Investors Unite Risk Sharing Call

~ jtimothyhoward

Earlier today I participated in a conference call hosted by Investors Unite titled, “What is Risk Sharing, and How Does it Work?” Below is the text of my prepared remarks for that call. Included at the end is a brief addendum, “Turning the Tables,” which didn’t fit the format or time allotment for the call but I think adds some useful perspective.

The topic I’ve been asked to address this morning is, “What is risk sharing, and how does it work?”

I’d like to start by making a distinction between what I’ll call traditional credit risk sharing and non-traditional credit risk sharing.

Traditional credit risk sharing was what Fannie and Freddie did before they were put into conservatorship, and for all of the 23 years I was at Fannie. When the companies purchased or guaranteed a mortgage, they took on the credit risk of that loan themselves, and backed it with equity capital. They would do risk sharing—typically either by asking a private mortgage insurer to provide more coverage for high loan-to-value ratio loans on the front end, before the loan was acquired, or by asking them to reinsure existing pools of loans after they’d been acquired, on the back end—whenever they thought it made economic sense, both for themselves and for the borrower.

What’s being done today, though, might be called non-traditional credit risk sharing. Fannie and Freddie are in conservatorship, and even though they’re once again making money and are highly profitable, because of the net worth sweep they’re not allowed to retain earnings or build capital. Ostensibly for that reason, Treasury and the Federal Housing Finance Agency, or FHFA, have been requiring them to use different types of risk-sharing mechanisms to transfer as much of their credit risk as possible to “private market” sources. But mandatory risk sharing—as FHFA and Treasury are requiring—removes the normal economic discipline that exists when it’s the company, and not the conservator or regulator, making the choices about which risks to keep and which to share, and on what terms. And that leaves open the question many people are asking: “In the current environment, how are Fannie and Freddie’s risk-sharing decisions being made, and are they good for the borrower?”

As far as I can tell, what FHFA and Treasury are doing now is taking as a given the guaranty fees Fannie and Freddie are charging—which average close to 50 basis points before the extra 10 basis point payroll tax fee—then saying, in effect, “as long as we have enough guaranty fees to cover the cost, any credit risk sharing we do is better than leaving the risk with the companies, because they have no capital.”

There are, however, at least four problems with that approach. First, it penalizes borrowers by enshrining an arbitrary guaranty fee that’s too high for the “squeaky-clean” loans Fannie and Freddie are buying or guaranteeing currently. Second, it doesn’t permit anyone to compare the relative efficiency of the different types of risk sharing being considered. Third, it doesn’t explicitly take into account risk-sharing costs borne by the borrower, such as for deep-cover mortgage insurance. Any finally, it doesn’t at all address the effectiveness issue—whether a particular type of risk sharing really does produce the result it’s alleged to have.

I proposed what I think is a much better way to set risk-sharing standards in my response to FHFA’s request for input on credit risk transfers. And that is, whether you think Fannie and Freddie ever will emerge from conservatorship or not, use their cost of equity capital as the basis for assessing all risk-sharing alternatives—as we used to do, successfully, with traditional risk sharing.

For this approach to work, though, FHFA has to follow through on the directive in the 2008 Housing and Economic Recovery Act and update the companies’ risk-based capital standards to reflect current requirements for taxpayer protection. FHFA should have done that some time ago, but it hasn’t. All of us need to insist that it do so immediately. We won’t be able to assess the value or desirability of any type of risk-sharing mechanism or transaction without a valid reference point, and that reference point is the cost of having the same risk backed by hard equity capital.

Once we know what it costs to back credit risk with shareholders equity, assessing risk-sharing alternatives is easy. You apply what I call a borrower benefit standard, and ask: will the risk sharing techniques or transactions in question result in a lower all-in cost to the borrower, with the same or a better standard of protection for Fannie or Freddie and the U.S taxpayer, compared with the companies retaining the credit risk themselves?

To show how this borrower benefit standard works—and to illustrate why it’s so critical for FHFA to update Fannie’s and Freddie’s capital standards—I’ll briefly address the three main types of risk sharing: “deep-cover” mortgage insurance on the front end, mortgage reinsurance transactions on the back end, and securitized credit-risk transfers.

The cost of front-end mortgage insurance typically is paid by the borrower. Deep-cover MI obviously costs more than standard MI, so for it to be a good deal for the borrower the guaranty fee associated with it has to be reduced by at least enough to offset the higher MI fee. Today, FHFA has no way of determining how much deep-cover MI is worth. If it arbitrarily lowers Fannie or Freddie’s guaranty fees by enough to offset the cost of deep-cover MI, it won’t know if it’s giving away too much fee for the reduction in risk. And if it doesn’t lower guaranty fees enough, deep-cover MI becomes more costly to the borrower. The only way for FHFA to get this right is to give Fannie and Freddie a real cost of capital; otherwise it’s just guessing.

A similar problem exists with back-end reinsurance transactions. Fannie or Freddie already have these loans—and their credit risk. To get reinsurers to take some or all of that risk, the companies have to pay an annual premium. How much should they be willing to pay? Again, without a binding capital standard to serve as a reference point, Fannie and Freddie, or FHFA, have no way of knowing. And if they just pay whatever the MIs ask, the economics quickly will move against them.

There’s one additional piece to the deep-cover or back-end mortgage insurance assessment. That’s counterparty risk. Private mortgage insurers don’t fully back their exposures with capital, so in a severe loss scenario there’s a chance they won’t be able to make good on all of their insurance obligations, as happened during the financial crisis. The way to assess and compensate for counterparty risk is for FHFA to apply the same stress standard to the MIs as it uses in developing Fannie and Freddie’s capital requirements. If the MIs can’t meet that standard, then they’re not providing full protection to the companies, who will be stuck with any losses the MIs can’t pay. To cover this risk, Fannie and Freddie either would need to price for it, limit the amount of risk sharing they do with these counterparties, or do both.

Now, compared with MI risk sharing, securitized credit-risk transfers are in one sense easier to evaluate today, despite their complexity, because their effectiveness and value don’t depend on Fannie and Freddie’s cost of capital; they depend entirely on the structure of the securities themselves, which is known at the outset.

The challenge with risk-transfer securities is determining how to equate a dollar in face value of these securities with a dollar of upfront equity capital. At first blush that would seem to be an impossible task, but in fact the prospectuses for both Fannie’s Connecticut Avenue Securities (or CAS) risk-sharing program and Freddie’s Structured Agency Credit Risk (or STACR) program give you everything you need to make a very good approximation of this equivalency.

I’ll use Fannie’s recent CAS issues to show how this works. In the prospectuses for these deals, Fannie projects credit losses for 64 combinations of annual credit loss and prepayment rates. The average cumulative credit loss for the 64 scenarios, over the life of the securities, is a little over 2 percent of the initial pool balance. The worst loss rate is 10.3 percent, and the loss rate at the 90th percentile is 5.3 percent. All of those are quite severe. The ever-to-date loss rates on Fannie’s loans from the early 2000s have only been about one-half of one percent.

Using the projected loss data, I next did an analysis that anyone with the prospectus, a calculator and 15 minutes of spare time could do. I distributed the projected credit losses from all 64 scenarios into the three categories that replicate the structure of Fannie’s CAS securities: the first 100 basis points of loss, which Fannie takes, the next 300 basis points of loss—from 1 to 4 percent of the initial balance—which the CAS tranche holders are supposed to take, and finally any losses over 4 percent of the initial balance, which Fannie again takes.

The distribution of these credit losses didn’t surprise me: 37 percent of them were at or less than 1 percent of the initial pool balance; 48 percent of the losses fell between 1 and 4 percent of the initial balance, and 15 percent of the losses were in excess of 4 percent. That means that in theory Fannie and its loss-sharing partners would split the credit losses roughly equally, with Fannie taking the first 37 percent, risk-sharing partners taking the next 48 percent, and Fannie the last 15 percent.

Except that’s not what would happen in reality, because Fannie has structured its current CAS risk-transfer securities so that they pay down before most of the credit losses can hit. And Fannie discloses the consequences of that structuring in its prospectuses. Over all 64 scenarios, of the 48 percent of the credit losses that fall between 1 and 4 percent of the initial pool balance—the range the CAS M-2 and M-1 tranches are supposed to absorb—these tranches are shown in the prospectuses as picking up only 4 percent, or less than one-tenth of what they could have taken.

Think about that for a second. In severe credit loss environments, using its current CAS “risk-transfer” securities, Fannie would take the first 37 percent of losses under 100 basis points, also pick up 44 of the next 48 percent of losses, and then take the remaining 15 percent. After the dust had settled, Fannie would have absorbed 96 percent of the credit losses, and holders of the CAS securities…4 percent. That’s it.

Those aren’t just my figures; anyone can calculate them from the data Fannie publishes. But apparently almost nobody does, or if they do they ignore the results.

There are two points I’ll make about them.

First, Fannie’s CAS issues are a complete waste of money. On the loans Fannie covers with these securities, it’s giving up close to a third of their guaranty fees in interest payments on risk-sharing tranches that will absorb at most 4 percent of their credit losses. That makes no sense from any perspective. It’s a waste of Fannie’s money if shareholders win the net worth sweep lawsuits, and it’s a waste of the government’s money if the government wins those lawsuits.

Second, and even more importantly, FHFA, Treasury and the members of the Financial Establishment who tout CAS-like risk-sharing securities as the future of mortgage securitization are pretending that the face value of these securities is the equivalent of equity capital, when they’re worth less than one-tenth of what equity capital is worth because they absorb less than one-tenth of the credit losses.

Saying you’ve transferred credit risk when you actually haven’t is a prescription for disaster. We’ve tried fooling ourselves with securitizations before. In the 2005-2007 bubble years, we had the collateralized debt obligation, or CDO, in which investment bankers gathered up toxic lower-rated tranches of subprime and other high-risk private-label securities and put them into new derivative securities, 80 percent of which the rating agencies gave AAA or AA ratings by assuming that the underlying risky loans couldn’t all go bad at the same time. We know how that turned out.

There’s not much difference between hiding credit risk behind inflated ratings and pretending to have transferred it to investors when you know you really haven’t.

I’m not happy about the fact that FHFA is contemplating doing deep-cover MI or back-end reinsurance transactions without any clear idea of whether they’re good for the borrower or for Fannie or Freddie. But I’m much more worried about the consequences of what FHFA and Treasury are doing with securitized credit risk transfers.

FHFA is making Fannie and Freddie do CAS and STACR securities because Treasury is telling it to, and Treasury is pushing FHFA on this because it wants us to believe it can replace the shareholder-provided equity of Fannie and Freddie—two companies Treasury historically has opposed—with securitized risk-sharing as the foundation of the secondary mortgage market of the future. But that’s a fiction. Fannie and Freddie’s CAS and STACRs, like CDOs, are exercises in deception.

We need to call Treasury and FHFA out on this. People need to write, phone or meet with their contacts at both agencies, and make clear to them that we know the risk-sharing mechanisms they’re forcing Fannie and Freddie to use are deeply flawed, and that they don’t transfer any meaningful amount credit risk. We must insist to Treasury and FHFA that they stop trying to fool us, and instead turn their attention to devising reforms for the system that might actually work.

 Turning the tables: a brief addendum

Imagine that using securitized risk sharing as a dollar-for-dollar substitute for equity capital was proposed not by Treasury and FHFA, but by Fannie and Freddie, in response to a change in the minimum capital requirement for their single-family credit guaranty business.

The 2008 Housing and Economic Recovery Act (HERA) permits FHFA to “establish a minimum capital level for the enterprises…that is higher than the level specified in [the 1992 legislation] to the extent needed to ensure that the regulated entities operate in a safe and sound manner.”

Let’s say that Fannie and Freddie were not in conservatorship, and that FHFA exercised its authority under HERA to raise the minimum capital requirement on their single-family credit guarantees from the pre-crisis level of 45 basis points to a full 4 percent. Fannie and Freddie respond with the following proposal: “We’ll use retained earnings and shareholders equity to cover the first one percent of the new capital requirement, but then we’d like to use our CAS and STACR risk-transfer securities to meet the remaining three percent of that requirement.”

Which of these two responses do you believe FHFA and Treasury would be more likely to make?

Response one: “That’s an excellent idea! We applaud you for taking the initiative to bring private investor capital into the mortgage market. Yes, we know some people question the effectiveness of these structures, and think they won’t be available in difficult times, but we’re confident you’ll be able to figure out something before any of that becomes a problem. One percent equity capital should be fine; you can cover the rest of your new 4 percent capital requirement with CAS and STACRs.”

Response two: “You’ve got to be kidding! You can’t possibly use the face value of CAS and STACRs to meet your equity capital requirement. Read your own prospectuses. The way you’ve structured these securities, they hardly ever absorb any losses. It’s your call if you want to issue CAS and STACRs, but the most we’ll give you as a credit against your new equity capital requirement is ten percent of their face value. You’ll have to get the other 2.7 percent in real capital.”

Not much doubt, right? It shouldn’t be the opposite if it’s Treasury and FHFA, rather than Fannie and Freddie, making that same proposal. Yet somehow it is.

147 thoughts on “Investors Unite Risk Sharing Call”

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    1. Many opponents of Fannie and Freddie have been saying for the past few years that it’s not possible for Fannie and Freddie to be brought out of conservatorship without their having to hold so much capital they would not be able to function effectively. It looks like the author of the Moody’s study found a few of those people.

      When Fannie was forced into conservatorship in September 2008, it had a $3.1 trillion book of business and $47 billion in capital. Even with all the toxic mortgages it talked itself into buying in a foolish attempt to win share back from the private-label securities market–including loans like interest-only ARMs and no-doc mortgages that can no longer be made today–it still did not lose money on an operating basis between 2008 and 2011. Technically, its meager $47 billion in capital would have been enough for the risks it took. Today, Fannie’s book of business is still $3.1 trillion (unrounded, it’s 2.3 percent larger than it was pre-conservatorship), and the credit quality of its loans is much higher than it was then. In addition, its mortgage portfolio today is one-third the size. So–where does this need for “hundreds of billions of dollars” in capital come from, per the Moody’s report?

      The people who don’t want Fannie and Freddie to exit conservatorship can and do come up with all sorts of invented obstacles that seemingly make it impossible. But let’s turn it around and say, “we’ve determined that the Fannie and Freddie business model is the best alternative for the U.S. secondary mortgage market going forward; so, how do we reform them, bring them out of conservatorship, and recapitalize them?” I believe that’s a question that will be asked in the negotiations between the Mnuchin Treasury and the plaintiffs in the lawsuits, and I think they’ll come up with a much more workable alternative than the author of the Moody’s report did. I’ll give my own thoughts on this topic in my next post, which I intend to put up on Monday.

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      1. Tim,
        Thanks for your great response to such unsubstantiated rhetorical opinion articles. Many of these entities/people from financial establishment have to re-establish public trust before anyone can turst them. But these entities/people still have access to powerful media.

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    1. This bill is a great reminder of why it’s such a good thing that Treasury Secretary-designate Mnuchin has promised to “get Fannie and Freddie out of government ownership…reasonably fast.” The only way he can do that is administratively, and that means moving responsibility for mortgage reform away from the legislature in Washington DC–where, as the Royce bill so clearly illustrates, people have no idea what they’re doing– up to the financial professionals in New York, where they do.

      Royce wants to make credit risk sharing mandatory for Fannie and Freddie, whether it is economically sensible or not. His bill has no provisions for measuring the effectiveness, or the equity capital equivalency, of the risk sharing he wants to force the companies to do; apparently it’s not important if Fannie and Freddie’s risk-sharing securities actually transfer any credit risk away from the companies, as long as they have the appearance of doing so. (And while we’re giving money away, let’s get the private mortgage insurance industry in on this as well.)

      I’d love to be asked to testify about this bill, if it ever gets that far.

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          1. Let’s see, what industry would do fantastically well, but is ill equipped to grow because of capital constraints, if something like Royce–Moore ever became a heavily used execution??

            The mortgage insurance industry is my answer.

            It’s worth noting that Rep. Moore comes from Milwaukee where insurer MGIC and the MI industry was born 60 years ago.

            But to the supporters for forcing the GSEs to sell off their well underwritten mortgages in these transactions–which, despite their generic names, do not transfer risk but cost the taxpayer money in foregone GSE income–I would add most any of the traditional GSE opponents scurrying now to hurt Fannie and Freddie before someone more reasonable takes charge at Treasury.

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        2. Follow the money. Find out who is buying CAS securities. Are Warren Buffett and Charlie Munger buying ? Why Moody’s (and Mark Zandi) are so involved in proposing housing financial reform?

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    1. I wouldn’t say that Freddie is “officially utilizing” the common securitization platform (CSP). According to Freddie’s press release, it completed and successfully tested some of the functional components of what ultimately will be a much larger and more complex project– the full CSP. Calling what Freddie has completed “Release 1” of the CSP seems a bit ambitious, but I think it, and FHFA, wanted to show progress on the initiative. The full Release 2 will be a significantly greater challenge.

      The CSP won’t, per se, lead to either merging Fannie and Freddie or opening up the technology to others. When FHFA, at Treasury’s urging, launched the CSP project in 2012, it had two objectives. The first was “building a secondary market infrastructure which will live beyond the Enterprises themselves” (which Treasury wanted to replace), that was “capable of becoming a market utility.” The second was helping Freddie overcome a persistent structural disadvantage the Freddie Participation Certificate (PC) has had relative to the Fannie Mae mortgage-backed security (MBS) for decades: Freddie’s PC pays investors earlier than Fannie’s MBS, but investors don’t pay full theoretical value for that early payment, so Freddie has to quote lower guaranty fees than Fannie to be competitive for the same loan.

      It makes great sense for Freddie to want to build the CSP, because the securities it will issue with it (assuming Release 2 is successful, which some doubt it will be) will have the same payment delay as Fannie’s MBS. Fannie is at best a reluctant participant in the CSP, because it is having to fund half the cost of an extremely expensive technology project that if successful will remove a key advantage it has over its primary competitor. But FHFA, as conservator, is requiring Fannie to participate.

      If the CSP is in fact completed and is successful, it makes merging Fannie and Freddie possible but it doesn’t make it likely. A merger between the two would require legislation, as would replacing the companies with some new entity or mechanism for guaranteeing mortgages, using the CSP to issue them. I don’t believe either of those developments is in the cards, and in any event for them even to be possible is a long way off, if indeed that time ever comes.

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    1. From reading the article the delisting seems to be a technical issue related to Irish Stock Exchange disclosure rules, although it does highlight the fact that CAS and STACRs are not easy securities to describe, disclose or evaluate.

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  7. Tim,

    Gov imposes many expensive public mission and social mandates on FnF without providing funding or reimbursement.

    Is this not violation of Fifth Amendment?
    “… nor be deprived of life, liberty, or property, without due process of law;
    nor shall private property be taken for public use, without just compensation.”

    How is that FnF BOD or FnF shareholders have never objected to public use of FnF without just compensation?

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    1. Let me make a distinction between the pre-conservatorship, the conservatorship, and the post-conservatorship Fannie and Freddie (and I’ll concentrate on Fannie).

      When Fannie was chartered in 1938, and again when it was spun out of the government and became a public company in 1968, it was given a charter that conveyed to it certain benefits (or “indicia”) that purely private companies did not have. In exchange for these indicia, it was given the obligation to support the housing market at all times during the business cycle, along with an obligation to make mortgage credit available and affordable to low- moderate- and middle-income homebuyers. Fannie’s (and Freddie’s) affordable housing obligations were formalized in legislation in 1992, which gave the Department of Housing and Urban Development the right to set annual affordable housing goals. In no sense were Fannie and Freddie’s “public mission and social mandates…a violation of [the] fifth amendment;” they were a compact between the government and Fannie and Freddie’s shareholders, which allowed the companies to function with the costs and at the scale that they did. For as long as I was at Fannie, we always were aware that if we did not meet or exceed Congress’ expectations for our affordable housing lending, they could (and likely would) introduce legislation to alter or remove some of our charter benefits.

      In the conservatorship, Fannie and Freddie’s affordable housing obligations have fallen by the wayside. The companies have been given arbitrary (and in my view unnecessarily high) capital requirements that have priced most affordable housing borrowers out of the market.

      Which leads to the question: what should be done with Fannie and Freddie’s affordable housing requirements if and when they are released from conservatorship and returned to private ownership? There are many different opinions on this, but I’ll give you mine. I think Fannie and Freddie SHOULD retain the benefits of their current charter–because those allow the companies to provide lower cost mortgage financing to a wider range of borrower types than they could with out the charter–and if they retain the charter they should have affordable housing goals. But that is also a reason that Fannie and Freddie should be given rigorous but not excessive capital requirements. There is a balance that must be struck between taxpayer protection and affordability. If the government requires post-conservatorship Fannie and Freddie to hold unnecessarily large amounts of capital, they’ll have to set guaranty fees at levels that will make it difficult if not impossible to finance a reasonable amount of homes for affordable housing borrowers.

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      1. Tim,

        Can you please provide a little more detail for your comment that “The companies have been given arbitrary (and in my view unnecessarily high) capital requirements that have priced most affordable housing borrowers out of the market.”

        Thanks

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        1. Sure. In its 2014 request for input on Fannie and Freddie guaranty fees, FHFA published a table of capital requirements and model guaranty fees that covered nine combinations of loan-to-value (LTV) ratios and credit scores. The average capital requirement–for a very high quality mix of business–was over three percent. And to cite just one example, loans with LTVs in the 81-97 percent range and credit scores of between 620 and 699 had required capital of 7.12 percent, and a model fee of 152 basis points.

          FHFA has never disclosed the basis for these capital requirements or model fees. But Fannie and Freddie’s average guaranty fee rate on new business has changed little since 2013, after Acting Director Ed DeMarco arbitrarily raised it by ten basis points in order to “encourage more private sector participation [and] reduce the Enterprises’ market share….”

          The loans Fannie and Freddie have been making for the past five years have performed better than any books of business in the companies’ history–including Fannie’s loans from 1999 through 2003, which have had lifetime loss rates of well under one-half of one percent. Three percent capital, and average guaranty fees of 50 basis points per year, are to me far in excess of what is warranted for loans whose lifetime credit losses likely can be covered with less than one year’s worth of guaranty fee.

          I’ll make one final point. In 2002, 17 percent of Fannie’s business had credit scores of 660 or less; in the third quarter of this year, only 4 percent of the companies’ business had credit scores below 660. Pricing on these loans almost certainly is the primary explanation for the drying up this this low credit score business.

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          1. With Trump’s stated plan to increase economic growth and recent talk by some that housing is going to be a part of the effort to accelerate growth, how much impact would changing the capital requirements and guarantee fees have on housing and subsequent economic growth? i.e. is there enough potential here that reforming and releasing is a no brainer from the standpoint of aligning with stated goals? Seems winding down and moving to a new system is fraught with economic risk and at odds with those goals?

            Also, thanks for your continued insights!

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          2. It’s very hard to quantify the impact of lower guaranty fees on housing activity and economic growth, but qualitatively the impact would be positive. The best way I know to think of it is to note that consumer spending accounts for about two-thirds of GDP, and leaving money in homebuyers’ (and refinancers’) pockets by not charging them more than necessary to guaranty the credit on their mortgages gives them more money to spend–and that’s a good thing for the economy.

            I also think if the Trump team is focusing on the impact of mortgage reform on economic growth–and I believe it is– they will be drawn to the alternative that shows the most obvious potential to have this effect. That’s the Fannie/Freddie model, which has a proven track record of success. I don’t believe the Trump team will be fooled by the claims of the anti-Fannie and Freddie crowd that the companies caused the financial crisis, are a “failed business model” and must be wound down and replaced, because those claims are so readily disprovable. As Bruce Berkowitz likes to say, “there is no alternative” to Fannie and Freddie.

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          3. Dear Mr. Howard,

            As the former Fannie Mae CFO, your analysis is consistently solid and measured and insightful. My only pause is your basis for comparing credit scores from 2002 and 2016. Hasn’t the metrics and formulae underlying scoring methods changed over time? And those changes might be substantial given the shifts in borrower sustainability? Such that 660 today is not the same (nor as credit worthy) as a 660 in 2002? It doesn’t necessarily change your basic premise. Credit availability has seriously diminished for ALL but the most spotless and higher income borrowers. This is caused by lots of factors. Which you have laid-out artfully in this blog over time.

            In the meantime, there are rumblings FHA is the next focus for mortgage banks. And proposals to privatize FHA into private-public ownership as the market underwriter of lower LTV risk — potentially replacing lower tier credit risk Fannie and Freddie had at one time supported — is in the planning stages.

            Do you have any thoughts or concerns about changes to FHA?

            Thanks.

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          4. I haven’t been close enough to the credit score analytics to know whether there is in fact a difference between a 660 today and a 660 in 2002. And I’ve not seen anything written about it.

            On the FHA, it has gained significant market share from Fannie and Freddie in the past few years, because its underwriting is less restrictive and its fees are lower than Fannie and Freddie’s. (That’s another indication that Fannie and Freddie’s capital and guaranty fees are too high, and have room to come down.) I’ve not heard any “rumblings” about changing the structure or ownership of FHA, however, and I would be very surprised if Congress takes that on.

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      2. Tim,
        Thanks for taking your time to explain in detail.
        No one can disagree with you except when Gov officials, lawmakers and WS media take for granted (or conveniently forget) “public mission and social mandates” imposed on private shareholders companies but only talk about “implicit guarantees” and “public losses and private gains”.

        In 2008 crisis official/media manipulated and staged ultimate sacrifice of FnF and FnF shareholder’s interest for the benefit of public and for the benefit of their crony private corporations. Essentially this has been continuing abuse of authority and trust especially when officials/media start picking winners and losers in a free private market economy.

        Since FnF are joint public and private for profit ventures, there has to be proper costing of flow of benefits and also safeguards to prevent abuse of each other. This becomes important when politicians and political appointees start running these companies through legal mandates without funding. We have seen how Politicians and other Private entities are good in espousing the cause of taxpayers to benefit their cronies. In this context it is interesting to hear from Steven Mnachin saying that “So let me just be clear— we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again.”

        Also how does one value the counter cyclical public mission of FnF.
        Is it fair to equate cost of Gov implicit guarantees with those costs of FnF during counter cyclical public mission?

        Similar parities can also be found in many benefits and costs.

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      3. Tim, Mnuchin must love to hear from you. He may be pragmatic. Some people hate government involvement. But ridding of that would cause an earthquake in housing and US economy. Congress unlikely pass such a bill.

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  8. Hi Tim and the readers that are lawyers:
    Is it possible that the Perry appeal is being delayed because the Court is waiting to see the “56” documents ? Does the Court of Appeals have to wait ? or can this Court (Perry’s) order the documents to be produced for “in camera” view?

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    1. there is no way to know.

      usually an appeals court decides based upon law not facts, but perry is likely to be something of an exception because perry made such a point out of judge lamberth being bagged by uguletti’s false declaration.

      so on the one hand, the appeals court has to decide a question of law (essentially whether motive is relevant in determining whether a conservator properly exercised its powers…lamberth said no), and in deciding that the appeals court may very well have an interest in seeing the “56”. but remember, appeals courts dont try facts, so it wont decide that the 56 conclusively proves anything, other than possibly the whole notion that the district court needs to conduct a fact finding trial.

      my personal view is that there is a dissent being written by judge millett. if i am right, then that would be favorable for plaintiffs. i believe there are good purely legal arguments made by perry that would result in reversal or remand, such that if there is a dissent, it would be written by the one judge who i thought was resisting this, based upon the oral arguments.

      but until opinion is issued, no way to know.

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      1. as to whether perry appeals court could get to see 56 in camera before court of federal appeals denies writ of mandamus appeal, that would be highly unusual. assume that wont happen.

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  9. Tim, I’m surprised that you are fine with the warrants being exercised especially considering all the accounting shenanigans FHFA implemented to drive the debt up to 187 billion. The bloating of the loan loss reserves, the immediate write down of the DTAs, and the circular draws. All of which was unnecessary and only served the purpose of drowning the twins in governmental debt with the hopes being that they could never pay it off due to the usury interest rate of 10%. Then in 2012 with the housing market starting to recover, FHFA could no longer hold down the balance sheets with fictional losses and had to start reversing them, at which time the US Treasury and FHFA amended the PSPAs to grant Treasury all future profits going forward. This of course resulted in a huge windfall for Treasury and conveniently keeps the balance owed at 187 billion, thus creating a perpetual conservatorship which could retroactively be turned into a receivership once all the capital reserves are depleted. This was a forced takeover of two private companies for ideological and political reasons. James Lockhart signed over 79.9% of the companies for nothing in return, and Demarco signed away all profits in perpetuity. FHFA has done nothing but undermine the companies, cook the books with losses, and hand both Fannie & Freddie over to the US Treasury on a silver platter. What message would be sent to the markets if Treasury is allowed to reap 79.9% equity of the companies after they have already received such a windfall, and what would stop the government from doing such a stunt again after wildly profiting from accounting fraud and unconstitutional takings?

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    1. I’ve never said that I am with “fine” with the warrants being exercised. I also don’t dispute any of the misdeeds by Treasury and others that you cite, or that Treasury has done nothing to earn the 79.9 percent of Fannie and Freddie’s common stock it in essence granted itself, after bullying the Fannie and Freddie boards into accepting conservatorships they didn’t need while refusing to tell them the terms that would be imposed upon them in the aftermath. All that is true, regrettable and deplorable.

      But what happens now? I believe that in a negotiated settlement between the Trump administration and plaintiffs in the lawsuits, it is more likely than not that the warrants will be exercised–although likely on terms different from and more favorable to shareholders than the original terms of the PSPAs–simply because that will be one of the components required to get a deal done. Do I wish it were otherwise? I certainly do. But what’s the alternative?

      None of the plaintiffs in the net worth sweep cases challenged the original action by the government to take over the companies in 2008, or the terms imposed upon them by the PSPAs. (There is a reason for that, which I don’t agree with–and if asked won’t say what it was–but that’s done; “it is what it is.”) The “takeover and the terms” of the 2008 conservatorship WERE challenged in the Washington Federal lawsuit, but as I first learned from the Rule of Law Guy and have subsequently confirmed elsewhere, the lead counsel in that suit took it on contingency with a view to settling, and are highly unlikely to want to invest the significant amount of time and money required to carve themselves out of a settlement and pursue years worth of litigation on their own. Without credible leverage of continued litigation against the warrants, which so far I’ve seen no evidence of, I have to conclude that–as unpleasant as it is to contemplate Treasury being rewarded for its illegal behavior–the warrants most likely are in play.

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      1. the warrants were not challenged by plaintiffs holding junior preferred stock because all they want to do is get back to par. the warrants really have nothing to do with that.

        but pershing capital took a look at the possible future scenarios and thought the common had even more upside than junior preferreds, if NWS invalidated, and pershing bought 10% of the common of each gse. pershing did this with eyes wide open to dilution from capital raises going forward that would be necessary to exit conservatorship. if you are unaware of this you should google pershing’s sohn fnma investment slide deck and have a read.

        so at the negotiation table, you will have pershing capital representing the common share interest, and you will have a guy like mnuchin who “might” see the wisdom of cutting back on the govt’s potential take from the warrants, so as to better enable the recapitalization to go forward…in order to have the good be attained over a speculative perfect.

        more than this we really cant speculate profitably about…so i think this warrant rant might best be tabled

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        2. I believe the SPSA clearly states:

          If any part is found illegal, the whole thing is voided. (Note the SPSA = Orginal + amendments.)

          It the Sweep is illegal, the whole deal is trashed.

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        3. ROLG,

          Please correct me where I’m wrong but my recollection of Ackman’s slides is he offered a few scenarios for recap all pertaining to G fees over various time durations, maybe up to ten years, some shorter? Did he put forth any scenario that incorporated capital dilution through new common shares?

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  10. Tim

    While I also agree the warrants will be exercised, does that not leave more lawsuits coming as in Starr ? Would it be possible/feasible for settlement to occur where warrants are cut back a bit but than no one is allowed to sue for those remaining exercised warrants?

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    1. @johnfedirico

      there will be a lot of moving parts to any restructuring. this will be a huge “come to jesus” negotiation where i think everyone will have to suffer initially, with the prospect that once GSEs get recapped and go into ordinary course of business, everyone who stayed course will benefit at the back end of the recap.

      first point i would make is that congress need not get involved. HERA authorizes FHFA to run this conservatorship with broad powers (almost broad enough to authorize the NWS), and there is nothing in senator corker’s loose jumpstart language that requires congressional sign off on a properly structured settlement.

      hence, mnuchin’s comment on tv that he thought the recap could be implemented “pretty fast”.

      to get to a recapped GSE, you are going to have to restrict outflows, such as junior pref dividends which, since they are non-cumulative, will vaporize when not declared. you will also have to do some serious common stock issuances, and this situation calls out for a rights offering to common stock holders, which may be enticing enough for junior pref holders to convert into common first in order to participate. i expect the govt will want its senior pref repaid (about $20B for fnma, assuming NWS is rolled back retroactively), so not all of the net proceeds from new stock issuances will go to rebuild capital.

      the govt’s warrants increase in value when the NWS is rolled back retroactively…and there can be no recap unless the NWS is rolled back retroactively, since govt has to signal to market that the NWS was an improper step to winding GSEs down…no one will put dollar one into GSEs unless govt says we go back to the original bailout deal. so the govt will not want to walk away from this substantial profit opportunity that was built into the original deal…the question is, to what extent will govt try to maximize this opportunity in full.

      given the original bailout deal, with 10% dividends on the senior pref, i think you will see that the GSE bailout has become very profitable for govt, even if govt takes a haircut on warrants. this haircut could take form of increasing exercise price, so that when govt sells its converted warrants, the GSE raises some money on exercise, and the govt gets a profit when it sells the converted common.

      why would govt do this? in order to facilitate recap. owning 80% of no value is worse than a lesser percentage of greater value.

      this is all very fluid and speculative.

      rolg

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      1. I agree with ROLG’s comments and description of the situation (including its complexity, fluidity and unpredictability). One area where I’d give a slightly different answer is the outstanding amount of senior preferred after reversal of the sweep. In the exercises I’ve done of crediting net worth sweep payments made to Treasury in excess of the 10% preferred dividend as paydowns of outstanding senior preferred–in which I include the requirement that Treasury pay 2.0 percent per annum interest on the outstanding amounts of its excess sweep payments– I show Fannie with $3.4 billion in senior preferred outstanding as of the end of the third quarter of 2016, and Freddie with $1.6 billion. All of the senior preferred at both companies should be completely paid off by the end of the first quarter of 2017.

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        1. i did not use an interest rate on overpaid amounts. so you can twist my arm to get the lower pro forma outstanding senior pref preference amount…

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          2. just one more thought about the recap negotiation…the role of washington federal.

            if i am mnuchin, and i work out a settlement with all parties except washington federal, such that wash fed’s claim against the warrants still survives, i would not think my work has been done. even though a subsequent prosecution of this claim by wash fed is unlikely, and it is even more unlikely that you would get a federal judge to overturn a massive settlement, there is no finality to any deal unless wash fed gives up its claim.

            so i think wash fed does have some holdup value in order to ensure that the common is treated well. but i think the greatest source of comfort for a common holder is that this is where the govt will realize any future value from a settlement.

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  12. Tim,

    I saw that you deleted my message twice about Preferred/Common stock (dilution & maximizing gov’t return). Please let me know if I asked a question outside the framework of your blog, as I thought the idea was helpful.

    Thanks in advance,

    Sean

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    1. Sean: I thought you asked a very good question, with some good ideas and creative thinking (although if you re-post it elsewhere, you might want to delete the point about the government making up lost dividends to junior preferred shareholders; Fannie and Freddie’s junior preferreds are non-cumulative, meaning that unpaid dividends are foregone and do not accrue). But, yes, the question is outside the scope of this blog, which is why I deleted it (twice).

      To build on a response I made to a comment by “ignorethecrowd” a short scroll below, in a negotiated settlement the fate of Fannie’s or Freddie’s junior preferred, as well as the warrants and their outstanding common stock, will depend on decisions made by the principals in that negotiation– the plaintiffs in the lawsuits and the financial people in the Trump administration. I don’t feel that my blog is the right forum for offering up advice to these people, who know far more about how to get deals like this done than most of us (including me) ever will.

      Beyond that, there is another issue I should be upfront about. I recognize that many of the readers of this blog are following the Fannie and Freddie saga because they have made investments in the companies that they hope will make them money. Now that there is a reasonable prospect not just of settling the lawsuits but keeping the companies alive in the future, there is understandable speculation about how the junior preferred and the warrants might be treated, as well as what the outlook for the common stock might be. Sometime back, I made a conscious decision not to get involved in opining on or speculating about the future value of Fannie or Freddie securities under different scenarios. That’s not where my expertise lies, and I also wouldn’t want people making financial decisions based on a judgment I made about something that really isn’t predictable.

      I hope other readers understand this position, and that they won’t view deletions of comments they may make in this same area as anything other than me wishing to stay “above the fray” on financial speculations about the companies. I’ll stick to things I think I know about.

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      1. Tim,

        Thank you for the detailed reply! There are many conflicting resources of information out there but as you know, yours is highly respected and I thank you for your insight. The only reason I mention retro-dividends to the preferred holders is that in a best case scenario where the gov’t loses a lawsuit on GSE accounting fraud and everything is unwound, they could be on the hook for those retro-dividends.

        Thank you again,

        Sean

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  13. Hi Tim.

    It seems there has been a lot of noise about whether or not the GSE model can work without an implicit government guarantee (e.g. because they would have a higher cost of funds without it). But even without a government guarantee, wouldn’t Fannie & Freddie still have a superior competitive positioning in guaranteeing mortgages versus for example the big banks? The capital requirements for Fannie/Freddie should be significantly lower than the big banks (by something like a factor of 4), and that alone should provide a discrete competitive advantage for the GSEs even without a lower cost of funds. In such a scenario, wouldn’t g-fees just be raised slightly due to the higher cost of funds? Which if anything makes the cost of funds discussion a public policy thought experiment, as wouldn’t the costs of removing the implicit government guarantee would ultimately eventually be passed on to the average Joe? Interested to hear your thoughts.

    Thanks,
    Chris

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    1. Chris: You’re right about the “noise” around the workability of the Fannie/Freddie model post-conservatorship, and people without a good understanding of the issue discussing this on the business news shows and in the print media unfortunately have amplified it.

      There is no doubt that Fannie and Freddie had a lower cost of debt because of the implicit guaranty, but that was a benefit for their portfolio businesses; their credit guaranty business does not rely on debt. Almost all reform proposals include limits on the size of the companies’ portfolios and restrict their activities to purposes incidental to the credit guaranty business. For that reason, the portfolios would be much smaller than they were historically (my reform proposal limits them to no more than 10 percent of outstanding credit guarantees), and at that size I believe they could be funded successfully (although less profitably) with a combination of debt that is a general obligation of the companies and derivatives.

      The benefit to Fannie and Freddie’s credit guaranty business of the implicit guaranty was in lowering the yields on the mortgage-backed securities (MBS) they issued. The benefit of those lower yields was passed on directly to homebuyers, since lenders used MBS yields to determine the mortgage rates they quoted to borrowers.

      I believe the implicit guaranty will be less important to Fannie and Freddie’s credit guaranty business post-conservatorship, because in the wake of the financial crisis the companies will have to hold significantly more capital against those guarantees than their 45 basis point capital requirement pre-conservatorship. The Housing and Economic Recovery Act of 2008 required FHFA to update Fannie and Freddie’s risk-based capital requirements to meet new post-crisis standards for taxpayer protection. A new, much tougher stress standard—and I have recommended that the companies be required to capitalize against a 25 percent decline in home prices over a five-year period—should give investors confidence that they can purchase significant amounts of Fannie and Freddie’s MBS post-conservatorship even if they have no implicit or explicit guaranty.

      BUT—MBS yields will be lower, and the market for them much broader and deeper, if Fannie and Freddie’s post-conservatorship MBS do have some form of recognized support from the federal government. In discussions about the companies’ future, this will come down to a policy decision. I know many disagree, but I think it’s an easy one to make. In my “utility” model, I have proposed that in exchange for the companies accepting regulated returns on their business, a rigorous risk-based capital standard, and tighter regulation, the government would put in place a formal agreement to extend short-term repayable loans to them in the remote event that their (new and much tougher) capital standards prove insufficient. With such an arrangement, the government would convey a great benefit to low- moderate and middle-income homebuyers—through the lower Fannie and Freddie MBS yields that would result from it—at no perceptible risk or cost to taxpayers.

      One last quick point about the banks. They have been consistent and vocal critics of a risk-based capital standard for Fannie and Freddie’s credit guaranty business for thirty years. Because their charters allow them to engage in many types of lending and risk-taking activities all over the world, they have more simple, ratio-based capital standards for all of their business. Banks know they will not be successful in convincing their regulators to give them the same risk-based standards for single-family mortgages that Fannie and Freddie will have, so their reaction is to insist that Fannie and Freddie be given the same arbitrary and inefficient capital standards they have, offering a number of contrived arguments as to why that’s the best thing to do. In the past, banks have been unsuccessful with these arguments because it’s transparently clear that their goal is to make homebuyers pay considerably more for their mortgages so that banks can get a bigger share of the credit guaranty business. Regulators and legislators have seen through and resisted banks’ self-serving arguments in the past, and I hope they continue to do so in the future.

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      1. Tim first of all thank you for your help in understanding what is going on with GSEs.I live in Europe so maybe my point of view is incorrect. It seems to me that in a negotiation the easiest way to solve the GSE capital issue would be to cancel the warrants and recapitalise them converting the government loan in equity. Clearly if this is positive or negative for the shares depends on the conversion price. If the loan is converted using a value of 1 dollar per share the stock price would converge to 1, if it is converted at 20 dollars the market price would converge to 20. Yet given that nobody is mentioning this option maybe there are technical reasons why it is not viable. Thanks for your thoughts.

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        1. There have been numerous points of view expressed and opinions offered about the best way to handle the warrants Treasury granted itself for 79.9 percent of Fannie’s and Freddie’s common stock. Whatever we may think about the merits of any of them, in a negotiated settlement what actually is done with the warrants will depend on what is agreed to by the principals of that negotiation–the plaintiffs in the lawsuits on the one hand and the designated representatives of the Trump administration on the other. None of us outside that small circle has any direct ability to influence the outcome (much as we/they may wish to.)

          The representatives of the Trump administration will in my view want to be able to extract some additional money from the settlement (over and above the $67 billion the government already has received through the 10 percent after-tax dividend on the companies’ outstanding senior preferred stock), while plaintiffs will want to receive full value for the outstanding junior preferred stock and also maximize the value of Fannie and Freddie as going concerns. Given that, I now think it most likely that the warrants WILL be converted, but at a strike price and over a time frame that balances the need to recapitalize the companies with allowing the government to extract value for their warrants without excessive negative effects on the companies’ stock prices (which would both jeopardize the recapitalization and reduce the proceeds to the government from warrant conversion). Fortunately, this sort of balancing act is what the investment professionals who now will be on both sides of this negotiation are good at, and we will have to wait and watch to see how they plan to pull it off. If it makes us feel better we can all express our opinions in the meantime, but speaking for myself I don’t pretend to know more about how to do this than the people who will be sitting around the table negotiating it.

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          1. Tim I believe that you are right . The warrants will be exercised but not sold until 2027 . I another words exercised before the expiration in 2027. At that time the GSE will be fully capitalized. “Time” is the wild card that creates the win-win situation.

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          2. The best argument to congress for quick release without a major restructuring overhaul is the fact that the bailout wasn’t necessary. If it can be established that the bailout was a sham, which will be easy to do, then a quick release cannot be challenged on substantive grounds. The housing business model survived a *bank* crisis!

            The icing on the cake is that the same argument pertains to expunging the warrants. If the sham bailout vindicates a viable business model, then it also proves the warrants are a form of taking. Add that to the overage-repayment, things fall into place quite nicely.

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          3. I agree with you that we have good arguments for reforming, recapitalizing and releasing Fannie and Freddie, and also for voiding the warrants. But in my view, Congress will not be receptive to these arguments. At the risk of being overly simplistic, there are “good guys” and “bad guys” in the debate over Fannie and Freddie’s future. The bad guys were the ones who came up with the phony rationale for taking Fannie and Freddie over in the first place, then burdening them with mammoth amounts of senior preferred stock they didn’t need, falsely blaming them for the crisis, and insisting that any credible mortgage reform involve getting rid of them and replacing them with some alternative mechanism that favors the bad guys and their allies. Those bad guys are still out there; they’re saying the same things–even though more and more people know they’re not true– and unfortunately they and their lobbyists have Congress’ ear. That’s why I’m pleased to see that the Trump administration seems inclined to resolve the Fannie-Freddie impasse without Congress, by negotiating directly with plaintiffs in the lawsuits.

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      2. Tim the dummies in the media like Gasparino on Fox wouldn’t dare to have you on the show as you would rip him a new (you know what).

        Thank you for the excellent blog.

        Billy

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  14. hey tim

    ideas are remarkable things. sometimes, the time is right for an idea to flourish and gain power; a good idea can only become a powerful idea when the logos or reasoning of the idea not only addresses the question (theory), but also engages the moment (praxis or real life).

    i am getting the sense that much of your work fits the moment, as the moment has by serendipity turned before our surprised eyes. i wish you courage not only of your convictions but also of the potential for the strength of your ideas. redemption may be too strong of a word, so i will not use it.

    rolg

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    1. Tim will be very good candidate for Senior Housing Finance Adviser to DJT.
      Alternatively very good fit for the positions like FHFA Director.

      Tim will help to solve all the issues and set the correct direction for housing finance.

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    2. ROLG: Thank you for your kind comment. I agree with you about the aptness of the moment. I plan to continue discussing, and elaborating on, what I believe will work best as a means of structuring and operating reformed and revived shareholder-owned versions of Fannie and Freddie, with optimism that the senior economic and financial appointees in the new administration will be more attuned to reality-based ideas than the politically-driven nonsense that has been coming out of Washington for the last several years. That doesn’t mean that the Washington contingent won’t fight fiercely for the objectives they seek, but they now will be dealing with people–plaintiffs and the Trump finance team–on the other side who are unlikely to be fooled by their unworkable ideas and self-serving arguments. At least I believe that will be the case.

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  15. Tim,

    The release of private shareholder companies from lawless conservatorship is stuck in arguments over Gov implicit guarantees or explicit guarantees.

    What are the other viable alternatives other than any type of Gov guarantees?

    One on the simpler viable option would be legally mandated sufficient credit-line from a non-political agencies like Fed ( definitely not from any politically appointed Gov agencies) on commercial terms with FnF assets as collaterals.

    Combined with regulatory reforms/monitoring, sufficient capital reserves and credit-line should be enough to safely run FnF without Gov implicit guarantees or explicit guarantees.

    Another badly needed reform is Gov should pay for social mandates.

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  16. Tim,

    While u don’t believe Obama would release the GSE’s from conservatorship before he leaves office. Do you think there’s a good chance he might at least stop the NWS so the GSE’s can build some capital before he leaves?

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    1. I have no information from anyone in the Obama administration as to how (or whether) the President or any of his staff might be thinking about this, but I would be very surprised if he takes any action with respect to Fannie or Freddie before he leaves office. Stopping the Net Worth Sweep–with no follow-on proposal for what to do with the companies going forward– would be a repudiation of the stance his Treasury and Justice departments have taken on the companies over last four years, while still leaving the critical issue of their futures in the hands of his successor. I see no reason why he, or his staff, would want to do that.

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  17. Thank you for your contributions Mr. Howard. I know you have previously stated you didn’t care to handicap what a settlement will look like from the new Admin, but could you put yourself in the driver’s seat for us and share what the timing and process would look like if you had absolute discretion in ending the sweep, removing the GSE charter, relisting on a regulated exchange so institutions can again participate, changes to the existing cap structure you would make, etc.? Thanks.

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    1. I don’t believe there’s much benefit to my attempting to do what you suggest. Yes, I have an opinion on all these matters, and have an idea of what I might do if I were king. But I’m not. The “getting from here to there” aspect of removing Fannie and Freddie from conservatorship will be a complex undertaking, involving numerous parties with differing initial views and objectives, and each of the steps you’re asking about will have to be taken in the context of the others. It will be a moving target with inevitable tradeoffs. That’s why hypothetical exercises of “what would you do if you were in control of everything” aren’t particularly productive.

      Where I think I CAN be useful is in helping the principals better understand what reformed and released versions of Fannie and Freddie could and should look like, and how they should function. I’ll stick to that, and be content to leave the “how should we get there” to those more experienced with and knowledgeable about corporate restructurings than I am.

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      1. Tim,

        Is there a particular post (or a link to any articles) that has your thoughts on what “reformed and released versions of Fannie and Freddie could and should look like, and how they should function”?

        Also, what are the major differences between these future versions and previous? What do those versions have/not have that detractors don’t want/want?

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        1. The post that best meets the description of what you’re looking for is the one titled “Fixing What Works,” (available on this site under both the “Most Viewed Posts” and “Papers and Documents” headings), which I did in March as a submission to the Urban Institute’s “Housing Finance Reform Incubator” series.

          My proposal is essentially to keep what worked about Fannie and Freddie (which was considerably more than the companies’ critics are willing to admit), and change what didn’t. That’s what I address in the piece I’m recommending to you. Critics want to replace Fannie and Freddie entirely–usually for self-serving objectives that would make mortgages more expensive and less readily available–and in putting forth their alternatives they tend to both mischaracterize the operations and past performance of Fannie and Freddie and make claims about their favored alternatives that are either inaccurate or unrealistic. One reason I’m pleased that the post-election focus of reform has shifted away from Congress towards a potential negotiated settlement between the new administration and plaintiffs in the lawsuits is that these two groups understand the issues, and what will and will not work in the real world with mortgage reform. I’ll be addressing this subject in more detail in future posts.

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  18. Tim,
    Have you met or discussed Peter Wallison re FNF. I know you know him as one of those who hates FNF politically. He has a recent article why FNF can not be privatized because of its government backstop and mandate. Does he have a financial background?
    Thanks

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    1. I’ve never met Wallison, but I’m aware of his work and his attitude towards Fannie and Freddie. (And I don’t know what his background is.)

      I looked at the article in which he claims that Fannie and Freddie cannot be removed from conservatorship and restored as private, shareholder-owned companies. The argument he advances is that, “(t)he fiction that Fannie and Freddie weren’t government-guaranteed has now been exposed. The markets now know for sure that if the two fail again they will be rescued by the government. If there is any honesty in budgetary accounting, their borrowing will have to be treated as government debt and added to the deficit. It is unlikely that the Trump administration or Secretary Mnuchin will be happy to add several trillion dollars in debt to the already bloated debt load.”

      A corollary of this argument, of course, is that the markets now know for sure that if the top six commercial banks fail again they too will be rescued by the government. Were Wallison to advocate adding these banks’ debt to the federal deficit I might take his argument against Fannie and Freddie re-privatization more seriously.

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      1. Tim I know that you don’t want this blog to become a message board, so I will not put here my personal opinion about Wallison, however , as a father of two kids that will need a mortgage in the future, I ask you to write a post explaining why Wallison is dead wrong -and maybe malicious-. I think that he needs to know that his lies will be always exposed. You know weather it is worth to do it.

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  19. Tim – Do you think there’s any real chance that Obama releases FnF from conservatorship prior to new admin. and agrees to settle with Fairholme so that a.) the docs and Sweeney go away and are buried for good and b.) he looks like the hero instead of handing it Trump, who can later take credit?

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    1. Since you said “real” chance, I would answer no. I don’t believe the Obama administration would release Fannie and Freddie from conservatorship without both settling all of the lawsuits AND determining what the companies should look like and how they should function post-conservatorship. Even if it had a desire to take on all that–and I don’t believe it does, for a variety of reasons (including the fact that it lost the election and I think believes these decisions should legitimately be made by the incoming President)–it would be too heavy a lift between now and inauguration day.

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  20. Tim – Daryl Issa just commented on Fox Business that Mnuchin is on to something regarding GSE’s. They need to be privatized and be made safe. “We need to stop using them as a piggy bank”.

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      1. I haven’t viewed the segment, but I wouldn’t read anything into Issa using the term “receivership.” If you put the companies into receivership you liquidate their assets, and need to come up with something to replace them with. Either Issa doesn’t know what receivership is, or that’s what he’d like to do, but in either case it’s not going to happen.

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  21. Tim – I’ve been reading your blog for a while but wanted to finally sign in & send a big thanks for all your hard work & insight! In addition, you should really find a way to get face time with Trump to share your the fruits of your labor on the GSE’s.

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  22. Evening Tim,

    Hypothetically, if the appointment and the agenda come to fruition, does this change the value of the GSE pass through securities and the market for these securities?

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    1. It’s too early to tell. Treasury Secretary-designate Mnuchin said that it is a top-10 priority to remove Fannie and Freddie from conservatorship, but that could be done in a variety of ways, with differing implications for or impacts on the market and valuation of the companies’ mortgage-backed securities (MBS). We’ll need to wait to see the specifics on what the Trump administration would like the post-conservatorship Fannie and Freddie to look like, and how they would operate, before assessing the potential impacts on their debt and MBS.

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  24. Tim – what are your thoughts about Mnuchin along with his and Ross’s comments on Fox Business this a.m.? He spoke about removing FnF from gov. control and restructuring as a top 10 priority.

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    1. I didn’t see the Fox Business report, but Mnuchin’s saying that removing Fannie and Freddie from government control and restructuring them would be a top 10 priority would be consistent with what I was hearing at the Distressed Investing conference on Monday. (I would add, though, that just because it may be one of Mnuchin’s top 10 priorities doesn’t mean it also will be one of Donald Trump’s….)

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      1. Probably DJT will not say anything about FnF to avoid any appearance of conflict of interest and to maintain distance from both the regulators (tsy,fhfa).

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      2. Tim – This might sound crazy, but does this make the current litigation efforts obsolete regardless of courts decision meaning that win or lose, FnF are released and recapped. The prf’d shareholders settle directly with the Trump admin. and the common shareholders see tremendous upside as well?

        Do you have any further opinions now regarding whether warrants are exercised, recap, dilution, etc.?

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        1. First of all, I’ll say that having the Secretary of the Treasury-designate (and I’m assuming he will be confirmed) call removing Fannie and Freddie from conservatorship and restructuring them a top-10 priority is a game-changer. The reason Fannie and Freddie have been in conservatorship for eight years–and have been run with a view of ultimately having them “wound down and replaced”– is that this has been the objective of the current Treasury leadership. If Treasury flips on this, FHFA also will flip, and the landscape becomes totally different.

          I certainly wouldn’t say that the current litigation is obsolete. The litigation is what got us here, and it gives shareholders (both preferred and common) leverage in any negotiated settlement of their outstanding claims. I don’t like making off-the-cuff predictions, but I do think the Mnuchin appointment significantly raises the chance of a warrant exercise, because they are a source of potential revenue for the Treasury, and settlement requires both parties to get something in return. The trick becomes how one (re)structures the warrant exercises so that all parties–Fannie and Freddie as going concerns and the government as warrant-holder–get the most long-term value out of the shares. Here I have confidence that the “adults in the room” who will be working on the restructuring will be able to figure this out (that’s their expertise). But I’m not in a position to do any specific handicapping as to how they might do it.

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          1. Tim – Thanks so much for your feedback! You’ve indicated that the folks at Fairholme know your opinions and stance on a way forward for FnF. Do you have an opinion as to whether or not they care about common shareholders and the future of FnF or is their stance simply pay us on our contract for prf’ds? I am curious if they believe enough in a model moving forward that they would be interested in a settlement price on prf’ds that were then converted to common as this could possibly be even more lucrative than simply cashing out.

            Wouldn’t Mnuchin deciding to keep the original 10% dividend, but not the NWS over payment create a situation where the prf’d and common would be worth the most, thereby, benefiting the gov’s stake and all shareholders?
            Thanks again!!

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          2. As a general point, the access I have to many key participants in the reform discussions depends in part on their belief that when we have discussions I will exercise good judgment as to what I make public and what I keep in confidence. My tendency is to “under-share.” With that as background, I will say that the Fairholme team does believe that the companies have maximum value as going concerns carrying out their traditional business, and for that to happen they need happy and committed common shareholders. I don’t intend to get into handicapping the likelihood of various negotiating strategies on the part of the plaintiffs (or guessing about what the government might do).

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      4. Was exercising the warrants discussed at the conference? Also is it possible to exercise a percentage of the warrants and cancel the rest as a negotiating tool?

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        1. The warrants did not come up during the general session of the Distressed Investing conference; they did come up during the breakout session, but since we agreed that this session would be off the record I won’t be able to comment on what was said about them.

          As to whether only a percentage of the warrants could be exercised–or for that matter whether their strike price could be changed–in a negotiation “everything is on the table.”

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      5. I believe it’s on the administrations top ten. It’s also my understanding that the top ten was not just economic top ten, which would be underwhelming, but the top ten of everything – and they want to move quickly. My guess it’s on the top three for finance.

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    1. The event will not be available on video (there were no cameras there), but I thought someone said there would be edited transcripts of the general sessions made available at some point. The breakout session of our panel was not recorded, nor was it open to the media.

      If you scroll down four comments, you’ll see a short summary of my thoughts and impressions from the Fannie/Freddie general and breakout sessions.

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  26. Mr. Howard, I see you appeared at a conference today with Josh Rosner. Was this a debate? I see that he had some rather harsh words for you recently: “I think the history makes it clear he was central to perverting and undermining Fannie Mae and increasing their risks,” Rosner says, noting Howard’s compensation topped $30 million between 1998 and 2003.

    This was from the following– https://finance.yahoo.com/blogs/daily-ticker/fannie-mae-didn-t-cause-housing-crisis-free-150042887.html

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    1. The conference was called “Distressed Investing 2016.” I was one of four people on a panel addressing “post-election prospects for GSE reform;” the others were Rosner (of Graham Fisher & Co.), Mike Fratantoni of the Mortgage Bankers Association and Mike Perini of Perini Capital. It was not a debate but a discussion, followed by a well attended off the record breakout session.

      The article you cite, with the quote from Josh, appeared when I was doing publicity for my book three years ago. I didn’t remember he’d said that, but I’m not holding it against him. Whatever he may have thought happened in the past (and it shouldn’t surprise you that I don’t agree with the interpretation he had at that time) we both agree that the focus now needs to be on the future, and this morning there were no significant disagreements between us on the issues related to that topic.

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      1. Tim,
        Thanks for your update. we want to know more about this conference. Hope you will summarize the discussions for all to read.

        Regarding Josh’s quote — Well before and after 2008, false narratives were fed by the people/media that were orchestrating the conservatorship. During that time even very well respected journalists were writing that FnF are Gov owned companies. Now many have changed their opinion about 2008 crisis and FnF. If you and your management team were to continue at FnF then FnF would not have gotten in to these troubles.

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        1. As I mentioned in a comment I posted yesterday, the participants at the breakout session of our panel requested that the discussion there be off the record, so this limits the degree of specificity I can give about what was said or addressed there (and by whom).

          I led off the panel by giving my summary of the current state of play. I said I thought the most important recent development was the election. “No matter which candidate you supported,” I said, “the change in administrations will likely lead to a ‘reset’ in the debate over mortgage reform, with potentially very significant favorable consequences for Fannie and Freddie.” I noted that we would have a completely new set of people in positions of influence in the executive branch, and also new people in a few important positions in Congress, adding, “All of them will need to get up to speed on the Fannie and Freddie situation at some point, and when they do they’ll benefit from a fact base about the companies, and the mortgage finance system in general, that’s much more complete and accurate than we had when the reform debate began.”

          I said that when reform discussions first started shortly after the crisis, everyone involved in them agreed that (a) Fannie and Freddie were the causes of the crisis, (b) they’d needed a $187 billion bailout because of all the bad loans they’d financed, and (c) their ‘failed business model’ had to be replaced with something better. Every major reform proposal put out to date has been built on these beliefs—except we now know that the first two are demonstrably false, and that’s it’s proven to be very difficult to come up with a secondary market mechanism that works as well as the Fannie and Freddie business model. I concluded by saying that in a reset of the reform debate—with new people becoming involved in it—“mortgage market fiction will have to compete against mortgage market fact,” and that I was optimistic fact would win out.

          I was giving this basic message to a receptive audience, composed largely of high-level investment people and lawyers involved in corporate bankruptcies and restructurings, who by their nature take a realistic and pragmatic approach to things. They understand that the Fannie and Freddie model did work, and that with achievable reforms—related to capital, business purpose (restricting or eliminating their portfolios) and regulation—it will work again. Equally importantly, they believe almost to a person that proposals like Corker-Warner or the Urban Institute’s “Promising Road” will NOT work, because, as they know from experience, “you’ll never be able to get the capital for them.” In the breakout session, I was asked (and answered) a number of questions about Fannie and Freddie’s business, including how I thought it should be capitalized and what their baseline earnings power was. I got the sense from the people asking the questions that they felt “we can get this done.”

          Finally, a widely held view among the attendees at both my general and breakout sessions was that the opponents of the Fannie and Freddie model have had eight years to come up with a way to replace them and have failed, and that the Trump administration should be receptive to a more pragmatic approach that the financial community has confidence in. And as I was speaking to some of the attendees during the breaks, I realized that many of them knew the President-elect personally, because they had worked with him on the bankruptcies and restructurings he’s been through. I suspect that Trump respects the judgment of these people—which certainly will help once they pull together a specific recapitalization plan they’re ready to present to the President’s team, after it’s been formed and is in place.

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          1. Tim,
            Thanks for your valuable time and efforts to keep all informed.
            So far we have not heard anyone challenging your facts and analysis.
            You stand out with your expertise, vision and integrity.

            Liked by 1 person

  28. hey tim

    this ft article states that fnma has over $30B in DTAs which, if corp tax rates are lowered, will result in a downward valuation of the DTAs and a noncash charge to capital, perhaps necessitating a treasury draw: https://www.ft.com/content/1742e4fc-b1d0-11e6-a37c-f4a01f1b0fa1

    i thought fnma’s DTAs relating to mismatching of federal taxes for accounting purposes were used up,. given that fnma has been a taxpayer lately. what’s your reaction to this? thanks

    rolg

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    1. The magnitude of a devaluation of the DTA’s will be fully offset in one quarter of pre-tax earnings and thus effectively a NON EVENT.

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      1. I don’t have enough information to make that prediction. Normalized quarterly pre-tax net income for Fannie is about $4 billion; for Freddie it’s about $3 billion. I’ll need to wait to see what Fannie and Freddie’s managements say about the sensitivity of their DTAs to tax rate changes.

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    1. Related questions:
      If lower corporate taxes are good for businesses, then should not it be good for FnF?
      How do lower taxes affect DTAs?

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      1. There are several things going on here. First, it’s important to distinguish between deferred tax assets and a deferred tax asset reserve. Because both Fannie and Freddie use very conservative accounting conventions–tending to defer income and accelerate expenses within the range permissible by GAAP–they often have to pay taxes in cash to the IRS before they can be expensed on their financial statements. The excess of cash taxes paid over book taxes expensed is put on the balance sheet as a deferred tax asset (DTA). As the Financial Times article says, Fannie currently has about $35 billion in DTAs, and Freddie has about $20 billion. DTAs can be carried forward to reduce book taxes in the future, unless a company concludes that it will not be profitable enough in the future to use them. In that case, it will set up a reserve against the DTA, effectively writing it off. That is what FHFA required Fannie and Freddie to do in 2008, although their DTA reserves ultimately were reversed after the net worth sweep was imposed (to Treasury’s benefit).

        What would happen if corporate tax rates were reduced following tax reform legislation is different. In this case, DTAs created at a 35% marginal tax rate would be worth less at a lower rate, and some or all (depending on the specific tax treatment) of that difference would need to be written off. Unlike a DTA reserve–which is unambiguously negative– a partial DTA write-off following tax reform is a “good news/bad news” item. The good news from a lower marginal corporate tax rate is that a dollar of pre-tax earnings turns into a greater amount of after-tax retained earnings going forward, helping a company build capital. The bad news is that before that can happen, in Fannie and Freddie’s case they would need to write down some of their prior years’ DTAs to reflect the fact that they effectively overpaid on some of the previous taxes they had to pay in cash, at the higher rate.

        Normally this wouldn’t be a problem; Fannie and Freddie would take the DTA write-down in quarter one, then recoup the amount of that write-down, and more, in future quarters through the effect of lower marginal tax rates on their current period earnings. But because the net worth sweep has taken virtually all of the companies’ capital, a DTA write down would very likely require another draw of senior preferred stock from Treasury–which neither company would be able to repay with future earnings, because Treasury does not permit repayment of its senior preferred stock.

        This is not an immediate problem, however. It will take some time for a tax reform package to be agreed upon–if indeed it is achievable at all–and there likely will be a phase-in period for some of its provisions if reform succeeds. Before a Fannie and Freddie DTA write-down becomes an issue, much could change with the companies– including a decision or decisions in the court cases that cause FHFA to break free from (its illegal) control by Treasury and begin acting like a true conservator, rather than a liquidator. A true conservator would allow Fannie and Freddie to build a capital buffer to accommodate unexpected events, such as accounting volatility or a DTA write-down.

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        2. So just to make sure I understand this. Right now FNMA has $35B and FMCC has $20B in DTAs on the books as an asset. If the tax rate goes from 35% when the DTAs were created to 29%, the drop of ~17%, DTAs would drop $6B for FNMA and $3.5B for FMCC in valuation on the DTAs? If the rate drops to 25% for ~29% tax reduction its $10B for FNMA and $5.8B for FMCC? So potentially there is a $15.8B loss of net worth if the tax rate becomes 25%? I would assume Trump would try to go for 25% rate. 29% is highly likely for $9.5B drop in net worth. What would be the possible ramification of such a loss on non cash items on the balance sheet?

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          1. I don’t have the answer to that question. My general recollection is that the effect of a cut in the marginal tax rate on either Fannie’s or Freddie’s deferred tax assets would not be proportional–that is, a 29 percentage point reduction in the marginal rate from 35% to 25% would not result in a 29% write-down in the DTAs; it would be something less than that–but I don’t have anything specific to back that up. This would be a good question to ask the companies’ managements in their next earnings conference call (which unfortunately won’t be until February), although I suspect they will disclose in their 2016 10Qs the effects of various corporate tax rate changes on their DTAs.

            Assuming that tax reform occurs and becomes effective before the net worth sweep is reversed, any DTA write-downs resulting from changes in the marginal corporate tax rate that exceed a given quarter’s net income plus whatever small amount of capital remains would need to be offset by a draw from Treasury.

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      1. FHFA and SEC are independent agencies. Their heads don’t even report to the President. Why does Trump send a landing team? Someone could help me?

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  31. Tim,

    Good afternoon. What are your thoughts on Timothy Bitsberger (Former Freddie Treasurer/SVP) being named to FHFA landing team by Trump? David Fiderer directed a comment to me on Twitter that Bitsberger absolutely knows the truth about Freddie Mac prior to being placed into conservatorship. This seems to be a positive development. Would it make sense for you to share your ideas/facts with Bitsberger directly?

    Thanks,
    #FannieGate

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  32. Hi Tim
    I have a question for you. I understand that, because of a clause in the last year omnibus bill, the government cannot sell the Sr preferred stock without congress authorization.That prohibition expires in Jan 2018. is it right? But can government cancel the Sr preferred by considering it paid? I mean without congress intervention?

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      1. The “Jumpstart GSE” clause Senator Corker inserted into the 2015 federal appropriations bill relating to redemption of Fannie and Freddie’s senior preferred stock reads as follows: “Notwithstanding any other provision of law or any provision of the Senior Preferred Stock Purchase Agreement, until at least January 1, 2018, the Secretary may not sell, transfer, relinquish, liquidate, divest, or otherwise dispose of any outstanding shares of senior preferred stock acquired pursuant to the Senior Preferred Stock Purchase Agreement, unless Congress has passed and the President has signed into law legislation that includes a specific instruction to the Secretary regarding the sale, transfer, relinquishment, liquidation, divestiture, or other disposition of the senior preferred stock so acquired.”

        This language would not constrain a court from requiring the net worth sweep–should it be found in violation of the law–to be reversed by characterizing the excess monies paid to Treasury pursuant to the sweep (relative to the 10 percent senior preferred dividend) as reductions in the amount of senior preferred stock outstanding. But a final ruling on the sweep is highly unlikely to come before January 1, 2018, so that really isn’t the issue.

        Of more relevance is how the Jumpstart GSE language might affect any negotiated settlement between the government and plaintiffs in the lawsuits. If I were on the team negotiating a settlement I first would consult with counsel, but it seems to me that there are a number of ways to work around that language. One would be to have Treasury and FHFA enter into a fourth amendment reducing the quarterly sweep payments to zero, to allow the companies to retain capital up to a certain percentage of assets. With a high enough percentage, sweep payments would remain at zero well beyond the January 1, 2018 expiration date of the Jumpstart GSE clause, at which point the senior preferred stock could be liquidated or reversed.

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    1. The two important words in your question are “realistic” and “they”. The “they” would have to be the senior economic and financial policy officials in the Trump administration, and a “realistic” recapitalization plan would one designed to achieve an identified objective as efficiently and effectively as possible. At the moment, we do not know who the key Trump administration officials will be, nor what their views are on potential Fannie and Freddie recapitalization. If, for example, the Trump administration does support recapitalization–but also wants to attempt to first pull $60- $80 billion out of the companies by converting Treasury’s warrants for 79.9 percent of their common stock, then selling these shares over time for cash to the public– that would leave a very different set of options for recapitalizing Fannie and Freddie than if the warrants were not converted. In my view, therefore, to get a better sense of what’s “realistic” on Fannie and Freddie recapitalization, we’ll need to get a little more information about the objectives of the people who would be attempting to do it.

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      1. The lawsuit will progress much faster after Obama’s departure. Washington Federal lawsuit must address the warrant. If voided, easy. Otherwise, it may take more than 5 years or even impossible.

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      2. Tim – thank you for commenting on the recap. scenarios. As an investor in both preferred and common shares, I find this to be a topic where it is very difficult to obtain accurate information. Why wouldn’t the gov choose to exercise the warrants under any situation given the $60-$80 billion available? Also, any additional info. that you could provide regarding implications for preferred vs common shares. I know that preferred are a safer bet given the higher priority and contractual argument; however, I believe the common have excellent potential depending on dilution. To me, this is the single most important topic as a shareholder. Much of the information circulated around this topic is simply incorrect so I sincerely appreciate hearing your assessment as an expert of FnF. Thank you!

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        1. I might qualify as an expert on Fannie Mae’s business, but I’m at best an educated layman when it comes to the political and the legal aspects of their future. And I’ve never given investment advice, including on prospects for their common or preferred stock.

          I would not expect the government to even consider exercising the warrants it granted itself for 79.9 percent of Fannie’s and Freddie’s common stock until there are developments in the legal cases. And if it did exercise the warrants, I have little doubt that lawsuits would be filed challenging the action.

          As I’ve noted elsewhere, the government already has extracted $67 billion from Fannie and Freddie shareholders as a consequence of its decision to take over the companies (against their will) in 2008. I suspect the next act in the Fannie/Freddie drama– outside rulings in the Perry Capital appeal and the writ of mandamus before the Court of Appeals for the Federal Circuit–will be for the economic and financial policy team of the Trump administration, once it is identified and in place, to assess the situation and decide what its objectives should be for Fannie and Freddie going forward. Once we have some “tea leaves” to read on that, we can start handicapping outcomes for the companies (and speculating on scenarios for their equity securities) with a little more knowledge and confidence.

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  34. https://app.voicebase.com/autonotes/private_detail/33205817/hash=bJeXYGltZ2PLSWaWyWxmNknWyPmZpolmZsmmeWkZpmxGdmx8eSZG1pbJ1sm8qa?vbt=0

    Tim,
    Above is the link address for the conference call today nov.18, 2016 , hosted by Bruce Berkowitz of Fairholme Fund. There is something that he said in the conference call that jibes with your solution on FNF. He said “We’re not telling our government or the people of our country what to do but we do have common sense solutions that will result in big way and for the country and he is ready to transform into low risk public utilities with regulated rates of return. Just like every one of the local electric company.”
    Have you discussed your utility model with Bruce? Could this be an opportunity for you to work with Bruce and using your financial expertise to explain to stakeholders as well as haters of FNF that utility model is the best and only workable to the housing mortgage reform both in practical politics and economic financial model?

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    1. I’ve looked at it briefly, and I’d say it’s not really relevant either to Fannie and Freddie or their shareholders. The GAO says it was asked to examine FHFA’s actions as they affected the future of the companies, and essentially said that for FHFA to accomplish the objectives of the conservatorship it needed better guidance by Congress, through legislation. Nothing to see here, move along.

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  36. Thanks for your presentation on risk sharing. It is very alarming that such give-aways are going on. I don’t understand the regulator’s motivations for creating them. Is it all smoke-and-mirrors?

    Another question, looking toward a potential reform and recapitalization plan, let’s suppose that the GSEs were to pay a fee to the government for an explicit guarantee. What would a reasonable fee be and how would it impact earnings of, say, Fannie?

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    1. I was asked about the motivation for forcing Fannie (and Freddie) to do non-economic securitized risk sharing deals during the question and answer session of the Investors Unite conference call. I said that I thought FHFA was requiring the companies to do them at the direction of Treasury, and added that I didn’t know what Treasury’s motivation was but that I had an educated guess. I believe the people at Treasury can read a prospectus, and know these transactions don’t transfer any meaningful amount of credit risk to investors. But in order to get Congress to pass legislation that “winds down” Fannie and Freddie–which Treasury desperately wants– it needs some alternative mechanism that can replace them. The most superficially appealing idea Treasury has been able to come up with is the risk-sharing model, which in theory has the advantage of spreading credit risk throughout the capital markets rather than concentrating it in the hands of two too-big-to-fail institutions like Fannie and Freddie (the “failed business model,” as Treasury persists in calling it). I think Treasury knows the risk-sharing model does not work and cannot work, but needs Congress to believe that it does for long enough to pass legislation killing Fannie and Freddie. If legislation IS passed, Treasury will wait for a respectable period of time before “discovering” that the risk-sharing model has problems (which it will describe as surprising and unforeseen), and then coming up with some other form of secondary market financing that doesn’t include either of the companies it has successfully buried.

      I obviously hope this strategy–if that in fact is what Treasury is doing–doesn’t work; that’s why I’ve been calling attention to the flaws of Fannie’s CAS and Freddie’s STACRs as risk-transference mechanisms. If enough people really look at them, the deception won’t hold up, and Treasury will have to come with a new and workable alternative to the companies. That won’t be easy to do.

      On the fee for a government guaranty, if my first choice approach–which is a repayable line of credit from the government, given in exchange for Fannie and Freddie agreeing to accept regulated “utility-like” returns on their capital–turns out not to be acceptable to policymakers (although I think it should be), my second choice would be to have the companies pay a nominal fee to the government–say five basis points, paid by the borrowers of loans financed by Fannie and Freddie–for an explicit guaranty. In this alternative, it’s important to recognize that the 5 basis points is not intended to be the equivalent of an insurance premium, designed to cover the expected cost of government support of the companies. The government’s risk of backing the companies should be built into their risk-based capital requirement, and covered through a combination of initial capital and annual guaranty fee. The five basis point fee is on top of that, priced in reflection of the likelihood that losses in excess of the stress amount built into the risk-based capital standard should be extremely remote.

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      1. Thanks. If your suspicions about the motivations for the risk sharing deals is correct, then the Conservator, Mel Watt, would have to be replaced if the new Administration intends to recapitalize the companies.

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      2. Tim,
        There is a need to regulate the regulator. These people use juridictional bar provisions to perpetuate these mischiefs. Courts should not accept jurisdictional bar provisions.

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  38. Hi Tim. Thank you for this invaluable resource of knowledge. You mention that a GSE policy decision will likely be led by new Treasury Secretary and I agree. I’m just curious if you have any knowledge of the current top pick’s (Mnuchin) views on the situation. I realize that’s asking a lot, but thought you may know him, at least better than I do 😉 Thanks again for you time and effort.

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    1. No, I do not know Mnuchin (although I met him briefly many years ago when I was at Fannie Mae and he was at Goldman). If he is appointed Secretary of the Treasury, I’ll be in a learning mode about him along with most everybody else.

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      1. i was involved in a deal with steve about 25 years ago when he was a young banker at goldman. i remember thinking initially that this was a nepotistic trust funder (steve’s pop was a bigwig at goldman), but i found steve to be both a smart and nice guy. given that steve and his father (and brother i believe) were goldman men, the guy is wall street born and bred. take this for what you will.

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  39. Tim,

    Thanks for presenting your clear analysis in IU.

    Are there any plans by DC/WS think tanks to invite experts to debate these risk sharing plans?

    If these scheming (by purpose, ignorance or arrogance) risk sharing plans are hurting FnF to benefit financial establishment, and also creating false optics where congress will be constrained to pass laws not favorable to FnF shareholders, then is your analysis conclusive enough for taxpayers (or shareholders) to get injunction from courts?

    Can you please publish a white paper with all the formulas and charts and forward to FHFA?

    In 2008, the same people brewed the criss and then forced congress to pass many bailout schemes and HERA. If these schemes are hurting taxpayers, then conservator can not claim jurisdictional bar and prevent review by courts.

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    1. I’m not aware of any organizations that are considering a forum or a panel to discuss and debate risk-sharing plans. I’d be happy to participate if anyone does set one up. I’ve had a number of informal discussions on the subject, and will be having more, and I’ve yet to have anyone tell me that my observations or analyses are wrong. And I wouldn’t expect anyone to– all I’ve really done is point out what Fannie discloses in its own issuance documents, and draw and then say the obvious conclusions from that (the securities transfer very little real risk, and because of this are extremely uneconomic, given what they cost). FHFA doesn’t need a white paper; I’m sure they know everything I’m saying, but they’re having Fannie and Freddie do these deals at the behest of Treasury. Hopefully the change in administration will shake things up at Treasury, but we’ll have to see.

      And, yes, I am aware of at least one potential plaintiff who is considering filing suit over Fannie and Freddie’s securitized risk-sharing transactions.

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      1. Tim,

        Taxpayers and FnF shareholders are grateful to you for your expertise and public service.
        Hope Current administration and Trump administration will recognize your expertise and public service and take your help in formulating housing finance policies for the nation.

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  40. So … as it is now risk sharing is only a new way of looting Fannie Mae and Freddie Mac. It is brightly explained in your written statement. I hope it lands on some honest desks (if any are left)

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    1. Not ALL risk sharing; with the right structures and at the right prices, deep-cover mortgage insurance and back-end pool reinsurance can be useful ways to tap broader pools of loss-bearing capital. But I do think that Fannie and Freddie’s current CAS and STACR programs either should be throughly restructured so that they actually do bear real credit risk (which I don’t think investors will accept) or ceased entirely.

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  43. Tim,

    Stephen Moore of the Heritage Foundation/ Cato Institute is named by NY Times as a member of Trump’s team of economic advisors. His policy views on the future of Fannie & Freddie are listed in this statement before the Committee on Banking and Financial Services –

    http://archives.financialservices.house.gov/banking/91200moo.shtml

    How do you view his comments and policy recommendations as it relates to Fannie & Freddie? It seems that these recommendations could be represented in a Trump Administration.

    Thank you in advance.

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    1. Well, Mr. Moore obviously isn’t a fan of Fannie and Freddie on any level, based on his testimony before Richard Baker’s subcommittee in 2000.

      The Trump administration is going to have influential people holding a wide range of views about Fannie and Freddie in positions of leadership, and it will be a challenge to reconcile those views on an important and controversial issue like what to do with the companies going forward. And of course we don’t yet know where this issue will fall within Trump’s ranking of priorities (it’s not in the top ten). I suspect it will be the Treasury Secretary who takes the lead on it, though, so that appointment will be a critical one.

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