narrow. Do you think the FRB and the banking system (who combined hold over $2 Trillion) could withstand any spread widening?


          2. Being critical is fine; I encourage people with different or dissenting points of view to express them.

            I’m well aware of what was in the Fannie Mae prospectuses! And that was the ambiguity I noted in my paper. We said the obligations weren’t guaranteed by the government, but most investors thought the government would step in if the company ever got in trouble (and for the debt and MBS–and, strangely enough, the subordinated debt–they were right).

            What will appear in the prospectuses of the “reformed” Fannie and Freddie will depend on the specific nature of the compact worked out between representatives of the companies and representatives of the administration. Certainly it will be critical to structure the capital standard and backstop in such a way that the government’s risk of having to support the companies would be remote, thereby not requiring the companies’ guaranty obligations to be put on the balance sheet. (I’m not fully knowledgeable about OMB’s scoring of contingent liabilities, but it’s possible that some small amount might need to go somewhere on the budget to account for the backstop, but that amount would be tiny compared with the $5 trillion in Fannie MBS and Freddie PCs outstanding now.)

            You’re partially right on the history; prior to 1981, Fannie did only mortgage purchases, not credit guarantees. But when Freddie was chartered in 1970, it did ONLY credit guarantees (following Ginnie Mae, which was spun off from Fannie in 1968). Fannie got into the credit guaranty business to diversity its risk, after losses from its mismatched mortgage portfolio almost put it out of business in the early 1980s. Ironically, Freddie got into the portfolio business (in the early 1990s) after Fannie developed and began using the agency callable debt market, which allowed it (and then Freddie) to manage the option risk that had almost sunk Fannie earlier. Following the conservatorship, however, Treasury has mandated that both Fannie and Freddie must shrink their portfolios, so the only significant means they have of carrying out their charter responsibilities is through securitization.

            I don’t know what you mean by a $185 billion “explicit guarantee” from Treasury. You may be referring to the $187 billion Fannie and Freddie were forced to take from Treasury after FHFA ran up their non-cash expenses following the conservatorship. They would love to pay that back, but Treasury won’t let them.

            Liked by 1 person

          3. What are the alternative options to avoid the Gov explicit guarantees and also avoid increase in national debt?

            It may be as simple as this. Increase the asset(AAA) based Credit line from Gov (Fed/Tsy) to cover the worst capital short fall in worst case scenario. A sufficiently big credit line from Gov is as good as explicit Gov Guarantees and also a substitute for big capital reserve requirements. This also does not require any approval from Congress.

            This provision (credit line) already exists and needs to be revisited and make necessary changes. This does not pose any risk to taxpayers and it should be ok with Congress. This is also far cheaper alternative for all.

            During 2008, if Gov were to re-affirm already approved asset based credit lines from Fed/Tsy, then there was no need for HERA, FnF seizure, conservatorship, PSPA, etc…

            Most people do not recognize that unexpected Gov seizure of FnF contrary to previous official statements about financial health of FnF, triggered catastrophic cascading failures leading to total financial meltdown. FHFA’s harebrained decision to put FnF in conservatorship caused 2008 financial meltdown instead of preventing it.


          4. what would the shareholders receive in exchange for BOTH capping their returns AND paying a fee now for this explicit guarantee from the government?

            the costs need to be shifted somewhere. shareholders are quickly becoming the red-headed step children unnecessarily.


          5. Tim,

            “Promising Road” was DOA because it is “Promising Road to nowhere”.
            It is too complex, riddled with too many uncertainties, requires massive changes to current system, too expensive to all, exposes taxpayers to unlimited risks. It does not identify the specific problems that it is trying to solve in any reasonable manner.


          6. MBS spreads jumped during the financial crisis, right along with corporates. Conventional wisdom holds this happened for different reasons. Corporates due to default and liquidity risk, and MBS due to prepayment risk.

            But MBS spreads during the crisis increased more than for similar interest rates changes during non-crisis periods. And credit tightening and availability of refinancing at the time should have reduced prepayment risk on MBS, not increased it.

            The market was pricing MBS with more than just prepayment or liquidity risk. (if liquidity risk was an issue, then why?) There was default risk. The phony ‘rescue’ of the GSEs were meant to change this perception, IMO.

            I don’t view this as being at odds with your thesis, rather it reinforces it. The utility-like function the GSEs should be stable and reliable, with minimal perceived or real default risk as occurred during the crisis.


        2. barry,

          I am spending good amount time to explain incorrect facts and incorrect contexts.
          Hope it helps.

          1. “This kind of ambiguity is what led to the crisis.”,
          “This created a moral hazard that should not be allowed to again happen.”

          FnF never defaulted on their obligation and were never any where close to defaulting.
          So these points are not relevant. Besides FnF and Gov, Congress (Barney Frank) had made it very clear that there are no Gov Guarantees of any sort. How can it be made more clearer? May be SEC should have prosecuted the people who were spreading these rumors.

          2. “Even today, the FRB is the largest buyer. It is not clear who replaces the FRB. ”

          Federal Reserve Board (Gov Agency)/Tsy are the real authorities for decisions related to public policies of credit and liquidity. It is done thru buying/selling Tsy/FnF securities. Federal Reserve Banks are private banks that carry out these policy decisions.

          So the question of replacing FRB does not arise. FRBs will continue doing their job as per Fed (Gov) directives. BTW all the interest and principle payments on FnF securities go to Fed.

          ” Recall that between 1981 and 2008, Fannie / Freddie were the largest buyers of their own securities. They are currently prohibited from such purchases.”

          You are confusing this with FnF retained loan asset portfolio business. Before 2008 FnF used to buy mortgage loans and keep their them instead of converting/selling them as MBS. This was done to generate higher profits but exposing FnF to greater risk. But after 2008, conservator directed them to reduce/eliminate portfolio business. So you do not have correct understanding.

          3. “What if the market wants 5% capital to feel comfortable with MBS. Does the Treasury advance over $100 billion to the GSEs?”
          FnF capital requirements are based on worst case scenario analysis done by experts / regulators. Markets do not decide on FnF capital requirements. It is the regulators that determine capital requirements.

          4. Tim explained this complicated question.

          5. “If you truly believe the risk of any loss is low, then why not just expand GNMA to handle all conforming mortgages?”

          Please read more about GNMA/FNMA. Initially GNMA/FNMA were one Gov agency. Private shareholder company FNMA was created to reduce Gov debt and for many other valid reasons. Please read further on this and explain why you want to merge FNMA with GNMA.

          “It would take legislation, but it could be done with 1/10 the staff and no need for quarterly multi-billion dollar derivatives losses.”

          Once again it is your lack correct understanding that makes you come up with such comments.
          Will Congress agree for additional 5T debt and for what valid reasons?

          GNMA do not work like FNMA. Ginnie Mae does not buy or sell loans or issue mortgage-backed securities (MBS). Therefore, Ginnie Mae’s balance sheet doesn’t use derivatives to hedge or carry long term debt. GNMA mainly guarantees loans insured by FHA, VA, RD, PIH.

          FnF are private shareholder companies without any Gov guarantees or tax payers support. So FnF have to operate like private shareholder companies.

          Liked by 1 person

          1. 1) I am an investor in Fannie Mae MBS in July 2008. I see AAA private label securities downgraded to junk. I look at the prospectus on my Fannie Mae MBS and it says that the MBS is not an obligation of the USA. Fannie Mae has about 15 basis points in capital. What would a prudent, interest rate risk investor do? Most of them, who could, bailed out the bonds and driving the spreads very high — raising residential mortgage rates. Those who could not lobbied for a federal bailout. They got their free lunch. Few were saying, “Gee, what a great buying opportunity!”

            2) Retaining loans and not securitiizing = securitizing the loans and buying the MBS. In both cases you have 100% of the interest rate and credit risk. F/F retaining both the interest rate risk and credit risk on mortgages was critical to the growth of mortgage credit since 1981. Who is going to replace Fannie/Freddie in that role?

            3) The FRB is the largest buyer of agency MBS. Prior to 2008 they didn’t own a dime. Now they own over $1.5 trillion. The FRB simply replaced what F/F were buying. If they stop buying, who will?

            4) “Markets don’t determine capital requirements” is pretty naive. If the markets are unhappy with 2% capital, they won’t buy any bonds.

            5) Tim’s proposal and the Zandi proposal both call for an explicit federal guarantee of Fannie/Freddie MBS. Both want to use some kind of accounting treatment to minimize the impact on the national debt. I just don’t see either happening.

            6) GNMA simply provide a guarantee on MBS and have an explicit Treasury guarantee. If you are going to give an explicit federal guarantee to F/F why not just expand the type of mortgages GNMA can insure and be done with it. No need for Fannie / Freddie.

            7) Take away the Treasury line of credit and Fannie/Freddie are undercapitalized insurance companies.


          2. barry,

            You can not prove or disprove anything, by simply asking all sorts of questions.
            The questions need to have relevance to the main problem of identifying flaws, how to fix the flaws in the current system, analyzing alternatives and make it work for all.

            In a practical world solutions exist only when there are well defined values the variables can take.

            Liked by 1 person

  5. tim

    at some point we would be interested to hear your analysis of zandi et al’s “promising road.”

    but i would be interested in your view as to whether the promising road proposal assumes that there will be a huge, vibrant, multi-party competitive private market for credit risk assumption. as i read promising road, this assumption is a crucial linchpin to the proposal.

    it seems to me that given what i understand to be the private capital market’s appetite for bearing (as opposed to shedding) mortgage credit risk, this assumption is wholly unrealistic.


    1. In his paper, Zandi asserts that the “Promising Road” proposal he and his colleagues put out earlier “addresses the system’s structural problems and keeps what works.” It does not. “What works” is having mortgage credit risk graded, priced, held and managed by institutions that specialize in this business, and that can keep fees and costs down by diversifying credit risks over product type, risk characteristic, geography and time. Zandi et al propose to replace that with what we now know does not work: basing a $10 trillion market on the ephemeral investment preferences of investors in credit risk-sharing securities.

      There are many problems with the Zandi et al proposal that should disqualify it from serious consideration, which I look forward to discussing and debating in the coming weeks and months. For now, let me focus just on its cost to homebuyers. Even before getting to the claim that capital markets investors will provide better terms for absorbing mortgage credit risk than Fannie, Freddie or mortgage insurance companies—for which Zandi offers no support, and none exists—there are three structural issues in his proposal that will lead to much higher mortgage rates for homebuyers.

      (1) Initial pricing. Zandi et al’s National Mortgage Reinsurance Corporation (NMRC) will have to quote guaranty fees to lenders before it knows the cost of the mandatory risk sharing it will be doing after acquiring their loans. We have seen how badly pricing for Fannie Mae’s Connecticut Avenue Securities transactions has deteriorated in the last year and a half. The NMRC will have to build a premium into the guaranty fees it quotes lenders to compensate for the uncertainty about what its actual risk-sharing costs ultimately will be.

      (2) Limited diversification. The individual pools of mortgages the NMRC will be insuring will be much less diversified than all of the business the NMRC does over time. To protect each pool against a “worst case” credit loss will require the NMRC to charge higher guaranty fees than if it were able to insure all its mortgages collectively at the firm level (as Fannie, Freddie and mortgage insurers can and do). Homebuyers will pay for that.

      (3) Unpredictable payment streams. This is an esoteric point, but an important one. When the NMRC (or anyone) does a risk-sharing transaction, it issues interest-bearing securities that carry high rates of interest and pay down slowly and predictably; it services that debt with income from guaranty fees on pools of mortgages that have much lower average fee rates and can pay down rapidly and unpredictably. There is a huge option mismatch between these payment streams, and with hundreds of individual transactions, managing this mismatch risk can become extremely complex, and potentially destabilizing. The ongoing costs of “rebalancing” the NMRC risk-sharing portfolio will get passed on to homebuyers, and may at some point cause the process to break down entirely.

      Zandi et al state that their scheme is low risk, and will work out just fine. Given that our last experiment with securitization—financing single-family mortgages with private-label securities, whose risks were packaged into collateralized debt obligations and resold to capital markets investors—ended in disaster, we must be very, very careful in accepting the contention that “this time it will be different.”

      Liked by 1 person

  6. Tim.
    As per your note ” Experts generally agree that the role of the government in the charters of Fannie and Freddie is too ambiguous, and that the balance of benefits tilts too far in the direction of the companies”
    During your time what were Fannie Mae and Freddie Mac share of the secondary MBS and subsequent years after you left and before 2008 great recession. It was my understanding that FNF were dominant at that stage and PLMBS become more aggressive( and FNF started to lose market share) by backstopping sub prime, NINJA and robo signing loans that created the bubble. What are the benefits that tilts too far to the directions of FNF? Can they be amended in the charter?
    My point it seems that the benefit is not the culprit but just the perceived notion that they are GSE and creates political ideology that counters what happened ( FNFas shareholders run private corporations and PLMBS are market based competitors).

    The other point Zandi et al missed in their papers is what happened to the $5.1 T MBS that will be backed by their proposal. Will it be in the treated in the federal books debt?

    Thank you!


    1. zandi et al have a cryptic (or maybe just plain confused) footnote 17 wherein they say “Whether NMRC debt is counted toward the Treasury’s debt load or debt limit depends on the NMRC’s charter. If the charter explicitly states that the NMRC debt securities are guaranteed by the U.S. government, then the securities would count against the debt limit. However, if the NMRC charter act is silent and the marketing of the NMRC securities instead relies on the decades-long line of Attorney General and DOJ Office of Legal Counsel published opinions that state that all obligations of all federal agencies (including government corporations) are equally backed by the full faith and credit of the United States, unless explicitly disclaimed in the respective charter act (as Congress did in the case of the TVA and USPS charter acts), then the NMRC securities would not count against the statutory debt limit.”

      rosner in his criticism of the proposal cuts through the obfuscation: “In considering the impact of moving the new corporations onto the government budget the authors ignore that the costs will rise dramatically in bad economic times – even if the government is eventually able to recoup its outlays. While the authors agree that the debt issued to support the portfolio of the NewCo would count toward the Treasury’s debt limit they fail to acknowledge that it would be politically impossible to sell that idea to Republicans. Placing another $5 trillion of debt on the government debt limits is politically unworkable, even if only on a temporary basis. Furthermore, in supporting claims that the impact of moving the federal government’s backstop onto the budget would be modest, PRSZZ is forced to rely on accounting machinations.”

      My 2 cents: comparing Tim’s “fixing what works” with zandi et al’s “promising road” is a prime example of the KISS principle in application. Tim’s proposal is understandable, practical and efficient. Zandi et al….meh.

      Liked by 1 person

      1. “Promising Road” proposal was DOA.
        Any reforms that require massive legislative work are DOA.

        The best reforms are the ones that offer gradual changes with as little uncertainty as possible.

        Please also read remarks from Michael Stegman about the “Promising Road” to nowhere.


  7. Tim, Thanks for taking the time to address such an important issue; the insights I have learned here combined with the blog have helped substantially. I know you have said that the two are not related but I do note similarities on several key points, either way keep it up.

    Liked by 1 person

    1. F. Smith, a hundred times “no.” that “Tim” ain’t the real Tim.

      I won’t malign the other guy, but there’s about 500 times more mortgage finance substance/history coming from this one than that one. (I wouldn’t exaggerate.)

      Keep it in mind.

      And, if you are a DC LA on the Hill, suggest your boss and all of your buddies in other offices, read this blog, if they care about GSE facts.

      Liked by 3 people

    1. According to the Urban Institute’s website, they will be Mark Zandi (who I assume will recap the “Promising Road” proposal released a couple of weeks ago); Patricia Mosser of Columbia University (and formerly from Treasury’s Office of Financial Research); Marc Morial, president of the National Urban League; Jim Carr, from the Roosevelt Institute (and formerly the Center for American Progress); Mark Calabria of the Cato Institute (and formerly senior staff on the Senate Banking Committee), and Andrew Davidson, president of his own firm.


  8. Tim, you wrote your proposal as a request from the Urban Institute, who also requested proposals from others, yes? Have you read theirs?

    If I’m reading this correctly, they didn’t take any of your thoughts seriously and this seems like a hit piece on the twins and gimmes for the banks.

    Although I don’t agree with certain aspects of your proposal, it is the most balanced that I’ve seen thus far.


    1. The Urban Institute has requested essays on housing finance reform from nine individuals, and through today has put three up on its website: Jim Millstein’s, mine, and Alex Pollock’s. I’ve read both Millstein’s and Pollock’s.

      I began my essay by saying that all authors should clearly state the objective of their reform proposal–i.e. “what is the problem for which this proposal is the solution?”–and by noting the importance of having proposals be based on an accurate assessment of what caused the previous crisis. Pollock’s proposal misses badly on both counts.

      Pollock’s diagnosis of the problem seems to be: “Fannie and Freddie.” His brief recounting of the mortgage crisis mentions only those two companies, and his contention that they “went broke.” (He says nothing about the lack of regulation of risky primary-market origination practices, or the lack of discipline anywhere along the chain of private-label securitization in the secondary market.) Pollock’s proposed solution is to do exactly what I recommended against doing in my essay: give Fannie and Freddie bank-like capital requirements without bank-like asset powers. As I noted in my piece, that would doom the companies to failure, which apparently is Pollock’s goal.

      What about homebuyers? He doesn’t mention them specifically, but has a couple of vague ideas he thinks might be helpful: letting the Federal Home Loan Banks create a “nationally operating mortgage subsidiary” (for some unstated reason, the Home Loan Banks would run this better than Fannie and Freddie), and relying more on the sorts of mutual savings associations that were around in the 1930s. Most of his recommendations, though, make homeowners unambiguously worse off: hamstringing Fannie and Freddie, forcing the two companies to raise guaranty fees by making them price using bank-like capital, making mortgage originators have “skin in the game” (which would remove all but the big banks as sources of mortgage credit), and creating “countercyclical LTVs.”

      What’s the objective of Pollock’s proposal? Other than turning the secondary market over to the big banks by sidelining Fannie and Freddie, and putting homeowners at the mercy of the free market, you’ve got me.

      Liked by 5 people

      1. Again…
        I may not agree on some things you suggest. But you are a smart, smart man and I have to acknowledge that. Your responses are well thought out. Thanks.


      2. Tim,

        What is the problem is turning FnF in to full fledged banks like the other banks?
        Even GS and MS become banks during crisis.

        May be, FnF can be converted in to Housing Federal Reserve Banks (HFRBs) like FRBs. Then HFRBs do not have to depend on Gov – just create free credit at will.

        Are not FRBs doing the same, with rate of return fixed at 6%?


    1. Just Carney, being Carney. Is this guy foolish, bound to an unyielding agenda, or both. I guess JC missed the part in your piece about adjusting GSE capital requirements based on the mix of business/risk. At a minimum, to make the comparison he makes to minimum capital for banks, he first needs to make adjustments to equalize the risk for the GSEs and the banks. Does he not realize – or does he simply ignore – the fact that the 2% relates to the lowest risk mortgage portfolio, which would represent risk far below the risk for the mix of loans on a bank’s book. Tim, you could not have been clearer… Of course, most telling is that fact the JC always restates his key point: “[blah, blah blah is] dire news for the holders of the common and preferred equity of Fannie and Freddie still in the public’s hands, suggesting the present value of the shares is approximately zero.” Gosh, it sure feels like his primary goal is to impact the prices of the publicly held shares.. He’s told readers why the shares of the GSEs are worthless every which way possible (even arguing that the 9th Circuit Adams case is the death knell for holders, when it can only be viewed as helpful, if anything, other than maybe by some stretch of the imagination in the single, solitary case before the Court of Federal Claims (and not even there)…in JC’s world, i guess, who cares about Perry and the dozen other cases that don’t require a “United States” defendant). There’s some chance he’ll be right (that’s the nature of contested situations involving somewhat binary outcomes), but for none of the reasons he’s put forth.. Meanwhile, thanks for your thoughtful piece Tim – I hope you respond to Carney.. It’s upsetting that the WSJ prints that stuff, especially when people probably do make financial decisions based on his authoritative sounding arguments..

      Liked by 1 person

    2. I don’t view it as a weakness of my proposal that I was unable to make a convert of Mr. Carney.

      As to the substance of his arguments, the 2 percent minimum in my proposal is not a substitute for a risk-based capital requirement; it is an addition to it. And his statement, “it’s [sic] worst case scenario isn’t nearly bad enough” leaves open the question, “what scenario IS bad enough?” In my proposal I say the administration gets to pick the scenario. The 25 percent decline in home prices is just my suggestion, and I think it’s plenty severe. Until we turned the mortgage underwriting and financing process over to the unregulated private-label securities market, there hadn’t been a sustained period where we had ANY nationwide declines in home prices since the Great Depression. As I noted in my piece, the CFPB has banned the most toxic forms of mortgages that were the biggest money-makers for lenders prior to the crisis, and investors have woken up to and rebelled against the massive conflicts of interest and lack of “skin in the game” of private-label securitization that produced the uncontrolled boom that led to the bust. You won’t have a future 25 percent drop in home prices unless it is preceded by a period where policymakers and regulators are as ideological, uninvolved and irresponsible as they were during 2005-2008, and I don’t see that happening again in our lifetimes. Perhaps Mr. Carney does.

      There’s also a larger point worth making here. For the administration to decide to base the mortgage finance system of the future around a revised version of Fannie and Freddie–whether using the proposal I’ve put forth or something else–it will have to become convinced that it’s the best alternative that exists for creating the type of secondary market system it wants to have. I believe it is. Someone who insists that a reformed version of Fannie and Freddie must hold 10 percent capital, for no specific reason, is simply saying “I don’t want Fannie and Freddie to survive under any condition.” Then you have to ask, “Well, what’s your idea?” What I like about the Urban Institute series is that we will get several concrete ideas on the table, to be compared and contrasted, not just reflexively criticized and dismissed. I’m looking forward to the discussions that ensue.

      Liked by 6 people

      1. It is impossible to ever convince “John Carney & Co”.

        These people are obsessed with only one self serving agenda – Destroy FnF and grab FnF businesses along with 100% Gov explicit guarantees – restore the golden era of mafia mortgage loans. 2008 crisis was fomented to rob the nation and its people. FnF are the last remaining ones in their list.

        How can anyone convince such people?

        Liked by 1 person

  9. Thanks for this Tim. Your paper’s premises are not dissimilar to the Community Mortgage Lenders of AmerIca (CMLA) GSE white paper (released 2012), and also very close to what Josh Rosner has been advocating. (Also, I can’t find any small lenders that think the two GSEs should be merged.)

    Liked by 1 person

  10. Tim.
    Did you hear any from the Perry appeal court re the amicus brief you filed for them. When is the oral argument? Is April 15 hearing still on?
    Thank you!


      1. My understanding is that oral arguments in the Perry appeal still are scheduled for April 15. I’m not expecting to hear from the appeals court on my amicus brief at all. You may be confusing the Perry amicus with the one I submitted in February for the Jacobs-Hindes case filed in the Delaware District Court, where the government opposed my motion for leave to file this brief. I understand that the court will not rule on the motion to oppose my amicus until it rules on the government’s motion to dismiss the case, which could take several months.


  11. Tim,

    I’m still unclear on:

    “Experts generally agree that the role of the government in the charters of Fannie and Freddie is too ambiguous, and that the balance of benefits tilts too far in the direction of the companies.”

    While I agree that the charters are ambiguous, from my perspective the federal government has fascist control of FnF to fund social mandates that haven’t had funds appropriated through normal congressional channels. In exchange for this FnF receive,

    “For example, the government provides the GSEs with a line
    of credit from the Department of the Treasury, fiscal agency services through the Federal
    Reserve, U.S. agency status for GSE securities, exemptions from securities registration
    requirements, exemptions from bank regulations on security holdings, and tax
    exemptions.” (

    From my perspective the big banks have a soft implicit guarantee as they were back door bailed out by FnF and AIG. Because of the bank’s regular bailouts FnF don’t have a large implicit guarantee advantage over the banks. Some people believing that the FnFs have an implicit guarantee shouldn’t be FnF shareholder’s problem. An implicit guarantee means not explicit. FHFA and UST choice to strengthen the public’s impression that there is an implicit guarantee shouldn’t cause FnF’s shareholders to be penalized.

    I understand the goal of getting the GSE out from under the unique political risk that is caused by both conservatives and liberals being unhappy with “big government” or “private profits”, however I suggest that the coming wave of imprisonments and bankruptcies of the CPAs that colluded in #fanniegate will dwarf the impact from watergate ( Watergate has had a long term impact on they way the government runs. I would suggest that the roll of convictions and bankruptcies that will result from the unwinding of #fanniegate will keep politicians off of our backs for quite some time. While I understand the desire to lock-in a permanent improvement in FnF’s political position, I would suggest that the NPV of the status quo is higher than the NPV of a utility model FnF with reduced political risk.

    In short, I prefer to send people to prison for breaking the existing laws rather than create new laws. I believe that changing FnF’s charters at any point in the unwinding of #fanniegate will represent a failure to follow the rule of law, a failure to respect property rights, specifically the shareholder rights. This failure to follow the rule of law will have a larger negative impact on the American economy that any housing finance failure.


    1. I do from time to time check some of the “GSE blogs,” and understand that there is a lot of emotion around the issue of the nationalization of Fannie and Freddie. Emotion often leads to extreme positions, however, and extreme positions seldom win the day.

      Is there a double standard for banks and Fannie and Freddie? Yes, absolutely. That’s been true for decades. But Fannie and Freddie’s charters also have flaws, and I believe there’s a much better chance of fixing those flaws than of changing the double standard.

      I am optimistic that both the “takeover and the terms” of the original conservatorships of Fannie and Freddie ultimately will be overturned in the courts, as will the net worth sweep. But I doubt there will be a “coming wave of imprisonments and bankruptcies of the CPAs that colluded in #fanniegate… [which] will keep politicians off our backs for quite some time.” In seeking the ideal, one runs the risk of missing out on the achievable.

      Liked by 2 people

      1. Tim,

        I agree with the pragmatism of your last paragraph. However, those who are in power and the many in the press appear to be conveniently oblivious to the obvious, that is, the Constitution is the Supreme Law of the Land, and HERA, etc. are subordinate to the Constitution and the Fifth Amendment. Indictments or court ordered limits of those in power and the press for abuse of their positions will drive home the supremacy of the Constitution and help realize the goals of your last paragraph.


  12. Tim,

    “Utility model,” with limited returns seems to be very simplistic model to account for complexities of FnF business model. We can start with this model but need to develop more sophisticated model to take care of complexities of FnF business.

    FnF risk models are totally different than the risk models of utility companies.
    FnF also operate in very cyclical economy and the roles to be played by FnF are entirely different during downturn.

    If one compares and contrasts business models of utility companies with that of FnF, then a better insight can be gained.

    FnF are insurance companies. There are no insurance companies that work on utility model any where in the world. There are only co-operative mutual insurance companies.

    Looks like more thinking needs to be done on “Utility model” and Returns.


    1. I put the term “utility model” in quotes to convey the notion that it just describes a concept– companies that carry out an important public function (in the case of Fannie and Freddie, financing 30-year fixed-rate mortgages affordably) and which receive specific benefits (for what you call “FnF,” an exclusive charter and a government backstop) in exchange for accepting a cap on the returns they can earn. The models the companies build and use to assess and manage their credit and interest rate risks are separate things entirely, and of course are different from the models built and used by, say, a power company.

      Liked by 1 person

      1. Tim,
        Thanks, You know the complexities involved in this better than anybody else.
        But it is better to be clear about this in the beginning itself.


      2. The rate of return can be capped based on (costs, risks, perceived value…) at each product or service level or businessline.

        When rolled up, the combined rate of return may change based product mix on quarter to quarter basis. This can be used to incentivize desirable business lines and deincentivize undesirable businesslines.


        1. For me, this approach opens up the Pandora’s Box of micro-management. Presumably it would be the regulator that would pick the product types, risk combinations and other categories that get the differential permitted rates of return, and if one goes that route, the regulator also presumably would have the flexibility to change both the categories and the individual rates of return over time, to create the incentives it wishes. I think that’s a dangerous path to head down. Better, from my perspective, to have the administration pick a single overall average permitted return, have the regulator set stress capital requirements (based on historical loan performance) and monitor the companies overall target return, but let Fannie and Freddie make the individual product mix and pricing choices, consistent with their overall return constraint.

          Liked by 1 person

          1. Tim,

            Yes, things get complicated when it comes to setting the caps at detail level.
            Even when single overall return is used, there will be political criticism on product mix that FnF use to achieve the single overall return.

            Current problem is hostile Regulators who have repeatedly violated all kinds of laws and also made up their own laws to destroy these two companies. On the other hand we have loving banking regulators (or self regulators) who have done every thing to prop up the banks at any cost.

            Things will work very well if regulators follow the laws and work with FnF management to set these limits. Things will change for better if FnF regulators are made to for all people rather than just for WS people.

            How about this.
            1. FnF and regulators work together to set return limits (min, max) at detail level so to achieve average overall return.
            2. Regulators/Gov take responsibility for company’s minimum average overall return.
            3. Regulators/Gov may also award additional incentive bonus return points for exceeding the performance criteria.
            4. In case of disputes let their be an option for arbitration / court adjudication.


  13. Tim,

    I really enjoyed reading your commentary and your answers to the questions others have posed. It is a valuable addition to the debate, which appears to be picking up steam again.

    A few more questions for you:

    1. I agree with your goal to have a system which provides access to credit at a sustainably low cost for middle income homebuyers. One important component of this is to be sure that the secondary market supports a highly competitive primary market, one where lenders of different sizes and business models can compete on a level playing field. Different lenders have different abilities to reach different groups of borrowers.

    Would a secondary market with two utilities provide this level playing field? Other options have leaned towards either a government entity or a competitive secondary market with the possibility of entry. This possibility of entry might negate the need for a capped return for the utilities. Would you grant FHFA chartering authority to charter additional competitors?

    2. With respect to capital, another important principle is to prevent capital arbitrage. Required capital should be based upon risk, not charter. If Basel III in its entirety is not the right capital requirement for a GSE, should they be held to the amount of capital required under Basel III for mortgages, i.e., 50% risk weight?

    3. For much of the past 30 years, mortgage rates on conforming 30-year fixed loans were typically 25 bps or so below those on jumbo loans. Today, rates on jumbo loans are 10-15 bps lower. At least a portion of this change is due to the much higher gfees being charged. To what extent are you looking at these types of market signals in thinking about required capital for Fannie and Freddie when you selected 2%?



    Mike Fratantoni, Ph.D.
    Chief Economist
    Senior Vice President, Research and Industry Technology
    Mortgage Bankers Association


    1. Mike:

      I’m happy to join the dialogue. Here are brief responses to your questions.

      1. In my proposal, Fannie and Freddie accept capped returns in exchange for an explicit commitment of support from the government if their (government-determined) capital levels ever prove insufficient. Adding open entry to others would be a “give” that makes the deal unfavorable to the companies. One of the reasons I allow both Fannie and Freddie complete pricing flexibility–subject to the overall cap on their target returns– is to set up the competitive pricing dynamic among lenders you cite.

      2. A couple of points here. First, banks’ Basle III risk-weighted capital requirements cover both interest rate and credit risk-taking; Fannie and Freddie only take credit risk in their guaranty businesses. Second, you got it right when you said, “required capital should be based on risk, not charter.” That’s what my proposal does. Required capital is based on the risk of the loans Fannie and Freddie guarantee; the minimum of 2% only becomes binding if that percentage is greater than the calculated risk-based percentage.

      3. Two things here, too. First, I do believe Fannie and Freddie’s current guaranty fees are too high. They are too high for three reasons: they include the 10 basis point payroll tax fee (which I thought was a terrible idea, a “tax on homebuyers,” when it was passed); they also include the 4.2 basis point affordable housing fee, which only Fannie and Freddie pay (in my proposal I advocate that any future affordable housing fees be levied on all loans, to avoid favoring the primary market over the secondary market), and I think FHFA is being too conservative in how they’re assessing the riskiness of the loans Fannie and Freddie are currently guaranteeing. Second, I didn’t “select” 2 percent as a minimum capital amount. I proposed that Fannie and Freddie be required to withstand a 25 percent nationwide decline in home prices over five years, then calculated, based on data made available by Fannie Mae, that had Fannie had its current product mix during the 2006-2011 home price decline, it could have survived with less than 2 percent capital.

      Liked by 1 person

      1. Tim,

        Thank you for this blog and your generosity of attention in sharing your insights pursuant to the GSE reform debate.

        Considering Mike Fratantoni’s comment above, to what extent do you feel the GSEs should be responsible for paying to create a platform that gives away their proprietary technology (the CSP initiative)?

        My own feeling is that if Blackrock wishes to get into the mbs securitization business, they should seek a charter from the FHFA, build their own platform from scratch, and be subjected to the same regulation that Fannie and Freddie are.

        Mike, since you’re here, could you comment on why the MBA feels it’s appropriate for the GSEs to pay for a platform that gives away their business to third parties?



        1. Andrew: I do not think Fannie and Freddie should be paying to develop the common securitization platform. But as I’m sure you know, they are being required to do it by FHFA, which in turn is acting at the behest of Treasury.

          Liked by 1 person

        2. The CSP is a joint venture of Fannie Mae and Freddie Mac. Per the latest updates from FHFA, they are going to be the sole users of this platform, although it is being developed with an open architecture so that others could potentially connect at some later date.

          Rather than have each GSE update its infrastructure, pooling resources for new infrastructure under the CSP should economize on costs, an important factor as they are trying to manage administrative expenses.

          Different bills in Congress and other proposals would treat the CSP differently with respect to ownership and access in a future model, but most proposals recognize the need for robust infrastructure.


          1. Mike: As you know, however, if Fannie and Freddie were independent shareholder-owned companies–and not being run by a conservator that openly admits it is not running them in the interests of shareholders, but the government–they would not building the CSP with an “open architecture” others could use in the future. Moreover, Fannie would not be contributing to the project at all, since one of its primary objectives is to eliminate a key competitive advantage Fannie has had over Freddie for decades: a timing of remittances that investors value more highly than the one built in Freddie’s mortgage securities, which causes Freddie to have to reduce guaranty fees to overcome. Absent the conservatorship, Freddie might wish to pay to eliminate this disadvantage, but Fannie certainly wouldn’t.

            Liked by 1 person

          2. I disagree with your last comment. Theoretically, Freddie’s security should trade at a higher value as investors receive their cash earlier. Correct? As you note, this has not been the case in terms of their actual market value, because Fannie’s liquidity premium, due the larger amount of its outstanding MBS, swamped the remittance difference.

            Moving to a single security should eliminate Fannie’s liquidity advantage, while potentially improving overall MBS market liquidity. Fannie and Freddie will be competing on a more level playing field, which should benefit the market.

            I see the CSP and single security efforts as distinct but obviously connected initiatives. The CSP is about updating the infrastructure and economizing on costs, while the single security is designed to improve secondary market competition.


          3. mike

            if i can enter this conversation, could you explain why you say “Moving to a single security should eliminate Fannie’s liquidity advantage, ” if the origin of this liquidity advantage is the greater amount of fnma v. fmcc guaranteed securities outstanding? it’s not as if the single security merges the separate respective guarantees.

            but as a side note, if tim’s “utility” model is adopted, wouldn’t their be strong economic incentives to merge fnma and fmcc?


          4. See FHFA’s plan for the single security: By allowing commingling of Fannie and Freddie securities in second level securitizations, investors should arbitrage away the differences in value between the two. By aligning the disclosures and remittance schedules, the securities should become very close substitutes.


          5. We’re not going to settle this one here, but it’s good to get the issues out.

            For Mike, I watched this dynamic for 20 years at Fannie. Freddie was (and still is) in a box. The market never paid full price for the theoretical value of the earlier cash remittances from Freddie securities (except during bursts of time when REMIC issuance took most current production MBS and PCs, since payment delays are irrelevant in the REMIC structure). Freddie offset some, but not all, of this difference by cutting guaranty fees, and because Fannie MBS still was better execution for lenders, more Fannie MBS were issued than Freddie PCs, and that’s where the liquidity advantage came from. If anyone had come to me and said, “I’ve got a great idea– let’s spend a ton of money to benefit the market by allowing Freddie to compete on a more level playing field,” I would not have responded favorably.

            For ‘ruleoflawguy,’ I would not merge the two companies. As was the case pre-conservatorship, I think there is great value in having two entities competing for a lender’s business.


          6. @mike

            ah, CDOs to the rescue. what a novel idea.

            seriously, if this arbitrage only benefits fmcc and only harms fnma, this will just be another instance where the fnma board of directors has breached its fiduciary duty to fnma and its shareholders.

            just add another lawsuit to the list…and i suppose pagliara v fnma is a prelude to that


    2. “Would a secondary market with two utilities provide this level playing field?”

      Currently no FI is restricted from entering secondary market.

      Except FnF all other FIs are free to compete in any markets in addition to primary as well as secondary mortgage markets. In addition no other FI is as much regulated as FnF eventhough FnF are used for public policy purposes without any Gov support other than imaginary implicit support.

      The idea of “Utility model, with limited returns along with contingency support from Gov” is to create level playing field and counter the gripe that “the balance of benefits tilts too far in the direction of the companies.”

      But here the big question would be, if other FIs are given the same balance of benefits, if other FIs are subject to same regulations, same regulatory scrutiny and same public policy social mandates, then, will other FIs even think of entering secondary markets.


  14. tim

    a question on your thinking about the capped return. let’s say capital required is 3% of outstanding guarantees. (compromise). this would imply a capital cushion of $84B for fnma. 10% after tax return on capital implies $8.4B of net income. this is $2.6B less than fnma earned for 2015.

    now, i understand you are at only a proposal stage, but i wanted to get a sense of feasibility and comparability to current conditions…plus, i have a feeling that you have modeled out your proposal, given your diligence.

    but these numbers imply that guarantee fees could be lowered, or maintained at current levels and support for low-income housing could be substantially increased. am i understanding this correctly?

    moreover, there is an interative process involved with respect to raising the capital that might be ticklish. in order to raise the $80B+ capital, investors have to believe the return is satisfactory. the market, not fhfa nor anyone else, will decide if it is a satisfactory return. assuming a combination of capital raises and retained earnings is used to build capital, the capped return must be structured (at least initially) with the demands that institutional investors will require.


    1. Let’s (briefly) break this into three pieces: (a) capital, (b) guaranty fees given that capital, and (c) returns on capital competitive enough to draw the required amount of equity investment.

      On capital, I don’t want to concede 3 percent even as a hypothetical compromise. One of the most important aspects of my proposal is that the government define the scenario it wants to be protected against; the capital number then will be determined from that (based on analyses of the companies’ crisis-year loan performance). If you turn the capital discussion into a numbers game, there is little incentive not to always have your answer be “more” (that’s how Corker-Warner got to 10 percent).

      On guaranty fees, the three key components of the guaranty fee build-up are return on capital (ROC), the loss provision, and admin expenses. Once you know the capital ratio the ROC falls out, but the loss provision is a function of what you think your expected losses will be. My proposed 10 percent “capped” return on capital is imposed on Fannie and Freddie when a loan is priced, so if the loan performs better than expected, shareholders get the upside. Shareholders also have upside if the companies can trim their admin expenses (and right now, I think for both companies those are way too high).

      But you’re right, if we set the capped target return on capital too low, we won’t get the dollar amount of equity investment we need to make this model work. I think 10 percent after-tax will be enough, however. As an shareholder, you’ll have a stake in one of two companies that provide guarantees for half, or more, of the loans in a $10 trillion market. You’ll start off each year with a pretty good idea of what you’re going to make at the end of the year, because most of the book you have in January will still be with you in December. And when loans in your guaranty book liquidate, there’s a pretty good chance the replacement loan will come back to you for another guaranty. Finally, you’ve got upside from managing credit losses and your admin costs. But obviously we’ll need to get feedback from the market to see if 10 percent really is sufficient.

      Fannie Mae’s 2015 earnings aren’t a great benchmark for the company’s future earnings– with or without capped returns– for two reasons: Fannie provided way too much for its losses in the years after the conservatorship, so it doesn’t have to provide much today (and that will end at some point), and the income from its portfolio will continue to decline. Thus, the dollar difference between Fannie’s earnings with capped versus uncapped returns won’t be as great as you’re implying with your 2015 earnings comparison. In addition, the difference that does exist very likely will be made up for (in share price) by a higher price/earnings ratio on those capped returns.

      Liked by 2 people

      1. great explanation!
        what would you consider a reasonable earnings benchmark (if not 2015 earnings) going forward for your proposal purposes?


        1. In a post I did in February (“Some Context, and the Coming Bailout Charade”), I estimated Fannie Mae’s “normalized” earnings at about $12 billion per year, pre-tax, or about $8 billion after-tax. With capped returns, I’d drop that figure to somewhere in the $10-11 billion range, which would be $7 billion plus-or-minus after tax.

          The reason the income doesn’t drop more is that even with a 40 basis point “capped” fee Fannie’s average guaranty fee still would inch up a bit from where it was last year–at 38.3 basis points, net of the payroll tax fee paid to Treasury. (Without the capped returns, obviously, the average fee would go higher.) Another offsetting factor is that we’re getting close to the point where my proposed limit on Fannie’s portfolio size (10 percent of its credit guarantees) would allow the portfolio to stabilize, then grow with the guaranty business, rather than continuing to shrink.


  15. Tim,
    Somebody already has suggested and I second that you send this great piece of work as letter to editors/opinion to major papers, LA Times, NY Post, WSJ and others. To help spread this, is it ok with you if we can reference this article when we send it ourselves to various stakeholders?

    Liked by 1 person

  16. First of all thank you and congratulations for your insights. The “utility model” concept is a great and a well thought compromise between the political divide of opponents and supporters of FNF .

    The “political risk” is so much that based on your personal experience and others who held management positions in FNF, opponents went to extent of charging you and others in court of “cooking” financial statements to destroy reputations and careers. The court has exonerated you and I salute you for continuing to help “fix” what is working despite what they have done to you personally.My apology for bringing this topic, but it is just to emphasize the “political risk”

    Now the table is turn in the court of law as opponents of FNF has resorted to “breaking the law” to advance their political agenda. Hopefully the “rule of the law” will prevail to accelerate the process of fixing what is working for the US housing industry which supports 25% of our economy and those who are guilty will be exposed..

    Fully agree with you on your following comments. There is no alternative for the “utility model” concept to correct perceived “unfair advantage” of FNF

    “I’m sure I and other commentators will have a lot more to say on this topic in the coming days and weeks, but I’ll make one other point at this stage. Fannie had uncapped returns when I was CFO, but we also were locked in a fight with our opponents and critics over whether the terms of our charter were fair, and if we had an “unfair advantage” over other financial institutions. This controversy gave rise to what became known as “political risk”– the chance that our critics might succeed in placing business limitations on us and Freddie Mac that would severely constrain our ability to earn a competitive return. That political risk cut our price-earnings ratio significantly. Personally, as a Fannie shareholder (which I still am), I would take a reasonable cap on the return Fannie could target in its pricing (and a subtlety I couldn’t get into in a 2000-word essay is that targeting a 10% return on capital doesn’t necessarily cap realized returns at 10% if the company underwrites prudently and manages its credit risks well) if that would greatly reduce or eliminate political risk, to the benefit of the company’s P/E ratio (and stock price)”.


  17. Thank you Tim for your awesome work.

    I hope the so called “housing finance experts” see the writing on the wall.
    I suggest them to read your proposal and your responses in comments section.

    Thanks again.

    Liked by 1 person

  18. Tim, i like the utility model as well. I remember discussing a similar concept with Syron over dinner in LA 10+ years ago. It’s a shame policy makers were never serious about engaging with the companies/industry about the long-term business model pre-crisis.

    Liked by 1 person

    1. Taylor: I agree with you; it IS a shame policymakers weren’t focused on the real issues (and potential solutions) with Fannie and Freddie a decade ago, rather than the phony ones promoted and pushed by FM Watch and others.

      For those of you who may not know Taylor, he works in San Francisco with Capital Research, and was one of the best buy-side security analysts I had the pleasure to work with when I was at Fannie (and presumably he’s still pretty good!)


  19. I would be very interested in a “More than 2000 word” publication of your vision on the subject matter Mr. Howard. I find you and Richard Epstein both easy to listen to and also among the most sensible of persons with legitimate credentials.

    Good luck to all of us who have been sacrificing much throughout this injustice. May the courts put a fair and reasonable end to this mess so we all may move forward.

    Expecting FedEx to deliver your book tomorrow 🙂 Thank you again for unselfish sharing of your expertise. The Government should take advantage of your immense vision and knowledge, their paying millions for advice and guidance that is lesser than yours to be sure.


  20. Tim – thank you for the comments regarding the credit performance of GSE loans versus the overall market and the true sources of the crisis. Helpful to continue to clear that air with the facts.

    With regard to your proposal, the Obama Treasury adopted as a principle of housing finance reform that the credit risk bearing function should be separated from the infrastructure of MBS securitization and servicing. I would prefer a reform approach that reflected this principle, as it would significantly reduce the moral hazard risks for future bailouts.

    I also believe that “big bang” reform plans have a very high risk of failure in practice, even if one could achieve the very delicate political balance necessary to pass such a bill. Therefore, emphasis should be placed on reforms that can be implemented gradually with the existing capabilities of the system that expand competitive private capital, can benefit lender and consumers with real competition, and reduce taxpayer risk.

    Thanks for your contribution to the discussion.


    1. Adolfo: I see this a little differently (although maybe not correctly). In my experience at Fannie Mae, I didn’t perceive there to be a significant operational risk in having the securitization function and servicing responsibilities (but not the actual servicing), done within the same company as was responsible for assessing credit risk and pricing the guarantees. And having servicing responsibilities was very valuable in loss mitigation. If all a credit guarantor did was assess and price credit risk–without the ability to direct servicing actions on non-performing loans to minimize both its default rate and loss severity–it would have higher credit losses, less profits, and have to charge higher guaranty fees. Am I missing something?

      Liked by 1 person

    2. @ mr. marzol

      “…the Obama Treasury adopted as a principle of housing finance reform that the credit risk bearing function should be separated from the infrastructure of MBS securitization and servicing. I would prefer a reform approach that reflected this principle, as it would significantly reduce the moral hazard risks for future bailouts.”

      since you support this principle, perhaps you can explain the reasoning. the GSEs don’t originate mortgages. securitizing mortgages into mbs is simply a structuring function, that introduces no moral hazard risk that i can see. servicing must be conducted in accordance with standards. if you want to control servicing activity, set the standards as you wish. the identity of the servicer is irrelevant.

      so why should the credit-bearing/guaranty function be separated from the securitizing and servicing functions? where is the moral hazard?

      the only support that i could glean for the idea was that it furthered the private interests of the mortgage banking industry, given the identity of the persons in the administration who seem to champion it.


  21. Tim,

    Thank you for taking the time to share your thinking with all of us.

    Since this is such a politically charged situation, shouldn’t any reform proposal take optics into consideration. While your idea speaks to the rational me, I can see the gov’t not liking it because it provides few optical wins for it.

    Regarding not increasing the 4.2bps contribution for affordable housing: Isn’t the resolution of the GSE situation one of a few shots at (positive) socializm in the US? I dislike the idea of handing the secondary mortgage market to the banks because I can see low income Americans being taken advantage off. By the same token, I like the idea of using Fannie and Freddie, to do more for those who need the most support. I’m far from certain that this is the right solution, but I think it’s a topic worth exploring. Would be curious why you think the 4.2bps contribution is the correct answer.

    What is your thinking around having the GSE pay a fee to the gov’t along the lines of what banks pay to FDIC for its support. The GSEs will definetly be classified as SIFIs, so if there is any shock for whatever reason, they will be provided support by the gov’t.

    Many thanks!



    1. The “optical win” my proposal has is the capped returns for Fannie and Freddie, which resets what many feel is a balance of charter benefits that unduly favors the companies. I can’t think of any other such wins that don’t impose a disproportionate cost either on homebuyers or Fannie and Freddie’s shareholders.

      The biggest win for the government in this proposal, however, is fixing an obviously broken system. I know the administration currently isn’t thinking this way, but I have a high degree of confidence that it’s going to lose the lawsuits challenging both the takeover and the terms of the conservatorships (including, obviously, the net worth sweep). When this or a future administration comes to the same realization–probably, as I note in the paper, after an adverse court action–it should see that it is in everyone’s best interest for it to take the initiative to unwind the conservatorships in a manner that leaves a robust, efficient and low-cost secondary market mechanism in its place.

      I am not against an affordable housing fee; I just believe that if Congress is going to levy one, it should be on all mortgages originated. I don’t see any justification for exempting mortgages originated and held by banks from the affordable housing fee, and levying it only on loans financed by Fannie or Freddie. As I said in my paper, that’s an excise tax on secondary market execution, and if the fee gets too large it will discourage the use of secondary market financing.

      Finally, I never have liked using FDIC insurance as an example of “what banks pay for government support.” It’s not; it’s what they pay to have their deposits insured by the federal government so that consumers will put money in banks without having to worry they’ll lose it. And it’s not a fair payment for services received; it’s a grossly underpriced government subsidy. Think of what would happen if we were to apply the same principle of “private market solutions” to bank deposit insurance that most now are applying to secondary mortgage market guarantees. This would involve replacing FDIC deposit insurance with insurance from private companies. If that were done, three things would happen. First, private insurers would charge MUCH higher premiums, because they would have to hold significant capital to back their guarantees, and have to earn a return on that capital. Second, a private insurer would place much stricter limits on the investments banks could make with their insured deposits than the FDIC now does. And third, consumers would require much higher deposit rates to put their money in a bank that had private versus government insurance. In reality, banks pay NO fee for the “too big to fail” government support they get, and the FDIC fee they pay for their deposit insurance conveys a massive subsidy relative to private deposit insurance.

      Liked by 4 people

  22. Tim, Mel Watt is meeting with Hal Scott (Harvard Law) next Monday to discuss the GSEs. Is Hal friendly toward the GSE model?


  23. Your proposal is far the best . Simple, fair and easy to implement. Your experience makes the difference. There is no substitute for experience.
    The truth will prevail.

    Liked by 2 people

  24. Well done! This is a well written and very insightful proposal. It is time to halt the third amendment sweep, recapitalize Fannie and Freddie and end the ‘temporary’ conservatorship.

    Liked by 1 person

  25. as to that part of the proposal re mortgage portfolio–“(2) restrictions on the size and use of their portfolios (limited to 10 percent of outstanding credit guarantees, and to purposes ancillary to the guaranty business),”– as of 2/16 fnma had mortgage portfolio of $337B and outstanding guaranteed mbs of $2,827B, so that part of proposal is almost already implemented

    Liked by 1 person

  26. Tim,
    Your ideas are brilliantly balanced! Thank you. I would just emphasize though that FHFA should only be a monitoring and enforcement agency and not manage FnF in any way, financially or otherwise.

    Liked by 2 people

    1. I had many issues with the Corker-Warner and Johnson-Crapo proposals, but one of the biggest ones was the degree of regulatory micro-management both prescribed. That would be a disaster in the real world. Making judgements on risk combinations, cross-subsidization schemes, loan variances and the like in real time at the regulatory level simply doesn’t work. In my proposal, FHFA sets the capital standards and the target return on capital, but leaves it to the management of the companies to make the day-to-decisions that allow it to balance its mission, shareholder and regulatory objectives in a constantly changing financial environment. FHFA oversees what the companies do, but does not tell them WHAT to do.

      Liked by 3 people

  27. Tim,

    Congratulations. Great article.


    “retroactively replace the 10 percent dividend on that stock with a more reasonable 1 percent markup over the cost of the funds Treasury borrowed to give the companies the $187 billion they did not need.”

    This 1% above cost of the funds is too generous. It should be break even with no profits.
    The conservatorship/sweep was imposed to rescue the flawed and failed financial markets and also rescue Gov.

    What about compensating FnF for use of FnF resources/services to stabilize and provide liquidity to markets, to rescue the flawed and failed financial markets and also rescue Gov?


    If other FIs can originate mortgage loans and also create/sell their own MBS (PLMBS),
    then why not allow FnF to start originating mortgage loans instead of depending on other FIs?

    FnF can open their retail offices employing thousands of people.
    FnF can also license or franchise small businesses to issue loans.

    This way FnF can,
    1. increase the reliability of loan quality.
    2. reduce costs of loan originations
    3. increase the FnF profitability
    4. reduce the costs to borrowers
    5. avoid dependency on unreliable and manipulative other FIs
    6. Provide employment to thousands of individuals and small businesses
    7. Avoid another 2008 crisis

    Liked by 1 person

    1. You said: “This 1% above cost of the funds is too generous. It should be break even with no profits.
      The conservatorship/sweep was imposed to rescue the flawed and failed financial markets and also rescue Gov.” Too generous to what party? Aligns with normal loan practices for the GSEs. If you just want a source of funds to bail out the banks so penalize the GSEs, then this is an injustice….go to the TBTF banks.


      1. 1stume,

        Too generous to what party? To Gov.
        (The context is very clear)

        Gov should not be making profits when Gov used FnF for public policy purposes.
        Gov should be paying FnF certain percentage on the bailout money they imposed on FnF.

        Liked by 2 people

    2. On the first point, I thought one percent pre-tax was fair, particularly in comparison to the ten percent after-tax dividends the companies were required to pay in the PSPA.

      On the second point, my years at Fannie made me a huge believer in the specialization of functions in the mortgage system. Fannie and Freddie are wholesale institutions; banks and other originators are retail. The personnel, skill sets and management required to successfully run a wholesale operation are very different from what you need in a retail operation. Even more importantly, there are valuable benefits to separating the origination and guaranty functions. There is an inherent tension between the two. Originators can make more money if they originate risky loans (on which they can charge higher mortgage rates and fees) but are able to pass them off to a credit guarantor as having less risk than they do. A specialized guarantor will always be on the lookout for that. If you merge the two, there’s a very good chance that the origination perspective (“we definitely will make more money by originating more and riskier loans [because we’re passing off the credit risk”]) will come to dominate the risk management perspective (“there’s a chance we MIGHT lose money on some of these loans.”)

      Liked by 1 person

      1. Tim,

        Thanks. Your opinions are well balanced with pragmatism.

        How about second part of Q1.

        What about compensating FnF for use of FnF resources/services to stabilize and provide liquidity to markets, to rescue the flawed and failed financial markets and also rescue Gov?


          1. Tim,
            It is quite understandable that you want to take balanced approach and provide practical solutions.
            In the the larger interest this may be the best approach.

            But if one looks at the ethical standards/tactics that were used by FnF detractors to stir up the anti FnF shareholder sentiments during 2008 crisis and subsequent fleecing of FnF and FnF investors (which includes thousands of gullible investors), this question does not seem to be unreasonable.

            What other private FIs would have done in similar situation?
            Also look at how Apple tackled most powerful Gov and also public relations.

            Even when we take your approach, it is not inappropriate to highlight this major concession from FnF shareholders side to get equally reasonable concession in return.

            We can not be less than any Great Negotiators.


          2. “Even when we take your approach, it is not inappropriate to highlight this major concession from FnF shareholders side to get equally reasonable concession in return.”

            Excellent to know I’m not the only one seeing shareholders giving concessions in this proposal and not getting anything in exchange for them.

            Liked by 1 person

      2. Tim,

        Do you recommend principles of “separating the origination and guaranty functions” to these other FIs?

        If other FIs were to be regulated just like FnF, then 2008 crisis would never have happened.


        1. oh man, i have a view on this comment by anon. if you want to find one culprit for the financial crisis, it was the ability of mortgage firms like countrywide to originate mortgages knowing that they wouldn’t hold them, but would securitize them and sell private label mbs.

          i agree, going forward, if there ever is going to be a rebirth of the private label mbs market, no one securitizing should be able to securitize what they originate.

          Liked by 1 person

  28. I like this approach very much. However, the 2% equity sounds incredibly aggressive. I would need to look at further modeling of loss exposure before I could support this but have confidence you were careful in your math. Politically, still an impossible hurdle to cross as is most politics now.


    1. Rick: It’s only aggressive compared with other capital ratios that have been proposed, most of which are either made up or based on bank capital requirements, which, as I note in the piece, are not applicable to Fannie and Freddie because banks can take so many more types of risks than Fannie and Freddie can. And remember that my approach starts with the government picking a defined level of stress against which it seeks to be protected. It then has FHFA use Fannie and Freddie data to determine–for the characteristics of the loans the companies are likely to purchase or guarantee– how much capital they will need to survive that stress. My analysis shows that 2 percent would be more than enough. And we also have the risk-based standard, that will make Fannie and Freddie hold more capital is their business shifts to a riskier mix. Remember, too, my objective of keeping secondary market financing affordable for homebuyers. Adding extra capital just because it feels “conservative”– but is more than is needed to protect against the defined stress standard– gets turned into higher required guaranty fees, and money out of homebuyers’ pockets.

      Liked by 2 people

      1. it seems that once you have GSEs accept a capped return, there is a direct trade off between the minimum capital ratio required to be maintained and the guarantee fee charged. one should be able to balance capital adequacy for GSEs with a fair G fee charged homeowners so that excessive capital adequacy does not become an unnecessary cost burden for the homeowner.

        so, it seems to me the key feature of this reform proposal is the utility model feature that calls for a return on capital sufficient to attract capital and maintain capital adequacy, but limited to extent necessary to ensure a market acceptable G fee level.


  29. I don’t agree with assessing risk models based on credit scores. The credit scoring model is deeply flawed. I believe everyone should put down a minimum of 20% down to obtain a mortgage backed by FnF. No exceptions, no credit score requirements. This allows for home buyers to have skin in the game.


    1. credit scoring is an accepted practice among personal lending and finance throughout all categories. while requiring down payments of 20% would provide more security, and thus require GSEs to retain less of a capital buffer, let’s keep our eyes on the objective, which is to promote a deep, responsible and broad primary mortgage market for all credit worthy home buyers, including first timers. “No exceptions, no credit scores” will not achieve this.

      Liked by 1 person

  30. Tim, you don’t address current shareholders. Is that by design?

    I’m confused…
    Isn’t turning FnF in to a utility essentially nationalizing them?

    How do you see current shareholders being compensated for the potential of lost returns when capped?

    It seems that most, if not all of the proposals I’ve seen clearly disregard current shareholders in order for the supposed “greater good”. Many of us have life savings in these companies believing the government in ’08 when we were told that everything was going to be okay. Some are now having to sell off in order to make ends meet. Some have died waiting.

    The word “shareholder” needs to cease being a dirty word.


    1. I did address shareholders, in the “Relationship with the government” section: “…Fannie and Freddie would remain shareholder owned.” The utility idea is a quid pro quo for getting the government backstop on their securities, after the boards of the companies have agreed to capitalize them to withstand a worst-case stress loss defined and agreed upon by administration policymakers. To me, this is a very fair trade that benefits homebuyers, Fannie and Freddie shareholders and the government (and the inaccurate shorthand for the government, “the taxpayer”) alike.

      I’m sure I and other commentators will have a lot more to say on this topic in the coming days and weeks, but I’ll make one other point at this stage. Fannie had uncapped returns when I was CFO, but we also were locked in a fight with our opponents and critics over whether the terms of our charter were fair, and if we had an “unfair advantage” over other financial institutions. This controversy gave rise to what became known as “political risk”– the chance that our critics might succeed in placing business limitations on us and Freddie Mac that would severely constrain our ability to earn a competitive return. That political risk cut our price-earnings ratio significantly. Personally, as a Fannie shareholder (which I still am), I would take a reasonable cap on the return Fannie could target in its pricing (and a subtlety I couldn’t get into in a 2000-word essay is that targeting a 10% return on capital doesn’t necessarily cap realized returns at 10% if the company underwrites prudently and manages its credit risks well) if that would greatly reduce or eliminate political risk, to the benefit of the company’s P/E ratio (and stock price).

      Liked by 1 person

      1. great work, as usual tim.

        couple clarifications. when you say…In an “exchange for consideration,” …do you imply that there would be a separate commitment fee paid to treasury? and would there by a cap on the governmental backstop? and this backstop, i take it, would only kick in only after GSEs ate through their “greater than risk-based or minimum capital” levels, correct?


        1. What I mean by “exchange for consideration” is that the boards of the companies agree to “exchange” their binding consent to accept caps on the returns they can target in their guaranty fee pricing and capital requirements that protect against a level of loss that it, the government, gets to define, for the “consideration” that the government commits to temporarily support the companies in the unlikely event that their losses exceed the government’s stress environment and their capital gets eroded (and management loses their jobs, and the value of shareholders’ stock falls precipitously). I do not include a separate fee paid to the government for this backstop commitment. If the government feels the stress standard isn’t severe enough, it should toughen it, not charge a fee.

          Liked by 1 person

      2. Thanks for the reply, Tim
        Perhaps there is something that I’m missing. In your original paragraph, you said homeowners and the government would benefit from this model. Nothing was said about shareholder’s benefiting. Are you saying that keeping the companies shareholder owned is a “benefit” to existing shareholders? That kinda screams arrogance (and I don’t mean that in a disrespectful way). Why would I, as a shareholder, feel grateful to keep my shareholder status? I would be giving away returns just to keep being a shareholder?

        Also, you may want to re-think your comments on FHFA having so much regulatory power without being specific about what they are allowed to do and not do with the companies. I’m basing this on past and current experience with FHFA, and Treasury’s current role in dictating what FHFA does.

        I can see why MetLife (and now GE today) want to get away from SIFI status. Privately owned companies beware.


        1. Maybe I should have been more explicit about the shareholder benefit (again, there are constraints to what one can say within a 2000-word limit).

          The best possible legal outcome for Fannie and Freddie’s shareholders is that every aspect of Treasury’s actions with respect to them–from before the conservatorships to now (and whatever they do before the courts rule)–gets overturned, and the companies are put back exactly the way they were at the end of August 2008. If that happens, I guarantee you that we’ll go back to having the old fight about whether Fannie and Freddie should exist at all, and if so with what constraints placed upon them. Why not try to fix what most of us, including me, think will make the companies work better for everyone, shareholders included?

          As to giving FHFA too much power, it will have no more power than bank regulators have. What made FHFA (and its predecessor, OFHEO) so dangerous previously is that it took the side opposite Fannie and Freddie in the fight over whether and how they should exist. You never would get to my proposed solution unless the regulatory establishment–including Treasury and FHFA–agreed it would work. I don’t know that we’ll ever reach the point where FHFA becomes as aggressively pro-Fannie and Freddie as the various bank regulators are pro-bank (and if we did it probably wouldn’t be a good thing), but if they just stop trying to make mischief and do their jobs as real regulators, I could live with that.

          Liked by 1 person

          1. I very much enjoy your thoughts. Just to be clear, I don’t have concerns with fixing certain aspects of the “flawed” model, Tim. And the only part of your proposal I’m having a hard time with is having the shareholders “benefit” in “exchange” for them giving away returns. I don’t see the benefit for shareholders, just giving.

            Guess it boils down to what a government guarantee is really worth? If the capital levels you suggest would be sufficient, why would a government guarantee be necessary still? No investor would buy the securities without it? Even with the capital levels you suggest?


          2. Your concern is totally legitimate, and I probably put a heavier weight on the service Fannie and Freddie provide to homebuyers/consumers than you might. The companies originally were chartered to provide affordable housing finance to homebuyers on a large scale, and I’ve always felt that the better they were able to do that, the more successful they, and their shareholders, would be.

            I do think the government guaranty is worth a lot. A Fannie or Freddie mortgage-backed security (MBS) with an explicit backstop from the federal government will trade at a very low spread over Treasuries, and at a premium to other fixed-income securities. That lower yield will be passed on directly in the form of a lower mortgage rate required on a loan that is financed through Fannie or Freddie. Lower mortgage rates to consumers mean more mortgages originated, and if Fannie or Freddie guarantee them, more business, more revenue and more profit for the companies. It’s a “win-win.” Might Fannie and Freddie earn more without government support for their MBS? I doubt it, but I honestly don’t know. From my perspective, however, it’s not an experiment worth trying.

            Liked by 1 person

  31. Thanks. Definitely support this series on GSE options that Urban is doing. Helps flush out the range of the perspectives and options.

    Looking forward to reading all of them.

    David H. Stevens President and CEO Mortgage Bankers Association 1919 M Street, NW, 5thFloor | Washington, DC 20036 TEL: (202) 557-2701 |

    Liked by 1 person

    1. David,

      You need to be one among these thought leaders to resolve these issues.
      But you need to be seen as someone who keeps the best interest of all and not just few.
      Rule of law, fairness and trust must be the key principals, and without these financial markets will vanish.

      This is a great opportunity for you to show your leadership.

      Liked by 2 people

      1. I emphatically disagree.

        David should stay out of the discussion completely, as he has never shown that he is interested in the nuts and bolts of complicated subjects and believes the rule of law is old and tired. He has never shown any interest in facts, and prefers to spin webs of inaccuracies to serve his own selfish greedy interests.
        Any judgment that David makes concerning any proposal should be disregarded.

        Yes, perhaps David can change his stripes, but he seems too old for that. It’s tough to teach old dogs new tricks. David needs to spend time looking in the mirror and face his transgressions instead of pretending to be a competent leader.

        In conclusion, David is not qualified to have a seat at the table in these discussions. Please go away David. We have heard enough from you already.

        Liked by 1 person

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