The Right Choice on Capital

~ jtimothyhoward

One of the recommendations of the “Blueprint for Restoring Safety and Soundness to the GSEs” released earlier this month by the investment firm Moelis & Company is the imposition of “rigorous new risk and leverage-based capital standards” on Fannie Mae and Freddie Mac. These include two fixed percentages. The first is a 4.25 percent minimum taken directly from the Basel III bank capital standards: 8.5 percent equity capital with a 50 percent risk weight for residential mortgages (which is risk-based in name only). The second is a “two-tiered leverage ratio,” made up of 3 percent equity capital and another 2 percent that can be “soft” capital such as credit risk transfer (CRT) securities, for total capital of 5.0 percent. Both versions would apply to all of Fannie and Freddie’s business, irrespective of its risk. Because the companies would add the interest cost of CRTs to their guaranty fees, pricing using the 5.0 percent leverage ratio and the 4.25 minimum should be about the same: Fannie and Freddie would likely charge close to a 70 basis point average guaranty fee (before the 10 basis point payroll tax fee paid to Treasury) in each case.

The rationale Moelis gives for this recommendation is that, “These illustrative capital requirements…are broadly consistent with approaches applied to other large financial institutions, and represent reasonable estimates of capital standards for the Enterprises.” The “other large financial institutions” are of course big banks, and in prescribing bank-like capital standards for Fannie and Freddie Moelis falls solidly in line with most other reform proposals. To its credit, however, Moelis also goes on to say, “Given the unique nature of Fannie Mae and Freddie Mac’s businesses, and particularly the scale of their mortgage guarantee businesses, FHFA may elect to implement a more nuanced risk-weighting system
 for mortgages, as compared to the fairly simplistic…approach applied to multi-product banks,” adding, “A more nuanced approach…could also help to broaden the ‘credit box’ that has historically excluded large groups of deserving Americans from obtaining a mortgage.”

Moelis’ instincts about the merits of a “more nuanced risk-weighting system” for Fannie and Freddie’s capital are correct, and I believe that once the firm does a more comprehensive analysis of the pros and cons of a true risk-based capital standard for the companies compared with a fixed ratio-based standard it will argue much more forcefully and convincingly for the former.

It is not possible to have a true risk-based capital standard for commercial banks, because their business spans numerous products and markets with multiple types of risk, many not statistically predictable. But such a standard is possible for single-product mortgage guarantors, who take residential mortgage credit risk for which vast amounts of historical performance data exist. To implement it, Treasury (or whoever the administration designates) first would pick the stress environment it wants the guarantors to be able to protect against. FHFA then would use Fannie and Freddie’s historical data (for loans they currently are allowed to acquire, that is, excluding the interest-only ARMs and “Alt-A” mortgages that caused half of their credit losses in 2008-2012) to project stress default rates and loss severities by risk category—at a minimum, combinations of loan-to-value (LTV) ratios and credit scores. The resulting loss amounts would be the basis for determining Fannie and Freddie’s new capital requirements, set at the risk-category level. I’ve recommended that FHFA also set a minimum capital requirement, derived from the individual risk-category capital requirements and a mix of business deemed prudent but also encompassing broad service to affordable housing borrowers.

The argument made against a true risk-based capital standard for Fannie and Freddie is that it would give the companies an unfair capital advantage over banks, which have to meet a ratio-based standard. Yet subjecting the companies’ credit guaranty business to the same fixed capital ratio as banks (whether 4.25 percent or some other figure) in the guise of a “level playing field” ignores the fact that the Basel III risk weights for banks do not differentiate between credit risk and interest rate risk, whereas Fannie and Freddie’s minimum (and risk-based) standards have in the past and almost certainly will in the future.

Commercial banks today hold $3.7 trillion of single-family whole loans and MBS on their balance sheets, $2.2 trillion of which have long-term fixed rates. They fund the vast majority of these mortgages with short-term consumer deposits and purchased funds (or “hot money”). Banks’ 4.25 percent Basel III capital requirement for single-family mortgages has to cover not just credit risk but also the risk of financing 30-year fixed-rate and capped adjustable-rate mortgages with short-term debt. In Fannie and Freddie’s regulatory standards, those risks are capitalized separately; there is both a 45 basis point minimum for guaranteed mortgages (now universally viewed as too little) and a 250 basis point minimum for mortgages held in portfolio. The companies have 205 basis points of required interest rate risk capital for on-balance sheet mortgages even though they can and do match their durations with a combination of long-term debt and derivatives, and “rebalance” to keep those durations matched as interest rates change.

Banks take much more interest rate risk in their mortgage portfolios than Fannie and Freddie do. To create an actual level playing field on capital between banks and Fannie and Freddie’s single-family credit guaranty business, therefore, at least 2.05 percent, and realistically considerably more, of banks’ 4.25 percent Basel III capital charge must be allocated to that risk, leaving at most 2.2 percent as the amount applicable to the credit risk in Fannie and Freddie’s guaranty business. Applying banks’ fixed capital ratio directly to the companies’ credit guarantees without this adjustment would result in Fannie and Freddie’s portfolios being capitalized at 6.30 percent (4.25 plus 2.05 for interest rate risk), which clearly is not level with banks.

If we take away the level playing field argument—as we should—no good reason is left for rejecting a true risk-based capital standard for Fannie and Freddie. A single ratio-based standard imposed on any guarantor’s entire book of business creates a capital incentive to take uncompensated credit risk and a capital disincentive to use cross-subsidization to more favorably price affordable housing loans. A true risk-based standard does the opposite. In addition, unlike a fixed capital ratio a true risk-based standard produces a clear framework for evaluating credit risk transfer securities to insure against unexpected loss, and for attracting and pricing private reinsurance to cover catastrophic loss.

Let’s begin by examining how a fixed-ratio capital standard distorts credit pricing decisions and thus a credit guarantor’s risk profile. Capital needs to be related to risk, and with a fixed capital ratio what happens is that required capital ends up determining the risk profile, rather than the risk profile determining the capital.

An example may help to explain this. In 2014, FHFA published a capital and pricing grid for all of the business done by Fannie and Freddie during the first quarter of that year, broken into nine combinations of LTV ratio and credit score ranges. There was a wide disparity between the lowest- and highest-risk 20 percent of that business. For the lowest-risk 20 percent, FHFA calculated economic capital of 115 basis points and target guaranty fees of 25 basis points, compared with economic capital of 600 basis points and target guaranty fees of 120 basis points for the highest-risk 20 percent. For all of the business combined, FHFA’s calculated average economic capital was a little over 300 basis points, and average target guaranty fees were a little over 60 basis points.

FHFA did not disclose how it came up with these economic capital figures or target guaranty fees, but for this exercise let’s assume that the capital numbers represent FHFA’s best estimates of capital required to pass a rigorous stress test, and that the guaranty fees are consistent with a reasonable return on that capital. Let’s further assume that all of Fannie and Freddie’s business is subject to a 300 basis point fixed capital requirement, irrespective of risk. Now we’ll ask: how would the companies set their guaranty fees for the loans in FHFA’s very different risk categories?

I can imagine facing this challenge, having done risk management for a credit guaranty business for two decades. With a fixed 300 basis points of capital we would need to charge an average guaranty fee of 60 basis points to earn our target rate of return. We wouldn’t be able to charge that on the lowest-risk 20 percent of our business (with a 25 basis point target fee) without losing most of it, but if we cut fees to get more our required capital won’t change and we’d fall short of our return target. So what do we do? Do we cut fees on our lowest-risk business from 60 basis points to, say, 40, then try to recoup that discount by charging not 120 basis points but 140 basis points for our highest-risk business? That would make credit guarantees even less affordable for the borrowers who take out these loans.

What I believe would very likely happen if regulators insist on putting a flat capital charge on a single-product business with variable categories of risk is that guaranty fees for all risk categories would stay relatively close to the average (in this example, 60 basis points), and the credit guarantor upon whom this capital regime has been imposed will end up with a significantly riskier book of business—with overpriced lower-risk business staying away and underpriced higher-risk business being attracted—than the fixed-capital ratio was intended to have produced. That’s the opposite of what a safety and soundness regulator should want.

With a true risk-based capital standard, in contrast, the credit risks of all types of business automatically get capitalized at the proper level, and the pricing dynamics encourage, not discourage, a balanced and diverse book of business, including loans for affordable housing. Guarantors would be able to employ a version of the cross-subsidization approach used effectively by Fannie and Freddie prior to the 2008 collapse: charging somewhat more than an economic guaranty fee for lower-risk business (although not so much as to lose a meaningful amount of it), and using the resulting overages to selectively lower fees to obtain higher-risk affordable housing business, while still meeting their return targets and passing their stress tests.

Another crucial benefit of a true risk-based capital standard is that it increases the efficiency and reduces the cost of third-party credit risk transactions by giving the concepts of expected loss, unexpected loss and catastrophic loss—which are either vague or arbitrary under a ratio-based standard—reliable numerical values. This enables proper economic analysis and market pricing of both credit risk transfers (CRTs) and catastrophic risk insurance.

Some “real world” detail is useful in explaining this point as well. When a credit guarantor guarantees the performance of a pool of mortgages, it does so without knowing the exact economic, interest rate or home price environments this pool will experience over its life. For that reason, the guarantor looks at a wide variety of possible outcomes for these variables, and prices to expected values.

When I was at Fannie we used 500 calibrated combinations of future interest rate and home price changes to project prepayments, defaults and loss severities for the mortgage pools we insured, based on their risk characteristics. Our expected loss was the average loss in all scenarios—usually in the 3 to 6 basis point range for our entire book, but considerably higher for riskier pools of loans—and it went into our pricing build-up, along with our administrative expenses and capital charge, to determine our target guaranty fee. Catastrophic loss was a specific number as well: it was the amount just above what our pricing model projected we could absorb on a pool of loans, based on the capital we put up and the guaranty fee we charged on it. (For a reformed Fannie and Freddie, the government would pick the stress scenario that determines this loss amount.) And an unexpected loss was any loss greater (or less) than the expected loss, but below a catastrophic loss (or above zero). Unexpected losses affected our profits, but did not threaten our solvency.

In the framework of a true risk-based capital standard the role of CRTs becomes straightforward. CRTs protect against unexpected loss, not catastrophic loss. The decision on using them therefore comes down to whether a guarantor wishes to pay the CRT interest costs in order to reduce the potential variability of its profits. That is a judgment the guarantor can and should make on its own; since CRTs do not directly affect solvency, there is no reason for a regulator to mandate their use. A regulator can make CRT use more attractive to a guarantor by giving equity capital credit for them, but in doing so it must be extremely careful in how it calculates their “equity equivalency.” If a regulator gives unwarranted equity capital relief for CRT issuance (as might easily happen under a number of current reform proposals) the guarantor will have a lower threshold of catastrophic loss, because it will have been allowed to exchange hard equity for less certain CRT coverage on too favorable terms, leaving some losses unaccounted for in a stress environment.

Finally, a true risk-based capital standard will make it much easier to use private reinsurance (rather than an explicit government guaranty or continued use of the current Treasury backstop commitment) to cover catastrophic mortgage loss, by providing specific thresholds, by risk category, at which that reinsurance kicks in. Again using as an example the capital and pricing grids published by FHFA in 2014, a reinsurer would know that for loans with LTVs between 61 and 80 percent and credit scores between 700 and 739, the companies could absorb nearly 7.5 percent in credit losses—through a combination of required capital and charged guaranty fees—before any claims had to be paid. Similar data would exist for all other risk categories. With a fixed-ratio capital standard reinsurers would know the size of a guarantor’s capital buffer but not the risk of the future business this capital will be protecting; to compensate for that uncertainty, they would have to add sizable cushions to their reinsurance quotes, if they didn’t elect instead to avoid the market for mortgage credit risk entirely.

In summary, then, the choice between a fixed ratio-based capital standard and a true risk-based capital standard for Fannie and Freddie, or any credit guarantor, is not a close call. The sole argument for the ratio-based standard—to create a “level playing field” with banks—is hollow, and a true risk-based standard offers overwhelming advantages in the areas of credit pricing, alignment of capital with risk, affordable housing, CRT evaluation and management, and the attraction of reinsurers such as property and casualty companies to the market for catastrophic mortgage risk.

The Moelis Blueprint is a practical and promising prescription for achieving the consensus objectives for a post-crisis secondary mortgage market. It uses proven mechanisms, can be accomplished administratively, and avoids the risk of transition to an untested system. One area in which I believe it should be refined, however, is the proposed approach to capital. The choice of a capital standard for Fannie and Freddie will have profound effects on how the companies conduct their business. With a true risk-based standard they will be able operate at much higher levels of effectiveness and efficiency than would be possible with a ratio-based standard. The more effective and efficient Fannie and Freddie are, the more valuable they will be to all of their stakeholders, and the easier and cheaper it will be to raise the amount of capital required to bring them out of conservatorship. Shareholders of the companies, the federal government and homebuyers all will benefit from the right choice on capital.

216 thoughts on “The Right Choice on Capital”

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  4. Tim, do you feel there is value in thinking about current market conditions when evaluating GSE reform options?
    Specifically, the bullish market is overpriced by most metrics and investors are taking on increased risk to chase for returns, almost nothing is available below intrinsic value, etc…
    If the GSE equity is to supplemented via a public offering taking into consideration current risk/reward conditions, wouldn’t it make sense to do this sooner rather than later because of where we are in the economic cycle?
    If we enter a recession in the next 12 – 24 months, isn’t it going to be harder to raise more money and consequently the longer Mnuchin waits, the more risk he takes on in reform prospects because less money may be available in the public markets for the GSEs?

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  5. Just listened to the Robinson appeal – Plaintiff’s lawyers need to simplify/dumb down their arguments as defendants lawyers use layman terms & that’s what resonates w these judges. It is clear the judges aren’t familiar with the complexity of this case, let alone read all the filings in their entirety! The government lawyer bops & weaves like Colombo and lures the judges right in

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    1. I thought plaintiff was very sharp and did a fine job. Defense did a great job repeating himself on how remarkably easy this case is. He was short on argument, long on assertion.

      Unfortunately, judge had little if any understanding of the role of Treasury, even thinking the Treasury paid out dividends with money’s collected from the sweep. There’s just so many finger puppets one can use. Deja vu all over again, a la Millett.

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      1. Listening to the transcript I found it hard to be confident that the plaintiffs will win here. The judge with the heavy southern accent seemed to have already made up her mind– she’s supporting the government–so the plaintiffs will need to win over both of the other judges (who I couldn’t tell apart, assuming each of them spoke). The advantage the defense has is in using simple arguments, even though they’re inaccurate, incomplete or misleading, while the plaintiffs are using complex arguments (which are factual, well reasoned and consistent with legal precedent). The judges clearly are new to all of this, so they’re naturally more receptive to the simple arguments, and also to the fact that it’s the government making them (not the “shareholders,” to whom the judges did not seem sympathetic).

        On tone, I thought the defense also had the advantage. Stern (Treasury) and Cayne (FHFA) sounded confident and composed; speaking for the plaintiffs David Thompson–who I know, like and respect– sounded nervous and a little too insistent. (At one point the judge with the southern accent told him, “you’d be more effective if you didn’t point your finger in our direction.”)

        I do have one strong caveat, however: I listened to the transcript of oral argument in the Perry Capital appeal and was very confident the plaintiffs would win. It could be that post-oral argument in Robinson the other two judges will focus on the law and the facts and rule for the plaintiffs. But if I had to bet I’d say the government probably prevails in this one, and plaintiffs will need either Saxton or Collins to get their “split in the circuit”.

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        1. I think these Judges will looking as if this conservatorship is different from other conservatorships. Much emphasis by the government on federal vs. state which may have been a mistake in the government’s argument.

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        2. Tim, I totally agree with you on this after listening to the transcript. Judges didn’t have a clue about the depth of the case at all. I lost my hope on this case. Relaxed and soft spoken defense lawyer was doing excellent to mislead the judges by saying this case is really simple.

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        4. These were the Judges:
          Judge Alice M. Batchelder
          Judge Julia Smith Gibbons
          Judge Deborah L. Cook

          All appointed by George W. Bush

          Probably Judge Julia Smith Gibbons is the one with southern accent from TN.
          Gibbons grew up in the rural Tennessee town of Pulaski. Gibbons received a Bachelor of Arts degree from Vanderbilt University and a Juris Doctor from the University of Virginia School of Law.[1] After graduation, she served as a law clerk to Sixth Circuit Judge William Ernest Miller. She was in private practice from 1976 to 1979 before joining Governor Lamar Alexander’s staff as a legal advisor in 1979. In 1981, she left the Governor’s staff to become a state trial judge in Tennessee.

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  6. Tim or Rule of Law Guy,
    Any concerns with Steven Mnuchun’s comments about changing the government guarantee from implicit to explicit? Or none at all? Sounds a lot like MBA verbiage.

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    1. My understanding is that Mnuchin said there can’t be an “implicit” government guaranty of the mortgage market; it must be either explicit or nonexistent. That seems a sensible formulation do me. I would point out, however, that the large banks don’t have an explicit government guaranty, but they would never be allowed to fail. So what do they have?

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      2. My thinking exactly! Mnuchin has made clear the taxpayers will not be at risk and the GSE’s out of government so I read the outcome being nonexixtent with a wink just like all institution of major importance have. Any future similar crisis will result in some majorly important looser being saved and Lehman Brothers not. Mr.. Howard, I know you commented on this before but what do you think would have happened had the GSE’s not been there to save the day?

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      3. What Mnuchin said isn’t a desire, it’s a tautology. Either there is an explicit government guarantee or there isn’t. Currently there is no such guarantee.

        While Mnuchin, Hensarling, Crapo, and others might not like the implicit guarantee that is currently in place, it is something that the market dictates and isn’t subject to the control of Congress or Treasury. Since the GSEs (if released from conservatorship) are of a scale with the TBTF banks, they would likely be viewed by the market as also being TBTF.

        In short, an implicit guarantee cannot be legislated or ordered away. If the market thinks there is one then there is, and if the market thinks there isn’t one then there isn’t. The only way around this is an explicit guarantee, which is generally incompatible with Mnuchin’s desire to minimize risk to the taxpayer and is anathema to Hensarling.

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      4. TBTF concept is simple. When the gov’t bails out bank equity is wiped out but depositors and creditors are made whole

        See for example Continental Illinois bank or Franklin Savings

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        1. Continental Illinois is a good example of a large bank (as I recall, one of the top ten in the country when it failed in the mid-1980s) deemed “too big to fail” whose shareholders were wiped out. Franklin Savings was a much smaller “rogue” savings and loan that I wouldn’t say came close to the definition of TBTF. But you’re forgetting Citigroup, which would have failed during the 2008 financial crisis had it not been for a rescue package put together by bank regulators that effectively guaranteed over $300 billion of the bank’s assets and injected $20 billion of capital to keep it afloat. The top six commercial banks today–JP Morgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley– all have more assets than Citigroup had in 2008, when it was bailed out.

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          1. the biggest tbtf was goldman, which was able to recoup its trades in full with AIG. if AIG declared bankruptcy goldman would have been banging on buffett’s door.

            but let me digress. it seems to me that with the death of health care reform, and tax reform looking like a major slog, noone in the administration is going to stomach an untried and unproven plan to reform housing finance along the lines of MBA/corker/warner. i suppose this line of thinking also supports the notion that the status quo is preferable to an unproven reform program except if there is one thing mnuchin has been consistent with, it has been his insistence that housinf finance status quo is unacceptable.

            rolg

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          2. The failure of the health care initiative makes what I felt was already an unlikely event–mortgage reform in this Congress–even less likely. But if Congress does not even take up mortgage reform, that makes near-term administrative reform unlikely as well, absent some unforeseen event in the court cases. Mnuchin needs help in both houses of Congress on the debt ceiling and tax reform, and almost certainly will be loathe to do anything on administrative reform to which members of Congress (the large majority of whom are aligned with the banks in favoring a legislative solution, if anything is done at all) might object. Because of the court cases, and Mnuchin’s continued statements about the status quo being unacceptable, I continue to believe it’s a matter of when, not if, we will see administrative mortgage reform. But that “when” is still a fair ways off.

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          3. Tim

            How are you defining a “fair ways off”? It seems to me that it is like sands through the hourglass given the declining capital and there isn’t much time left. Do you think just stopping the sweep buys that much more time into 2018?

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          4. Another way to say “a fair ways off” would be “beyond my level of comfort in predicting.” I don’t think you’ll get legislative reform before the 2018 elections, and I don’t think you’ll get administrative reform before the administration either succeeds or doesn’t succeed with whatever it decides to do on taxes. And I have no idea how long it will take for the latter to play out.

            I hope Watt decides to suspend sweep payments to allow Fannie and Freddie to build capital buffers, but if he doesn’t I do not think having the capital buffer go to zero by the end of this year changes what I’ve said above.

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          5. Thanks Tim. While all of this flies in the face of common sense to me the idea of capital going to zero and not having a sense of urgency around that is mind boggling to say the least. So you are assuming Mr Watt would be willing to make a draw from Treasury in the absence of administrative reform.

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        2. tim

          re “I don’t think you’ll get legislative reform before the 2018 elections, and I don’t think you’ll get administrative reform before the administration either succeeds or doesn’t succeed with whatever it decides to do on taxes.

          i would agree that taxes is the higher priority, but i dont see any quid pro quos where mnuchin needs corker/warner on taxes, and therefore must defer or accommodate on housing reform. all friends of tbtf such as corker and warner want a lower corporate tax rate. as for personal rates, again, i would think friends of tbtf are at least somewhat aligned with administration.

          as belichick, we’re on to hindes/jacobs.

          all best

          rolg

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  7. I took a quick look at the table, and it’s not immediately clear to me how its author is deriving the amount of the “gross draws.” But I’d call your attention to the base case net income projections for Fannie and Freddie (combined) at the top of page 4. In only two years (2014 and 2015) does this projection show the companies’ combined net income exceeding the initial annual PSPA dividend requirement of $18.7 per year. So this table, at least–done some time before December 2011–is still attempting to justify the death spiral scenario.

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    1. One more point about this forecast.

      If you look at the net draw lines, just below the net income lines you reference, they are negative beginning 2013/14. This indicates that draws/dividends are not circular but that dividends exceed draws.

      I just can’t see how this forecast supports the death spiral narrative.

      Rolg

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      1. As I said, I can’t make sense out of this table. For the base case (as well as the stressed case) each year’s “dividend” line should be 10 percent of the previous year’s “gross PSPA draw,” but it’s not, and each year’s annual “gross draw” should be the current year’s “dividend”–shown as a negative in the table–less the current year’s “net income,” but it isn’t either. The gross draw number each year is unexplained. The “net draw” is simply the gross draw less the dividend (at least this is shown correctly in the table), but since it’s not clear where the gross draw figure comes from, the net draw is equally unexplained. And in any case, it’s shown as a negative, just like the dividends, so if it WERE an accurate number it would support the death spiral negative.

        I’ll leave this comment up for a while, but then intend to delete the sequence, since it is more likely to be confusing than helpful to most readers.

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  8. “Fannie Mae and Freddie Mac transferred $5.5 billion worth of credit risk in the first quarter of the year, primarily through debt issuance. The Federal Housing Finance Agency released a credit-risk transfer progress report Wednesday afternoon showing that the risk was transferred on mortgage loans with $174 billion in unpaid principal balance.
    Debt issuance was the largest category of CRTs, accounting for 77 percent. That was followed by reinsurance transactions, which represented a much smaller share at 19 percent. Whole loan securities came in at 2 percent, while lender recourse and front-end reinsurance accounted for 1 percent of total CRT transactions.
    Fannie led in CRT transactions in the first quarter, having transferred risk on $108 billion in UPB. Freddie handed off risk on $65 billion in UPB. The FHFA noted that loans targeted for transfer represent about 60 percent of the government-sponsored enterprises’ single-family loan production for 2016. That percentage has increased each year since the CRT program was launched in 2013 to reduce taxpayer risk and accounted for 40 percent of single-family loan production.”

    Hey Tim – the above is from IMF Pubs but similar misinterpretations are rampant in the news media about CRTs.

    Did they transfer $5.5B worth of risk? I very much doubt it. Can you please provide a clarification for all these journos who don’t know what they’re saying about CRTs? Set the record straight type of thing.

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    1. No, they did transfer $5.5 billion in “risk.” But risk is not the same as losses. And the “risk” Fannie and Freddie are transferring in these deals is extremely remote– that is, it is risk of losses that are highly unlikely to occur. My criticism of Fannie and Freddie’s securitized CAS and STACR programs is that the companies are paying very high interest rates to issue (at the direction of FHFA and Treasury) “risk-transfer” securities that are highly unlikely to actually transfer any credit losses.

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      1. Well the point of my comment is that the risk being quoted isn’t actually the amount being sold. They’re selling near the first loss exposure to be sure but the amount of CRT balance being sold doesn’t actually protect them on $5.5B in exposure – the actual amount is much much less. Is that not correct? EG the reference pools may add up to $5.5B but the actual amount of CRT face amounts is much less… is that not correct?

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        1. No. The $5.5 billion IS the face amount of the risk-bearing tranches, but they generally don’t begin to take losses until after Fannie or Freddie have taken the first 100 basis points of loss, which is a threshold the pools that have been insured over the last four years are very unlikely to exceed. I say “generally” take the first 100 basis points of loss because recently Fannie has begun experimenting with selling risk-transfer tranches that kick in below that threshold. They sold some (called “B-1” tranches) where the buyers take losses on a pari passu basis with Fannie, but they’re being paid 1-month LIBOR plus more than 1000 basis points per year to do it. And in Fannie’s last deal it sold a B-1 tranche that takes losses from 50 to 100 basis points, but investors are getting LIBOR plus 505 basis points for that. Given that these B-1 tranches will be the last to be prepaid (after the M-1 and M-2 tranches) they will be outstanding–and paying very high floating rates of interest–for a long time. This means that Fannie is committing itself to a large cumulative amount of interest payments for these tranches that are very likely to exceed, probably substantially, the dollar amount of losses transferred to the B-1 tranche-holders (which is the reason investors are buying them).

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  9. The Robinson oral argument is tomorrow (7/27) morning and I haven’t seen P counsel provide the circuit court any notice that it will discuss the recently released fairholme discovery documents. P counsel has notified the circuit court that treasury has in briefing interpreted “may” in HERA as mandatory in one usage and should not be permitted to insist it is optional regarding the preserve and conserve context. See http://gselinks.com/Court_Filings/Robinson/16-6680-0041.pdf

    So it appears P counsel is playing its cards without emphasizing these documents

    Rolg

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    1. Ahead of 6th Circuit Oral Arguments tomorrow at 9am, here are the 3 judges presiding over the Appeal:

      1. Judge Alice Batchelder (R) – appointed to District Court by Reagan, then to the 6th Circuit by Bush in ’91. Bush also considered her for Supreme Court.
      2. Julia Gibbons (R) – appointed to District Court by Reagan, then 6th Circuit by Bush in ’02
      3. Deborah Cook (R) – 6th Circuit by Bush ’03

      Hopefully they look at the case based on its merits and not politics.

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    2. “Which is why in the Robinson oral argument in the 6th circuit on 7/27 P counsel should argue strenuously that the government has perpetrated a fraud on the Robinson district court in proffering a false narrative as justification for the NWS.

      It is one thing to have broad authority but quite another to act in bad faith…or at least the district court should be given the opportunity to determine the good/bad faith issue at trial.”
      I hope P lawyers have at least read your above comment.

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      1. @yaquino

        P counsel has been granted only 15 minutes of oral argument though this is often extended by the judges if they have an interest. I sense with the letter counsel sent to clerk that I linked to that they will simply hammer away at the reasons why the perry dissent opinion should be followed. At some point a transcript will become available.

        Rolg

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    1. In the segment you refer to, Senator Lankford of OK is expressing concern about the impact of the qualified mortgage (QM) rule on the ability of community banks to make residential mortgage loans. Mnuchin’s answer that community banks “should be encouraged to make loans and keep them on their balance sheets” is followed up by his adding that they should not be forced to sell these loans to the FHA or Fannie and Freddie. I view that answer more as being community bank-friendly to a Senator expressing a concern about community banks in his state than as anti-Fannie and Freddie (or FHA).

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        1. Mnuchin has spoken in the past about getting the balance between FHA, Fannie and Freddie and “private lenders” (read banks) right, but he hasn’t yet tipped his hand as to what he thinks is the best way to do that.

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    1. This is an appearance on CNBC this afternoon by Dick Bove of Rafferty Capital and Josh Rosner of Graham Fisher (both of whom covered Fannie when I was there, pre-conservatorship), discussing the meaning and implications of the 33 documents from the Court of Claims discovery that were unsealed last week and made public on Monday. I thought each did a very good job explaining a complex topic in understandable terms to CNBC’s large, generalist, audience. And I give CNBC credit for giving them air time; to date the financial media in general has significantly under-reported this story.

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      1. Hi Tim,

        Would these released documents be more useful to the plaintiffs in the respective court cases/appeals? We have seen in the District of Columbia Court of Appeals how judges can be swayed by the unreasonable and unsubstantiated defense even with hard facts (and numbers) and sworn testimony of ex Fannie CFO. The important question is: do these documents shine the truth like daylight that even the defense team could not argue to the contrary?

        Thks..
        RF

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        1. @rf

          I’ll give you my two cents and Tim can follow on.

          The perry circuit court essentially said that the conservator had the option but not the obligation to preserve and conserve GSE assets. But the opinion seemed to assume that the government defendants were acting in good faith. That the death spiral fear was real at the time and the NWS was not an opportunistic money grab.

          If judges millet and Ginsburg were presented with the new docs that indicate that the death spiral fear was not genuine and they did not change their opinion, they would have to conclude that the conservator was under no obligation to act in good faith, much less have an obligation to preserve and conserve.

          This seems to me to be a rather extreme position to take in interpreting HERA.

          Which is why in the Robinson oral argument in the 6th circuit on 7/27 P counsel should argue strenuously that the government has perpetrated a fraud on the Robinson district court in proffering a false narrative as justification for the NWS.

          It is one thing to have broad authority but quite another to act in bad faith…or at least the district court should be given the opportunity to determine the good/bad faith issue at trial.

          Rolg

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          1. The defense will be in a much different, and more difficult, position with the appellate courts in the Robinson, Saxton and Collins cases than it was with Perry in the DC Court of Appeals. Given the content of the documents made public this week, the defense argument in the pending three cases now essentially will be, “Yes, we knew the companies were about to become profitable but we didn’t want them to keep the resulting capital because that would have made it harder for us to put them out of business (which was our real objective; we only were pretending to be ‘conserving’ them). And yes, we lied about that by making up the story about the ‘death spiral’ because we didn’t think you’d let us get away with just stealing the money outright. But that really shouldn’t matter; we still contend that Congress meant for HERA to be interpreted as allowing us to do whatever we want with Fannie and Freddie, with no judicial review, irrespective of our motive or whether we lie about it to the public and the courts.” It’s hard to imagine the government will get even one of the appellate courts to go along with that argument, let alone all three of them.

            Liked by 6 people

      2. You opined that releasing GSE docs wouldn’t have much of an overall, administrative impact. If TS Mnuchin, FHFA Director Watt or Econ Advisor Cohn do not at the very least mention they’re reviewing the latest information made publicly available, I would have to unfortunately and wholeheartedly agree with you. I didn’t, then. Their silence, in the face of new info would be surprising given their prior statements.

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        1. I’m not sure what earlier comment you’re referring to, but let me briefly try to clarify my position on the release of the documents (both these, and ones that are likely to follow).

          I think they WILL have an administrative impact, by making it appear more likely to key figures in the administration–certainly Mnuchin, and probably Cohn as well–that the government is unlikely to prevail in its contention that the net worth sweep was legal, and that reform efforts, whether legislative or administrative, will need to incorporate a resolution of the lawsuits in order to be successful. I know Senator Corker maintains that reform and the lawsuits are separate issues, but they’re not– as the 33 documents released from their protective orders last Wednesday showed, the two are intricately intertwined.

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          1. The comment was a reply, sometime in mid July, on your previous article “The Path Forward”. At any rate, your point today about the effect the documents could/should have on the courts and admin going forward would be the takeaway here. Obviously a fluid situation that albeit at times doesn’t feel or look like it.

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    1. There are a number of newly unsealed documents that make it unmistakably clear that Treasury entered into the net worth sweep because it knew Fannie and Freddie were about to begin reporting outsized profits, and believed that if they were allowed to retain the resulting capital it would weaken the case for winding them down and replacing them, which was Treasury’s objective.

      The new documents also reveal that in August 2008, BEFORE Fannie and Freddie were put into conservatorship, Blackrock wrote to FHFA saying that Freddie’s “long-term solvency does not appear to be endangered–we do not expect Freddie Mac to breach critical capital levels even in stress case.” This statement by a credible and knowledgeable third party (which had been a consultant to Freddie for years) calls into question the legitimacy and legality of FHFA’s decision to set up a reserve for Freddie and Fannie’s deferred tax assets in the third quarter of 2008 on the grounds that they would not be sufficiently profitable in the future, and it also explains why FHFA was so aggressive in boosting the companies’ loss reserves based on its own estimates of future losses, which turned out to be wildly inflated. And of course if Treasury and FHFA knew that Fannie and Freddie’s post-conservatorship losses were artificial, they also knew those non-cash losses would reverse at some point. Treasury’s public story about both the conservatorship and the net worth sweep is now publicly crumbling.

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      1. One of the things that toll the statute of limitations clock is information not being known. Now that the conservatorship, and critically the associated warrants, are publicly being shown to be based on fraud, are any of the existing plaintiffs likely to amend their complaints to include the warrants and the excessive interest rate? Is it more likely to file a new action targeting conservatorship as a whole? Is someone likely to join Washington Federal to help fund that action?

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      2. I remember there was a clause: if anything found illegal in original purchase agreement, Treasury can unwind everything (without punishment). It has prepared for legal defeat.

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    2. ROLG-

      For those of us who are not as versed in the law as you, how does this evidence (essentially proof that the NWS was done with full knowledge that it going to be more than the 10% (see page 19) affect the overall legal standing? Put differently, I would imagine it helps the Fairholme case tremendously, but how would it affect the Perry case? How can it be introduced as evidence in the Perry case on appeal (which usually does not allow for such)?

      Has there been any testimony by Treasury officials in any of the cases that would be “undone” by the new information?

      Thanks

      MDC

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      1. “Has there been any testimony by Treasury officials in any of the cases that would be “undone” by the new information?”

        I would also like to ask ROLG about testimonies that have previously been shut down due to privilege claims that have since been rolled back via Sweeny’s court.

        Are there now people who have claimed exec privilege in lieu of testimony who now have to testify? IF so who would that apply to?

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        1. @ Michael and anon

          As I recall the ugoletti affidavit was the only factual submission made by the government defendants at D.C. District court. And it was not truthful. It may have been to the best of ugoletti’s knowledge but it was a fraud perpetrated by govt lawyers on court. I say this because only the govt lawyers had access to their documents which were withheld on an insubstantial assertion of privilege. This memo by ms Miller is a prime example. You simply violate legal ethical principles if you have and withhold ms millers memo (whether or not they read it, they are charged with knowing its contents) and then you provide the court ugoletti’s affidavit as the sole factual submission. This is a clear fraud on the court by treasury.

          Now treasury will respond that since HERA provides fhfa can do anything as conservator facts are irrelevant to the case and to the final decision. That govt could have won this case with no factual submission.

          Except one thing: if you read the D.C. Circuit court opinion carefully it recites (improperly in my view) many factual claims that are favorable to govt. improperly because there was never a trial to conclude these claims were facts.

          Now I assume this Miller memo is not news to P counsel but only us. So I also assume that they have concluded that there is no avenue to reopen the perry case. But I do assume that P counsel will ask scotus to grant cert and I think P counsel should argue that not only were there errors of law made, but the whole case has been infected by govt fraud. Using the Miller memo as a prime example. This may only be color but I certainly hope Ps counsel use it.

          Litigation has been called a liars contest but I just think this goes beyond the pale.

          Rolg

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          1. One more thought. A sealing order specifies named individuals who have access to documents under seal. I assume atty gen sessions was not so named. Now with the seal lifted, if I may presume to state what I would do if I were chuck cooper (counsel to fairholme) I would call my good friend jeff sessions and scream bloody murder to him about the fraud that his attorneys have pulled off, albeit before his watch began. Might get some attention focused at senior levels of DOJ and Treasury

            Rolg

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          2. “Now I assume this Miller memo is not news to P counsel but only us.”

            Assuming it is part of the 3,500 documents that were provided to Fairholme that have been unsealed, I don’t think it would available to Perry’s lawyers. Let’s assume they did NOT have this information for a moment. Is there any way it could be used in the Perry case?

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          3. @michael

            Assuming perry counsel just recently read these docs as well, they could file a petition in front of lamberth arguing that there are questions of fact raised by Ps complaint that have not been properly tried, and Ds fraud in withholding relevant evidence and presenting only ugoletti’s false affidavit require that complete discovery should be performed. Ds will argue that based on circuit court opinion no set of facts could let Ps win. But I think there is room even under circuit court opinion for a district court to hold that govt cannot act in bad faith as a conservator, justifying an action with a death spiral rational that clearly the government did not believe

            Rolg

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          4. For example fhfa counsel has said repeatedly that fhfa had authority to adopt NWS because it reasonably believed this was the only way to “staunch the bleeding” of the death spiral. If fhfa/Treasury has withheld from the court that their own proffered justification is fraudulent and that the government never proceeded on this basis then the court may find government has abused its authority even given that this authority was broad.

            Rolg

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          5. ROLG-

            Do we know who made the comments in the memo that the NY Times posted? Is BR the initials for someone at Treasury? I assume the document that they provided as the “original document” is truly original. Unless BR is a reporter, those comments are problematic for Treasury.

            Aside from all the double speak and various projections, the NY Times left out an interesting quote on on page 30.

            In response to the notion that the 10% dividend was unstable as the businesses shrunk, there is a quote that says, “Doesn’t hold water. Their businesses won’t reduce in the short term”

            Who said that quote? If it is someone at Treasury, it basically says that everything in the memo that says they can’t make the 10% is not true.

            More broadly, they discuss a pending increase in the g-fee, but they did not include the benefit of expected increases to G-fees in their projections in 2011 at the time of the memo. That said, by the time of the NWS, the G-fee on new business had increased by 10 bps in 2012.

            Thanks again.

            Best regards,
            MDC

            Liked by 1 person

          7. ROLG,

            Pretty sure the panel did not place its imprimatur on the lame justification for the sweep, namely it was the only way to stop the bleeding. The judges understood payment in kind. It’s my recollection that two judges went so far to say that intent was irrelevant because Congress in their estimation, through HERA, gave unprecedented latitude to FHFA.

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  13. Michael Jones:

    American Banker recently ran an opinion piece written by a member of a large, mortgage industry trade association touting that trade association’s plan for reforming the government-sponsored enterprises as being good for small lenders. I am a senior executive of a small lender, and a member of the board of directors of a small-lender trade association.

    I can tell you from this small lender’s point of view that most of the various GSE reform proposals that have been offered, in very c l e v e r and d i s g u i s e d ways, are designed to advance the interests of the big-bank lenders and their Wall Street enablers, at the expense of companies like mine and the consumers whose mortgage needs we serve. It even places the American taxpayer at risk as will be explained later.

    So yes, GSE reform, if done the wrong way, would be bad for small lenders, our customers and even hardworking Americans otherwise not involved in the mortgage and real estate industry.

    Liked by 5 people

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    1. I wrote a very long, detailed post on how working at a Top 50/Top 25 aggregator a removal of the GSEs would create a waterfall effect impacting access to credit. However, clicking post comment made me log in and then deleted it…

      I am working on educating the C-Suites, Capital Markets, and Sales groups, on why they should check out the Moelis plan and revoke our membership in the MBA.

      I feel stupid asking this now since the post is not what it was before, but it would be excellent if Tim could meet with some of our executives as I believe we are local. (Delete this if that’s too much information, but the invite stands).

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  14. “Since returning to a positive cash flow in recent years, the terms of the conservatorship as amended have remained in place. Though funds swept to Treasury have been substantial, the amount falls substantially short of the taxpayers’ direct investment plus the waived interest obligations on that investment.”

    Huh?

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  15. house budget proposal for FY 2018

    “Privatize the Business of Government-Controlled Mortgage Giants Fannie Mae and Freddie Mac. In 2008, the federal government placed Fannie Mae and Freddie Mac in conservatorship to prevent them from going bankrupt. The Treasury has already provided $187 billion in bailouts to Fannie and Freddie, and taxpayers remain exposed to $5 trillion in Fannie Mae and Freddie Mac’s outstanding commitments, as long as the entities remain in conservatorship. Our budget recommends putting an end to corporate subsidies and taxpayer bailouts in housing finance. ”

    p.26 of https://budget.house.gov/wp-content/uploads/2017/07/Building-a-Better-America-PDF-1.pdf

    doesnt sound corkerish, though to tell you the truth it is hard to tell what exactly this means other than serving as a hensarling placeholder

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    1. I had a question for Tim. I was wondering about the comment, “Fannie and Freddie, and taxpayers remain exposed to $5 trillion in Fannie Mae and Freddie
      Mac’s outstanding commitments, …”
      How risky are these commitments? Doesn’t Fannie & Freddie have high standards for guaranteeing mortgages or for making other commitments?

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      1. At the moment, the main thing taxpayers are “exposed to” is the $15 billion per year they’re getting in payments swept from the earnings on “$5 trillion in Fannie Mae and Freddie Mac’s outstanding securities [not ‘commitments’].” Any risk to the taxpayer from the companies’ operations could be mitigated, if not eliminated entirely, by giving them new risk-based capital standards (as discussed in this post), ending the net worth sweep, allowing them to rebuild their capital, and releasing them from conservatorship.

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  16. the perry circuit court revised its opinion to delete language instructing the district court to measure Ps damages based upon their respective reasonable expectations at the respective times they bought shares, and basically told district judge to use the correct legal rule (without specifying what it is). i believe that Ps counsel accurately stated the rule in its briefing for rehearing, that the reasonable expectation of a shareholder, whenever he/she bought shares, is measured at time shares were issued, and all junior preferred stock was issued before NWS. circuit curt did not adopt this rule in revising its opinion but it at least did not erroneously preempt the district judge on remand from adopting it after briefing from parties on remand.

    bottom line, the $19B of claims for breach of contract for fannie alone are back in play

    Click to access 14-5243-1684471.pdf

    rolg

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    1. ROLG,
      Are just the plaintiffs in the Perry Appeal eligible for damages or is this a class action suit where all preferred shareholders are eligible for damages?

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          2. to be clear, to me this perry opinion reissuance is noteworthy more as a basis for the administration to take the litigation into account as another reason to pursue an administrative solution, and settle the litigation in connection therewith, than for the present value of any damage award that may arise from it. congress is ignoring the litigation. the administration would be more justified in pursuing an administrative solution that settles the litigation to the extent the litigation is more viable.

            Liked by 3 people

  17. Tim,

    Is there a number for the risk based capital standards that outsiders can come up with or would we have to wait first for Treasury and FHFA to determine that number based on the scenario they pick? Am I understanding that correctly? Are you saying its not as easy as just picking a number like for banks because all F and F do is one thing (insure mortgages)?

    Bill Ackman at this event said, “We believe the right amount of capital here, conservatively, is 250bp of capital (42:50)”

    I am assuming he was conservative at 2.5% because he doesn’t know the scenario they will choose either right? I believe he alluded to that somewhere in this video that it is “a calculable number”.

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    1. A true risk-based capital requirement for Fannie and Freddie (or any credit guarantor) is a calculable number, if you know all of the elements that combine to make it up. First the government would have to pick the stress scenario it requires a guarantor to be able to protect against. I believe that a 25 percent nationwide drop in home prices over a five-year period is a good choice; it’s very severe but not excessively so. Next, FHFA would need to determine the “risk buckets” it will use in setting capital requirements by category. At a minimum, these should be combinations of loan-to-value ratios and credit scores, for several different types of mortgage products (i.e., 30-year fixed, 15-year fixed, and adjustable). FHFA also will need to define the parameters for how the test is run, including whether it’s done assuming a liquidating book (with no replacement business) and how guaranty fees earned during the course of the test are treated. Then, FHFA would use Fannie and Freddie’s historical data to project the default rates, loss severities and mortgage prepayments–by product and risk category–that determine the amount of capital required for each category to pass the stress test. And even after you’ve done all that, you still will need to know the guarantor’s mix of business (again, by product and risk category) to come up with a single percentage capital requirement for the entire company, and this percentage will change as the product and risk mixes change.

      I’ve made my own estimate of all of these elements, based on Fannie’s loss experience during its worst credit loss years of 2008-2012–and adjusted for the fact that the two product types that caused half the company’s losses during that period, no-documentation loans and interest-only adjustable-rate mortgages, no longer are being acquired by the company–and have come up with an overall capital requirement, using Fannie’s current mix of business, of somewhat less than 2 percent. Bill Ackman’s description of a 2.5 percent capital requirement for Fannie and Freddie as “conservative” is consistent with this estimate.

      Liked by 5 people

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      1. @xxx

        Don’t get your assertion. Banks hold plenty of whole mortgage loans. If mbs risk weight=mortgage risk weight why shouldn’t banks that hold mortgage loans not be willing to hold mbs?

        Rolg

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  18. Hi Tim,

    Sorry if I missed your previous commentary on this and please point me in the right direction if so, but do you have any insights with regard to what actually happened to justify the conservatorship in the first place?

    The Twitter crowd always points to this: https://www.housingwire.com/ext/resources/images/A-Forensic-Look-at-the-Fannie-Mae-Bailout-Parts-I-II-III-FINAL-20150616.pdf

    And I find it hard to swallow the lines I keep reading from bulge bracket banks on this situation in their research wherein they never question that the GSEs needed a bailout (Of course why would they?) in the first place.

    I’ve just never been convinced that the bailout was needed.

    It seems like this part of the big lie is really coming back en vogue recently and there needs to be an expert analysis from someone like yourself that is publicly available so we can have honest conversations about what actually happened.

    Thanks in advance and apologies if this is a huge rehash for you.

    Liked by 2 people

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    1. If you want the full story on this, along with some background, I would suggest you read my book, “The Mortgage Wars.” If you just want the final chapter, covering what actually happened with Fannie and Freddie’s conservatorships, I suggest you read the amicus curiae brief I submitted for the Jacobs-Hindes case in Delaware, which can be found here: http://www.gselinks.com/Court_Filings/Jacobs_Hindes/15-00708-0026.pdf

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  19. Tim, this came out today; could you please comment on this part:

    “Meanwhile, on Friday morning Cowen & Co. released a report saying one factor driving a GSE bill is the “fear” that the Treasury Department and Watt will use the receivership authority under the Housing and Economic Recovery Act of 2008 to “administratively” reform the system. Cowen analyst Jaret Seiberg writes that the FHFA could “terminate the existing enterprises and turn their charters over to new entities…”

    is this possible? thanks
    Billy

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    1. I don’t have any insight into whether anyone in Congress might be considering legislative reform because of “fear” that FHFA’s receivership powers could be used for administrative reform, but I think the chance of that actually happening is almost zero. Receivership means liquidating the companies’ $4.5 trillion in MBS and $0.5 trillion of mortgages in portfolio. Even if it were possible to transfer the companies’ existing charters to new entities (I’m not a lawyer, but it would surprise me if that could be done), these new entities would have to be able to ramp up their new business as fast as Fannie and Freddie’s books were paying off or being liquidated, in order to avoid wrenching dislocations in the market. And since the new entities would have the same charters as Fannie and Freddie do now (which the big banks are insistent on having changed), what would be the point of going through that?

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    1. It will if Fannie and Freddie’s second quarter net income gets swept by Treasury. If second quarter profits are retained by the companies to begin the building of a capital buffer, by my calculation Freddie still will have paid Treasury back (in a scenario in which the net worth sweep is unwound) with its first quarter sweep payment, made on June 30, while Fannie has almost paid Treasury back (within about a billion dollars).

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    2. What can’t be overlooked is the fact that all these settlements undermine the failed business model narrative. Secondly, eventually there has to be an accounting of money paid back. Settlements have to be indexed to the GSE payments. After all, it wasn’t Tsy or the FHFA but the GSEs who got left holding the bag because of the loans issued by banks. Lastly, this is a timely reminder that banks were the problem in 2008, not the GSEs.

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  24. tim

    you and your readers may have an interest in reading this transcript of bruce berkowitz speaking on fairholme CC, GSE discussion pps 13-28:

    Click to access ConferenceCall20170629.pdf

    counsel at cooper & kirk referenced perry scotus petition for cert by end of year, presumably after petition for rehearing on preferred stock damages issue at Dc circuit is settled.

    rolg

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    1. I just finished reading this a short while ago and agree: it’s very informative, with Bruce Berkowitz speaking to the investment case (and the future prospects for the companies on the merits), and David Thompson giving his analysis of the pending legal cases. Both make strong arguments for outcomes most readers of this blog expect and support.

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    2. Equity guys do not understand fixed income markets. Do munis (adjusted for taxes) trade at Treasury levels? Not in the USA.

      And who are the largest buyer of MBS? The FED and the much despised banks. They have replaced the portfolio function once performed (rather poorly) by Fannie. Why shouldn’t banks get capital relief for taking on risk no one else wants?

      Besides at 60 BP GFees banks have no incentive to sell to Fannie. Alternatives will develop

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      1. @xxx

        you have it backwards. banks would get capital relief on fed guaranteed mbs not for taking on risk no one else wants to take, but for taking on no risk. now if you are suggesting banks should get cap relief for gse guaranteed mbs, that might make sense (especially if there if a fed equity line of credit as per moelis blueprint). as for portfolio function, not sure what you mean, but given that PLS mbs market is nil, banks aren’t creating mbs for anyone’s portfolio.

        rolg

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        1. @xxx

          gses require financing in order to provide financing. only fed can keystroke money.

          many credit investors happy to buy gse corp debt and gse guaranteed mbs at a rate. yes fed has distorted markets, but across credit and equity spectrum. i assume that credit buyers of gse debt and mbs match fund their purchased assets against liabilities they incur to finance themselves. such goes the wheel of finance.

          you are making little sense to me when you say gses dont provide funding for mortgages.

          rolg

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        2. @rolg

          Fannie does not fund mortgages. It is the buyers of MBS. And that is now the FED and banks

          Prior to 2008 Fannie was the biggest funder as it was the biggest buyer of MBS. Not anymore

          And no one can match fund an MBS. Not even the FED

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        3. I’m on travel this week and checking this blog much less often than I usually do. On reading through this thread, I decided to delete the rest of it because there were a number of things said that I thought were inaccurate or potentially misleading. I’d like this site to be a source of information, not confusion.

          I’m not sure of the point “xxx” is making. Yes, the Fed and the banks are the largest investors in MBS, but international capital markets investors still account for the majority. And you need to distinguish between interest rate risk and credit risk. Capital markets investors will not invest in MBS without a high-quality credit guaranty. Mutual funds and so-called “contractual” fixed income investors, such as life insurance companies or pension funds, look at interest rate risk differently from the banks: banks have to worry about their funding mismatch (the chance that their cost of funds will rise above the coupon on their fixed-rate mortgages), whereas for contractual investors and mutual funds the issue is prepayment risk: whether they feel they are getting enough in yield to compensate for the fact that MBS prepay when you don’t want them to (when rates fall) and don’t prepay when you do (when rates rise). It’s a very different calculus from banks’.

          The capital relief banks would get under the MBA plan is provided (at potential taxpayer expense) through an explicit government guaranty covering credit risk only, because government-guaranteed securities are given a zero risk weight in the Basle III capital requirements. And as noted in this post, those same Basel III capital requirements do not explicitly take into account interest rate risk, meaning banks can short-fund fixed-rate MBS and incur no capital penalty from doing so.

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          2. The Fed currently holds $1.77 trillion in agency residential MBS. Banks hold $1.51 trillion in residential MBS (and another $2.16 trillion in whole loans). I don’t know what your source is for overseas investors. And I also don’t know what point you think you’re making by citing these figures.

            Liked by 1 person

          3. Source is FDIC and US TREASURY

            The point is that Fannie no longer serves as a liquidity provider for borrowers.

            And your readers think that is good. As do Berkowitz Moelis et al

            Who will provide liquidity. Not foreign investors that is for sure

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          4. If you are equating “liquidity provider” with being a final investor in mortgages–i.e, being in the portfolio business– it is true that Fannie and Freddie do much less of that today than they did nine years ago, because Treasury made mandatory portfolio shrinkage a component of the Senior Preferred Stock Purchase Agreement. (The Fed has more than offset Fannie and Freddie’s portfolio shrinkage by going from zero to $1.77 trillion in its MBS holdings during that same time period.) What the companies are left with is the credit guaranty business. There, I contend that properly recapitalized, with a true risk-based capital standard, Fannie and Freddie would be able to guarantee MBS at a lower cost, and to a wider range of borrowers, than any alternative credit guaranty mechanism proposed to date. These Fannie and Freddie MBS would be purchased by capital markets investors of all types, not just foreign ones.

            Liked by 3 people

          5. @tim

            One of the agree to disagee

            Investors in MBS don’t even want to think of credit risk. In your model they need to determine if Fannie is adequately capitalized. And investors may disagree on that level

            And even if there was an explicit guarantee there still are not sufficient buyers willing to take the interest rate risk of MBS.

            Buying and managing the interest rate risk of MBS became the main role of FANNIE since 81

            Banks fulfill that role now

            Regardless, few banks will want to pay 60bp for protection against credit losses that rarely exceed 10 bp

            Fannie has priced themselves out of the market

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          6. I doubt we will agree on this, but for the benefit of other readers let me add two final points. First, the interest rate risk on MBS is no different from the interest rate risk on whole (or unsecuritized) mortgages, and $10 trillion of both have found their way into investors’ portfolios. Second, the 60 basis point target guaranty fee for Fannie and Freddie is based on capital percentages set by Ed DeMarco in 2012 (and not materially changed since) that had the explicit objectives of “encourag[ing] more private sector participation [and] reduc[ing] the Enterprises’ market share,” and are unnecessarily and unjustifiably high. That is why I continue to make such a big deal (including in this post) of having Treasury allow FHFA to implement a true risk-based capital requirement for the companies: it almost certainly will bring their target guaranty fees down, while providing investors as well as taxpayers with protection against a defined stress scenario, and enabling investors to make their own assessments of the quality of the companies’ credit guarantees.

            Liked by 2 people

      2. @xxx

        I believe there are lots of different types of buyers of MBS and not just banks. For example, pension funds, retail funds, sovereign nations etc. The list is pretty long so not sure why you may be suggesting that the banks are the only buyers of MBS securities.

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        1. Banks FED buy nearly 60% of all MBS

          FED wants out but there is no one there to replace them

          And if Berkowitz Moelis win, banks will also bail

          No guarantee no market

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        2. So, the implicit guarantee worked before with high credit quality on their securities so why wouldn’t it again? Banks wouldn’t bail. They have low cost funding from the fed reserve window, nice fdic insurance on their funding to invest favorably in MBS like they had before and do now. Doubt they go away. Where else will regulators allow them to place their money with their risk based capital?

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  25. I am guessing Tim will delete our posts but in the meantime it’s worth noting that the Treasury isn’t required to exercise their 79% of the warrants. Let’s say they exercise 50% of their warrants for roughly 40% of the companies then less is more meaning less dilution in a capital raise and a higher net price as a result leaving the government with the same net dollar amount by exercising less. Just a possible and plausible scenario

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  26. Hi Tim,

    I don’t know if you have discussed this before, but in the MBA white paper, it states that:

    “Treasury also may ultimately exercise its warrant for common equity and sell its common and senior preferred equity interests in the GSEs to private investors, choosing the time and manner to the benefit of taxpayers and the future stability of the housing finance system. ”

    I was under the impression that only the Moelis plan allowed treasury to profit from the sale of its equity interests in the GSEs. Under this paragraph, who are the “private investors”? I assume its not retail investors.

    How would this sale of equity interests not be a “win” for the American taxpayer in the same vein that it would be under the Moelis plan?

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    1. It is absurd to sell the warrants and preferred stock. The preferred is entitled to all profits. Leaves warrants valueless. Does MBA contemplate first voiding the NWS in order to create value for warrants. Clearly MBA hasn’t thought this through because it has no interest in promoting the taxpayers’ interest.

      Rolg

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    2. That’s a “throwaway” sentence from the MBA, and I have no idea how to make sense of it.

      The senior preferred stock owned by Treasury currently gives it the right to all of Fannie and Freddie’s earnings in perpetuity (along with a $189 billion liquidation preference in the companies, that can’t be reduced without Treasury’s permission). Assuming Treasury can find “private investors” willing to take the litigation risk associated with the senior preferred, those investors would obtain this claim to all of Fannie and Freddie’s earnings, but the companies still would have no capital, and no way to raise any. What does that accomplish?

      The MBA also insists that there be new credit guarantors, in addition to Fannie and Freddie. If Treasury converts its warrants, Fannie and Freddie would have to issue 7.2 billion shares of common stock to Treasury (which over time would sell those shares to other investors, keeping the proceeds for the government) before they could issue any shares to the public that raise new capital for themselves. De novo credit guarantors would have no such handicap; they would bring in capital with every new share of stock they issued. If investors can own an undiluted share of earnings in a de novo credit guarantor by buying a new issue of its common stock, why would they have any interest in buying new shares of Fannie and Freddie, who, because of the warrants, would have to cut 7.2 billion more shareholders in on any earnings they’re able to generate?

      For the Moelis plan to work, the value of Fannie and Freddie’s federal charters has to be preserved by allowing them to continue to be the only credit guarantors in the system, and Treasury has to be committed to reforming and capitalizing them in a way that allows them be successful. The 7.2 billion shares of Fannie and Freddie common stock from conversion of the warrants can be viewed as the government’s price for agreeing to do that. If, on the other hand, the goal is to have Fannie and Freddie be just two among many credit guarantors, issuing MBS off a common securitization platform they built and gave to a third party, then the government won’t be able to make money off the warrants (or the senior preferred). It can’t have both; it will have to choose which it wants.

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      1. Tim

        I agree with this but would note that as a “compromise” (which I sense will be required in some fashion) treasury could agree to a process whereby once it has fully monetized and sold off its warrant position then some sort of additional monoline guarantor program could be pursued (lending out GSE infrastructure perhaps but only for a fmv fee)

        Rolg

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        1. I was attempting to draw a distinction between a legislative alternative–which would permit changed charters for Fannie and Freddie, similar charters for potential new credit guarantors, an explicit government guaranty and other features–and an administrative alternative, where Treasury would have to work with the two companies that already exist (and their charters). In the latter case the warrants would have value–and I believe Treasury would make choices to maximize the value of those warrants that also would benefit the companies’ shareholders and homebuyers–whereas with a legislative alternative the warrants would not have value. If after undertaking administrative reform of the companies, and selling the stock obtained after exercise of the warrants, Treasury were to decide to advocate for legislation opening up Fannie and Freddie’s business to new entrants it certainly could, although there would be a “pull the ladder up Jack” aspect to that which wouldn’t sit well with investors who had just participated in Fannie and Freddie’s Treasury-approved recap.

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          1. Why is everyone assuming that Washington Federal with its complaint against the warrants will lose or settle for nothing more than what the other plaintiffs are asking for? My understanding is that _all_ of the suits need to be settled, including Washington Federal, as part of either an administrative or legislative solution.

            On 04/06/2017 Karl P. Barth, lawyer at Hagens Berman Sobol Shapiro LLP for Washington Federal Plaintiffs gained access to the protected information. My assumption is that they would amend their complaint once Sweeney’s court is done with discovery.

            Liked by 2 people

          2. If Washington Federal does not want to settle it will have to be prepared to carry its lawsuit to conclusion. I’ve been told that lead counsel for Washington Fed has neither the inclination nor the resources to do that, but it’s possible that’s not correct.

            Liked by 1 person

          3. That makes sense for today. However, Fairholme and others are currently fighting for 20% of the going concern worth of FnF. While the Washington Federal plaintiff may not be well funded, or particularly motivated while the NWS is being challenged, that would change if the NWS was struck down. I’d contribute funding to Washington Federal in an effort to gain control of the other 80% of value and I assume other investors would also. On the other hand, if the NWS were to be upheld at SCOTUS, litigating Washington Federal would probably be a waste of time. It makes sense to idle Washington Federal. I doesn’t make sense to me to assume that the warrants will necessarily be executed without challenge.

            Does anyone see any error with this line of thought?

            Liked by 2 people

          4. @wheed

            hagens is an excellent law firm, but they are class action lawyers. here, they rep only wash fed. even if wash fed has damages of $50MM, that is at least one zero away from the kind of cases they bring on contingency. hagens is not in the business of litigating contingency cases over years on cases that promise this level of payout.

            rolg

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          5. Te legislative approach has a potential legal problem. Congress gave FnF a charter, and FnF sold shares based on the charter. Now if Congress takes away or changes significantly the charter, FnF become much less valuable. This can be a taking. ROLG?

            Liked by 1 person

          6. @peter

            yes. fhfa is already being sued for a taking with net worth sweep so congress would be thinking fine, let shareholders sue for two takings.

            as a side note, i visited an old friend who is a house member. while he said all real work is done by staff, congress folk have to get involved at some point to green light staff work. while he wouldnt hazard a guess re senate banking committee, he did give me impression that less gets done than you think usually during summer, and what gets done is stuff that is really bumping into a deadline.

            rolg

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  27. Tim,

    Jerome Powell of the Federal Reserve spoke today on housing reform & it sounded a lot like MBA’s David Stevens & Bob Corker brainwashing – insuring MBS securities rather than the GSE entities, creating more competition to use the CSP’s, etc. As others have stated, your voice / interaction with Treasury, Congress, and others remains critical to balance out the TBTF banks influence in this debate: https://www.federalreserve.gov/newsevents/speech/powell20170706a.htm

    Sean

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    1. Tim

      Additionally, do you remain optimistic that the appropriate balance of viewpoints are being heard by the Treasury and members of Congress as the debate heats up the second half of 2017?

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      1. The MBA plan is what the big banks want, and Jay Powell’s speech to AEI makes clear that he currently supports that plan.

        The big banks want multiple credit guarantors, with high fixed capital requirements unrelated to the risks of the loans they finance, using a common securitization platform to issue securities carrying an explicit government guaranty, because that gives them the economic “superfecta” I described in an answer to a comment below. No arguments coming from me or anyone else will change the degree of effort they put into seeking that result. It’s not about the merits of arguments, or what’s best for consumers and the economy; it’s about market power and money.

        Banks and their supporters are going to make a very strong push for legislation, but as I discussed in the post previous to this one (“The Path Forward”), I don’t believe they’ll be successful–not because anybody convinces them that they’re wrong in trying to get what they want, but because it’s politically too complex for them to pull off. The right arguments made to the right people at the right time may contribute to that result, but it’s not a matter of “give your opponents the right arguments and they’ll do the right thing.” There are a very large number of powerful people with an interest in giving the banks what they want who either know the facts and are acting in spite of them, or who wouldn’t be swayed by the facts if they knew them.

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        1. Tim

          While understanding that is where we are it seems you take the position that Congress will not agree legislatively so that while the debate is skewed in favor of the big banks you are optimistic towards an ultimate solution administratively.

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          1. we are in a twilight zone, or a waiting room if you prefer.

            there is activity in the courts, with the briefing in hindes/jacobs scheduled to be finished in a week. there are promising cases asserting constitutional claims in bhatti and rop, but they are just at the complaint stage. there is even a chance that scotus might grant cert in pizel (which might be of tangential benefit). but this activity is not headline news and nothing will happen quickly.

            there is noise coming out of senate banking committee, but no bill yet, no committee vote, no senate approval (needing 60 votes unless somehow tucked into a tax/budget reconciliation bill) and no house take up of that senate-passed law. dems and repubs have a divide, and it seems so does house and senate.

            we honestly dont know if mnuchin is just letting the political process play out for political advantage, on the belief that any administrative action will be viewed more kindly after a failure of congressional action rather than as a perceived preemption of congressional action…or whether he has just punted on what he once described as a priority.

            i suppose our next tell is in mid august when gses report on 2q; in addition to 2q profits, before then rbs may have paid fhfa about $5B, which would also needs to find a resting spot.

            until then not much to do but have patience.

            rolg

            Liked by 3 people

        3. Hi Tim, I began reading your book, Mortgage Wars, yesterday and I am 4 chapters in. I have a strong biology and food science and processing background so I appreciate that it is written simply enough for the average person to understand if they go out of their way to familiarize themselves with a few terms. Anyway, I like that you go over the history of Fannie Mae from its inception discussing key motions and players along the way. I get the clear impression that Fannie Mae has always had a very active opposition from the banks, as well as from many key players in the legislative branch, Fed, and Treasury, who were willing to entertain and spread misinformation in the same way that we see today. Despite this opposition Fannie Mae persevered, even through very tough years.

          Today Fannie Mae stands as a very profitable giant in the market, and fights strong opposition as well as another misinformation campaign. So I have to ask, how different/similar does this “mortgage war” feel from the last? Many of us here see all these housing reform speaking forums and all the unbalanced opposition present there, as well as opposition from the Treasury now, as well as support from Corker and friends in legislature, as well as a very vague administration continuing to participate in the NWS, which makes many feel disheartened at any prospects for economically and legally sound housing reform. Despite all of this opposition from all these big players, you anticipate that the opposition will not be successful and that their plan is too complex to enact. Is this political environment familiar to you? Is this why you claim that it is too politically complex to enact?

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          1. It’s still the same “Mortgage Wars,” except that Fannie and Freddie are no longer fighting, and their supporters have pretty much scattered. Opponents of the companies, and supporters of banks, scored a big win in 2008 when Treasury forced Fannie and Freddie into conservatorship without statutory authority, then burdened them with confiscatory Senior Preferred Stock Purchase Agreements. And they got another win–for now, at least–with the third amendment to the SPSPAs in August 2012, taking all of the companies’ earnings in perpetuity. But killing Fannie and Freddie off completely has proven to be much more difficult. Supporters of banks have for nine years been unable to devise replacements for them that legislators are willing to take the risk of going forward on, and the companies’ adversaries now have serious complications brought on by plaintiffs in the lawsuits filed pursuant to the third amendment. These lawsuits, plus the unworkability of proposals like Corker-Warner, Johnson-Crapo and those from the Urban Institute and Milken Institute, made administrative reform of the existing companies seem a more realistic alternative.

            The banks, however, don’t want that, so they’ve come back with a variation of their earlier “wind down and replace” schemes: they’ve accepted that Fannie and Freddie should be preserved in some form, but they want the companies to be sufficiently changed– with capital unrelated to risk, competition from ‘de novo’ guarantors, regulated returns, and other constraints–so that their operations pose no real competitive threat to banks’ activities in the primary market. But they still have to get a divided and fractured Congress to agree to replace a secondary market system that works well–and could be made better with sensible administrative reform–with one deliberately designed to work less well, and which would entail significant transition risk. My bet is that with everything else bedeviling the current Congress, this will be too big an “ask,” and won’t get done– and that before too much time has gone by (no, I don’t have a precise estimate) we’ll be back looking at administrative alternatives.

            Liked by 4 people

          2. tim

            isn’t it true that the moelis blueprint is the only plan that specifically addresses treasury’s financial gain from implementation of plan; moelis shows that treasury should get $75-$100B by end of 4 year recapitalization period. seems to me that all of the other plans do not address this. if gses are to wither on vine if not be wound down under these other reform plans, what is treasury’s financial incentive?

            all best

            rolg

            Liked by 1 person

          3. Yes, and I believe any other realistic administrative reform plan also would yield significant benefits to Treasury from conversion of the warrants. That’s a primary reason I think that at some point “we’ll be back looking at administrative solutions.” The MBA’s plan would leave Treasury with no sweep proceeds and no gains from warrant conversion, and also exposed to likely claims from the outstanding lawsuits. An essential component of administrative reform would be the settlement of those suits, and because of the warrants Treasury would have a financial incentive to reform and recapitalize Fannie and Freddie in a way that enables them to be as successful as possible (increasing the warrants’ value), which would benefit homebuyers and the financial system as well.

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          4. Amen and amen, Tim. These posts are getting better all the time.

            ROLG,

            In other words, Corker and those like him would rather keep the treasury from collecting filthy lucre, not because these lawmakers have integrity but because they’re in bed with the TBTF banks and, therefore, want the GSEs to be expunged. One lust restrains another. The unquenchable desire to favor the banks tempers any desire to exercise the warrants on behalf of the treasury, for the latter presupposes GSE survival. How twisted is that?

            Liked by 1 person

          6. ROLG, in Senator Johnson’s last hearing, he told Watt to talk with Treasury to end sweep. I sat there in the hearing.

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        4. I’ll add one historic addendum to Tim’s response.

          When Fed Governor Jerome “Jay” Powell, as he likes to be called, was a Treasury official in the George H.W. Bush admin, Fannie lobbied him, extensively, and found him basically anti-GSE, which likely hasn’t changed as his comments suggest.

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          1. Bill, hope you can post something on your blog like Dem leadership’s plan. Everyone except Warner is quiet on the topic. Senator made a 180 degree turn by asking Watt to talk with Treasury about NWS.

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  28. Tim

    Followers on your blog will recall that at one point you mentioned the possibility of meeting with Secretary Mnuchin. Have you had that meeting yet or do you still plan to in the near future?

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    1. I normally don’t report on private meetings, but since this one was mentioned by Stevens in a (now-deleted) post, I’ll make an exception for it.

      My primary interest in having the meeting was to learn what Stevens’, or the MBA’s, objections to the Moelis plan were. (That was the issue that led to his posting on my blog.) Stevens did not offer criticism of any specific aspect of the plan; his objection instead is that the Moelis plan does not do what the MBA plan does, so he opposes it. Most of our discussion involved Stevens giving me his rationale for the features of the MBA plan that require legislation– principally the explicit government guaranty on securities issued by the envisioned rechartered guarantors. He was surprised to learn that I do not favor, and never have favored, an explicit guaranty, so we talked about that for a while. Neither of us seemed to have changed our views on the subject as a result of that discussion.

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        1. We agree on the general objectives of reform, but disagree on how best to meet them. David seems adamant that even if you recapitalize Fannie and Freddie to meet a government-set standard of stress the companies should not be preserved with their current charters. I find his reasons for taking that position to be weak and unpersuasive. And, as noted above, I also think an explicit government guaranty is a mistake: it’s unnecessary if a credit guarantor is properly capitalized (and uses private reinsurance for catastrophic risk); it’s odd, at best, to claim that an explicit government guaranty somehow “protects the taxpayer,” and–although some housing advocates may disagree with this– I think an explicit government guaranty on qualified mortgages puts too heavy a “thumb on the scale” in the allocation of capital, threatening an over-investment in housing to the disadvantage of (virtually all) other sectors that don’t benefit from that guaranty.

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        1. There’s really no mystery here. The large banks insist that Fannie and Freddie, or their successors, hold large amounts of capital unrelated to the risks of the mortgages they are guaranteeing, claiming that this excess amount of capital is necessary to protect the taxpayer from the risk of the government having to pay on the guaranty they want attached to the mortgage-backed securities issued by credit guarantors in the future.

          What the banks DON’T tell you is that they would get a “superfecta” from this. The excessive amounts of capital would push up guaranty fees on 30-year fixed mortgages, which homebuyers pay for. With high levels of capital applied to all guaranteed mortgages irrespective of risk, bank originators (as discussed in the current post) would keep the high-quality, low-risk mortgages they originate for themselves, and swap their higher risk originations as MBS. They then would buy the higher-risk loans back as government-guaranteed MBS, and fund them–at very attractive spreads, due to the higher mortgage rates–with short-term federally insured deposits and purchased funds. They won’t pay market rates on their deposits because of FDIC insurance; they won’t have to hold any capital against the higher-risk mortgages backing their government-guaranteed MBS because Basel III gives these MBS a zero risk weight; holding only low-risk loans as unsecuritized mortgages (saving themselves the inflated guaranty fee) will keep their credit losses down, and they won’t have to hold any capital to offset the risk of funding all of their 30-year fixed mortgages–both securitized and unsecuritized–with short-term deposits and purchased funds because Basel III doesn’t require them to hold any capital linked to interest rate risk-taking. What could be better–for them? Not such a great deal for homebuyers, or taxpayers, or the financial system, or the economy, however.

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          1. Tim

            Thanks for reportage and explanations. I find it so absurd that corker etc rail against federal bailouts and then contemplate a federal mbs-level guarantee. It recalls the emperor with no clothes.

            Re your aversion to explicit to explicit federal equity guarantee I note that moelis referred to a transition to private reinsurance once capital levels are restored. This sounds sensible to promote the transition out of conservatorship no?

            Enjoy our nation’s birthday

            Rolg

            Liked by 1 person

          2. So the plan is to balkanize the GSEs, have TBTF banks subsume the balkanized parts and then obtain the explicitly guaranteed ‘superfecta.’ What could possibly go wrong?

            My question is what if inertia rules (and let’s assume the court cases go nowhere) and the never-ending conservatorship just settles in? It seems the only threat really is Fannie and/or Freddie needing a draw, but maybe Corker is right and the markets will shrug it off. The real risk, it seems to me, is that because of the de facto nationalization, Uncle Sam essentially now holds title to an awful lot of houses. If we were to experience another downturn a la 08/09, what type of political football does this become, and how do we attempt to forecast the domino effects for housing finance?

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          3. That is obviously a hypothetical, but I would say that if the government’s claim that it can keep Fannie and Freddie in a “non-conserving conservatorship” indefinitely prevails legally, then the companies would be nationalized not just de facto but also de jure: they would be owned by the government–with the government getting the profits in good times and having to bear any losses in bad times–with no way of escaping that status absent government action. In that case I don’t know what the argument would be for not adding Fannie and Freddie’s $5 trillion of liabilities to the national debt. This prospect, however, very likely would not sit well with either the administration or Congress, giving renewed impetus to efforts to truly “get them out of government control,” whether through administrative or legislative reform.

            Liked by 1 person

  30. Tim – Now that we know that Mel isn’t dancing alone (at least this quarter) to retain any capital before it goes to $0 in 2018, where do we go from here now that there is basically no chance a draw won’t be prevented and there likely won’t be enough time to raise enough capital to prevent it when the losses occur?

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    1. I have edited the above comment for length, and this also seems like a good time to remind readers that this site was created to be a source of information and analysis about issues related to U.S. mortgage finance. It is not a message board, or a venue for a general “airing of views.” To keep the site interesting and relevant to its intended readership, personal opinions about developments in the reform debate, or Fannie and Freddie, need to contain some insight or perspective that is of interest (in my judgment) to informed observers. Comments that are don’t meet that standard—which becomes higher for those who post frequently—will be deleted. As I’ve said earlier, this policy isn’t meant as a criticism of posters; it’s been adopted to make the site more valuable to its target audience.

      On Watt, I was disappointed to see that he did not follow through on his announced intent to allow Fannie and Freddie to suspend their net worth sweep payments in order to allow the companies to build a capital buffer against accounting-related earnings volatility. He had said publicly that it was important for Fannie and Freddie to have such a buffer, and as director of FHFA he has the power to create one, but we now know that in the face of Secretary Mnuchin’s saying he “expect(s) the dividends to be paid” Watt chose to go ahead and pay them.

      It has been over five months since Treasury and FHFA came under the control of the Trump administration, and to date there have been no visible signs that any of the policies of either agency toward Fannie and Freddie have changed from what they were under the Obama administration, which was openly hostile to the companies. While it’s still too early to draw any firm conclusions from this, I have to say it’s not what I was expecting.

      FHFA has done exactly what Treasury has asked it to do since Hank Paulson told the agency’s predecessor, OFHEO director James Lockhart, to put the companies into conservatorship in 2008. Watt’s decision on the capital buffer shows a continued unwillingness on FHFA’s part to act without Treasury’s approval. But it’s not clear what Mnuchin ultimately wants. The view I expressed in “The Path Forward” was that his hands on administrative reform had been tied by the appellate decision in the Perry Capital case, and that he would wait to see what if anything Congress came up with before giving any indication of what he would like to do with Fannie and Freddie. That’s still my view, although I can understand how some might think that the career people at Treasury are having success in winning Mnuchin over to “the dark side.” We’ll just have to wait for further indications to see what’s actually happening there.

      On the subject of future draws, I would not completely rule out the possibility that Watt backed off on his request for a buffer this quarter because he learned (from the companies) that neither will have a second quarter loss. The most likely source of a book accounting loss would be a write-down in the value of the interest rate swap book due to a fall in interest rates. But ten-year Treasuries were down only 10 basis points from the end of March to the end of June, and that shouldn’t be sufficient to trigger derivative losses big enough to offset the companies’ core earnings from their credit guaranty and portfolio businesses.

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      1. the dividend you speak of being paid was announced before watt spoke.

        the real question is will additional dividends get announced with q2 earnings coming out in the next 30-40 day time frame

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        1. Glen: What is your source for saying that the first quarter dividend had been “announced” before Watt made his statement about the companies retaining capital? I’m not aware of any such announcement.

          Both Freddie and Freddie made noticeable changes to the way they referred to their planned quarterly sweep payments in their full year 2016 earnings press releases, put out in mid-February of this year. Freddie for the first time referred to its payment as “scheduled,” a modifier it had not used before. Fannie had previously referred to its upcoming sweep payments as “expected,” but in its full year 2016 “Treasury Draws and Dividend Payments” table it no longer included the upcoming quarterly payment in its cumulative total of dividends paid, nor showed that payment in its bar graph, as it always had done before. These changes made in the 2016 releases stayed the same in the releases for the first quarter of 2017, put out in early May. I read that as the companies (and FHFA, who has to approve the wording of the releases) leaving the door open to not making the sweep payments on June 30, and read nothing elsewhere to the contrary. Did I miss something?

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          1. If (big if) mnuchin is tracking pro forma payback as per original deal then it makes sense for 1q div to get paid. Especially if one wants to give congress some time and deference. And as you say especially if 2q is profitable. RBS reported to be close to a Fnma put back settlement that would get Fnma paid back.
            Rolg

            Liked by 1 person

          2. I was looking at this a little differently. Whether in a judicial ruling that the net worth sweep is illegal, any likely settlement of the lawsuits, or implementation of the Moelis plan, Fannie and Freddie’s net worth sweep payments in any quarter that were in excess of the 10 percent dividend would be re-characterized as paydowns in the outstanding senior preferred stock. By that method, payment of the second quarter dividend eliminates Freddie’s senior preferred stock entirely, and comes close to eliminating Fannie’s. So from this point forward–given the payment of the second quarter dividend–any future unwinding of the sweep, for at least two of the three reasons mentioned, will involve Treasury writing a check (for now just to Freddie, soon to both companies). I thought Treasury would have preferred to avoid the more difficult optics of having to do that, which it could have by allowing FHFA to permit the companies to begin building a capital buffer against earnings volatility. That’s the main reason I was expecting the companies not to make this quarter’s payment, but obviously I got that wrong.

            Liked by 1 person

      2. Tim, doesn’t Moelis plan include conversion of any outstanding PSPA into common equity after considering a 10% original pre-sweep dividend arrangement that takes into account surplus payments as preferred stock pay down?
        If that is the case, doesn’t this quarter’s dividend payment reduce the PSPA conversion by a significant amount, if not eliminating that conversion outright? Thus it is less dilutive to common shareholders and increases the common value… On the other hand, given that there is almost no equity at the companies is it even possible that the GSE’s avoid a draw when tax reform gets inacted?

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        1. Had the second quarter sweep dividends been retained by the companies they would have had the capital, and in implementing the Moelis plan could have used it to pay off any remaining senior preferred stock owed to Treasury. As I mentioned in my response to ROLG above, remittance of the sweep payments last quarter pays off Freddie’s senior preferred and comes close to paying off Fannie’s. I personally believe that if Treasury implements something like the Moelis plan it will eliminate the senior preferred but not write either company a check for any overpayments. That means a portion of Freddie’s second quarter sweep payments–and future quarterly payments by both companies–will simply be lost as capital given the decision by Watt not to go ahead and allow them to build capital buffers.

          Draws related to the impact of tax reform on the value of the companies’ deferred tax assets (DTAs) are a different matter, but here too the sooner Fannie and Freddie are allowed to retain capital the better their chances are of being able to absorb declines in the value of those DTAs without having to take a draw.

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      3. Tim,

        Maybe I can offer you a different point of view of why I believe the June 30 dividend payments were never on the table for discussion to begin with, and Watt was speaking specifically about future dividends during his Senate hearing.

        My hunch is that since the Q1 div was already “scheduled” / “expected” to be made at the time of Watt’s Senate hearing, all parties involved (FHFA / UST / Corker) were expecting it to be paid (on June 30) and off the table for discussion. During Mnuchin’s most recent Senate testimony, Corker specifically mentions that there are 75 days to settle the differences he has with Watt over future dividends. So it appears that they are focusing their attention onto the Q2 div, which should be announced during the 1st week of August when Fannie/Freddie are expected to release their earnings (75 days after the exchange between Mnuchin/Corker). If they were discussing the June 30 scheduled payment, Corker would have said 45 days and not 75.

        All the reasons that Watt mentioned as rationale to begin allowing the companies to build up sufficient capital remain in place today, so I see no reason why his view should have changed so dramatically in such a short period of time. All-in-all I would be disappointed and surprised to see the NWS in its current form past Q2.

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        1. Your explanation is completely plausible, and I hope it’s correct. I’ve been focused on the evident change in the way both companies began talking about their impending sweep payments in their full year 2016 earnings press releases in February (doing so again in May), but I can see how, after Corker said he and Watt had 75 days to work out their differences, Watt might not have wanted to antagonize Corker by moving before that time was up. We’ll now need to wait five to six weeks to see if there is any indication in the companies’ second quarter earnings releases as to what will happen next.

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  32. Nothing on that list.

    The only other thing really asked for by anyone of significance, to use that term loosely, is “competition” where Dave Stevens and the MBA (i.e. Wells Fargo) want Fannie and Freddie to give up for free the assets (infrastructure, IP, other stuff) with which new entrants (owned by the banks and Dave’s buddies) can compete with F/F. Good luck with that, Dave. Competition in the secondary market was never a problem, and it’s not a problem now.

    The traditional antitrust complaint about a duopoly — technically, F/F are a duopsony as they are the only two buyers of residential mortgage loans, of course putting aside the options of banks holding originated loans on their balance sheet and the long-dormant PLS market — is that they raise prices too high. The problem here is that pre-conservatorship F/F never kept g-fees (the prices here) too high, they kept them too low and that is why they never built up capital and got in trouble. This is yet another false meme propogated by the big banks, who colluded with the Obama Administration who wanted the money for Congressionally-UNappropriated (illegal) spending, to use their political muscle and political bullshit to move into and take over the secondary mortgage market having dominated the primary market. The Empire Strikes Back.

    As for why the small banks want a government backstop on securities rather than on entities, it’s got to be regulatory capital arbitrage (see Rosner piece in The Hill last Friday) and resulting capital gains. Capital at F/F will protect them from credit losses on F/F MBS just like a government “promise to pay at the end of the day” will.

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  34. Nothing we can do. But, honestly, prior to 10 or so months ago all we saw was garbage like that. I’d say it’s a win that they’re relatively few and far between.

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  35. Ignore. Paper doesn’t resist ink, unfortunately not the ink of liars and plain old ignoramuses. At any rate, so ludicrous and uninformed it can have no affect other than to make the broader more “moderate” nay sayer camp look foolish. So what if they’re lumped together?

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  36. DeMarco:

    “The government-protected GSE duopoly should be replaced with a structure that serves consumers by promoting competition, affordability, transparency, innovation, market efficiency, and broad consumer access to a range of mortgage products.”

    ++++++++++++++++++
    WHY?

    Do GSEs serve consumers badly?
    No affordability?
    Little transparency?
    Poor market efficiency?
    Restrict consumer access?

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  39. Fwiw mortgage professionals do not want Fannie and Freddie changed.

    From inside mortgage finance:

    Poll: Industry Wants Fannie and Freddie Preserved with ‘Existing Operations’

    By Paul Muolo
    pmuolo@imfpubs.com

    Almost 60 percent of mortgage professionals want Fannie Mae and Freddie Mac preserved with their existing operations remaining intact, according to poll results compiled by Inside Mortgage Finance and IMFnews.
    Just 18 percent of respondents said they do not want the GSEs preserved in their current state while another 23 percent expressed the opinion they don’t expect to see any type of GSE reform in their lifetime.
    Although the poll is light on details, it suggests that an overwhelming majority of the industry supports the current model and does not want meaningful change. Fannie and Freddie have been profitable for several years now, but most of their earnings are upstreamed to the U.S. Treasury, which owns their senior preferred stock.
    On Thursday, the Senate Banking Committee will hold its first hearing of the summer on the topic of GSE reform. Scheduled to testify are Mortgage Bankers Association President Dave Stevens, former Federal Housing Finance Agency Acting Director Ed DeMarco and Michael Calhoun, president of the Center for Responsible Lending.

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    1. I used to work for a company who helps clients sell mortgage loans to Fannie. If Fannie is abolished or some like change, the company’s software has to be developed from ground up. It would take many people and many years. A complete disaster to benefit no one.

      60% prefer no change? I think 90%. Do not under estimate power of the SILENT majority.

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  40. Tim

    Bbg reporting that senators warner and corker are considering breaking Fannie and Freddie into smaller firms along lines of business and geography. See https://www.bloomberg.com/news/articles/2017-06-27/senators-said-to-consider-breaking-fannie-freddie-into-pieces-j4fa7uex

    This would espouse a small multiple player competition model as opposed to a large player utility model. Seems to me to be highly adverse to primary mortgage market and increases risk to taxpayer.

    This seems to go beyond the MBA proposal which also sought more players. I would be curious to hear your thoughts. My own thought is that this would be a logical nightmare and would occasion more litigation.

    Rolg

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    1. Thinking through the logistics of this break up, imo it could only possibly work after the companies were recapitalized and out of conservatorship. If done before this, private capital would look at this plan as presenting far too much uncertainty and risk along every possible investment analytic issue you can examine…unless the spin companies are simply captive insurers of #tbtfs

      Rolg

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      1. My reaction is, “What is the problem for which breaking up Fannie and Freddie is the solution?” The fact that Corker and Warner are talking about doing it along “lines of business and geography” shows how much they’re just throwing out ideas. The companies have one line of business, residential mortgages, with two subcategories– single- and multi-family, which are pretty much independent within the companies now and wouldn’t be much different if broken up, except you’d need to staff all of the administrative and many of the operational functions separately, with more people. And breaking the business up geographically is just loony: you’d get less portfolio diversification, and more risk.

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        1. Tim

          Isn’t that the set up they would long for though? Meaning make the business model less efficient and set them up for more risks and failures to make the alternatives look better? A loony plan could be exactly what they are wanting.

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          1. I don’t think so. The plan of the opponents of Fannie and Freddie to make them inefficient is to have them hold a fixed amount of capital that’s far greater than is warranted by underlying credit risks of the loans they guarantee; having geographical compartmentalization just makes them riskier, to no one’s benefit.

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    3. All these bills are making these Senators lose credibility. For years, they have put forward this or that, with the common theme being to kill FnF. Nothing less than their complete destruction. Especially with Corker saying to short, they have zero respect left. They preach increasing competition, yet not once have entertained the idea of keeping FnF alive while doing so. You would imagine that there would be some sort of way of increasing competition while keeping FnF alive, and they would have gravitated in that direction by now. Hopefully it prompts Mnuchin to see that nothing good is going to get through with Congress.

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      1. That’s because most public officials are incredibly shallow–and still retain dated and false GSE comprehension–and while they insist they do grasp details, there are less than a handful–if that–among US Senators who can comprehend what Mr. Howard wrote in this blog about capital

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        1. You must be joking to assume there’s a single, solitary Senator that can assimilate Tim’s latest post in any sort of practical, Real-World application. Ample proof being nary a Senator, Association, Group etc has ever broached even a single post. He’s like The Mountain from GOT awaiting an adversary in the pit, to no avail. Yet many Senators love dancing around the stadium declaring how they see weakness from above, and from safety. (Corker’s exchange with Watt, one simple example)

          What am I missing? Unless they can produce and defend a soup to nuts proposal that doesn’t merely mimic what currently exists, how can they and anyone else expect to take them or whatever malarkey they propose seriously? Also making it more palatable for TS to act unilaterally given the sheer absurdity of breaking up entities that are already, supposedly dead. Yet they’re talking about a Bill to dismember a corpse. Ok, cool, so if they’re coming from a position of such strength then why don’t they step into the pit with Tim?

          Easy to question the direction of a driverless carriage. Particularly so for non passengers.

          GL folks,

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    1. I hope Mr. Howard can straighten me out to some degree but at the same time take all my points into consideration. I am using the value of $20 per share if all warrants exercised “8,871,231,469 shares” both FnF’s and $100 per share now warrants “1,808,135,000 shares” both FnF’s. Granted maybe Mr. Howard chops all this in half but again there is a huge tax revenue benefit one way Vs the other, plus liabilities, and etc. to consider.

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    1. I can’t tell if you’re agreeing with me (I know it doesn’t) or disagreeing (i.e., since Basel III doesn’t consider interest rate risk, it’s not correct to bring interest rate risk into the “level playing field” comparison).

      If it’s the latter, I believe you’re wrong. At a minimum, the playing field should be level between banks’ and Fannie and Freddie’s portfolios, since those are the two businesses that are most alike (even though Fannie and Freddie hedge their on-balance sheet risk much better than banks do). Then, on Fannie and Freddie’s side, you have to deduct the 2.05 percent in interest rate risk capital they’re required to hold to get to the comparable “level playing field” amount for mortgage credit risk. That’s the example I used in my post.

      Ignoring interest rate risk entirely leads to indefensible capital arbitrage: if banks insist that Fannie and Freddie’s credit guarantees have to have the same percentage capital as the mortgages held on bank balance sheets, Fannie and Freddie would have to put non-economic fees on their credit guarantees, pushing lower-risk loans to the banks, where they would be allowed to earn very wide spreads on them from short-funding, without having to hold any capital at all to compensate for that risk-taking. (If your response to this is, “Well, that’s the way Basel III works,” I’d say, “Only if you force Fannie and Freddie’s guaranty business into a system that clearly wasn’t designed for them, when a much better alternative exists.”)

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  43. Tim – based on my reading of your thoughts related to CRT transactions – I think it is fair to say your view on them is that they’re largely a giveaway to their buyers as the risk outstanding is never really time tranched to hit the buyers. Please correct me if that is wrong. Also, the CRT issuance keeps getting larger by the week. It does seem odd that they always reference the notional balance rather than the actual size of the tranches that are being sold as CRTs… What would say is really the reason that the GSEs keep issuing these things and also why are the announcements always showing the sizes that aren’t representative of the amount of risk being transferred?

    -moose

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    1. I believe that the CRT securities Fannie and Freddie have been issuing for the last four years will result in few if any credit losses being transferred to the buyers of the risk-absorbing tranches. That’s the result of the interaction of three factors: (a) the very high quality of the loans these CRTs have been issued to protect, (b) the very high first-loss thresholds (initially 30 basis points, but quickly stepping up to 100 basis points in all later issues) before any losses are transferred, and (c) the prepayment feature attached to the tranches, which except in the most extreme environments cause them to pay off fairly quickly, before the losses could hit.

      Fannie and Freddie are issuing these for two reasons: they’ve been told to by their regulator, and they have no capital (because Treasury is taking it all in the net worth sweep), so they feel that CRTs are the only tool they have to protect against credit risk. The latter is true, but in my view that just means that it’s the government’s money they’re wasting with the CRTs, since the government would be getting higher quarterly sweep remittances were the companies not paying so much interest on their CRTs.

      As I noted in this post, if Fannie and Freddie were real companies, with their own capital, they would be making the decision about issuing CRTs based on whether they thought they would get something of roughly equal economic value for what they were paying for them. Given the three factors identified in the first paragraph, I would say the answer they would give today is, “absolutely not.” But that’s not the position they’re now in, so the give-away continues.

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      1. Tim – Thank you very much for responding and everything you do here. It continues to be an invaluable resource to have you doing this type of Q&A openly. Also I’d like to say I fully enjoyed your book but I’m not all the way through it yet, so far it’s been great.

        If I may, a quick follow up question:

        Regarding:
        “but in my view that just means that it’s the government’s money they’re wasting with the CRTs, since the government would be getting higher quarterly sweep remittances were the companies not paying so much interest on their CRTs.”

        I’m somewhat surprised that this is your view as it seems to indicate having little regard for the litigating shareholders who, in many people’s view, have been repeatedly wronged by the government. However, I agree that the reality of the situation is that the NWS continues so your view is more grounded in the current reality of this unfortunate situation they find themselves in.

        – moose

        [Comment edited for length]

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        1. I’ve been expecting to see two lawsuits filed for more than a year: the first by a Fannie shareholder over the expenditure FHFA has forced Fannie to make to build the Common Securitization Platform (CSP), which is intended to eliminate a competitive advantage it has over Freddie (related to the payment structure of Fannie’s MBS compared with the Freddie Participation Certificate, or PC), and the second by a shareholder of either company over the wasteful issuance of CRTs by both. So far, though, nothing. Until a suit is filed, there is no legal reason for the companies not to continue building the CSP, and to issue uneconomic CRTs.

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          1. I wonder if it would be better for a GSE employee to file a lawsuit rather than a shareholder, due to the restrictions of shareholder lawsuits?
            In any case I hope you’re right and I hope someone with the means files a lawsuit against the senseless practice of issuing credit risk transfers that transfer insignificant amounts of risk.

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          3. FHFA says shareholders have no rights under HERA,
            So these 2 lawsuits will be dismissed under the same flawed logic that has been applied to other dismissed cases.

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  45. tim

    great job.

    given that GSEs are insurers of a single asset class with a particularly robust historical data set to price risk, any comparison to commercial bank multi-product loan portfolio standards is not only analytically lazy, but will result in harming the pricing of a broad swatch of home-buyers that most need an efficient secondary housing finance market.

    have you made this analysis to congressional committee staffs privately? this should be done outside the glare of televised committee hearings given the kind of partisan grandstanding we have seen too often in committee hearings lately. what you have to offer is more an educational process than a partisan argument.

    rolg

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    1. A renewed round of meetings with congressional staff is on my “to do” list for the summer (now that I’m back from my spring travels). I had a few meetings with staff last year but since there was nothing going on legislatively there wasn’t much interest in digging deep into any of the issues. My sense is that’s now changed.

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      1. Tim,

        As I’ve stated before, thank you for all that you’ve done as well as your continued efforts as you stand up for Fannie and Freddie supporters and Americans everywhere.

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  46. Tim,

    “Creating a level playing field” does seem to be their only argument for the MBA plan. It is pitched as allowing for more private capital and competition in the market, preventing such a heavy reliance on just FnF. This is facetious in many ways, but do the following quotes from the Treasury report seem to imply agreement with this argument, that a more level playing field is needed?

    ” Treasury supports regulatory changes to encourage the emergence of a safe and sound PLS market that accommodates more private capital and “provides for more consumer choices in mortgage products”. Decreasing the market share of government-supported mortgages, while increasing private sector funding of mortgage credit, should be a key policy goal consistent with the Core Principle that calls for decreasing the risk of taxpayer-funded bailouts. ”

    ” While the GSEs’ credit risk transfer (CRT) securities have provided an avenue for mortgage credit exposure for investors, the largest source of private capital for residential mortgage credit in recent years has come from bank portfolios”

    “The objective of the reforms is to increase the viability of private sector lending so the share of government-sponsored lending can decrease.”

    Now, I am not an expert by any means, and none of these quotes explicitly favour one plan over another, however, comparing these statements to the available plans, it seems to be most in line with principles that the MBA put forward. Talking about decreasing regulations to encourage private capital, then saying how banks are the largest source of private capital, saying we need more consumer choices in mortgage products… all sounds to me like “the banks are important to the market and we need to lower regulations to get them in, we can’t just have FnF dominating the market”. Thoughts?

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    1. First of all, as I discuss in the post, applying banks’ fixed-ratio capital standard to Fannie and Freddie’s credit guaranty business does NOT create a level playing field, because banks do not have an explicit capital charge for interest rate risk on mortgages held in portfolio, whereas Fannie and Freddie do.

      Beyond that, the quotes you cite from Treasury do not surprise me. As an institution, Treasury has for decades been pro-bank and generally anti-Fannie and Freddie.

      The U.S. financial system relies on both deposit-based funding and capital markets-based funding. Fannie and Freddie’s main contribution to the mortgage market has been their success in tapping the international capital markets to bring large amounts of low-cost funds to support 30-year fixed-rate mortgages. (Prior to 2008 they did this in two ways: with their portfolio business and their MBS credit guarantees; with the restrictions imposed on their portfolios by Treasury, they’re now primarily credit guarantors.) Purely for profit reasons, banks would like more mortgages to be funded by depositories, and fewer by capital markets investors. So they and their trade groups, including the MBA, make arguments supporting giving advantages to banks and restrictions to the credit guarantors that make 30-year fixed-rate mortgages attractive to capital markets investors (few capital markets investors will invest in mortgages without some form of reliable, high-quality, credit guaranty).

      My expectation is that the Mnuchin Treasury will view the mortgage reform issue from a public policy perspective: to make mortgages more available and low-cost (which frees up consumer income that can be spent in other areas, contributing to economic growth), it should want BOTH the deposit-based and capital markets-based sources of mortgages to be as efficient as possible, subject to the same high standard of taxpayer protection. But the reform debate is happening in a political environment, where special interests make arguments–many of them specious–to try to gain advantage. Mortgage reform is not going to be a pretty process, but hopefully it will end up in the right place.

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      1. Yes, it boils down to politics. You’ve stated previously that you don’t see a pressing timeline for reform that would force administrative action. With all the compromise and leniency being given to banks and their congressman and senators, is there anything that would make Mnuchin feel politically motivated to quit on the banks and Congress and go for administrative reform? So far it seems like they will wait forever and mull over how to make this work for the banks without completely messing things up.

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        1. I can think of 100b reasons why Mnuchin might want to go with an administrative solution.

          Time is also not the administrations friend, between having zero capital on 1/1/18 and tax reform that will impair the DTA’s, they must make these decisions sooner rather than later.

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          1. I can think of those reasons as well, but all those reasons apply to him putting out reform a month after taking office, and letting GSEs build capital by having them retain first NWS. As it stands, Mnuchin is playing along with the banks and Congress, letting them deliberate and mull over their success in the market. The question really is, how much does Mnuchin (and Phillips) want to see the banks succeed, and is a simple recap and release even on their table?

            I am hoping it is like Howard responded to this comment, where Mnuchin gave into political pressure and is giving the banks time to come up with their plan that works. I don’t know Mnuchin’s or Phillips’ motives, but hopefully they are giving the banks only so much time and leeway in formulating their plan. The fact that Mnuchin has repeatedly said in interview that he “would LIKE to have housing reform done through Congress” and always left the door open for administrative reform, makes me agree with Howard that administrative reform is on the table but that time is being given to MBA and friends to come up with their own plan that works.

            I just wish I knew what would make Mnuchin say “enough is enough” and cut the banks out.

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        2. As I’ve noted previously, absent some surprise development in favor of the plaintiffs in one of the legal cases, the mostly likely course for Mnuchin to follow is to give Congress a reasonable amount of time to pursue its legislative efforts before he moves independently on administrative reform. But I don’t think he’ll let Congress do a “rope-a-dope.”

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          2. Isn’t it true that regarding all of the GSE reform proposals only the moelis blueprint 1) monetizes the treasury warrants, and 2) uses an existing institutional structure? Understanding Potus’s (and the treasury secretary’s) background and business orientation, one would think leaving as much as $100B on table and implementing an untried institutional framework would not be viewed charitably

            Rolg

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          5. You usually don’t comment on legislation, so I was surprised to see you mention a potential “surprise development in favor of the plaintiffs” here. The rehearing request in Perry is as clear cut as can be. If the judges can see past their own biases and make a ruling based on law rather than their feelings, it is an easy win for plaintiffs, and implications are huge. Are we that beaten down that we are just expecting to lose everything at this point? This rehearing should be a no-brainer. The amount of precedent that Millet and Gorsuch are going to have to go against to uphold this silliness is extraordinary, especially since they know that Judge Brown is going to call them on it. I refuse to be ‘surprised’ if and when judges do the right thing and ask that you adopt the same approach.

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          6. I was using the word “surprise” not in the sense of unlikely (and therefore surprising were it to happen) but in the sense of not knowing what the timing might be (and therefore not anticipated). I think it’s very likely that plaintiffs will prevail in one if not several of the various legal tracks being pursued.

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      2. Tim,

        Yes. And your point has (or at least had) support from a useful source: Laurie Goodman and Jun Zhu from Urban Institute way back in 2013 argued for more nuanced capital requirements (and vs application of fixed-rate standard). “Collateral composition, house price experience, and diversification significantly affect credit risk, and thus the capital requirements,” they wrote. “If capital requirements are too low, the government guarantee will be invoked too often; if they are too high, banks will shift the ultimate risk of their lower-quality loans to the government.”

        Goodman & Zhu came to the conclusion (again, in 2013) that 5% was the right requirement based on ‘the diverse 2007 composition of the GSEs’ books of business and 2007 experience of a 30–35 percent decrease in home prices’. They contrasted the ‘catastrophic insurance’ (an idea you’ve nicely debunked elsewhere) mandated by the previous Corker-Warner bill as being 39 basis points higher than 2013 GSE fee levels.

        So, even the the Urban Institute seems leery of some of the worst-case reform scenarios imaginable. If, as Sen Warner recently argued, UI, MBA and Milken Institute are ‘in the same room’ (which, again, you’ve provided reason to doubt) they may wind up with differing views–Jim Parrott’s protestations notwithstanding.

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      1. I agree with you on the affordable housing point; pre-conservatorship, though, I think the record was a little more mixed on support for small lenders. Then, both Fannie and Freddie competed aggressively to lock up the business of large lenders through what were termed “partnership agreements,” in which the main incentives to get a lender to agree to do a very large percentage of its business for the coming year with one of the companies was a combination of guaranty fee cuts and underwriting concessions. Smaller lenders were not offered the same agreements and thus were disadvantaged by them (although they still generally got a better deal from Fannie and Freddie than they did from the big correspondent banks). Post-conservatorship the companies have been much better in offering similar pricing for comparable loan quality, irrespective of lender size, and this is something they should continue to do if and when they exit conservatorship.

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  47. Tim, again, endless thanks for continuing to bring facts and wisdom to a debate short on both. Especially liked the point that a monolithic capital charge will disproportionately attract the under-priced, high risk mortgages, creating the very weakness that should be avoided. Cheers

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  48. Tim,

    Good morning. Best of luck during your meeting with David Stevens this week. The only question I would have for him is, why does the MBA reform proposal state that they are apathetic to shareholders? In contrast, the ICBA clearly states that shareholders rights MUST be upheld. Why would they jeopardize having a legitimate voice in the reform dialogue by taking this position with the Trump Admin?

    Thanks,
    @FannieGate101

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