Economics Trumping Politics

For the past eight years, what I refer to as the Financial Establishment—large banks and Wall Street firms, and their advocates and alumni at Treasury and elsewhere—has been engaged in a well designed, carefully scripted and highly orchestrated political campaign to convince Congress to replace Fannie Mae and Freddie Mac with a mechanism more financially beneficial to themselves. Then, seemingly out of nowhere, five weeks ago Treasury Secretary-designate Steven Mnuchin announced his intention to “get [Fannie and Freddie] out of government control…reasonably fast.” With this statement, the odds immediately flipped to favor the prospect that the fates of Fannie and Freddie will be determined not by a misinformation-based political process likely to benefit banks, but by a fact-based economic process likely to benefit borrowers.

Banks’ battle for control of the U.S. residential mortgage market began in earnest in the late 1990s, following a decade of concentration of assets and mortgage originations in that industry. Large banks saw Fannie and Freddie’s activities in the secondary market—principally their underwriting standards and the impact of their guaranty fees and mortgage-backed security (MBS) yields on mortgage rates—as constraints on banks’ flexibility to customize and price their mortgages in the primary market. In 1999 three large banks, one subprime lender and two large mortgage insurers banded together to create and sponsor a lobbying group called FM Watch, whose purposes were to put out information depicting Fannie and Freddie in as negative a light as possible, and to lobby Congress for changes to the companies’ charters to raise the cost and restrict the scope of their business. FM Watch had relatively little success in its efforts, however, in large part because they so transparently served banks’ interests at borrowers’ expense.

The 2008 financial crisis provided Treasury with a serendipitous opportunity to accomplish what the large banks and FM Watch could not. Under pretense of a rescue, it forced Fannie and Freddie into conservatorship, against their will and without statutory authority, and deliberately withheld from them the onerous terms that would be imposed in the aftermath, which were intended to prevent them from ever returning to private, shareholder-owned status.

The takeovers of Fannie and Freddie in 2008 were accompanied by an aggressive and highly coordinated disinformation campaign that was far more ambitious and audacious than anything attempted by FM Watch. Using the technique of “fake facts” that since has become a standard weapon in the political arsenal, members and supporters of the Financial Establishment ignored the obvious evidence—including the disastrous credit performance of loans financed with private-label securities and the vastly lower delinquency numbers put out by Fannie and Freddie each month—and simply blamed Fannie and Freddie for the crisis. With that, they had a mantra they could repeat endlessly: Fannie and Freddie had a “flawed business model;” they (alone) caused the financial crisis, and it had taken $187 billion in taxpayer money to paper over their mistakes. The Financial Establishment also had a proposed remedy: the companies must be “wound down and replaced,” with whatever secondary market mechanism it recommended.

This complete misrepresentation of the causes of the crisis—and the appropriate response to it—encountered virtually no resistance or opposition. That, too, was by design. One of the conditions imposed by FHFA on Fannie and Freddie, in writing, on the day they were put into conservatorship was that “all political activities—including all lobbying—will be halted immediately.” The executives at Fannie and Freddie had the most knowledge about the true causes of the crisis, but with the FHFA edict their voices, and those of the consultants and lobbyists they employed, were silenced. And when discussions on mortgage reform began in Washington in 2009, it was understood even by the independent think tanks that in order to have a “seat at the table” you had to accept as a given that the mortgage finance system of the future would not include Fannie and Freddie, or any entity that looked or functioned like them.

The mortgage reform debate in Washington should have been an economic exercise in how best to apply the lessons from the housing bubble and subsequent meltdown to make our mortgage finance system safer and more resilient, while maintaining its accessibility and affordability for consumers. Instead, it became a political exercise in deliberately misstating and distorting those lessons, to justify giving control over the availability, terms and pricing of $10 trillion in mortgages to the large banks and investment firms.

Large bank mortgage originators in the primary market have long known that the most sure way to minimize the constraints and disciplines imposed upon them by credit guarantors in the secondary market is to make those guarantors less efficient by forcing them to hold (and price for) more capital than is warranted by the risks they insure. Thus, the one consistent element in every reform proposal made or endorsed by the Financial Establishment has been that any entity or mechanism that replaces Fannie and Freddie must have bank-like levels of capital backing its credit guarantees. Advocates for this position advance two politically powerful arguments to support it: to create a “level playing field” for all competitors, no form of financing mortgage credit risk should have a lower capital requirement than any other, and “more capital is better” because it keeps the taxpayer safer.

Economically, however, a single, artificially high capital ratio applied to the entire range of credit risks for all single-family mortgages made throughout the country violates the principle that capital must be related to risk, and cripples the credit guaranty business model (which the Financial Establishment understands). For example, a 5 percent fixed capital ratio requires a credit guarantor to charge an average annual guaranty fee of between 80 and 90 basis points (before the 10 basis point payroll tax fee paid to Treasury) to earn a market return on its capital. To average an 80 to 90 basis point fee rate on the mortgages being made today—which have an expected annual loss rate of less than 4 basis points—a credit guarantor would need to significantly overcharge for most of its guaranteed loans, and grossly overcharge for higher-quality loans. Borrowers would be badly hurt by those pricing distortions, while banks and Wall Street firms would profit from them.

Interest rates on 30-year fixed mortgages are based on the cost of selling into MBS, so any increase in average guaranty fees would be passed on directly to borrowers. Let’s say that excessive capital requirements result in 40 basis points of “unnecessary” guaranty fees. On average, mortgage borrowers would pay that amount, while portfolio lenders would receive it. Commercial banks today hold $1.7 trillion in single-family first mortgages in their portfolios (up 9 percent from a year ago); a 40 basis point rate increase rolling into them, as old loans pay off or refinance and new ones replace them, would raise banks’ net interest income by almost $7 billion per year. Higher 30-year fixed mortgage rates, over time, also would lead more borrowers to choose adjustable-rate mortgages—which banks can match with their short-term deposits, with borrowers bearing the risk of interest rate adjustments—and, for Wall Street firms, would make private-label securitization more competitive with (overpriced) guaranteed MBS. Finally, 40 basis points more in mortgage rates and 80 to 90 basis point guaranty fees would allow banks to increase their interest income and reduce their credit losses by keeping their lower-risk mortgages in portfolio (funded with low-cost, government-insured deposits) while swapping and selling their higher-risk mortgages as guaranteed MBS.

The Financial Establishment is well set up to obtain these results from the political process. Eight years of constant and unchallenged repetition of falsehoods about the causes of the financial crisis and the alleged weaknesses of the Fannie and Freddie business model has erected a solid wall of disinformation in the media, among the general public and in Congress that has proven very difficult even for confirmed facts to break through. In my view, all that has kept the Financial Establishment from being successful in Congress has been its inability to come up with a workable alternative to the two companies it so desperately wants to replace. (Its latest attempt—risk-sharing securities that only pretend to transfer credit risk—is a step backwards.)

Now, however, comes Mnuchin’s pledge to resolve the impasse over Fannie and Freddie “reasonably fast,” which decisively changes the reform dynamic. In an administrative process, responsibility for accomplishing mortgage reform shifts from a large number of misinformed members of Congress with political incentives to get it wrong to a small number of informed finance professionals with economic incentives to get it right. Moreover, the deceptions, inventions and falsehoods about Fannie and Freddie that have served the Financial Establishment so well in the legislative process will work against it in an administrative process, where the focus will be on facts produced in the course of judicial proceedings.

A key element of Treasury’s strategy of blaming Fannie and Freddie for the financial crisis was to bury them under a mountain of non-repayable senior preferred stock by directing FHFA, as conservator, to put massive amounts of non-cash expenses on their books. But because the resulting losses were not real, there was nothing FHFA or Treasury could do to keep those losses from reversing. Between the fourth quarter of 2012 and the first quarter of 2014, most of them did. Recognizing that this was about to happen, Treasury and FHFA entered into the net worth sweep in August 2012, preventing the companies’ from rebuilding their capital by taking all of their future income for the government. Treasury’s public defense for the sweep was that it was in Fannie and Freddie’s own best interest, to avoid their entering “death spirals” of borrowing to pay the dividends on their senior preferred stock.

Treasury had gotten away with countless dishonesties about the companies before, but this was too much. Numerous lawsuits were filed challenging the legality of the sweep (with one challenging the conservatorship) in several courts under different theories of law. The judge in one of the courts—Margaret Sweeney in the U.S. Court of Federal Claims—granted plaintiffs requests for discovery. From this discovery, documents have slowly emerged, and more are in the process of being compelled, that make clear that far from rescuing Fannie and Freddie, Treasury planned and carried out their takeovers for ideological and policy reasons, then lied to both the public and the courts about what it had done and why.

Plaintiffs in the court cases have had three and a half years to learn the facts about what really happened to Fannie and Freddie. Mnuchin’s plan to “get [the companies] out of government control” requires settling the lawsuits, and when settlement talks begin he, and the rest of his (new) senior Treasury staff, will learn those facts. Just that quickly, eight years of investment by the Financial Establishment in a fictitious account of the mortgage crisis, and a mythical depiction of Fannie and Freddie, will lose its influence. Fiction only has power where facts aren’t known.

The fact-based settlement discussions between plaintiffs in the lawsuits and senior economic and financial officials in the Trump administration also will set the tone for how the parties think and decide about what the post-settlement secondary market system should look like, and how it should function. Plaintiffs know that Fannie and Freddie were not the causes of the financial crisis, that they didn’t need to be rescued by the government, and that their secondary market business model works better than any other. They also know that because the alternatives to Fannie and Freddie proposed by the Financial Establishment are deliberately designed to be inefficient, it would be impossible to raise the requisite amount of capital to set them up (a point continually missed by advocates of these alternatives), whereas recapitalizing Fannie and Freddie post-conservatorship is eminently achievable. Plaintiffs emphatically will make these points, and others, to Mnuchin and his team.

In an administrative reform process, plaintiffs and the government each will have powerful economic incentives not just to reform, release and recapitalize Fannie and Freddie, but also to set them up to succeed. Plaintiffs know that Fannie and Freddie have much more value as ongoing entities than in liquidation, and both Bruce Berkowitz and Bill Ackman have said repeatedly that “there is no alternative” to the companies. For its part, the Trump administration will have at least two reasons to support them. First, it will understand from facts unearthed for the lawsuits that a secondary mortgage market built around Fannie and Freddie is far better for consumers and the economy than the bank-centric proposals supported by the Financial Establishment, and will know it will be held accountable for the negative consequences of choosing the latter. Second, the Trump Treasury will inherit the warrants for 79.9 percent of Fannie and Freddie’s common shares created by the Bush Treasury, which will become worthless if the companies are wound down.

While the Trump Treasury could (and should) cancel those warrants on the grounds that they were granted improperly, their financial value makes this unlikely. And as warrant holder, the Trump Treasury will share the plaintiffs’ goal of setting Fannie and Freddie up to operate as cost-effectively and efficiently as possible (benefitting borrowers as well as shareholders). It also will have strong incentives to alter the terms of the warrants—their strike price, percentage amount or both—and to manage the timing of conversions so as to maximize the value of all three categories of stock the companies will have as going concerns: existing shares, converted warrants, and the new issues of equity required for recapitalization. Plaintiffs, the Trump administration, existing shareholders and borrowers will be aligned around common objectives.

Members and supporters of the Financial Establishment will fiercely oppose an administrative solution to mortgage reform that maintains Fannie and Freddie—indeed they’ve already begun to do this in the media—but they will be dealing from a position of weakness. They have no realistic legislative alternative to offer, and because Republicans in the executive branch will know the facts about Fannie, Freddie and the financial crisis from discovery in the court cases, Republicans in Congress will not be able to sustain their myths about them. There never has been any economic case against reforming, releasing and recapitalizing the companies, and without the myths the political case falls apart.

It is by no means a certainty that the Trump administration will arrive at the right solution on mortgage reform. But because it has made the issue a “top ten” priority, and the path to a successful outcome is so obvious and wide open, for the first time in quite a while there is great cause for optimism.

194 thoughts on “Economics Trumping Politics

      1. ROLG,

        Will not this ruling allow FnF cases to be heard in State courts?

        So far all cases filed in State courts are moved to Federal courts.



        [January 18, 2017]

        JUSTICE SOTOMAYOR delivered the opinion of the Court.
        The corporate charter of the Federal National Mortgage
        Association, known as Fannie Mae, authorizes Fannie
        Mae “to sue and to be sued, and to complain and to defend,
        in any court of competent jurisdiction, State or Federal.”
        12 U. S. C. §1723a(a). This case presents the question
        whether this sue-and-be-sued clause grants federal district
        courts jurisdiction over cases involving Fannie Mae.
        We hold that it does not.


        1. i do think that for example hindes/jacobs could be withdrawn from federal court and refiled in delaware chancery court. but that may be a long run for a short slide


          1. ROLG,
            Thanks, Will this apply to below Deloitte case ruling?
            Judge Scola entered an order today denying the Edwards Plaintiffs’ motion to remand their lawsuit to Florida state court and granting FHFA’ motion to substitute.


  1. Hey Tim,

    Thanks for everything.

    I know you posted a great take down of the ‘risk sharing’ CAS securities in ‘Far Less Than Meets the Eye”

    Do you know if Freddie is also going to be attempting a similar risk sharing ploy? And if so do you expect it to transfer any risk?


    1. Freddie has had its own risk-sharing program for about as long as Fannie has been doing CAS. Freddie’s program is called Structured Agency Credit Risk (or STACR) securities. I’ve done an analysis of the risk transfer efficiency of STACRs, similar to the one I did and wrote about for Fannie’s CAS. Although I haven’t published or written publicly about the STACR results (I’ve sent notes about that analysis to various individuals privately) they’re similar to what I found for CAS.

      In their prospectuses, both Fannie and Freddie give a range of scenarios combining loss and prepayment rates, and show the amount of credit losses transferred by their “risk-sharing” securities in each case. Fannie’s scenarios are much more realistic than Freddie’s: Fannie has an average cumulative credit loss rate over 64 scenarios of 2.1 percent, and a worst-case loss rate of 10.3 percent; Freddie has an average credit loss rate over 48 scenarios of 6.6 percent, and a worst-case loss rate of 27.9 percent. Freddie’s loss rates are really not defensible. The worst ever-to-date credit loss rate either company has had in any single year has been about 5 percent for loans from 2007, when half of that year’s mortgages were no-doc or interest-only ARMs (now no longer eligible for sale to the companies). The AVERAGE loss rate for Freddie’s 48 scenarios is well above that 2007 experience, and its worst case of 27.9 percent would require a 70 percent default rate and a 40 percent loss severity (which is ludicrous). But even at these unrealistic loss rates Freddie’s STACRs don’t pick up materially more credit losses than Fannie’s CAS: over all 64 of Fannie’s scenarios, CAS absorb slightly under 4 percent of projected losses, leaving Fannie with 96 percent; in its 48 scenarios, Freddie’s STACRs absorb slightly over 5.5 percent of losses, leaving Freddie with 94.5 percent.

      Again, these efficiency (or inefficiency) percentages are easily calculable from data both companies publish in their prospectuses. I have brought them to the attention of over a dozen policy analysts and journalists, in each case asking them to tell me if I’ve made a mistake in analyzing the data. No one has claimed that I have. I’ve then followed up, asking the journalists to write about these securities that patently don’t do what they’re claimed to be doing (transferring credit risk to capital markets investors) and asking the policy analysts why, given the obvious and intentional defects of CAS and STACRs, they continue to assert that the mortgage finance system of the future can and should be based on risk-sharing transactions, which are not remotely equivalent to equity capital in risk absorption. The response has been stony silence. Everyone seems to be waiting for some other member or supporter of the Financial Establishment to blow the whistle on these deals, and in the meantime the charade (and the waste of Fannie and Freddie’s revenues on interest payments with miniscule chance of offsetting loss savings) continues.

      And one final point. For the last several years, the risk profile of the loans Fannie and Freddie have been purchasing or guaranteeing has been exceptionally good (the Urban Institute calls it “squeaky clean.”) Based on the performance of the companies’ 1999-2003 books of business—which weren’t as high-quality—it is likely that the lifetime credit loss rates of the loans Fannie and Freddie have been insuring with CAS and STACRs won’t exceed one half of one percent. CAS and STACR risk transfers don’t even kick in until after Fannie or Freddie have taken the first one percent of losses. So—FHFA and Treasury are forcing Fannie and Freddie to pay one-third of the unjustifiably high guaranty fees they are charging on very high-quality loans to buy credit insurance that (a) is very unlikely ever to be needed, and (b) in the remote chance that it is, will pay the companies at most only 4 to 6 cents for every dollar of credit loss they experience. It’s really hard to come up with a “risk-sharing” program more wasteful than that.


  2. Just a quick question I can’t find an answer on. In fairholme, we are waiting on the mandamus appeal result. When will that come about? Will that finally get all the privileged documents to see the light of day or is there some other legal delay step that is likely to come after that? I sense that whatever is in those 11,000 documents will spur new lawsuits altogether that challenge the original conservatorship, much less the net worth sweep in today’s lawsuits. At which point, I assume Mnuchin will not be able to use the warrants as leverage as you described above in any settlement talks. Anyone have a date on mandamus and thoughts on above?


    1. There is no timetable for a decision from the Federal Court of Appeals on the writ of mandamus, nor is there a timetable for a decision from U.S. Court of Appeals in the Perry Capital case.

      I have no non-public information about either, but I believe both courts of appeals are waiting for the inauguration—so as to only have to deal with a response from the Trump Treasury and Justice Department—and I also expect a decision on, or resolution of, the writ of mandamus before we see a ruling in the Perry Capital case.

      The question on the writ of mandamus is whether the Trump Treasury and Justice Department will even continue to seek it. The Obama Treasury and Justice Departments have come under heavy criticism for the obsessive secrecy with which they have attempted to shroud all documents even remotely related to the net worth sweep cases. It’s not at all clear why the Trump Treasury and DOJ would want to take this on. I personally doubt they will.

      But that still leaves open the issue of timing. It is possible that Secretary-designate Mnuchin will tip his hand on this topic at his confirmation hearing on Thursday, but I don’t think he will. And I don’t think the judges on the Federal Court of Appeals will wait indefinitely before they rule. My hunch is that we’ll get a decision in favor of the plaintiffs’ opposition to the writ of mandamus within a month of inauguration day (but that’s pure speculation on my part). All that means, however, is that the 56 documents in question will be made available to the plaintiffs (and likely to the U.S. Court of Appeals as well, for the Perry Capital case). They won’t be made public, unless Treasury agrees to it or Judge Sweeney issues an order requiring disclosure of some or all of them.

      And even if the documents are made public, the notion that they will “spur new lawsuits … that challenge the original conservatorship” is unrealistic. First, the statute of limitations on suits from 2008 has already run. And second, if the Trump administration is going to settle the lawsuits it will want to do so quickly. New documents damaging to the government will strengthen the plaintiffs’ hand in settlement negotiations, but beyond that simple statement it’s hard to say anything more definitive (including anything related to the possible cancellation of the warrants).

      Liked by 1 person

      1. Tim, if the released documents show clear fraud, won’t you reckon now that Washington Federal or its backers will go full steam ahead to litigate this? Because the difference in the potential rewards for plaintiffs for invalidating the NWS and the conservatorship is very huge..


        1. Again, we should be clear that the 56 documents subject to the order to compel (and the writ of mandamus) won’t be “released” even if they are produced by the government, unless the Trump administration releases them voluntarily or is ordered to do so by Judge Sweeney. Second, while the 56 documents, taken together, likely will include strong circumstantial evidence of the nature and extent of the government’s misbehavior in its takeovers and subsequent post-conservatorship management of Fannie and Freddie, there is no indication from the descriptions of these documents in the privilege log that any of them will contain clear evidence of fraud. Finally, even if the circumstantial evidence from these 56 documents (and others among the 11,000 still to be produced) is extremely strong, litigating the Washington Federal suit to a final adjudication would be very expensive. As we’ve seen from the three dozen-plus Fannie and Freddie lawsuits filed since 2013, the U.S. judicial system isn’t exactly “built for speed.” I think a more likely case would be that one or more of the plaintiffs in the other lawsuits would use the threat of funding the continuation of the Washington Fed suit as leverage in settlement negotiations; the issue then would become whether the government viewed that threat as credible, or would dismiss it as a bluff.

          Liked by 1 person

  3. If GM, Citi, BoA, JP Morgan, or GS fails, will government bail them out? They don’t have gov Guarantees, implicit or explicit.


    1. All saw what Gov and Fed did when GM, Citi, BoA, JP Morgan, or GS needed taxpayer bailouts?

      They even allowed investment banks to become regular banks overnight to get credit lines/bailouts from Feds, at the same time denying pre-approved statutory credit lines to FnF.


    2. I would argue implicit with the Too Big to Fail. Precisely for that reason they would be bailed out just like last time. Also with the banks their should be some recognition as to how FDIC works to back stop their deposits. Just some additional thoughts on the aforementioned.


  4. Tim, Warren Buffett’s lack of comment has been one of the big mysteries for me on the GSEs. He was a major shareholder of the companies in the 80’s but hasn’t voiced his opinion on the Net Worth Sweep when his position on this should clearly support the truth considering he understands the business and how it has been reformed since the crisis to reduce portfolio risk.

    Here’s a video of Buffett responding to some questions by our beloved Peter Wallison.

    I don’t know the date of the hearings but note a part of the exchange:

    Q: Why did you sell FMCC stock?
    A: ‘… they bought RJR bonds or Phillip Morris bonds… but they bought some bonds that had nothing to do with housing at all.’ ‘Here they were using gov’t credit to enlarge this hedge fund type of portfolio that had nothing to do with housing…’

    Q: Did you follow Fannie and Freddie enough to know that they had affordable housing requirements? And did you know the size of the affordable housing requirements?
    A: ‘ Yeah, They were predicated on being able to use the tax credits that were involved and they set them up as assets on the balance sheet and have no income now, so they became very dubious assets.’

    My questions:
    1. Why would FMCC get into Phillip Morris bonds? It seems like a clear deviation from the business.
    2. Buffett’s view of the DTAs looks pretty short sighted if this is a video from 2008-2010 period. Shouldn’t he know that the DTAs would be valuable as soon as the economy picked up?
    3. What can possibly prevent him from expressing his opinion on the Net Worth Sweep now that he must be aware of valuation allowance reversals? I just can’t reconcile his stance – being an advocate for ‘sunlight is the best disinfectant’.

    Thank you for your time!


    1. I don’t think Buffet has looked closely at Fannie and Freddie in quite a while, as this interview with Wallison indicates. For example, Wallison tries to get him to opine on the role of the companies’ affordable housing goals in the crisis, but Buffet thinks he’s talking about their low income housing tax credit (LIHTC) transactions, which both companies did as a (small) part of their multifamily business. As it did with Fannie and Freddie’s deferred tax assets (DTAs), FHFA forced the companies to write off their LIHTC balances by claiming they wouldn’t generate enough taxable income to use them. (Unlike the DTAs, however, Fannie and Freddie still could have received value for their low-income tax credits by selling them to another company, but Treasury refused to authorize any sales.)

      The Phillip Morris bonds (and it was Phillip Morris, not RJR) were in my view a mistake on Freddie’s part. In the fall of 2000, both Fannie and Freddie agreed to what we called our six “voluntary initiatives” to improve the quality of our risk management and enhance our risk management disclosures. One of those initiatives was to hold sufficient liquidity to be able to survive at least three months without access to the debt markets. Each of the companies built substantial liquidity portfolios in furtherance of this objective, and in its liquidity portfolio Freddie decided to reach for yield by buying longer-term non-mortgage bonds that were liquid enough to sell if necessary. But because the Phillip Morris bonds were so obviously not within Freddie’s housing mission, it came under a lot of criticism (including from Buffet) for buying them. Not to exempt Fannie from criticism, however, it also did something Buffet didn’t like: announcing in 1999 a goal to double its earnings per share in five years.

      One final point about Buffet and Fannie and Freddie. HIS involvement in the housing crisis was owning 13 percent of the stock in Moody’s, which along with Standard and Poor’s (and, to a lesser extent Fitch) facilitated both the private-label securities boom and the collateralized debt obligation idiocy. Buffet did not do himself much good by essentially giving Moody’s a pass on this behavior–“nobody knew how bad these loans were”–and I think partly because of his Moody’s involvement he’s chosen to keep his distance from housing-finance related issues in general, including the futures of Fannie and Freddie.

      Liked by 2 people

  5. Hi Tim, I read your book this weekend. It was absolutely fascinating, and I thank you for writing it.

    In the afterward, you advocate for a straightforward entity based mortgage credit guaranty with govnt backing. You then assert that a new system must have broad support and not be controversial.

    The impression I got from your chronicling of the gses history, however, is that as long as there is some government involvement, they will be hopelessly controversial and political. How then, are we to proceed in our efforts to “evolve” to a new system, unless we resort to a fully privatized model (its inherent disadvantages notwithstanding)? Is it even politically feasible?

    A second question I have is, I got the impression that under maxwell, johnson and raines, the gses built up a considerable network of supporters and allies. Where did all these allies go in the early 2000s when political attacks reached its peak? And where were they when the government implemented the NWS, an egregious overreach of govnt power?

    Im hopeful that like Paul Oneill did when he took over as treasury sec, Mnuchin will favor substance over spin. But I also worry that the forces working against the gses are simply too great for a rational treasury secretary to overcome.

    Liked by 1 person

    1. Historically– that is, pre-crisis– almost all of the opposition to Fannie and Freddie was to their portfolio business (even Alan Greenspan thought the credit guaranty business was a legitimate function for them to be carrying out). When I wrote the book, I thought that phasing out the portfolios as stand-alone businesses would make it easier for a political consensus to form around having them continue, with more capital, as the primary credit guarantors of 30-year fixed-rate mortgages, but it obviously hasn’t worked out that way. As I discuss in my latest post, the persistent misinformation campaign run by the Financial Establishment seems, for now at least, to have convinced the majority of members of Congress that the companies should be “wound down and replaced” with something else (even though nobody has yet come up with a great idea as to what that “something else” might be).

      Which brings me to your second question: how did Fannie and Freddie lose the bipartisan political support they had for most of their existence? This is a matter of opinion rather than fact, but I’ll give you mine.

      If you just finished my book, you’ll recall that what I term the “mortgage wars” really ramped up following Fannie’s decision in 2003 to seek consensus legislation clarifying Fannie and Freddie’s roles in the market and more precisely defining certain aspects of their regulation. During the legislative process, however, the companies’ critics realized that a bill that was good for all parties would make Fannie and Freddie stronger, which the critics did not want. Accordingly, Treasury took the lead, first in the House and then in the Senate, in insisting on provisions that were not in the companies’ best interest. Negotiations on the legislation broke down, and in response the Bush administration began a coordinated regulatory assault on Fannie and Freddie (nicknamed, by them, “Operation Noriega”), involving Treasury, HUD, the companies’ then-regulator OFHEO, and others.

      OFHEO took Operation Noriega the farthest, accusing Fannie of deliberately falsifying its financial statements to inflate its income and pay its executives more money. THAT, in my opinion, was the first big blow to Fannie and Freddie’s political support. Post-Enron, the easiest way to get a company’s supporters to abandon it was to accuse it of accounting fraud. Fannie’s then CEO, Frank Raines, and I lost our jobs over the OFHEO accusations, and the new management team that took over–led by Dan Mudd and Steve Ashley–made the strategic decision not to challenge OFHEOs claims of misdeeds by prior management (instead, they simply said they wouldn’t in the future do any of the things the company had been accused of doing in the past). I personally believe that was a mistake, since it allowed the perceptions of wrongdoing to stand. There was no legal ruling on the OFHEO accusations for eight years, and even when a ruling favoring Raines and me came it was not covered in the press.

      By then Fannie had been badly weakened (as, by association, had Freddie). When OFHEO’s successor agency, FHFA, gave in to pressure from Treasury in September of 2008 and reversed itself on the companies’ safety and soundness–switching from a just-published regulatory finding that the companies were safe and sound, and fully in compliance with their capital standards to issuing a scathing letter raising never-before-mentioned concerns in contending they were teetering on the brink of insolvency for which conservatorship was the only alternative–the companies lost any remaining political support they had. Treasury and others then publicly fingered Fannie and Freddie as the causes of the financial crisis, and with no one taking the other side (Fannie and Freddie were banned by FHFA from “lobbying”), even previous staunch defenders of the companies like Barney Frank gave up on them, and agreed that they had to go.

      That’s where we are today. It’s also why I believe the political path to a mortgage reform solution that preserves Fannie and Freddie will be very difficult to navigate, and that the real “promising road” to reform is an administrative solution based on economics and fact rather than politics and fiction.


      1. Tim

        As a Fannie shareholder I thank you for your clairvoyance on this matter. I read or think about Fnf everyday and how we have gotten here. It’s a shame, truly. I also wonder where else our government is pulling shenanigans that we are not privy too. All of this is why I believe the electorate feels the way they do as fed up with D.C. and is anti establishment, even though not many know the GSE saga.


      2. “(instead, they simply said they wouldn’t in the future do any of the things the company had been accused of doing in the past). I personally believe that was a mistake, since it allowed the perceptions of wrongdoing to stand.”


        I’d say not merely a mistake but also a dereliction of duty. Hiding truth in such a way is equivalent to besmirching the good name of others.


      3. Thanks Tim. I applaud you for having the courage and integrity to stand up to the FE, then as CFO and now with your book and this blog. In our sad state of affairs where “fake news” emanates from the highest levels of government and authority figures*, your voice of reason and truth gives me hope.

        *Falcon’s wiki reads “[Falcon] is credited with raising early warning signs about the risks posed by both companies”.


    1. I’m not sure what you have in mind with the phrase “convenient timing,” but I think the settlement IS timing-related. The Obama administration would like to get this litigation tied up before its term ends (next week), and Moody’s would like to put the episode behind it. We may have different views as to whether a third of Moody’s pre-crisis profits is the right penalty for it to have paid, but virtually all settlements with financial institutions for alleged misdeeds leading up to, during and after the crisis have left those institutions accused of committing them better off for having done so (assuming that they did)–not a great deterrent for future misbehavior.

      Liked by 1 person

  6. Hi Tim,

    Wouldn’t you agree that if/when the 11,000 documents are released to the public this would have a strong bearing on what the government would do with the warrants? Especially if fraud and self dealing are apparent?

    (First time poster, not sure why my previous attempt to comment was moderated and deleted.)


    1. I get a LOT of questions about the warrants, and I’ve pretty much run out of things to say about them. Yes, Treasury granted itself the warrants improperly; yes, they are outrageous compensation for two companies that didn’t need to be rescued in the first place and who, had they ever needed assistance, could have been given low-cost, repayable loans by either the Fed or the Treasury, fully collateralized by their (ample) holdings of agency mortgage-backed securities, at no risk whatsoever to the government.

      There are many scenarios under which the warrants might be cancelled, and you’ve mentioned one of them. But as I look at the various paths for ending Fannie and Freddie’s conservatorships (including liquidating them), I think it’s most likely that the warrants will not be cancelled—although their strike price may be raised and the percentage of stock granted to the government on exercise may be lowered, as part of settlement negotiations with plaintiffs in the lawsuits—simply because ownership of the warrants gives the Trump administration a financial incentive to make the right choice in mortgage reform by preserving Fannie and Freddie, which it might not do without that incentive.

      Liked by 1 person

      1. Thanks for your time. I ask as a Fannie investor since 1996. Having the government impair my 30 year investment by 80% based on fraud and self dealing is something that should never be allowed by any sense of decency or rule of law.

        I do appreciate that you have attempted to address this before. Thanks for your response and please continue to assist us with your knowledge.

        Liked by 4 people

      2. >> fully collateralized by their (ample) holdings of agency mortgage-backed securities, at no risk whatsoever to the government.

        How would that have worked? Wouldn’t those be limited by the minimum amount of capital they needed to maintain, which was already under pressure?


        1. No. If Fannie or Freddie were to have used their MBS holdings as collateral for loans from the Fed or Treasury, they still would have needed to hold capital against them. The reason the Fed or Treasury did not make collateralized loans to the companies had nothing to do with capital; it was political. Ben Bernanke is very direct about this in his book, “The Courage to Act.” After describing the regulation that allowed the Fed to make collateralized loans to Fannie and Freddie (sections 13(13) of the Federal Reserve Act), he says, “I certainly didn’t want to do that. How ironic would it be for the Fed to help rescue [Fannie and Freddie] after all the years criticizing them?”

          Liked by 1 person

  7. Tim, I find it hard to believe that the anti gse narrative was concocted by evil banks for profit purposes and pushed by influential players in wall st and washington in a highly orchestrated and deliberate manner, as if by some master plan for wall street to conquer the mortgage market. Isnt it far more plausible that having the government sponsor private entities is a controversial concept and that these guys honestly believe that gses are fatally flawed? im talking about the WSJ, stevens, demarco, parrott, summers, greenspan etc. It seems to me that grouping them and labeling them as the Financial Establishment is oversimplifying the issue and underestimating the challenges to releasing f&f back into the private markets


    1. Grouping all of the opponents of Fannie and Freddie into a single category and calling them the Financial Establishment IS an oversimplification but not a distorting one, and I think one that enhances understanding of the situation rather than muddies it.

      The primary objections the people I collectively group as the Financial Establishment have to Fannie and Freddie are ideological, competitive and political. The ideologues do not believe that Fannie and Freddie should have a unique charter that gives them benefits other companies do not have. The competitors share this view (while conveniently ignoring the fact that the U.S. commercial banking system would not exist as we know it without government-insured consumer deposits, and that the Federal Reserve drops market interest rates–banks’ cost of funds–whenever that industry gets into difficulty) because restricting Fannie and Freddie’s business, or eliminating them, would give those competitors more control over the terms and pricing of the $10 trillion mortgage market, and allow them to make more money. And the political opponents view Fannie (in particular) as a “Democratic” company.

      Is it reasonable to believe that these three groups of opponents “honestly believe that GSEs are fatally flawed?” No, for one simple, and I think undeniable reason: to support their arguments for restricting Fannie and Freddie’s business or eliminating them, these opponents routinely distort the truth or simply make things up about them. Honest critics don’t do that.

      Take the “flawed business model” claims. The real, incontrovertible, “flawed business model” leading up to the crisis was private-label securitization. Fannie and Freddie’s opponents NEVER mention private-label securities, or the fact that the complete lack of regulation of this “private market” mechanism allowed everyone who participated in it to make money from loans that had little chance of being repaid, because all the credit risks were shifted to investors who were relying on inflated AA and AAA credit ratings, bestowed by rating agencies paid by the issuers and who had no skin in the game themselves. And the critics of Fannie and Freddie who blame these companies for the financial crisis also ignore the fact–available to anyone who cares to check–that in the three years leading up to the crisis, private-label securities financed more home loans than Fannie, Freddie and Ginnie Mae securities combined, and that the subsequent credit losses on those private-label securities were nearly EIGHT times the credit loss rate of loans purchased or guaranteed by Fannie and Freddie. Critics of Fannie and Freddie simply pretend that the disastrous private-label securitization experience never happened, and counterfactually blame Fannie and Freddie for the crisis.

      So, no, it’s not honest opposition. But I do agree with you that releasing Fannie and Freddie back into the markets will be a challenge. People who do not play fair also fight hard.

      Liked by 5 people

      1. “The Group that would benefit by such [financial] policies, having such a direct interest in them, will argue for them plausibly and persistently. It will hire the best buyable minds to devote their whole time to presenting its case. And it will finally either convince the general public that its case is sound, or so befuddle it that clear thinking on the subject becomes next to impossible.”
        From Economics in One Lesson, by Henry Hazlitt


  8. Do you have any comments on credit enhancements being done by Fannie Mae to make CAS securities more acceptable to Moody’s?

    I suspect Treasury may be trying to unload more of these instruments by making them more appealing to investors, thereby trying to wind down the GSEs as much as possible before Trumps team is in place.


    1. This is a good opportunity to lay out another “ground rule” for avoiding deletion of a comment: before commenters ask a question on this blog about an article or a news item, they need to have read it themselves, and made a reasonable attempt to interpret or understand it. It does not appear that “McGrail7” has done that in this case (although, to illustrate the point, I’m leaving his comment up).

      This is a straightforward press release from Moody’s, announcing an upgrade in the ratings of two existing tranches Fannie Mae Connecticut Avenue Securities issues. There were no “credit enhancements being done by Fannie Mae to make CAS securities more acceptable to Moody’s,” nor does this release have anything to do with Treasury wanting to make CAS more appealing to investors.

      Instead, this is Moody’s, on its own, looking at recent prepayment rates and delinquencies of the collateral underlying these two CAS tranches, and concluding that they warrant higher credit ratings than they were given when they first were issued. That’s it.

      But the action illustrates what I’ve been saying about Fannie’s CAS and Freddie’s STACRs for the last several months. They are designed to minimize the chance of credit risk actually being transferred to investors, because the risk-bearing tranches are deliberately engineered to pay off before the credit losses can hit them. That’s what’s happening with these two tranches. As time has passed, the prepayment rates on the underlying collateral have been relatively high (causing the tranches to pay off faster), while the credit performance on that collateral has been extremely good (reducing the chances that there will be ANY losses that reach the threshold at which the risk-sharing securities provide coverage, let alone that this threshold will be reached before the CAS tranche has paid off).

      To me, the surprise is that Moody’s still rates these two tranches as Aa2 and Aa3, rather than Aaa. Given their structure, and the subsequent delinquency and prepayment experience of their underlying collateral, there is virtually no chance investors in these tranches will lose a penny of principal. (And, no, giving these securities ratings below Aaa does not make up for that fact that in the mid-2000s Moody’s rated thousands of CDOs–comprised entirely of low-rated tranches of subprime securities–Aaa ratings.)

      Liked by 1 person

      1. I did read the article through but made the unwarranted assumption that Fannie Mae was doing credit enhancements based on the following sentence: “The upgrades are primarily due to an increase in credit enhancement supporting the affected subordinate bonds.”
        Thanks for your reply. I will strive not to make such unwarranted assumptions or statements in the future.


      2. Tim,
        Most probably your analysis is affecting the intrinsic rating and value of these Securities and the demand for these securities is going up (and their market value). Moody’s may be acting on this information.


  9. “While the Trump Treasury could (and should) cancel those warrants on the grounds that they were granted improperly, their financial value makes this unlikely. And as warrant holder, the Trump Treasury will share the plaintiffs’ goal of setting Fannie and Freddie up to operate as cost-effectively and efficiently as possible (benefitting borrowers as well as shareholders).”

    Doesn’t this statement contradict itself? If warrants were granted improperly, they should be voided. Plain and simple. However since they have value, they are now fair game in potential settlement talks? Err.. I guess I don’t (and probably a lot of other shareholders) think the government/treasury should be allowed to use for negotiating so they can steal even more money.

    Maybe I have a myopic view on this but with all the findings from the court stuff one would argue against the validity of using the warrants as a negotiating piece.


    1. It’s a question of leverage. None of the worth sweep suits challenge the legitimacy of the 2008 decision to put Fannie and Freddie into conservatorship, and so they also don’t challenge the terms of that conservatorship– including the warrants. The Washington Federal lawsuit does challenge the takeover and the terms, but knowledgeable observers say that counsel leading that lawsuit has neither the resources nor the inclination to carve it out of any settlement talks and litigate it to the end. So, unless one or more of the deep-pocketed “big dog” plaintiffs want to essentially take over the Washington Fed lawsuit and finance it for as long as necessary either to win it or get it settled–which may happen, but isn’t likely–then Treasury has no financial incentive to void the warrants, even though as I said in my piece, it should do so because they were improperly granted.

      Liked by 3 people

      1. Wonder if there would be a market for those self dealt non voting shares they would have to keep separate from voting shares. Going to leave a bad taste in many investors mouth once they understand the truth on how acquired. Plus to exercising all the warrants would dilute there own shares. Anything over 60% of the warrants exercise the dilution kills there own value. Factor in the tax revenue lost it probably closer to 45%. he biggest bang for all combined would be 20% in my calculations. Anyhow, just sharing my thoughts on this and think the gov would do more harm then good if they tried to go this path.


      2. Hi Tim,
        Thank you for the detailed and well thought articles and answers. I agree with your reasoning as to why the warrants may not be canceled. However the plaintiffs know that if they win in court there will be penalties and interest in addition to the reversal of the sweep. Don’t you think that this may be enough of an incentive for the Treasury to cancel the warrants?

        Thank you in advance for your response.


        1. There may be interest awarded in a reversal of the net worth sweep, but I do not believe there will be penalties. And if the interest is awarded at the current IRS crediting rate for corporations (2.0 percent), that won’t be enough of an incentive for Treasury to cancel the warrants.


          1. tim

            i dont think interest would be applied if excess dividends from NWS are applied retroactively to reduce senior preferred principal. interest should be applied if there is a cash payment now, to make recipient whole for what was taken improperly in past. if you reclassify the payment by going back into the past, and then run your dividend rate on the pro forma reduced principal amount, then interest would be a windfall.



          2. I looked at this again and you’re correct; if the excess net worth sweep payments are credited against the amount of outstanding senior preferred stock during the quarter in which the excess payments occurred, then they would be deemed to be repaid and would not earn interest. If I adjust my calculations of the pay-downs in senior preferred stock for both companies from the reversal of the net worth sweep to remove interest payments, Fannie would have about $10 billion in remaining senior preferred stock outstanding at the end of the third quarter of 2016, and Freddie would have about $5 billion. Thanks for the catch.

            Liked by 1 person

      3. I’ve read the terms of the warrants a while ago. It was my understanding that the warrants apply to whatever shares outstanding are at the moment of the exercise. I’m not a lawyer, but floating number of shares in the warrants is an unusual warrants contract. It’s open ended and prevents recapitalization, because if the secondary is done while the warrants are outstanding, that secondary is immediately diluted. It has a certain stench to it if you ask me. Delaware case challenges NWS as an illegal preferred shares dividend. If you ask me, this is similar in spirit to NWS. It’s main goal was to prevent any equity raise. I see the problem with the terms of the warrants with no fixed shares number. They can’t sell or dispose of part of warrants because there are no shares spelled out. It’s all one contract. It’s not as much a warrant as the block to any secondary issuance. It’s not a conventional derivative. The terms essentially lock the enterprises for any new capital. It can’t possibly be legal.

        Click to access warrantfnm3.pdf

        It’s just an observation, because I never saw this particular feature of the warrants discussed.


  10. None dare to put J. Timothy Howard up against the questions posed in the Fox News report cited below. Tim would crush Freeman, WSJ and any other who spew this B.S.

    How weak Mr. Rood’s responses were, generally speaking, to all the other persons involved in the questioning.

    Investors are taxpayers too. WSJ is the scam as are all who mislead the public with this verifiable fraud.

    Fannie and Freddie bailed out the US government and banking system, not the other way around. To say anything else is not a matter of opinion at this point, it is a verifiable fact.

    Liked by 2 people

    1. The author of this article is defining “privatization” as the removal of Fannie and Freddie’s ties to the government (through the revocation of their charter benefits), compared with the alternative definition of privatization, which is returning the companies to the ownership of their private shareholders. Under the former definition of privatization, I agree with the author: it’s not a good idea, and it would have negative consequences to homebuyers and the housing market were it to happen.

      Liked by 1 person

      1. the term “privatization” has lost all meaning in the GSE reform debate. just this morning, ms. maria bartiromo mistook (in my view) mr. mnuchin’s prior statement re privatizing the GSEs to mean that he would advocate their wind down. my takeaway from this is that the debate has become recondite, even amidst the hallowed halls of the senate finance committee, where mr. mnuchin’s nomination will be vetted. this goes to tim’s point that the political mindset discourse will be replaced by business/common sense mindset, which is an auspicious course of future events.


        1. All along the official position of Gov (FHFA and Tsy) has been that FnF are private shareholder companies under temporary conservatorship as per their court filings. Also Gov claims that FnF are under absolute control of FHFA conservator during conservatorship (defacto nationalized) as per their court filings.

          Any changes to Corporate status as Gov or private corporations can only be done by laws and so far no such laws have been passed.

          The discussion of FnF privatisation starts as one of the 3 options that Tsy officials discuss in their internally circulated plans (discovery document). In this document “FnF privatization” refers to termination of conservatorship and returning the FnF to private shareholders. Probably Tsy offcials use the term privatization, because as for as Tsy is concerned FnF are defacto nationalized. Probably Mnuchin was referring to this option as Tsy Sy nominee.

          It has been the wicked practice of financial establishment and sponsored media to always spin any favorable news so as to mean liquidate or wind down FnF. The current discussion of FnF privatization in media shows their lack of any understanding of FnF conservatorship or their intent to confuse the public.

          FnF can only be privatized administratively (defacto denationalization) by terminating conservatorship.

          FHFA imposed conservatorship without any challenges from regulated entities or shareholders. However receivership will not happen without such challenges.


        2. Disagree. Just listened. She contributed little. Didn’t conflate privatization. Freeman is an imbecile and Tim R should’ve taken discussion in a different direction. Cluster.


    1. Edit to above: There are several stories now linking Mnuchin to the Paulson Fund and discussing how Paulson can benefit from FnF. I think FnF is going to be a central topic of discussion in his hearing. Short of a decision in Perry, would you agree that this is of monumental importance as Mnuchin will likely have to inform the committee of his/admins views on what happened with FnF and the plan forward. He may even have people in favor of his nomination push him on this, i.e. Crapo. What are your thoughts and given that Chuck Cooper prepped Sessions, do you think it would be likely that he could prep Mnuchin on matters regarding FnF?

      Liked by 1 person

      1. I’m traveling this morning, and will respond to this and other comments in more detail later today or tomorrow. For now, I’ll just say that the spate or articles about Fannie and Freddie that we’re now seeing–and I’m sure will continue to see–is an entirely predictable response by the Financial Establishment to the prospect of mortgage reform discussions shifting from political fiction to economic fact. That does not favor the banks. Because of the lawsuits, Mnuchin (assuming he’s confirmed) and his staff will at some point learn the facts about the causes of the mortgage crisis–and therefore the right policy response to it–from the plaintiffs. That may not happen immediately, but it will happen at some point. And when it does, it will be substantially less likely that the Mnuchin Treasury will support a bank-centric alternative to Fannie alternative based on a fictional version of what happened in the crisis, because it will “own” the result and be accountable for the consequences of supporting and implementing a wrong-headed policy. These are business people, not politicians.

        But this will take a while, and maybe a long while, to play out. In the meantime, there will be countless articles about why “recap and release” can’t ever or shouldn’t ever happen, or about why what Mnuchin REALLY means, or intends to do, is X, Y, or Z. We can read these articles and fret about them, or keep our eyes on the larger issue: with new people coming into positions of influence in the Trump administration, fact will have a dominant advantage over fiction, and that favors a solution to mortgage reform that preserves the roles and functions of Fannie and Freddie, because they work, and the proposed alternatives to them don’t.

        Liked by 3 people

        1. With barrage of attacks that Mnuchin made money off Paulson fund, do you think it will weaken what Mnuchin was going to do? I mean right thing to do? Looks like Trump doesn’t care what others say, but thought to check in.

          Liked by 1 person

          1. No. I think Mnuchin will have both an economic and a political incentive pick the mortgage finance solution that will work best for homebuyers and the economy, and that’s one based on the Fannie-Freddie model.

            Liked by 2 people

        2. How long do you think this will take to resolve? Mnuchin could do it in a week. Why does he need congress that hasn’t done anything in last 9 years? Also, do you think he will turn on the dividends on junior preferreds? The GSE’s need to build capital, so what would be the reason to start giving dividends, if at all?


          1. If Mnuchin and Trump do elect to “reform, release and recapitalize” Fannie and Freddie– as I’m betting they will– it will take a lot longer than a week. They will need to settle the lawsuits, decide on what reforms to make to Fannie and Freddie and their structure, capital requirements and operations, develop a transition plan for bringing them out of conservatorship and returning them to shareholder-owned status (including recapitalization), then sell the deal politically (although Congress will not have to approve it, the administration will want to minimize active opposition). What happens with common and preferred stock dividends will be determined by the negotiators in the settlement; I’m not going to try to guess about it.

            Liked by 3 people

  11. Hello Tim,
    With all the articles coming out, it seems like one big topic that is glossed over, is the amount of good fnf provide for both the banks, home owners and the economy. For example, is it possible to quantify or estimate the amount of money that homeowners have saved using the fnf model? A small percentage times $5T in mortgages seems like it would be a large number. Could you touch on a few other positives FnF provide?

    Thanks in advance

    Liked by 1 person

    1. In my opinion it would very difficult to quantify the benefits Fannie and Freddie provide, and have provided, to our economy. But they have been significant, and undeniable.

      In the mid-1970s, the U.S. had a deposit-based mortgage finance system (in 1975, three quarters of all residential mortgages were held on the balance sheets of commercial banks and thrifts). Two thrift crises later, thrifts’ share of mortgages held plunged 40 percentage points, from 57 percent in 1975 to 17 percent in 1995. Because of Fannie and Freddie–and only because of them–the U.S. mortgage system was able to undergo a seamless transition from a deposit-based system to a capital markets-based system, due to the ability of these two companies to tap the international capital markets for massive amounts of low-cost fixed-rate mortgage funding. It’s really not possible to put a dollar value on that.

      In fact, Fannie and Freddie’s success gave rise to what I call the “mortgage wars,” in which large banks and Wall Street firms fought to wrest control of the terms and pricing of mortgages from Fannie and Freddie. Having Treasury and Fed take big banks’ side of that fight set the stage for unregulated private-label securitization to temporarily do that (take control of underwriting and pricing) in 2004, which resulted in three-plus years of undisciplined lending that led to the housing bubble and subsequent bust. We now have the scorecard from that period, and even though both Fannie and Freddie foolishly allowed themselves to try to win market share back from the private label market, the loans they purchased or guaranteed leading up to and during the crisis still performed three times better than loans made and held by banks, and nearly eight times better than loans financed with private-label securities. There is a more calculable “value added” by Fannie and Freddie from that comparison.

      This really is what the current debate over “mortgage reform” is about. Do we want to go back to a combination of the deposit-based system that failed in the 1980s and the Wall Street securitization system that failed so spectacularly in 2008, or stick with the proven value-added model of Fannie and Freddie? It should be a no-brainer, but the relentless misinformation campaign mounted by the advocates and supporters of the big banks and Wall Street firms–who pretend the 2004-2007 private label disaster never happened, and counterfactually assert that the best source of mortgage finance leading up to the crisis (Fannie and Freddie) actually was the worst–has made the outcome of the reform debate much more uncertain than it should be.

      Liked by 2 people

    2. it’s not *just* the $5T, as Tim mentions in his book. FnF’s benefits flow to the ENTIRE MORTGAGE MARKET structure, NOT merely their $5T balance sheet. There’s NO telling how bad plunder could be with FnF terminated.


  12. Tim – I noticed that you deleted my post regarding Cooper prepping Sessions. I’m curious as to why given the importance and relevance of this?


    1. The fact that Chuck Cooper is prepping Senator Sessions for his confirmation hearings as Attorney General is a relevant fact, in view of the pending legal cases. The rest of your comment, however, was about other peoples’ speculation as to what Mr. Cooper might do for his client given his access to Sessions. In my view, this speculation was (a) completely unsupported (as most speculation tends to be), and (b) not particularly flattering to Mr. Cooper (assuming he might actually do what these people suggest). There are numerous uninformed rumors out in the blogosphere about who might do what to or for Fannie and Freddie, and I feel I need to be selective as to which of (the few of) these to respond to. Yours didn’t make the cut.

      Liked by 4 people

      1. Many silly shareholders unintentionally impress the world we would win legal cases because some shareholders have personal relationships with some important people.


        1. No. It’s more about having a direct line to educate those at the very top of the new admin as to what the truth is regarding FnF and the documents being withheld.

          Liked by 1 person

      2. Tim – One other clarification that I should have specified. The real question I was asking is what is your opinion as to how likely it could be that non-class action shareholders wind up being left with nothing? This was seen already in the PwC case.



          38:00 minute mark.

          As explained by Hamish Hume, one must have a CLAIM of at least $10,000 in order to opt into or out of the class.

          From my amateur perspective, the direct claims seem much stronger than the APA claims, however, I am unclear as to what constitutes a claim of $10,000?

          In the case of jr. preferred shareholder’s, is the claim based on par value of shares held, or possibly market value of shares held?

          I’ve concluded, perhaps incorrectly, that the claim will be based on total dollar amount of dividends foregone as a consequence of sr. preferred “leapfrogging” the jr. Preferred in order to pay their common position (warrants.)
          Common shareholders claim would be based on dividends not paid

          Any clarification would be greatly appreciated.

          Regardless, I do believe Hume mentioned elsewhere, that if successful, they may pursue another class action on behalf of shareholders with a claim of less than $10,000.


    1. outstanding opinion by judge kavanaugh (unfortunately not on trump’s scotus list). this opinion certainly supports notion that fhfa director may be removed by potus w/o cause.

      this decision has been appealed by obama doj for en banc reconsideration, so it is in a state of suspense. if denied before 1/20, obama doj could always ask for cert to scotus. what trump doj does post 1/20 re any of this is up for grabs. seems to me that if trump doj wanted to pull this decision from reconsideration, it would have power to do so


  13. Tim, have you commented or would you please comment on the allegations that part of the way in which FnF ‘helped’ during the ’08 downturn was by purchasing garbage MBS from the TBTF banks (as allegedly directed by…Paulson I think?)? This has been a regular topic in the pro-shareholder circles but no one with real credibility has come forward to confirm or deny it. It would seem to my layperson’s mind that it should be easy to determine if this did or did not occur.

    Thanks in advance.


    1. I’ve commented on this a few times before, but my last comment was a while ago (and I’ll also say that my response has changed somewhat as I’ve learned more of the backstory).

      The claim that’s frequently made is that as soon as Fannie and Freddie were put into conservatorship, Treasury required them each to purchase or guarantee (as MBS) $20 billion per month in toxic loans, or $40 billion total, from commercial banks.

      The part of my answer that has not changed is that neither company ever purchased $20 billion in toxic loans, or as far as I can tell ANY significant amount of toxic loans, in any month post-conservatorship. My basis for saying that is an analysis of mainly Fannie’s, but also Freddie’s, monthly financial summaries, quarterly 10Qs (filed with the SEC), and annual 10Ks. The monthly summaries give dollar volumes of mortgage purchases and MBS guarantees for each company, while the 10Qs and 10Ks give descriptions of the credit characteristics of the loans they acquire each quarter. Had either one bought $20 billion in toxic loans in any month, let alone for many months, it would have been apparent in their monthly and quarterly financial data. There is no evidence at all of either a surge in volume or a deterioration in credit quality. In fact, on the latter the opposite is true: the risk profile of both companies’ loan acquisitions in the five quarters after conservatorship is better than in the five quarters prior to conservatorship.

      Where I’ve changed my view is that I now believe, based on news stories that came out at the time, that Treasury may well have intended to force Fannie and Freddie to buy $40 billion per month in toxic loans, in conjunction with its own intention to use the bulk of the $700 billion in TARP money it received from Congress to buy bad loans from banks and other holders. Treasury, however, could not figure out how to administer such a program (mainly how to price its purchases), so it quickly gave up on the idea, and instead used most of its TARP money to put capital into banks. Once that decision had been made, Treasury couldn’t very well insist that Fannie and Freddie buy toxic loans (for the same reason: how would they price them?) so it dropped the idea.

      Most likely, therefore: yes, there was a plan by Treasury to have Fannie and Freddie each buy $20 billion in toxic loans per month from banks, but, no, it never happened.

      Liked by 2 people

      1. while there may not have been an extraordinary program for GSEs to buy toxic loans, there was plenty of garbage (no docs/liar loans etc) mortgages that the GSEs bought in the ordinary course that was the subject of putback litigation and GSE recoveries from TBTF banks. Indeed, whatever demarco’s faults as conservator, demarco was smart in retaining quinn emanuel to prosecute its civil litigation. how many tens of billions of dollars did the GSEs recover…not that the money stayed in the GSE coffers?


  14. could someone please clarify as to how (HYPOTHETICALLY, of course!) “Accumulated Deficits” on FNMA equity get resolved?

    The accounting treatment of this confuses me: a balance sheet is AS OF a certain date; and yet AD are a sum of past losses. I have no “feel” for this line-item.

    Are they for real or just an accounting artifact? I realize there have been losses in the past…but i’m confused how this line item will be treated going forward, because NET of AD, FNMA still shows an equity of $4Bn in the black. thanks (i hope i’ve expressed my question meaningfully).

    Liked by 1 person

    1. Sure. Let me start with the accounting framework.

      At the end of each quarter, a public company reports its income and expenses for that quarter in its income statement; the combination of all these items either is net income (income exceeds expenses) or a net loss (the opposite). These net results then get transferred to the balance sheet, which is reported as of the end of the quarter. Companies that have a history of profitability will have a category on their balance sheets called “retained earnings.” If a company makes a profit in a quarter, that profit is added to retained earnings (as of the end of that quarter) on the balance sheet.

      Prior to being placed in conservatorship, Fannie Mae’s $47.0 billion in core capital included $27.9 billion in retained earnings. All of those retained earnings, and more, however, were wiped out by the non-cash losses FHFA recorded on the company’s books post-conservatorship. When Fannie’s retained earnings went negative, the “retained earnings” line item turned into an “accumulated deficit” line item, which kept growing as FHFA ran more non-cash losses through Fannie’s income statement. To make Fannie’s balance sheet balance, the growing amount of accumulated deficit was offset by increased amounts of senior preferred stock, which appeared next to a line item of that same name on Fannie’s balance sheet.

      As of September 30, 2016, Fannie had total equity of $4.2 billion, which it said would be reduced to $1.2 billion after payment of its net worth sweep obligation to Treasury at the end of December. (The remaining $1.2 billion would be Fannie’s capital cushion, which is scheduled to fall to zero at the end of 2017.) Fannie also had an accumulated deficit of $126.3 billion, and senior preferred stock of $117.1 billion. These are all “real” numbers, and not accounting artifacts.

      The most likely way Fannie’s accumulated deficit will get resolved is through a ruling in one of the courts that the net worth sweep was illegal. In that case, the remedy in all probability would be to apply all quarterly sweep payments made since the first quarter of 2013 that exceeded what Treasury would have been owed under the original 10 percent dividend arrangement as pay downs of outstanding senior preferred stock. I have calculated that, were these accounting reversals to be made, Fannie’s senior preferred stock balance would be at or close to zero by the end of first quarter of this year. In that case, the “senior preferred stock” line item on Fannie’s balance sheet would go to zero, and the “accumulated deficit” would fall by $117.1 billion, ending up at $9.2 billion. That revised accumulated deficit would be offset by other positive balance sheet line items (most prominently outstanding junior preferred stock of $19.1 billion), leaving net capital close to zero, but with both the senior preferred stock and the obligation to pay a 10 percent dividend on it gone.

      I hope this is helpful.

      Liked by 7 people

      1. Many Many thanks! Greatly appreciate your solid knowledge and experience and “open-door” to ordinary folk. (Loved your book, BTW!; Your view into the 2008 financial crisis is THE ground zero analysis, completely ignored by MSM!)

        Liked by 2 people

      2. Tim, if you don’t mind, one follow up on this point: this hypothetical resolution you referred to via the courts, appears in the accounting literature as an “Quasi-Reorganization”.

        1) are the courts hearing the present cases re wrongful third amendment sweep (NWS) possessed with power to levy judgements effecting quasi-reorgs, or is that the sole jurisdiction of bankruptcy courts?

        2) IF these same courts CAN rightfully issue an order of quasi-reorg, can they nullify the “senior preferred stock” line item you mentioned or, are they limited to “additional paid-in capital” as most “normal” quasi-reorgs seem to suggest, for eg:

        greatly appreciat your 2 cents here, (really more like $1K in my book!) thanks!


        1. To my understanding, none of the courts hearing the cases against the government for its handling of Fannie and Freddie in conservatorship (or for putting it into conservatorship, in the Washington Federal case) can issue an order of quasi-reorganization.

          For each case, the petitioned outcomes are shown near the end of the initial filing, in a section titled “prayer for relief.” The regulatory takings cases (Federal Court of Claims) request “just compensation under the Fifth Amendment,” legal fees, and “such other and further relief as the court deems just and proper.” The administrative procedures act violation cases (filed in the U.S. District Courts) seek “vacating and setting aside the Third Amendment…”, plus legal fees and “such other and further relief as this Court deems just and proper.” And the case that claims that the sweep was in violation of Delaware state law (Jacobs-Hindes) seeks broader and more varied relief, on the grounds that the sweep was “void ab initio,” but does not include any type of reorganization.


          1. thanks again, we’d be blind, w/o you, no question. i can only empathize the time it takes to do it. thanks!


  15. Tim. Spot on! We are hopeful that we can have an adult conversation on this with the new Administration. For starters they could just follow the law (HERA)! Thanks again!

    Liked by 1 person

  16. Tim – I assume that you know Sean Duffy (R-Wis.) will chair the housing and insurance subcommittee, which will now include oversight of Fannie Mae and Freddie Mac. His op-ed from March 2016 clearly shows that he is not pro FnF. When I look at the members of the Senate Finance committee and the members of the Senate committee for Banking, Housing and Urban Affairs, it is striking how many members are anti FnF. When I couple this with the all of the other opposing forces, I have to really question the cause for optimism as a shareholder. What if Mnuchin’s comments regarding “out of government ownership/control” are actually agreeing with these forces? And if not, how is he and the Trump admin. going to convince these forces to support them? When a guy like Sean Duffy has had years to gain knowledge on the crisis and FnF, but still writes less than a year ago that they caused the crisis and taxpayers had to bail them out, it really makes me question how someone like him can be converted to supporting recap and release. Worse, what if Trump is convinced by FnF opponents that their line of thinking is correct? Nov 4, 2011 Trump Tweet: Malfeasance at Fannie Mae and Freddie Mac helped cause our current financial meltdown.


    1. Duffy’s taking the chairmanship of the Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises (under the House Committee on Financial Services, chaired by Jeb Hensarling) doesn’t change my views on the prospects for getting mortgage reform done administratively. The Republicans in positions of leadership in both the House and the Senate have long been solidly anti-Fannie and Freddie (and most of them pro-bank); the fact that a few of them change seats on occasion doesn’t have any real significance, and doesn’t change the overall alignment of forces.

      As I tried to say in my piece, what’s new–and I think very positive–is that fact that Mnuchin wants to address the Fannie and Freddie issue “reasonably fast” (unlike Congress, which has been doing it “excruciatingly slowly”). To do that, he’ll have to settle the lawsuits against the net worth sweep, and when he starts to negotiate with the plaintiffs, he’ll learn the facts about Fannie and Freddie, and the causes of the financial crisis. Fortunately, Mnuchin (or Trump) doesn’t need to go through Congress to get Fannie and Freddie out of conservatorship; the Bush Treasury put them in without Congress. It’s a virtual certainty that leading Republicans in Congress–Hensarling, Duffy, Corker, Shelby et al–will object to “recap and release.” But THEIR problem is they don’t have an alternative. If they try a version of their fables about Fannie and Freddie causing the crisis and being a “flawed business model,” Mnuchin will have the facts to shoot that down. And if they tell him to try a bank-centric alternative, say the Urban Institute’s “Promising Road to GSE Reform,” based on fake risk-sharing securities, give me–or any other knowledgeable and objective housing finance professional–five minutes with Mnuchin, and he’ll say, “well, that won’t work; what else have you got?”

      Again, as I said in response to an earlier question, getting reform done won’t be a layup. But once you introduce facts into the dialogue–which have been kept out of the Congressional debate for eight years, but an administrative process will let in–the “good guys” have much the better hand. We’ll have to see how they play it, but I like their chances.

      Liked by 4 people

    2. John, I feel your points too! there’s NO sense in becoming a cheerleader of ANY pol, thinking they are on your side; There’s NO sense of what’s coming down the Pike with the trump admin. that tweet is NOT reassuring to say the least. investor beware!

      Tim, (and John,) if you go to p. 785 (! trees dying) of the following


      and CTRL-F “Sense of Congress” it suggests ANY Treas Sec MUST go through congress, willy nilly, no questions asked! No “outside” action on the matter!

      above that, just the prior para, RESTRICTS any action on FnF before Jan 1 2018:

      “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”

      Obama signed this travesty into law. deep hidden in this 900+ page sausage they call “appropriations”. (rant: I mean if bits and pieces of law are hidden away in sausages like this, and we the electorate even have NO idea on the policies presidents “say” they will enact, it’s not much of a democracy other than for show}.


  17. Tim-this is an impossible question to answer as no one knows details but do you have any feel for the timing of, and I’ll just lump everything under the heading of “reform”? The clock is ticking no? At the end of this year the GSEs will have no capital correct?

    The reason I ask is that even if the NWS is undone, it is going to take a couple of quarters to start building a cushion again.

    Or do you believe Mnuchin will go further to address the capital issues (faster). ie. through dilution, etc.

    Because at the end of the day, for all practical purposes all that needs to be done today (tomorrow works too) is for the NWS to be stopped. At that point the administration has bought itself time. Time to figure the rest of it out.

    Liked by 2 people

    1. I haven’t learned anything new from what we’ve heard already, which is that getting Fannie and Freddie out of the government was a “top ten” priority that Mnuchin wants to accomplish “reasonably fast.”

      When I first heard that I thought, “reasonably fast” was pretty aggressive phrasing (more so than, say, “reasonably soon” would have been), possibly even meaning the first half of this year, before everyone leaves Washington for the summer. But even if that were the initial timetable, things can slip for a variety of reasons, including a delay in Mnuchin’s confirmation, competing priorities, or a full court press against recap and release by the bank lobby.

      I don’t, however, think the Trump administration will just give up the net worth sweep. That’s part of the negotiation, and if they give it up before the negotiation even starts they won’t get anything for it. I think they’ll do this comprehensively, beginning with deciding where they want to end up. Then, the “how do we get there” will be where the horse-trading occurs.

      And I wouldn’t worry too much about Fannie and Freddie’s possibly needing a draw in the next few quarters because their (small) capital cushion is about to disappear. Any book net income loss at either company wouldn’t come out of the blue; its cause would be visible (i.e., a sharp drop in interest rates, triggering mark-to-market losses in the floating-to-fixed rate swap book) in advance. If the Trump Treasury felt that a draw would complicate its strategy for getting Fannie and Freddie released—and I believe it would—there are a host of things it could direct FHFA to do (including waiving the sweep payment for income made in the previous quarter) to prevent a draw from happening.

      Liked by 2 people

      1. Mnuchin meant a solution without action from Congress and without much sacrifice / resistance of shareholders. He also believes FHFA would agree with his plan.


  18. ———————————————————–
    Feeling better than I have in a long time.
    Thank You Mr. Howard.


  19. Tim , sorry to keep you busy . I did not post my thoughts to bother you but for you to consider that outcome in your mind. I know your mind works for the benefit of all of us. Anyway, I will not post again, so you don’t have to worry about the blog showing my thoughts. I only will post again to say thank you once everything is over.


    1. This seems like a good opportunity for me to reiterate the policies I’ve adopted for deleting comments made on this site.

      I want the site to be readable and informative for those who access it, and also want commenters to be able to react to what they read and to express their own views. I’ve found that balancing those two objectives, however, can be tricky, so I’ve adopted some informal guidelines to follow in deciding when to delete a comment. One very firm guideline is that any comment that makes ad hominem attacks on someone, or is abusive or obscene, will come down as soon as I see it. Another is that if a question contains so many false premises or misstatements that before I can answer it I’d have to correct, reinterpret or explain it, that too will trigger the delete button.

      Other guidelines are more subjective, and the commenter above, Eric, has run into one of them. Some post more frequently than others, and for people who have made a noticeable number of comments over a given period, I apply a tighter screen for accepting each new comment, having to do with whether I think it contains information or insight that will be of interest or value to a broader group of readers. I recognize that someone on the deleting end of such a decision may not agree with it, but there are two ways they have of getting around it in the future: either back off a bit on the frequency of comments, or “up their game” on the usefulness or relevance to other readers of their latest comment.

      Liked by 5 people

      1. Tim,
        Another option is to allow non-offensive comments to remain for a day or so and then delete them at the end of day.

        Can you also please rate the comments so that readers can directly go to good comments?


  20. “because Republicans in the executive branch will know the facts about Fannie, Freddie and the financial crisis from discovery in the court cases, Republicans in Congress will not be able to sustain their myths about them”

    two assumptions here: 1) discovery from court cases will yield indisputable evidence that the nws was unlawful and 2) republicans in exec branch will respond pragmatically without ideological or political bias. yet, there seems to be plenty of room for alternative scenarios: that discovery doesn’t yield any indisputable proof after all, or that trump and muchin are unable or unwilling to navigate the political waters to do the pragmatic thing. how do you “handicap” those odds, or get comfortable with your assumptions?

    Liked by 1 person

    1. @anon

      let me take a crack at this. i will look forward to tim’s response as well.

      re your 1) discovery need not be produced, and it need not prove that the NWS is “unlawful”.

      by this i mean that, while i do expect the appeals court for the federal circuit will affirm judge sweeney’s order compelling production of the 56 documents, by denying the govt’s appeal for writ of mandamus, the trump administration will not need to wait for such order in order for it to know what is contained in the documents. the trump administration will know what’s in the documents as soon as it wants to after 1/20/17.

      assuming the documents are released to plaintiffs under seal, and the plaintiffs make a filing with the perry appeals court under seal, assuming a decision has not theretofore been issued in perry, all plaintiffs have to show is that the administrative record produced by treasury and the “document compilation” produced by fhfa at the perry district court were false and misleading. i believe the perry appeals court has already seen enough by way of produced discovery from fairholme, released from seal by judge sweeney, to make that determination, but these additional documents are likely to be even more persuasive that the perry district court was misled (hence they have not yet been produced).

      so the trump administration will have a look at these documents and it may want to act accordingly, or eventually these documents may be useful in getting the perry appeals court to remand the perry case for full trial. so these documents need not be a haymaker, and they dont even have to be produced in order for the trump administration to decide to proceed.

      re your 2) the trump administration does not seem to have an ideological bias, but rather wishes to use common sense to make sound business deals rather than to rigidly hew to a political objective. you may disagree, but this is my read of the emerging trump administration. since the treasury (and fhfa) can act independently of congress to settle the litigation and amended the Senior Preferred Stock Agreement, you dont have to measure the politics or bias of republicans in general, or even republicans in the trump administration, but rather mnuchin (and trump).

      no situation calls out for a common sense business solution, as opposed to an ideological/political response, more than a GSE resolution. this is a business settlement of business litigation that will require a business/capital solution. if you carry a ideological/political mindset to this situation, you get what we have gotten for the last 4 years: bubkis.

      mnuchin has said he wants to solve this situation reasonable fast. we dont know the details, but reasonably fast is not corker/johnson/crapo time, seeking to achieve a political or ideological result.


      Liked by 3 people

      1. To both anon and rolg:

        I’m being more pragmatic than legal in my analysis. I know the principal plaintiffs and their senior staff, and they’re convinced to their bone marrow that Treasury took over the companies not because they needed rescuing (the plaintiffs can parse financial statements), but because (a) Treasury saw a quick way to achieve a longstanding ideological and policy objective, and (b) it legitimately was worried that, as private companies, Fannie and Freddie might not be up to the task of cleaning up the mess caused by the implosion of the private-label securities market (which Treasury had championed as a superior means of mortgage finance to what the companies were doing). Fannie and Freddie were the most disciplined and reliable sources of mortgage finance leading up to, during, and after the crisis, and they remain so. The plaintiffs will convey their conviction on these points to Mnuchin, whom they know well, and I suspect that Mnuchin will believe them. In addition, as ROLG says, we’ve already got enough confirmation on Treasury’s actions and motivations from the documents that have been made public to date; anything more will just be fleshing out the details.

        Could Mnuchin and the Trump administration, knowing what they soon will learn, still decide to throw their lot in with the Financial Establishment, and shutter Fannie and Freddie and turn their business over to the too-big-to-fail banks? Sure–that’s why I said that successful administrative reform is not a certainty. But that’s not how I’d bet, for the reasons I give in this post: the Trump administration will “own” the calamity that will follow if they go along with any of the big banks’ reform proposals that have been submitted to date (all of which, the plaintiffs will tell Mnuchin, don’t have a chance of working), and they’ll also be walking away from the warrants. And if the R’s in Congress want to fight back against administrative reform, they don’t have much to fight with. All they’ve really got is catch phrases–“failed business model,” “private gains and public losses,” etc. –which won’t impress the business types they’ll be hurling them at.

        Liked by 8 people

        1. @anon

          i think we agree that mnuchin is a former GS partner who ran its mortgage finance desk and a world-class dealmaker in the mortgage finance space, given his indymac coup. he will seek to find a business solution to the GSE’s business/capital problem. i agree that we dont know yet whether, when he said he wanted the GSEs out of govt control and ownership reasonably fast, he had any particular GSE-friendly scenario in mind.

          but mnuchin is a businessman and, unlike politicians and ideologues, he will cost out any proposed solution.

          the cost of turning over the GSE business to the Financial Establishment is highly uncertain, given ongoing litigation; could be well over $100 billion in payments owed to private shareholders. moreover, the effectiveness of whatever the Financial Establishment comes up with is also highly uncertain. plus, the treasury throws away its warrant position value.

          a recap and release ends the litigation, eliminates a contingent liability that may be owed to shareholders and lets the only experienced financial guaranty businesses get on with running their business, which they have been doing quite well. plus treasury ends up with a very valuable warrant position.

          you think mnuchin will express a preference for one of these paths?



        2. @anon

          i have taken your comment as an opportunity to push back on my confirmation bias, and so i went back to a transcript of the only thing mnuchin has said about the GSEs since his nomination: his Fox business news interview.

          “Maria: Would you move to have these privatized?
          Mnuchin: Absolutely. We gotta get Fannie and Freddie out of government ownership. It makes no sense that these are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe; 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 but we gotta get them out of government control.”

          you will notice that mnuchin used the term, “restructured”. capital structures are restructured. they are not reformed.

          you might also notice that whenever the Financial Establishment refer to the GSEs, they always refer to the term, reform. as in GSE wind down and reform, never GSE restructuring.

          now, we still dont know what mnuchin is thinking with any specificity or, as you point out, whether he and others in the trump administration will have the ability or willingness to “navigate the political waters”. but i think just based on what he has said to date, he represents someone that looks at the GSEs as a financial restructuring opportunity.


          Liked by 1 person

          1. Furthermore, Mnuchin has direct experience at OneWest working with TSY-HAMP. A total fiasco. He likely doesn’t need much convincing that FnF are superior business models to anything proposed or attempted by TBTF cronies.


    2. @anon,
      After the elections the ecosystem hostile to FnF (politicians, media, bureaucrats, public …) has suddenly turned into a friendlier one. This comes out clearly from many for and against FnF articles. This is going to definitely influence even the opinions of the courts.

      Actually this change started a long time back through discovery process in Judge Sweeney’s Court and still continuing. This has been painfully slow process of piecing together publicly available information by many experts. As shareholders and public have discovered truth about 2008 crisis and FnF conservatorship, FnF detractors have kept on changing their anti-FnF strategies. Currently it seems to be drag and delay.

      There are no reasons to believe that defendants have vehemently denied even limited and protected access to withheld documents without a overwhelming cause. If one reads Judge Sweeney’s order for release of documents, it is also very clear that Judge Sweeney thinks that these documents are material evidence to the case and will help plaintiffs in their case. Otherwise Judge Sweeney would have denied the plaintiffs’ request.

      Another factor one needs to consider is, why would DJT administration carry the baggage of previous administration without the associated benefits (Even though FnF are profitable, they are almost without any capital and may need draws from Tsy in future).


  21. Tim – have you given any thought to the admin raising G-fee’s to 75bp or 1%? Seems that this would have relatively small effects on borrowing costs, but would dramatically increase profitability that would strengthen co’s.


    1. Only to the extent to know that arbitrarily raising guaranty fees (which is what acting FHFA Director Ed DeMarco was in the process of doing, before Mel Watt stopped his last proposed 10-basis point per annum increase in early 2014) is a bad idea, for two reasons. First, Fannie and Freddie were chartered by Congress to increase the availability and reduce the cost of single-family mortgages for low-, moderate- and middle-income homebuyers. To do that, they historically have charged guaranty fees no higher than required to earn their target return on the capital they are required to hold. I think that’s what the companies should be doing–and I also think that if they continue to do that, Congress should maintain the charter benefits they have (with updates as proposed in my Urban Institute essay, “Fixing What Works”). Second, as I discussed in this current post, unjustifiably high capital or guaranty fees causes the credit guaranty business model to fall apart. You end up with much less business than if you priced your business fairly, and with a risk mix that approximates the fees you charge (i.e., the higher your fees, the riskier are the loans you end up with). So, no, I do not agree with raising Fannie and Freddie’s fees to help them recapitalize.

      Liked by 2 people

      1. Thanks Tim. I was just inquiring as this would seem to fit with treating FnF like utilities similar to what Ackman recently proposed. That said, I trust your knowledge and judgment as to what makes the most sense moving forward.

        Liked by 1 person

  22. hey tim

    another WSJ article on the GSE endgame, trying to rally johnson-crapo.

    not worth a read, but here’s a thought: why wouldnt the trump administration pursue an administrative solution much as you propose in this post, and while doing so simply tell congress, hey if you think a mutual insurer owned by tbtf banks is such a great idea, pass legislation to set one up to compete with the GSEs that we are recapping and releasing.

    of course, the trump administration would review any such proposal before signing to make sure it doesnt try to disadvantage the GSEs, beyond representing a competitive threat, but in principle adding a market competitor to GSEs is a put up or shut up proposal that could be easy enough to put forward to disarm congressional (and as you note, tbtf banks lobbyist) reaction.

    all best



    1. I wasn’t able to read this article, because (on principle, due to three decades of negative editorials and articles on Fannie and Freddie) I don’t intend to pay the WSJ to read what they write.

      My hope is that the Trump administration, working with plaintiffs, agrees to release Fannie and Freddie with updated (real) risk-based capital standards, set to survive an identified stress scenario, that will determine how they price their business, by category of risk. Once they do that, sure; if Congress wants to authorize mutually-owned credit guarantors in order to increase competition, great.

      But that’s not what the Financial Establishment (or the WSJ) wants. They want all guarantors of mortgage credit to have the same lowest-common-denominator, bank-like capital standards, that will make them inefficient and drive business to Wall Street securitizers and bank portfolio lenders, at borrowers expense. That’s what we should be speaking out against.

      Liked by 5 people

    2. It is highly doubtful that financial establishment will agree for mutual insurer based alternative option.
      They could have got it long time back if they had wished for it.
      Their current idea is to kill the competition and grab all the profits as long as they can with explicit Gov guarantees. Then create another crisis and find another victim to blame.


  23. Great post Tim.

    Do you think investors will be able to participate in a rights offering if recap is forthcoming or do you think Treasury will finance the whole thing via increase in strike price? Correct me if i am wrong, but if they increase strike price to $40 and only exercise 40% of warrants (2 billion shares), will that not put 80B of equity capital into the GSEs without needing any rights offering? Wouldn’t this qualify as “reasonably fast”?

    Liked by 1 person

    1. I view my expertise as knowing how to set up a mortgage creditor guarantor to operate with maximum efficiency for borrowers, for a given (identified) level of risk tolerance. The plaintiffs in the lawsuits–and Mr. Mnuchin–are the ones that have the restructuring and corporate finance expertise to figure out the best way to recapitalize a “reformed and released” Fannie and Freddie, given the market and political constraints they will face. I wouldn’t presume to give them advice on that.

      Re your comment, though, remember that the proceeds from any warrant exercises by Treasury do not go to Fannie and Freddie. The government would be taking shares it got from the companies for essentially nothing (thus diluting existing shareholders’ ownership) and selling them to other investors. The monies spent by those other investors would be paid to Treasury (not Fannie or Freddie), for it to spend as it wishes.


        1. Yes, but the exercise (or strike) price of the warrants is a tiny amount. The strike price Treasury gave itself for exercising warrants for 79.9 percent of Fannie and Freddie’s common stock was one one-thousandths of one cent. Taking just the warrants for Fannie Mae stock, that means that Treasury can receive 4.6 billion shares of Fannie’s common stock by paying the company only $460,000. That’s right–less than half a million dollars. Fannie will get that, but the full amount of the warrant exercise proceeds will round to zero on its income statement. And once Treasury gets these shares, it can sell them in the open market, with the proceeds of the sales going entirely to Treasury.


          1. Thanks.. yes I omitted the part where the strike price is raised, I meant to imply it since you had raised that issue before, and as you just wrote it makes little sense without a raise in strike price. They can raise the strike price (to what $20 or more) and then sell the warrants (for what $30-40 dollars) I don’t know. But if done correctly I believe could provide a nice kitty to the new administration and recap the GSEs in one fell swoop. I figured Mnuchin et al. could work their magic. But I don’t know; I’m certainly not the expert on such financial engineering. But you so excellently underscore the importance and significance of alignment between ALL the parties save the few aforementioned Wall Street thieves.

            I think my other comment was never posted for whatever reason probably I didn’t hit the send button but wanted to say:

            Thank you for your excellent article and writing. I am reading your book Mortgage Wars right now and it is fantastic. Your epic journey as well as the story of the GSEs themselves is mind-blowing. I hope we can read some more at some point about the origins of the great attempted theft of Fannie and Freddie, and try to gain more understanding of the shadowy underworld of crime bosses try to execute one of the greatest thefts in history.

            Mr Howard you make me feel proud to be American! You are a stalwart of scholarship, honesty, and honor.


          2. Timothy,

            I know you’re in the camp that thinks the Trump administration won’t cancel the warrants BUT you have noted in the past that they may be open to adjusting the strike price of the warrants as one piece of resolving the lawsuit and/or recap & release. However, based on you latest post, have you since changed your mind – i.e., that adjusting the warrant price is now off the negotiation table?



      1. Tim,

        Is this a possibility?

        Question from johnfedirico:
        “if they (Tsy) increases strike (convesrion) price to $40 (instead of $ 0.001) and only exercise 40% of warrants (2 billion shares), will that not put 80B of equity capital into the GSEs without needing any rights offering?”

        Liked by 1 person

        1. In theory, sure. But in practice, why would Treasury pay a strike price of $40 dollars to obtain a share of stock it could only sell for $4 today? The reason Treasury would exercise the warrants is to make money for the government, not use government funds to recapitalize Fannie and Freddie.

          Liked by 1 person

          1. As you have pointed out, its in everybody’s best interest for the stock be as high as can be with everyone benefitting. If Treasury communicates to market that they are only exercising 40% with increase in strike (maybe $40 would be too high), I don’t believe the stock would still be $4. Just using 40$ strike as example, this would leave Fannie with 3.1 Shares outstanding. If they earn your estimated 10.6B after tax which equals eps of 3.42. Giving them a multiple of 15 would equate to 51$/share(multiple can be debated). Everyone wins. Taxpayers make quick 30%. Essentially fully recapped GSEs. Shareholders get increase in stock price. The only thing I left out is preferred shareholders.

            And obviously this is all speculation and only helps us all vent out but I do agree with you that if treasury wants to exercise the warrants for pennies than restructuring could be really hard.


          2. Tim,
            are the warrants for 79.9% of “the company” (regardless of how many shares are outstanding) or for 79.9% of “the currently outstanding shares” (ie. a fixed amount of ~1bn or so shares, fixed w/o regard to future dilution)??

            Liked by 1 person

          3. That’s a very good question. I had always assumed that the warrants were for 79.9 percent of the outstanding common stock of Fannie and Freddie as of the date the warrants were granted. But I checked Fannie’s third quarter 2008 10Q, and that’s not right. That 10Q says, “The warrant gives Treasury the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise,” and also notes that, “the warrants may be exercised in whole or in part at any time on or before September 7, 2028…”

            These two features highlight the importance of the negotiators in discussions to settle the outstanding lawsuits against Treasury and FHFA getting agreement on specific language that amends the warrant provision in the Senior Preferred Stock Agreements. Under the language as it now stands, Treasury would have the right not just to warrants for 79.9 percent of the existing shares of Fannie and Freddie, but also to warrants for some percentage (dependent on what already had been exercised) of any FUTURE shares raised by the companies between now and September 2028. Leaving that provision of the PSPAs intact would make it impossible for the companies to recapitalize. (This feature of the PSPAs makes clear that Treasury really DID write them to be “death sentences” for the companies….)

            Liked by 2 people

          4. Thanks Tim; wow! I checked in the 2015 10k and sadly same language as to the warrants is there. They’ve really put a tourniquet on the NECK of some legit cash cows and do not want to let go! scary stuff.

            {rant: Sadly, the GSEs have to rely on the *messed up* political aspect of relying on a “Federal” judge ruling against the “Federal” treasury for rather large sums! Wow! what a shame. Shame on wall street, they got bailed out and stood up (worst was AIG), GSEs being put down. }

            While digging into GSE operations best i can, i am seeing that these 2 GSEs have a real MOAT against wall street (in the good, Warren Buffet, way) :
            (1) 50+ year operational and actuarial expertise laser focused on mortgages alone; UNPARALLELED
            (2) automated, and instant computer tie-ins to lenders who literally rely on GSE “qualification” via computer to lend in the first place; an up-stream integration on par with Walmart and their suppliers, from what i’ve read in case studies (at school)!
            (3) Global branding.

            ALL 3 UNPARALLELED


  24. Tim,

    This article completely exposes the worst hypocrisy (BS) of Financial Establishment.
    We know you as unbiased, objective, honest mortgage finance expert and also very restrained in your articles. This article from you finally confirms the real facts that all should know.

    Please publish this article in all major newspapers and media.

    Liked by 2 people

  25. Is there any concern from plaintiffs that if there is a settlement before the appeals court ruling that the all of the bad rulings from the judges that dismissed all these cases would set precedent for the future?


    1. i have discussed this before on a prior post.

      the GSEs are currently highly profitable, and once they are released from conservatorship, there would be no authority for fhfa (let’s assume under potus warren in 2020) to put them back into conservatorship unless GSEs went back into financial distress. moreover, if the NWS was voided by settlement by treasury mnuchin, there would be no authority for fhfa to suddenly try to reverse this. so all good there.

      what i wonder is whether new institutional investors would put fresh capital in GSEs if the lamberth ruling was never reversed or remanded. on one hand, lamberth’s version of conservator power would only come back to haunt investors if a new conservatorship was necessary, and if that is the case, the investors likely have already lost their money. on the other hand, adherence to the rule of law is such a bedrock principle for institutional investors that some might be wary to put fresh capital in under any events without a lamberth exorcism.

      Liked by 2 people

  26. a tour de force, tim.

    i didnt appreciate that new bank held mortgages will scrape a meritless profit equal to the excess guaranty fee that an overcapitalized GSE would have to charge until you pointed it out.

    clever but devious.

    all best



  27. Great write! I disagree with the warrants as they were self dealt and the Trump will want to make a clean break and not invite more lawsuits. I understand you logic but I think a better path would be to get BOD to issue new commons but I don’t even think that is necessary and capital can be accomplished through DTA’s. Gov will get it revenue through equity gains in taxes. All government has to do is release and recap with DTA’s. Enough greed on government part has taken place.

    Liked by 2 people

  28. Tim, you are an American Hero! Please keep your truth information campaign up. Articles like this will make a distinct difference to inform the Trump administration and Congress how to correctly reason through this complex mess. I agree with you that the warrants need to be horse-traded with changes made to the exercise price and percentage of warrants exercised, so that all classes of the capital structure come away with a fair solution. In the end, its a simple exercise of maximizing joint utility with a pie that is plenty big in size to make all happy once again.

    Liked by 2 people

  29. I am printing this article and mailing it to my Senator and Representatives requesting them an answer with their position. I am sure that the cookie cutter or template used before ( taxpayer protection) will no longer be used in the answering letters.

    Liked by 2 people

  30. Tim – Great article! I know that you’ve had communication with Fairholme and that they are aware of your views/insight. Do you believe that the major litigants hold the same views as to what is the best way to move forward regarding settlement? In other words, do you see litigants going to the table with their own goals in mind vs litigants united together with a plan that makes the most sense for all involved?

    Liked by 2 people

    1. There are differences in the primary objectives of some of the parties (existing preferred versus common shareholders in Fannie and Freddie, for example), but I believe they all have a commonality of interest in returning the companies to private ownership, setting them up to succeed, and minimizing the cost of getting them recapitalized.

      Liked by 2 people

  31. Tim,

    Happy New Year! I felt this was a great blog post to reintroduce the accounting fraud research that was published by Housing Wire. Two gentlemen I now consider friends of mine were the authors.

    The article below contains the fraud allegations that were at the center of the suit against PwC (which was settled by PwC outside of court). This accounting fraud research was also verified by a leading forensic accounting specialist, Dr. Larry Crumbley. I suspect these could be part of the 11,000+ hidden document cache that might invalidate the SPSPA.


    Liked by 2 people

  32. Tim, are you aware if principals at fairholme/perry are expecting settlement negotiations in the near future? I’m very curious to know if the key players are on the same page in terms of seeing how this plays out with Mnuchin as the treasury sec


  33. Thank you JTimothyHoward,

    The President elect Donald Trump and Treasury elect Steve Mnuchin would be remiss not to invite Timothy Howard to a joint Administrative Meeting at the White House for a private consultation and appointment to assist with leading the transitional landing team for reformation of FHFA.

    Liked by 2 people

  34. Tim,

    Thanks for what is again a simple, truthful explanation of the current GSE saga. Excluding certain drawbacks (unnecessarily opening a can of worms), if timed correctly, I can also see where it would be beneficial to go on a show like 60 minutes to educate America on this very subject.

    Thanks for your continued efforts to shine light on a topic that touches all Americans.

    Liked by 1 person

Leave a Reply

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

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

Twitter picture

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

Facebook photo

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

Connecting to %s