It should sound familiar: in a severe housing market collapse—with home prices falling by 25 percent—Fannie Mae and Freddie Mac are able to remain profitable on an operating basis, with their revenues exceeding their expenses. But temporary or estimated non-cash accounting entries booked by their conservator, FHFA, cause them to need to take over $100 billion in senior preferred stock from Treasury to maintain a positive net worth. The engineered “bailout” leads long-standing critics of the companies to label them a “failed business model,” and insist they be replaced with some unspecified alternative secondary mortgage market financing mechanism that allegedly will be better and more reliable (but in reality will not be).
This first happened in 2008-2011, after Treasury forced Fannie and Freddie into conservatorship and they came under the control of FHFA. And it happened again last week, when FHFA released the results of the Dodd-Frank “Severely Adverse scenario” stress tests done on the companies’ December 2015 books of business.
The second episode followed a predictable script. Bloomberg quickly put out a headline, “Fannie, Freddie Could Need as Much as $126 Billion in Crisis.” Its article began, “Fannie Mae and Freddie Mac could need as much as $125.8 billion in bailout money from taxpayers in a severe economic downturn, according to stress test results released Monday by their regulator. The Federal Housing Finance Agency said that the government-controlled companies, which back nearly half of new mortgages, would need at least $49.2 billion.” Senator Bob Corker (R-TN)—a long-time opponent of Fannie and Freddie—came forth on cue with his analysis and recommendation the next day. “This stress test is another reminder of our housing finance system’s failed model: taxpayers are on the hook during bad times, but investors benefit greatly during good times,” he said. “Reforming Fannie and Freddie remains the last major piece of unfinished business of the financial crisis, and this news highlights the need for comprehensive housing finance reform.”
Except it wasn’t, it didn’t, and Bloomberg got both the headline and the lede wrong. The headline should have read, “Fannie, Freddie Pass Stress Test; FHFA Fails It.” And the lede should have been, “Stress tests conducted on Fannie Mae and Freddie Mac this year by the Federal Housing Finance Agency showed sharp improvement from both 2014 and 2015, with projected credit losses now less than the companies’ revenues. Fannie Mae and Freddie Mac’s 2016 stress test results also were markedly superior to the results of 2016 stress tests conducted by the Federal Reserve on the nation’s 33 largest banks.”
As with so many other issues related to Fannie and Freddie, the facts about the Dodd-Frank Severely Adverse stress test—both for the companies and the banks subject to the test—are “hiding in plain sight,” readily available to anyone wishing to form their own independent opinion about them.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires the Federal Reserve to conduct annual stress tests of bank holding companies with assets of $50 billion or more. In these tests, the Fed projects six categories of income and expense (and the resulting total net income or loss) over a nine-quarter period, based on three different scenarios—baseline, adverse and severely adverse—developed annually by the Fed. The Fed has conducted Dodd-Frank stress tests on banks since 2013. FHFA implemented Dodd-Frank’s stress test requirement for Fannie and Freddie, using the Fed’s scenarios, in November of 2013, publishing the first results of those tests in April 2014.
For the 2016 stress tests for banks, Fannie and Freddie—conducted using data as of December 31, 2015—the Fed’s severely adverse scenario has real GDP declining by 6.5 percent through the first quarter of 2017, unemployment rising to 10 percent by the middle of 2017, and home prices falling by 25 percent through the third quarter of 2018. The Fed released the results of the 2016 bank stress tests on June 23; FHFA released the 2016 Fannie-Freddie stress test results on August 8.
The most striking results from the two sets of stress tests were the magnitude and trends of their respective credit losses. The 33 banks with assets of over $50 billion had $385 billion in 2016 stress credit losses—6.1 percent of their average loan balances and nearly half again as much as the $267 billion they were projected to have in 2014. In contrast, Fannie and Freddie had just $27 billion in 2016 stress credit losses—0.5 percent of their average loan (mortgage) balances and barely one-quarter of their $92 billion in stress credit losses projected in 2014.
Fannie and Freddie’s 2016 stress loan losses, in fact, were $3 billion less than their $30 billion in projected net revenues, meaning that on an operating basis the companies remained profitable during the stress period, just as they had throughout the financial crisis. Objectively, Fannie and Freddie “passed” their stress test. Yet as had been the case during the crisis, that was not the result FHFA (or Treasury) wanted to portray. And FHFA knew that by using the same types of non-cash losses it had relied upon to force the companies to draw $187 billion from Treasury during 2008-2011—this time helped by the companies’ near-total absence of initial capital because of the net worth sweep—it could produce the media headlines and public reaction it, Treasury, and Fannie and Freddie’s opponents were looking for.
Unsurprisingly, FHFA began with the loss reserve. With only $27 billion in stress credit losses, Fannie and Freddie’s loss reserves still rose by a combined $39 billion over the stress period. We can compare this with the reserve increase for the 33 banks subjected to similar tests. In the four Dodd-Frank bank stress tests done to date, the average credit loss was $327 billion, and the average increase in bank loss reserves was $23 billion. Fannie and Freddie’s 2016 credit losses were less than one-tenth the four–year average of the banks, yet the addition to the companies’ loss reserve, in dollars, was larger by more than half. Had the same percentage of Fannie and Freddie’s credit losses been added to their loss reserves as was added to the banks’, the companies’ reserves would have increased by $2 billion, not $39 billion.
Next, the $11 billion in non-cash market value losses shown for Fannie and Freddie during their 2016 stress test amounted to 1.6 percent of their $700 billion combined mortgage portfolios; bank market value write-downs of $29 billion in the 2016 test, on their $6.3 trillion loan balance, were one-third that magnitude, at 0.5 percent.
The Dodd-Frank stress test includes two categories of loss that the Fed applies to fewer than one-quarter of the banks it tests. The six bank holding companies with “large trading and private equity exposures” (JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) are subjected to a global market shock, while these six institutions plus State Street Bank and Bank of New York Mellon, with “substantial trading, processing or custodial operations,” also have a counterparty-default scenario component. Like the other 25 banks with $50 billion or more in assets, Fannie and Freddie fall into neither of these categories, but FHFA nonetheless used both of them to add a further $25 billion in estimated non-cash losses to their 2016 stress results. FHFA did not disclose how it arrived at that amount.
Finally, there was the deferred tax asset reserve. This category appears nowhere in the Fed’s stress tests, but FHFA trotted it out—despite the companies’ profitability on an operating basis during the stress period, and their indisputably becoming more profitable after the hypothetical stress is over—to suggest the possibility of another $77 billion in non-cash losses “depending on the treatment of deferred tax assets”. FHFA gave no rationale for the creation of such a reserve (it has none), but by including it in the tabulation of stress test results FHFA was able to publish a high-end “bailout” figure of $126 billion, which the media dutifully reported.
Any serious evaluation of Fannie and Freddie’s 2016 stress test, however, must differentiate between non-cash entries and credit losses. For as long as they remain in conservatorship, the only aspect of the stress test the companies can control is the quality of the loans they own or guarantee at the time the test begins. Here they have made remarkable progress. As of the end of 2015, 84 percent of Fannie’s $2.8 trillion in single-family loans had been acquired after 2008—comparable data aren’t available from Freddie—and the credit quality of those loans has been superb (perhaps even too good from an affordable housing standpoint). The Fed publishes stress losses by category, so we can compare banks’ residential mortgage losses with those of Fannie and Freddie. For 2016, the $1.2 trillion in first-lien residential mortgages held by the 33 largest banks (which account for 80 percent of all banking assets) produced stress losses of $38 billion. Subjected to the same test this year, Fannie and Freddie’s combined $5.2 trillion in single-family loans—over four times the size of the large banks’ holdings—had much lower stress losses, at $27 billion.
The real message of FHFA’s 2016 Dodd-Frank stress test, then, is that Fannie and Freddie have re-emerged as reliable, efficient and low-risk credit guarantors. FHFA is being a good soldier for Treasury in trying to disguise this fact by smothering the companies with non-cash expenses of $75 to $152 billion (depending on whether the deferred tax asset reserve is included) in the stress test. And while that may fool the media and the casual observer, FHFA is fighting a losing battle. Fannie and Freddie only will get stronger with time, and FHFA will run out of ways to hide it.
FHFA is the one failing the stress test. It would not be at all difficult for FHFA to do a true stress test for the companies—one that does not require (or allow) estimates or assumptions of future losses to determine its results. FHFA could subject Fannie and Freddie’s books of business to a 25 percent fall in home prices over whatever time period it chooses, then project their income and expenses, by major category, for as many quarters as it takes to produce a peak dollar amount of losses. The exercise would be all cash flows, without estimates or timing differences, and the maximum loss amount reached would be the basis for setting the companies’ capital requirement.
Yet FHFA is highly unlikely to devise and conduct such a test as long as it is under the influence and control of Treasury, because Treasury does not want it to. A no-gimmick stress test would make it readily apparent that—contrary to Treasury’s fabricated claim that Fannie and Freddie have “fatal structural flaws” requiring them to be wound down and replaced—the companies could in fact be very effective credit guarantors, posing little or no risk to the government, with far less capital than Treasury, Senator Corker and others insist they hold. Derived from an honest, FHFA-run stress test, credible capital requirements for Fannie and Freddie would make it difficult if not impossible to stampede Congress into replacing them with alternatives that serve a narrower range of homebuyers at higher costs than Fannie and Freddie would be able to do. The companies’ opponents know that, and their plan is to stick with fiction over fact for as long as they can. So far, it’s working.
Two things can change this. One is a ruling or rulings against Treasury and FHFA in the net worth sweep cases, which would force FHFA to conclude that it must follow the law and start complying with its statutory duties as conservator of Fannie and Freddie, independent of Treasury. (Setting capital standards for the companies, using a true stress test, would be a top priority of an independent FHFA.) The other is for mortgage reformers and policymakers to open their eyes to the deceptions being carried out in front of them. Whether it’s the 2008 takeovers of Fannie and Freddie disguised as a rescue, the artificial expenses booked by FHFA during 2008-2011 that forced the companies to take $187 billion in senior preferred stock they didn’t need and aren’t allowed to repay, or the phony FHFA Fannie-Freddie “stress test” being peddled to the public in the guise of an honest one, the curtain has been pulled back on the activities of Fannie and Freddie’s opponents. Anyone can now see behind it—provided they wish to.
HOWARD ON MORTGAGE FINANCE 
Tim,
I hope you had a nice Labor Day weekend. Today, National Mortgage News made the following prediction:
Conservatorship Era Comes to a Close
“No matter which party wins the White House and Congress, this one is bound to happen, and soon. After all the talk, in the end Fannie Mae and Freddie Mac will become fully-privatized companies and returned to their shareholders because it’s the easiest thing for the government to do.”
“In the future, Fannie and Freddie won’t have any government charter or guarantee, which will open the door for others to compete in their space. That makes it quite likely one or both will be acquired by a financial exchange.”
In your professional opinion, how likely of a scenario is this prediction? Thank you in advance.
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I hadn’t seen this, but in checking it I note that the quote you cite is from an article titled “10 Bold Predictions for the Future of the Mortgage Industry,” with no attribution of authorship. For this one, I would say bold perhaps; accurate, highly unlikely.
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I find it interesting that Wells Fargo is the leader in mortgage finance among the big banks and also the most sound financially as far as its mortgage holdings [if I’m understanding the news recently and since “the crisis”]
Given where you came to Fannie Mae from Mr. Howard…
Coincidence? or can you possibly take some credit for this? If so, it would seem that is another example of the expertise the media should be made aware of when considering the validity and value of your opinions and statements when presented to the public.
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I don’t know that I would call it a coincidence, but there is no connection between Wells Fargo’s leadership or performance in the residential mortgage market and the fact that I was senior financial economist there 35 years ago. In fact, it’s not even the same bank; Wells was acquired by Norwest Bank of Minneapolis in 1998. Although it then was called it a “merger of equals,” the reality was that Wells, though slightly larger, was the weaker company, since a few years previously it had done a hostile takeover of First Interstate Bank and was struggling to integrate it. Most of the senior people who ended up running the combined entity came from Norwest, although they sensibly retained the Wells Fargo name, the stagecoach as their symbol, and the headquarters in San Francisco.
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Apropos of absolutely nothing, except Tim’s memory of the old Well’s HQ in SF and with its old west theme. Four years before I went to Fannie and was working on the Hill for a HBC Member, Wells had a flamboyant lobbyist–whose name I won’t mention–but who liked to leave his “business card,” which was a piece of fringed leather with the bank’s logo and contact info stamped into it–and other tchotchkes with congressional offices staff.
However, one time–to underscore his importance and to build some goodwill– he came around and handed out to Members and their staffs one or more of the soon-to-be-issued “Susan B Anthony” dollar coins, gloating about his bank’s importance as an issuer (as all national banks were).
A very pissed off House Banking Committee professional staffer, whose subcommittee approved the “Susan B” enabling legislation, blew the whistle on him and Wells to the Secret Service for “early distribution,” and the SS made the guy–by now red-faced and embarrassed–go back to all of those offices and collect the coins.
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tim
i read through the urban institute GSE risk sharing piece. I was struck by the following quote, which the authors insert approvingly:
“Federal Reserve Board Governor Daniel Tarullo made this point eloquently in a recent speech. Rather than dwell on definitions…I think it more productive to focus on the characteristics of shadow banking-related financial activities and institutions that are most likely to pose risks to financial stability and to the economy more generally.
Front and center among these risks is that of runnable liabilities…As has been frequently observed, the recent financial crisis began, like most banking crises, with a run on short-term liabilities by investors who had come to doubt the value of the assets they were funding through various kinds of financial intermediaries. The difference, of course, was that the run was not principally on depository institutions, as in the 1930s, but on asset-backed commercial paper programs, broker-dealers, money market funds, and other intermediaries that were heavily dependent on short-term wholesale funding.
Lacking enough liquidity to repay all the counterparties who declined to roll over their investments, these intermediaries were forced into fire sales that further depressed asset prices, thereby reducing the values of assets held by many other intermediaries, raising margin calls, and leading to still more asset sales. Those financial market actors who did have excess liquidity tended to hoard it, in light of their uncertainty as to whether their balance sheets might come under greater stress and their reluctance to catch the proverbial falling knife by purchasing assets whose prices were plummeting with no obvious floor.”
it seems to me that in order to avoid these periodic disappearances of private capital availability and the resulting liquidity runs, the most salient method of ensuring permanently available capital is through common and preferred stock raises by the GSEs. this capital is permanent and once raised not subject to any vagary on availability. we can debate about capital ratios, but what is the debate about GSE equity capital’s suitability to fix this problem?
it also strikes me that the national stock market is the best way to promote price discovery for taking on this equity capital. so in terms of permanent availability and price discovery, why go through all of the contortions in the so-called private capital markets when the most promising form of private capital, GSE equity capital, is always available and repriced daily?
all of which leads me to believe that the authors smell a new income source, advising on different ways to raise private market capital, since the most efficient way, raising GSE equity, is far too efficient for them to contribute any value added.
all best
ROLG
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I completely agree with you on the superiority of what I call the “entity-based model” of credit guarantees– having a public, shareholder-owned company with up-front equity capital taking single-family mortgage credit risk while putting its own name on the guaranteed mortgage-backed securities it issues– compared with the risk-sharing model the authors originally proposed in the “Promising Road” paper they published back in March. Hard equity capital has a known and measurable cost and, critically, there is no question as to whether it will be available if and when it’s needed: it’s right there, sitting on the balance sheet.
What I found most intriguing about this latest Goodman-Parrott-Seidman-Zandi paper is what I would term its “policy ambiguity.” The authors clearly are backing away from the notion that securitized risk-sharing (which had been featured prominently in the original “Promising Road” proposal) could ever be a reliable form of attracting capital to the mortgage market. Indeed, at the end of their piece, they say, “…the FHFA and the GSEs should be cautious about relying so heavily on back-end capital market transactions, given the volatility of the capital involved.” (I’m tempted to say, “Well, yes, but weren’t YOU among the ones originally telling them to do that?!!) Now they’re saying that FHFA, Fannie and Freddie should look at other forms of risk sharing, but as you read their paper the authors admit (to their credit) that each of the mechanisms they discuss has their limitations, weaknesses, uncertainties and drawbacks. That leads me to wonder: do they STILL think the mortgage finance system of the future should require mandatory risk sharing of some sort, or they coming around to the recognition that you need SOME type of entity-based guarantor or guarantors at the center, which can do risk sharing when it makes sense, but aren’t forced to do it when it doesn’t. That’s certainly been my position.
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The title should be changed from “A more promising road to GSE reform” into “The most improvised road to GSE reform”.
Definition of improvise: to compose and perform or deliver without previous preparation.
Think tanks should refrain from improvisation and adopt higher standards and ethics
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hey tim
hope you are enjoying your summer.
i thought you would be interested in this, from zandi: https://www.economy.com/mark-zandi/documents/2016-08-25-How-to-Improve-Fannie-and-Freddie's-Risk-Sharing-Effort.pdf
it’s beyond me but certainly not you.
all best
ROLG
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I hadn’t seen this article (on risk sharing) yet; thank you for pointing it out to me. I think it’s a good piece.
By way of background, prior to publishing my recent post on Fannie Mae’s risk-sharing transactions (Far Less Than Meets the Eye), I had shared its main points and conclusions with two of the authors of this article. They did not dispute them. Thus, I’m not surprised at their title: “How to Improve Fannie and Freddie’s Risk Sharing Effort.” It certainly does need improving.
Early on in the article, the authors (Laurie Goodman, Jim Parrott, Ellen Seidman and Mark Zandi) say, “We recommend expanding the CRT [credit risk transfer] effort to include greater focus on a wider range of structures and sources of private capital to provide the broader experience and price discovery needed to understand what mix of structures and sources of capital will best serve the housing finance system, not just today but through the business cycle and over the long term.” My translation of this sentence (not theirs) is: “Yeah, we know Fannie’s CAS transactions don’t work very well, but there are other things they ought to try.”
I agree with that, up to a point. Over the balance of the article, the authors discuss four other types of risk-sharing mechanisms: lender recourse, deep cover mortgage insurance, back-end capital market transactions by LTV and credit score range, and catastrophic risk transfers. I think each of these mechanisms has a potential role to play. The one very strong caveat I would add, though, is that each of them has to make economic sense relative to alternative risk-taking approaches. If they do not, using them will either be more costly to the homebuyer, less safe for the mortgage finance system, or both. Risk sharing simply for the sake of risk sharing is not a virtue.
Finally, I also couldn’t help but notice one other sentence at the beginning of the article: “And although we believe our recommendations are consistent with the FHFA’s existing authority, if the FHFA believes that any are not, then we suggest that it work with Congress to enable the FHFA and the GSEs to continue to make progress on this increasingly critical endeavor.”
My interpretation of THIS sentence is straightforward. I mentioned in a comment a couple of days ago that I was surprised no Fannie shareholder had yet sued FHFA for having Fannie pay half the cost of the common securitization platform, since it benefits Freddie at Fannie’s expense. I’m also surprised no Fannie shareholders have sued FHFA for wasting the company’s money by forcing it to issue billions of dollars of CAS transactions that transfer little or no credit risk but carry very high interest costs. FHFA will have the same legal vulnerability if it “experiments” with new forms of risk sharing without regard to their economics. The authors seem to agree, saying in essence, “FHFA, if you think doing more experimental risk sharing with the companies’ money might be inconsistent with your role as a conservator, you should get Congressional approval.” I could not agree more with that advice.
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Gee, I guess I missed that section where the authors gave you credit for making your suggestions which they adopted. I hate that when it happens!!
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I’m grateful for your rational discussion with other interested people. I think a consensus is a likely result. Stegman has recently said something rational too.
My key questions to be considered: How much higher rate for people with good credit if a new system is adopted? How many will not get a loan at all? What is impact on house price and economy?
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I hope we can reach consensus. A more likely outcome is that we can get better clarity on what the true alternatives for mortgage reform are, so policymakers can make an informed choice. Today’s mortgage reform debate is more political than economic (unfortunately), and advocates for a particular outcome—which favors institutions or ideologies they support—deliberately overstate the benefits and underplay or ignore the drawbacks of the reforms they’re promoting. To arrive at the best reform idea, reformers and policymakers first need to understand that much of what they’re being told is true in fact is not. That’s a slow and tedious process (which the financial media to date has shown little interest in advancing). Hopefully, though, we’re making progress with it. “Howard on Mortgage Finance” is aimed at helping with that effort.
As to your question about the effect on credit availability, mortgage rates and housing in general of the “new system,” that’s what the battle is about. If we can get reform right—which in my view means designing the system to benefit consumers rather than financial institutions—we should see improvements in all three.
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Tim,
I raise what a I believe is a similar point on another site. How may a conservator implement certain mortgage refinance programs?
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Ron: What FHFA SHOULD be doing is acting as a true conservator– taking actions that maximize the value of Fannie and Freddie’s assets. FHFA clearly has not been doing that since the time it was made conservator (by Treasury); it has been acting to further Treasury’s objective of winding down the companies and replacing them (the “with what” part keeps changing).
FHFA’s insistence that Fannie do large amounts of costly risk-sharing transactions that transfer little or no credit risk away from the companies was an egregious example of its putting Treasury’s interests ahead of the companies. My fear is that FHFA may do something similar with these other forms of risk sharing. It should not.
As I’ve said many times in many places, I have no objection to any of these risk-sharing mechanisms, as long as they make economic sense. I DO object–and will continue to object– to risk sharing initiatives that are done to make an ideological statement, to “experiment” at the companies’ expense, or to (cynically) move revenues out of companies Treasury doesn’t like to capital markets investors (which they do).
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Aristotle said the whole is greater than the sum of its parts. As such, the Fannie and Freddie GSE business model is an example of synergy which benefits borrowers, investors and taxpayers. Its beneficiaries include Wall Street and Main Street.
US Treasury is pushing the 1980s Michael Milken meme “the parts are greater than the whole”. Let’s be real. The goal is more wealth transfer to the 1%. And the alternative risk-sharing transactions outlined in the aforementioned paper all result in a transfer of benefits from Main Street to Wall Street. Cuz the effect is costlier transactions. Born by borrowers and taxpayers. As well as outright theft of tangible and intangible assets from shareholders to crony industry participants. Since 2008.
In the end, credit markets operate via systemic trustworthiness. Without which is no there, there.
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After all the years still experimenting…lol
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You can count on FHFA to do the right thing after they’ve tried everything else. Winston Churchill
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Mr Howard,
If all court cases are dismissed by 2018, in your opinion, what would happen to the US Economy 5-10 years from now if one of the following two scenarios materialized?
1. Republicans wind down FNMA and hand over the securitization platform along with any other residual business to the big banks.
2. Democrats find a way to merge FNMA and FMCC into one nationally owned firm, eradicating all current private shareholders, as well as creating some legislature to keep the debt off the gov’t balance sheet.
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I think your first scenario is easier to address. In this case, we would go back to having primarily a deposit-based mortgage market. That would mean a much higher share of adjustable-rate mortgages (ARMs), since those match up better with banks’ short-term consumer deposits. A higher ARM share initially wouldn’t have too many noticeable effects, but over the 5-10 year time frame you’re asking about if the economy overheats and the Fed is forced to raise interest rates, consumers would face rising interest payments on their ARMs, which would reduce the amount of money they have to spend elsewhere and exacerbate the economic downturn when it arrives (this wouldn’t happen with fixed-rate loans).
In the first scenario banks also would very likely run a fixed-rate mortgage securitization program, but one that would charge considerably higher guaranty fees, since it undoubtedly would be capitalized with the same percentage of capital banks use for their on-balance sheet mortgages (with a fifty percent Basel III risk weighting), even though the capital requirements for the mortgages banks hold in portfolio cover both interest rate and credit risk, and the guaranty function only would be taking credit risk. Much higher capital would lead to much higher guaranty fees–which would be added on to mortgage rates–and that would result in considerably lower volumes of fixed-rate mortgages being originated. Housing starts, home sales and home prices all would be lower as a result, although how much lower is difficult to quantify. Banks also would do explicit risk-based pricing for all of the fixed-rate mortgages they guarantee, and since affordable housing loans would have the highest fees, the availability of fixed-rate loans for low- and moderate-income homebuyers would suffer disproportionately.
Your second scenario, in my view, has too many unknowns to permit meaningful speculation. It would depend heavily on how the “nationally owned firm” chose to guarantee mortgages. If it guaranteed fixed-rate loans the way Fannie and Freddie do now–at the firm level, with broad risk diversification– the main impact on the market would depend on how the firms were capitalized (which would affect the pricing of their credit guarantees) and how they were regulated (here I’m thinking primarily about affordable housing initiatives). But even here there are unknowns, with the main one being the transition from the existing system (which has $5 trillion in Fannie and Freddie guaranteed mortgages outstanding) to the new one. And unfortunately you can’t rule out the possibility of Congress doing something unwise. An obvious example would be requiring the new national guarantor to lay off most or all of its credit risk in the capital markets. I could easily see them starting off down that road, only to realize three or four years later that they wildly overestimated the market depth for securitized risk-sharing structures, but now have no alternative to them. The ensuing calamity could make us pine for the “good old days” of 2008.
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May I suggest the Great Depression as a model of what could and probably would go wrong, mortgage insurers going bankrupt, the foreclosure rates skyrocketing, as people are left homeless and unemployed?
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Tim,
Have you been asked to go on any business news networks to discuss the biggest rip off in US History? Have you considered writing a follow up book to “the Mortgage Wars”?
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Yes, I have been asked to go on business networks to discuss Fannie and Freddie, but not for a while. I was reminded of this last week, when several people called my attention to a segment done on Fox Business, in which a number of their reporters interviewed Tim Rood of the Collingwood Group about Fannie and Freddie issues. One was the Fannie-Freddie stress test. Behind a huge “$125.8 Billion” sign, Maria Bartiromo said (paraphrasing), “A new stress test shows that Fannie and Freddie may need another $126 billion bailout, and the public is not happy about it. What’s your reaction?” Rood did not challenge the premise of the question, and really didn’t give an answer to it, while the $125.8 Billion stayed up on the screen.
I bring this up not to be critical of Rood—who isn’t a mortgage finance expert and I’m sure is not familiar with the mechanics of either the Fed’s or FHFA’s Dodd-Frank stress tests—but because this episode relates so directly to the last time I was invited to appear on a major business show. It was on Fox Business, and it was to appear on a segment with Tim Rood.
Fox called me one morning to ask if I would be willing to appear with Rood that afternoon to discuss the Johnson-Crapo bill. I said I would. Someone who knew both Rood and me arranged for us to talk by phone prior to the interview, which we did. Fox emailed me a set of questions about the issues they wanted to discuss, and I answered them and sent them back. An hour or so before the interview, Fox sent a car to my house to take me to its DC studio. While it was waiting outside, however, I got a call from them, saying there was “breaking news” and they wouldn’t be able to do the interview they’d scheduled with me. I sent Rood a text asking if he knew what the breaking news was. He texted me back, saying, “I’m still on. They said you had a conflict.” I responded, “That’s [expletive deleted]. They disinvited me. I’m sitting here all dressed up with no place to go.” Sure enough, the interview aired, with Rood but not me.
There is no explanation for my being dropped from the interview other than that Fox did not like the opinions I’d expressed in their questionnaire, and they did not want to give those opinions any air time. I believe a version of this same thing is what’s keeping me off the business news shows now. In any event, I’m not getting the invitations I once did, even though, because of “Howard on Mortgage Finance,” I now have a higher public profile.
As to a follow a follow-up book to “The Mortgage Wars,” I don’t plan one. I wrote “The Mortgage Wars” primarily because there were important facts and information about the mortgage crisis and mortgage reform that I felt needed to be put into the public dialogue, and the book was a good way to do that. Now, the issue isn’t that the facts aren’t available. They are. It’s that people—including many in the print and broadcast media—are committed to pretending that those facts don’t exist.
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Here’s the only guy at FOX that supports the GSEs.
http://radio.foxnews.com/2013/08/09/video-tom-dont-kill-the-housing-recovery-by-killing-fannie-freddie/
Unfortunately, it appears he’s been cut off from speaking up.
In my view, the Republicans have cut a deal with the top level Democrats who are tired of being vilified for supporting the “toxic” twins. They both want to get rid of the GSEs, but just have different ideas on what to replace them with. That’s why the congressional Republicans are allowing the fraud to continue uncontested.
The only thing saving the GSEs now are the honest congressmen fighting against their leaders that want what’s best for their constituents.
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Thanks for sharing Mr. Howard! Perfect example of why everyone has to take the STAGED media feed with a grain of salt. Sometimes a block of salt.
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Thank you, Tim, for background on the history of media coverage post 2008 as it pertains to the GSEs.
Have you thought about contacting Gretchen Morgenson with your thoughts on Risk-sharing, the CSP, and the overall nature of the “conservatorship”? Her coverage of the “reform” efforts and the forces behind that movement has in my opinion been very well done. I have to imagine she would entertain a conversation with you about the assertions you have made.
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Thank you for your suggestion. I am in fact thinking about followup contacts with a few journalists who might have an interest in several of the issues I’ve raised in recent posts (or, as with the CSP, in the comment section). While the “usual suspect” journalists who cover Fannie and Freddie on a routine basis and whom I or others have contacted have not been receptive to requests that they treat these issues more objectively (or honestly), I agree with you that there are others who would, if they chose to look into them and found what I’ve said about them to be credible and newsworthy. It’s definitely worth pursuing, and I plan to.
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Tim,
Since Ralph Nader has gone silent on this #fanniegate scandal, we humbly turn to you to get the word out in the media. Micah Morrison of Judical Watch has expressed an interest into covering, do you have any suggestions on what average investors can do to get the truth out?
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Tim, I tweeted Gretchen Morgenson earlier today and asked her if she was doing another F&F article, She replied “For sure”….maybe you can contact her.
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Tim, your blog is much appreciated by many. There has been much speculation about the CSP and how it will affect Fannie/Freddie moving forward. Many believe it is an avenue to transfer assets away from the GSEs. In your opinion, is the CSP a true threat to shareholders as the court cases continue to play out? Thank you in advance.
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I’m not that worried about the Common Securitization Platform (CSP) as a threat to Fannie and Freddie.
The CSP is one of two initiatives being pushed on the companies by Treasury (and FHFA) as part of their plan to ultimately replace them with a mechanism that is more beneficial to the large banks and investment firms (and more costly and burdensome for homebuyers). The other is mandatory securitized risk sharing, which I wrote about in my previous post.
Treasury envisions having Fannie and Freddie complete the CSP, then turning it over to a de novo entity, with the companies being wound down by the government. The new entity then would issue mortgage-backed securities backed by some form of non-Fannie or Freddie credit guaranty. Treasury’s “idée du jour” for the guaranty is securitized risk-sharing, but as I hope I demonstrated in last week’s post, there is very little demand among capital markets investors for risk-sharing securities that actually do share risk, which is why Fannie is having to issue securities that only pretend to. Treasury, and Fannie and Freddie’s other opponents, still haven’t come up with any workable idea for replacing them.
Thus, I don’t view the CSP to be that much of a threat because I don’t believe there will be anybody (or thing) to give it to. Fannie and Freddie’s key competitive advantage is their business model: prudently underwriting mortgages, then diversifying their credit risk across product and borrower type, geography and time. I can’t see Congress shutting down Fannie and Freddie just to replace them with new companies (with all the attendant start-up risk, and less liquidity for their securities) that do exactly the same thing as Fannie as Freddie do, and de novo credit guarantors that DON’T look and work like Fannie and Freddie either won’t work at all or won’t be as effective as, and will serve a narrower range of homebuyers at higher costs than, the companies.
Having said that, though, I do think the CSP is a threat to Fannie’s shareholders, and I have been surprised for some time that no Fannie shareholders have filed suit against FHFA to stop it. FHFA (and Treasury) are spending Fannie’s money to build a securitization platform that will eliminate a competitive advantage Fannie has over Freddie—the payment structure of its MBS—that allows Fannie to attract much more business from lenders at the same guaranty fee as Freddie, or the same amount of business at a significantly higher fee. It makes complete sense for Freddie to build a new securitization platform that mimics Fannie’s; it makes no sense for Fannie to foot half the bill for building the same thing, as it’s doing now.
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Mr. Howard,
I hope you have read the Aug 20-26, 2016 issue of ” The Economist”. The front page is titled “Nightmare on Main Street” and a caption ” the horror underlying America’s housing market.The article is a lot of deception justifying to give 100 percent of the secondary mortgage market to the wall st.big banks that primarily caused the 2008 crisis.
As you have said before there should be a rebuttal on the deception and the title should be ” Nightmare on Main Street caused by Wall st. ”
I wish and hope you can write a letter to the editor considering your expertise to counter their lies or allow any one of us to write using your articles in your blog.
Anyway I salute you for all your efforts. I hope you do not mind the above request.
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No, I certainly don’t mind the request. I hadn’t seen the Economist article until I read your comment. I’ve now reviewed it, and actually didn’t think it was all that bad (for The Economist, which has done some really awful pieces in the past). The authors don’t repeat the old “Fannie and Freddie caused the crisis” fiction, get most of the history of the crisis right, and also are correct that the system shouldn’t continue as currently structured (with Fannie and Freddie in perpetual conservatorship, and Treasury taking all their earnings and leaving them with no capital). I disagree with their one soft conclusion—that Fannie and Freddie should have bank-like capital (10 percent)—because they’re not banks, don’t have bank-like risks, and forcing them to hold that much capital would cause much higher mortgage rates and greatly reduce the availability of mortgages to lower-income borrowers. But overall I didn’t find the article that problematic.
I have no objection at all to anyone using material from one of my posts in writing a letter to the editor to The Economist (or any other publication). As to writing one myself, I’d say “probably not.” To date I have a perfect record in acceptances of op-eds and letters submitted to major publications: several offered, none taken. I haven’t given up, but recognize I need to be selective in the opportunities I go after.
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Mr. Howard, Myself and number of shareholders which I am in various groups with would like to send a group letter with all our signatures on it to he Board of Directors for both GSE’s. I personally hate talking about the fact I was one who bought shares before conservatorship but have also averaged down since. We can easily come up with 30 to 40 signatures. The question I have is what should our letter contain. Is there any possibility you can provide a draft on what such a letter should look like. We are split in commons and preferred shares. Any recommendation would be much appreciated.
Regards,
Randal
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Randall: Unfortunately, there’s not much the boards or management of Fannie or Freddie can do about the market values of your investments in the companies, be they common or preferred. That’s up to the courts. If the net worth sweep is upheld as legal, Treasury will own all economic value in the companies in perpetuity, and your shares will be worthless. If you’d like to send the boards a letter, however, you might consider something along the lines of what I suggested to “Halo Hat” (below): urging the board and management to do everything in their power to run the companies in a manner that will increase the value of your investments when—as you expect—the courts do rule against the net worth sweep.
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Thank you for your quick response! I do agree and we were thinking letter after Perry Appeal ruling but we are obviously getting ahead of ourselves as this has not happened yet. Much regards! Randal
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Why the truth of this situation is not greater news than the politics, fraud and greed shown by our government is truly sad given how little it takes to learn the truth.
I would love to hear your opinion on what individual “small” investors may do to make a difference at this point, if you have an opinion you would be willing to share. Given your position at Fannie, how far would you say an individuals voice could be heard within FnF and where might we most productively direct our energy towards our voice being heard.
Thank you again for all you have given us so unselfishly.
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Individual investors, and indeed everyone involved in this issue, need to take the long view. Provided you’re not expecting to get an immediate positive reaction from your efforts, I think it’s a very good idea for investors to tell Fannie and Freddie’s management, and board members, what you believe they should be doing to maximize the value of your investment in their companies. Most of the companies’ top management and board members probably already know this, but hearing it directly from stakeholders would buttress that awareness, and could pay dividends later on.
The reality at the moment is that Fannie and Freddie’s management and boards feel constrained from acting independently of FHFA, and FHFA feels constrained from acting independently of Treasury. I don’t believe this will change until one or more of the court cases goes against the government, but when plaintiffs DO win in the courts–and I believe they will–those constraints will be greatly lessened. I’m confident that Fannie and Freddie’s management and boards want to do the right thing, but feel they can’t under the current circumstances. “Bucking them up,” as it were, by telling them that you understand their dilemma but nonetheless want them to do everything they can to act in investors’ best interests, certainly wouldn’t hurt, and very possibly could help.
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Tim,
Thanks for your service to the nation and
helping the cause of openness, transparency and fairness.
You are amazing with financial analysis and facts.
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Masterfully communicated. One question. Do you think that the FHFA, if and when released from the spell of the Treasury, will not only see through the cloud of smoke but have the integrity of will to think and act independently from the same myths promulgated by both broken political parties?
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I wish I knew. If FHFA is released from the grasp of Treasury it will be because the government has lost one or more of the court cases. In that instance, Fannie and Freddie will be in a stronger position vis-a-vis mortgage reform, because in any transition to some new mechanism the companies’ shareholders will likely have to be dealt with. This, by itself, will raise the odds of the companies surviving, and if that becomes clear to FHFA it will have more reason to regulate them rationally and sensibly. An early litmus test of FHFA’s intentions (and competence) under those circumstances will be what it does with their risk-sharing programs.
Still, FHFA won’t be able to detach itself from the economic and financial policies of whichever party takes the White House this November. If the goal of the economic policy team of the next administration is to replace Fannie and Freddie, I believe FHFA will support that. It will just have to walk a finer line, legally, than it’s doing now in conjunction with Treasury.
But having said that, I also think whichever party wins the election won’t want do anything with Fannie and Freddie that will risk roiling the mortgage and housing markets. And since I still haven’t seen a mortgage reform proposal that I believe would be workable (and my recent work on Fannie’s risk-sharing transactions convinces me that anything remotely similar to the recent “Promising Road” proposal would be disastrous), I’ve become more confident that we could end up with something not too different from what we have now with Fannie and Freddie. Should that happen, I believe FHFA could pull itself up and become a competent regulator.
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Tim,
Tracking and it does sound cogent. So many variables but rationality could very well prevail. The alternative is to undermine housing and the only way to do that is to break the law. So, in a word, I think rule of law not only protects shareholders, it’ll save housing in the end.
Thank you for your labors.
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Very good write Mr. Howard and thank you for it! Just very sad our government does not tell the public the truth! What are we as citizens of this great country to think! I suppose we must think we are no longer a great country and our leadership is propagating deception. Just very sad! Thanks again for your expertise and the truth nobody else will tell!
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Mr. Howard,
Thanks for this article. This is a great article to counter the lies on the financial health of FNF. This is big time manipulation and deception (on your own word), similar to what they have done starting 2008. They accelerated the losses through artificial expenses. Under acceptable GAAP rules do you think they are legal? We have so many cases pending in the court on the legality of what FHFA in collusion with Treasury are doing. From your point of view as financial expert, is putting in artificial expenses the same as putting in artificial income (which are both considered illegal)?
Deception is illegal similar to what executives of Enron did and confirmed by the court verdict on that case.
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What I (and others) believe to be the booking of artificial expenses by FHFA for Fannie and Freddie during the 2008-2011 period IS illegal, and it’s being challenged in court, most prominently by Washington Federal in a case filed in the Federal Court of Claims. And both companies’ outside auditors (Deloitte for Fannie, and PricewaterhouseCoopers for Freddie) are being sued for signing off on financial statements that plaintiffs contend were fraudulently prepared (by FHFA) and filed with the SEC during this period.
But a stress test is different. It isn’t audited, and FHFA has considerable leeway in the assumptions it chooses to make in running it. About all one can do here– as I attempted in my piece–is to call attention to the unreasonableness of the assumptions FHFA makes in conducting the test, to note that the resulting “total loss” figure that results is essentially meaningless, and to point people to the one aspect of the test that does have integrity–the projected stress credit losses.
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Right on! I like it!
“Fannie, Freddie Pass Stress Test; FHFA Fails The Stress Test.”
Thank you very much!
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You are a true patriot.
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Wow….after every article you write I am just amazed by your vast knowledge of the numbers and mortgage finance. Thank you Mr. Howard.
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Thank you for the work you do. I have long admired the integrity of Mel Watt for the many years he served in the US Congress. That being said, it amazes me how he and many Democrats have abandoned the cause of fair housing policy. It sadly appears that our politics truly are one big party for the benefit of BIG banks and business. Again thanks for all you do.
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Mel Watt, integrity, same sentence? What integrity? He knows the truth and allows illegal acts to continue. He might as well be holding up a bank with a gun!
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