A Pattern of Deception

~ jtimothyhoward

On July 19, Judge Margaret Sweeney unsealed 33 additional documents produced in discovery for the lawsuit brought by the Fairholme Funds in the U.S. Federal Court of Claims. They were made available to the public early last week.

Not surprisingly, the documents that attracted the most attention were those that contradicted the “death spiral” explanation given to the public and in the court cases by Treasury and FHFA as the reason for the net worth sweep. Excerpts from the new documents reinforced what had been apparent from evidence unsealed earlier: that Treasury and FHFA were fully aware that Fannie and Freddie were about to experience a surge in profitability well before the sweep was announced; that the sweep was imposed precisely to prevent the companies from retaining those earnings as capital, and that stripping the companies of their capital was viewed by Treasury as essential to achieving its goal of replacing Fannie and Freddie in the U.S. secondary mortgage market with a system more to its liking.

Included among the items unsealed on July 19 were:

Ÿ – A memo dated June 25, 2012—more than seven weeks before the sweep was announced—from Counselor to the Secretary of the Treasury for Housing Finance Policy Michael Stegman to Assistant Secretary for Financial Markets Mary Miller, summarizing a meeting at which FHFA acting Director Ed DeMarco told Treasury Secretary Tim Geithner that “the GSEs will be generating large revenues over the coming years, thereby enabling them to pay the 10% dividend well into the future even with the caps;”

– An August 13, 2012 memo from National Economic Council senior advisor Jim Parrott to Treasury’s Brian Deese, stating, “We are making sure that each of these entities pays the taxpayer back every dollar of profit they make, not just a 10% dividend….The taxpayer will thus ultimately collect more money with the changes” [emphases in original], and

Ÿ – An August 15, 2012 email from Treasury’s Adam Chepenik to Stegman, Parrott and others that said, “By taking all of their profits going forward, we are making clear that the GSEs will not ever be allowed to return to profitable entities at the center of our housing finance system” [emphasis in original].

These and similar emails and memos show that Treasury and FHFA have not been truthful about their motives for agreeing to the net worth sweep. But beyond that, other documents among the 33 reveal a pattern of deception extending back before Fannie and Freddie were put into conservatorship and carrying forward to the current proposals for mortgage reform supported by Treasury and what I call the Financial Establishment. Three particular items stand out in this regard: the August 25, 2008 “Freddie Mac Confidential Capital Review” by BlackRock, the December 12, 2011 Draft Information Memorandum to Secretary Geithner, and an undated Treasury document titled “Housing Reform Questions and Answers.”

BlackRock’s “Freddie Mac Confidential Capital Review”

The most surprising revelation from all of the documents released last week was that on August 25, 2008—nearly two weeks before Fannie and Freddie were placed into conservatorship on September 7—the investment firm BlackRock submitted a “Confidential Capital Review” of Freddie Mac to Treasury and FHFA that concluded: “…[L]ong-term solvency does not appear endangered – we do not expect Freddie Mac to breach critical capital levels even in stress case.”

We already knew that Treasury Secretary Paulson had forced Fannie and Freddie into conservatorship without satisfying any of the twelve requisites for that action set out in the newly passed Housing and Economic Recovery Act (HERA), relying instead on what he termed “the awesome power of the government” to pressure the companies’ boards to submit to it. We also learned after the fact that both Fannie and Freddie remained profitable on an operating basis throughout the crisis. But until now we did not know that Treasury and FHFA had been told something very similar at least about Freddie’s financial condition before the fact by BlackRock, an independent and respected third party with a long familiarity with Freddie, having been a consultant to them for at least a decade. Treasury and FHFA ignored this assessment and went ahead with their pre-planned conservatorships anyway, with Paulson boasting to President Bush, “Mr. President, we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.”

Following the conservatorships Fannie and Freddie booked massive amounts of non-cash losses through the end of 2011, causing them to have to draw $187 billion in non-repayable senior preferred stock from Treasury. The unsealed BlackRock document provides important insight into how the large majority of those losses—and the resulting Treasury draws—were deliberately engineered. First, the contemporaneous analysis of Freddie’s future financial condition by BlackRock makes it impossible to defend the legitimacy 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; FHFA knew this not to be true. Second, on the penultimate page of its review BlackRock explicitly identifies and describes the method used by FHFA to create most of the other non-cash losses at the companies. It notes, “’Other Than Temporary Impairment’ accounting rule can trigger mark-to-market declines more severe than expected principal loss. Accounting treatment requires securities to be marked to market if any principal loss is deemed ‘probable.’ Given the current market environment, MTM losses will likely exceed actual principal losses. Impairments diminish capital immediately. Future recoveries in market value do not flow through capital.”

I do not know whether staff at either FHFA or Treasury had previously been aware of how powerful impairment accounting could be in making a company’s capital disappear immediately, then reappear only slowly, as income. But this accounting technique was used extensively by FHFA following the conservatorship. At Fannie, impairment accounting allowed FHFA to book $17.3 billion in market value losses on private-label securities held in portfolio—very few of which became economic losses—and an astounding $62.8 billion in loss reserves on “individually impaired” loans. As I noted in my amicus curiae brief for the Perry Capital case, “Impairment accounting allowed Fannie to record as immediate expenses not only credit losses that otherwise would have been booked over time but also estimates of future losses and even the present value of foregone interest payments.” The large majority of these impairments were on loans that returned to paying status, but most of the reserves cannot be released until the loans repay. As of December 31, 2016, Fannie still had $28.6 billion locked up in reserves on individually impaired loans.

Together, the unwarranted write-down of Fannie’s deferred tax assets and the aggressive use of impairment accounting allowed FHFA to balloon Fannie’s losses by $144 billion between 2008 and 2011. (I have not calculated the comparable dollar amount for Freddie.) Treasury knew at the time it took Fannie and Freddie over that they did not need rescuing, and it also knows that virtually all of the $18.7 billion the companies were obligated to pay each year prior to the net worth sweep were the results not of the companies’ business decisions but of FHFA’s accounting decisions.

December 12, 2011 Draft Information Memorandum to Secretary Geithner

This memo, prepared by Assistant Secretary Mary Miller, presented “policy options, which taken together could serve as the basis of a comprehensive non-legislative Administration reform proposal.” As we now know, Treasury ended up choosing “Policy Option 1– Restructure the calculation of Treasury’s dividend payments from a fixed 10 percent annual rate to a variable payment based on available net worth (i.e., establish an income sweep).” But what drew my attention was “Policy Option 2- Develop a plan with FHFA to transition the GSEs from their current business model of direct guarantor to a model more aligned with our longer term vision of housing finance.” The idea behind this option was to “Amend the PSPAs to add additional contractual obligations for the GSEs and FHFA associated with transition.” Policy Option 2 had four elements:

– “Guarantee fee price increases – pricing for direct GSE guarantees could be increased by a minimum of five to ten basis points per annum (or at a pace determined annually by FHFA and Treasury) until pricing reaches levels that are consistent with those charged by private financial institutions with Basel III capital standards and a specified return on capital.”

Ÿ- “Risk syndication – consistent with the phase-in period of guaranty fee increases, the GSEs could be required to sell a first-loss position (or the majority of the credit risk) to the private market on all of their new guarantee book business within a five- or seven-year time period. It is important to note that risk syndication would likely reduce the earnings capacity of the GSEs (similar to how the winding down of the retained portfolios also limits income generation).”

Ÿ –“Single TBA delivery – require the GSEs to align payment standards and issuance process to establish a fungible TBA market for common delivery of Fannie Mae and Freddie Mac securities,” and

– “Additional transition requirements – additional requirements could also be considered, such as down payment levels, faster retained portfolio wind down…etc.”

With the exception of the faster run-off of Fannie and Freddie’s portfolios, none of these activities were codified in the Third Amendment to the PSPAs. Instead, FHFA did all of them (clearly at the direction of Treasury) in its capacities as conservator and regulator. Yet they remained Treasury’s initiatives, intended to further the goal of “winding down and replacing” Fannie and Fannie with a bank-centric alternative. And the initiatives were exceptionally cynical.

Begin with the guaranty fee increases. Why were they being proposed? Not because of credit risk, but to reach “levels that are consistent with those charged by private financial institutions with Basel III capital standards,” i.e., banks. Homebuyers, of course, would pay those unnecessarily high guaranty fees. Prior to the financial crisis, Treasury (and the Federal Reserve) had aggressively promoted unregulated private-label securities (PLS) as the preferred alternative to Fannie and Freddie financing. When the PLS market imploded to trigger the crisis, Treasury and the Fed quickly intervened to ensure that the commercial and investment banks would suffer no lasting negative effects, but left homeowners to fend for themselves, with eight million of them ultimately losing their homes. Here, in another attempt to replace Fannie and Freddie, Treasury proposes to have homeowners pay higher guaranty fees solely to make it easier for banks to compete with those companies.

The Miller memo also introduces the idea of mandatory credit risk sharing. Note, though, the statement that “risk syndication would likely reduce the earnings capacity of the GSEs (similar to how the winding down of the retained portfolios also limits income generation).” Earnings are income less expense, and if the envisioned risk-sharing transactions reduce earnings it only can be because the interest expense on them exceeds the income from transfers of credit losses they supposedly will produce. In fact, forcing Fannie and Freddie to buy insurance for up to 400 basis points of credit losses on pools of loans with better risk characteristics than books from the early 2000s—which only experienced about 50 basis points of credit losses even through the financial crisis—is burning up their earnings just to make them look less profitable, and easier to replace. I’ve suggested that publicly; in this memo Treasury actually says it privately.

Miller’s reference to the income effects of winding down the portfolio business is telling. Elsewhere in the unsealed documents we find the statement: “Many commentators tend to point incorrectly to the retained portfolios as the cause of Fannie Mae and Freddie Mac’s collapse; while the losses were significant and were indicative of the risks Fannie and Freddie took, the Investment/Capital Markets (Retained Portfolio) segment has only accounted for 9% of cumulative losses.” That is an accurate assessment. With relatively low credit losses, the spread income from the mortgages Fannie and Freddie held in portfolio was helping them absorb losses from their mortgage-backed securities business. That was of no import to Treasury, however. It always had opposed the companies’ portfolio business, and when it imposed the PSPAs on them in 2008 it required them to shrink their portfolios by 10 percent per year (increased to 15 percent in the Third Amendment). One neither rescues nor conserves a company by reducing its income, but Treasury’s mandates to Fannie and Freddie to shrink their portfolios and to issue risk-transfer securities without regard to their economics had that deliberate intention and effect.

Housing Reform Questions and Answers

One of the questions in this undated document is, “What caused the crisis in the housing market?” After saying “No single cause can fully explain the crisis,” the paper identifies five “structural flaws” that contributed to it, including “A complex securitization chain [that] lacked transparency, standardization, and accountability and allowed lenders to pass toxic product through the system without regard for its risk” and “Inadequate capital in the system.” In this piece marked “Not Intended for External Distribution” there is no mention of a “flawed business model” at Fannie and Freddie being one of the causes, let alone the most important cause, of the crisis. To the contrary, in response to the question, “Did Fannie/Freddie cause the financial crisis by lowering their underwriting standards, allowing consumers to get loans they couldn’t afford?” the answer is, “No. Rather than leading the market into subprime and other risky mortgages, Fannie and Freddie followed the private sector.” Internally, Treasury well understands why and how the crisis occurred.

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There can be little doubt about why the government has been fighting so hard to hold on to the documents Fairholme requested in discovery for its regulatory takings suit: the ones produced so far reveal that what Treasury knows to be true about Fannie and Freddie privately—and tells itself in memos, emails and other materials—is starkly at odds with what it has been claiming about the companies publicly.

For whatever reason, and perhaps it is nothing more complicated than wanting to support the institutions it is responsible for regulating, Treasury has for decades sought to “rein in” or replace Fannie and Freddie, whose activities in the secondary market reduce the market power and the potential profits of banks in the primary market. Treasury and the Federal Reserve saw the financial crisis as a serendipitous opportunity to seize control of the companies, burden them with a mammoth and non-repayable amount of indebtedness, reduce their earnings, and in 2012 take all of their capital in the hope this would prod Congress to replace them. To execute its plan, however, Treasury has had to be untruthful about virtually everything having to do with Fannie and Freddie—their health going into the crisis, the reason for taking them over, the source of their losses in conservatorship, and why the net worth sweep was imposed, among others. Documents released in discovery to date lay bare this pattern of deception.

When the truth about Fannie and Freddie is substituted for the fictions about them, the rationale for the legislative mortgage reforms being proposed by the Financial Establishment—whether Corker-Warner, Johnson-Crapo or the latest version from the Mortgage Bankers Association—crumbles. If, as Treasury admits in an internal document, Fannie and Freddie “followed the private sector…into subprime and other risky mortgages,” why is the right public policy response to dismantle the more responsible entities, Fannie and Freddie, and turn the secondary market over to the “private sector” companies who were more culpable in the crisis? And if the real problem in the crisis was “inadequate capital in the system,” why not allow FHFA to follow HERA and implement a true risk-based capital standard for Fannie and Freddie, updated to meet current standards of taxpayer protection? Fannie and Freddie are not the “failed business model” their critics claim; loans they financed leading up to the crisis performed far better than loans from any other source.

The banks see great profit opportunities from substituting themselves for Fannie and Freddie as the centerpieces of the secondary mortgage market, and historically Treasury has supported those ambitions. But Treasury now has new leadership, and is taking a fresh look at Fannie and Freddie in conjunction with its commitment to “get them out of government control.” The documents released by Judge Sweeney make clear that in order to advance the banks’ agenda, past leadership of Treasury has had not only to make claims about Fannie and Freddie it knows to be untrue, but also to require millions of homebuyers to pay higher guaranty fees not because of the risk of their loans but to put banks in a better competitive position to get their business. I believe that current Treasury leadership will recognize the folly of the course its predecessors have been on, and that they will change this course to one that builds on Fannie and Freddie, and benefits homebuyers rather than banks.

162 thoughts on “A Pattern of Deception”

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    1. Yes. The call will be at 11:00 am on Tuesday, September 26, for the clients of the D.C.-based investment firm Compass Point. I’m planning to do about 15 minutes of prepared remarks, which will be followed by Q and A until around noon. I intend to publish the text of my prepared remarks as a blog post on Wednesday morning, the 27th.

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    1. Without information from Fannie or Freddie on the number of properties affected, the extent of damages incurred, and the presence and impact of various forms of insurance–private, state and federal– I have no way of making an estimate about the companies’ potential dollar losses from hurricanes Harvey and Irma (or others that still may come this season).

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      2. Mr Howard,

        Can garantors of MBS securities with the collateral being the damaged property from natural disaster be forced to make P&I payments?Who has to make good first property insurers or FNMA?

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        1. Fannie and Freddie must either make regularly scheduled principal and interest payments on loans in the MBS pools they have guaranteed, or, at their election, buy those loans out of the pools at par. It’s then up to Fannie or Freddie to collect any reimbursements if the property is insured, with the proceeds going to the companies.

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          1. Is it hard as a practical matter for GSEs to recoup these insurance proceeds? Or do the GSEs notify insurers to make payment to GSEs?

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          2. If Fannie or Freddie foreclose on a damaged home because of nonpayment (beyond any period of forbearance the companies may grant), they become the owners of the property. Insurers of a property make payments to the owners of record, which in these cases would be Fannie or Freddie. I can’t recall from my time at Fannie exactly how it made this change of ownership known to insurers, but I do know that having insurance payments go to the wrong beneficiaries was not a significant problem.

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          3. Could it be that people living along the hurricane plagued coast would have more equity in their homes now than they typically would have had before the financial crisis? Thus, more individuals in these areas, or at least in the areas not permanently impaired, would be more likely to collect insurance so they can make repairs and stay in their homes. It would seem to me that Fannie and Freddie would want to help and encourage such behavior so, that more individuals could rebuild rather than default.

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  8. Tim,

    Good afternoon. This article below (page 2) by Roosevelt Institute visiting fellow, James Carr, says:

    “There are many ways to release Fannie Mae and Freddie Mac from conservatorship in a manner that overcomes inherent weaknesses of a stock ownership structure with implicit federal backing while also enabling them to better meet the homeownership desires of our nation’s families while simultaneously operating in a safer and sounder manner.”

    I thought you might have a more structured rebuttal than this article that provides zero explanation for how that statement would be accomplished. Thanks!

    https://www.forbes.com/sites/jameshcarr/2017/09/18/playing-russian-roulette-with-the-u-s-housing-finance-system/2/#17db79065df1

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    1. Carr (who worked at Fannie Mae when I was there) was one of about twenty individuals or teams asked to contribute an essay on mortgage reform last spring to the Urban Institute’s “Housing Finance Reform Incubator” series; this article for Forbes is an argument for the proposal he made in that essay.

      In both his essay and the Forbes article, Carr argues that Fannie and Freddie’s “shareholder-owned structure…made quarterly earnings growth more important than either good public policy or financial common sense,” and for that reason rather than recapitalizing and releasing the companies it would be preferable to transform them into a government-owned “Federal Housing and Community Investment Corporation.”

      I think Carr overstates the weakness of the shareholder-owned structure (Fannie and Freddie, as shareholder-owned companies, had by far the best financial performance of any major sources of mortgage finance leading up to, during and after the financial crisis), and also understates the complications of moving a $5 trillion residential secondary mortgage market inside the government, and giving that corporation comprehensive community development responsibilities. Perhaps more importantly, though, there is not a broad constituency for doing what Carr recommends, so it’s not an idea that’s likely to go anywhere.

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  9. I’m sorry, but you’re just speculating. Mnuchin did NOT say that. His answer was limited to “We expect our dividends to be payed”. You may be right, but that was not what he commented.

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    1. That’s why i used the words “basically said” and “most likely” that is just my humble interpretation of what could happen (although of course it may not happen!!). Nobody knows the ultimate outcome, reading tea leaves is tricky business!!

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    1. This resolution is a significant shift in the position of the Republican National Committee on Fannie and Freddie. Its introductory section praises the past performance of the companies which, as Lorraine Woellert of Politico noted yesterday, is in sharp contrast to the “corrupt business models” language the RNC used to describe the companies just last year. Similar to the letter sent by several Senate Banking Committee members to Treasury and FHFA yesterday, the RNC resolution focuses on the risk to taxpayers of allowing Fannie and Freddie’s capital to fall to zero, and “calls upon our President, Members of Congress, and Governors to protect taxpayers from future bailouts by supporting administrative action that restores safety and soundness to Fannie Mae and Freddie Mac.”

      The RNC resolution clearly supports at least a temporary suspension in the companies’ net worth sweep payments to Treasury, but it also goes further than that. Its reference to the fact that “Treasury can generate an estimated $100 billion in additional cash profits by monetizing its warrants for 79.9% of each company’s common stock” is an indirect endorsement of keeping the companies at the center of the future mortgage finance system, since the alternatives of replacing them, or crippling them with burdensome changes to their charters, would either eliminate or greatly reduce the value of those warrants.

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      1. tim

        my eyes were popping out as i read the RNC resolution. now of course, the RNC has no legal authority, but i think corker/crapo/hensarling will look at this and conclude, ok, i am now on the other side of the party on this issue, and do i want to continue to fight the “good (anti-GSE) fight” and be a hero on this? sometimes optics drives politics.

        rolg

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        1. To me a significant aspect of the RNC resolution is that both it and yesterday’s letter from Senate Banking Committee members expressed agreement with the positions on Fannie and Freddie taken by the Independent Community Bankers of America, the Community Home Lenders Association and the Community Mortgage Lenders of America, among others. So we’re now beginning to see public alignment around one of two polar choices for Fannie and Freddie: administrative reform to strengthen and preserve them, as advocated by the smaller community banks and detailed in the proposal by Moelis & Company, or legislative reform to weaken or eliminate the companies, as advocated by the big banks and outlined in the proposal by the Mortgage Bankers Association. “Whose side are you on?” I believe that’s a very positive development, because it will bring the arguments for and against each alternative into the open, where it will be harder for transparently empty arguments to sustain themselves.

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          1. Mnuchin has just reaffirmed he expects Watt to pay the dividend, completely disregarding both letters. Any thoughts? I fear he is more and more away from the idea of recap and release than ever.

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          2. I hadn’t seen that, but I’ll take your word for it. I wouldn’t read too much into it, though. Mnuchin has said that before, and it’s what I would expect the Secretary of the Treasury (who would be the recipient of the sweep payments) to say. You can read the Senate letter and RNC paper as anticipating Treasury’s position, and giving Watt support for doing something he said he wanted to do in his testimony before the Senate Banking Committee in May, and which he clearly has the statutory authority to do. We’ll see what happens at the end of the month.

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          3. Well, when the guy in charge says “we expect to collect our dividends”, I would expect exactly that to happen. I think Secretary Mnuchin wants to keep filling the treasury’s “piggy bank”. He is postponing “reform” until 2018. It sounds like the same ol same ol to me. He is using the same non sensical jargon that we’ve heard for more than five years (Fannie and Freddie only exist because of the treasury’s line he says). No, we shareholders and joe public will have to prevail despite secretary mnuchin, not because of. I really do hope I’m wrong Mr Howard. I really do.

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          4. I looked at the video of Mnuchin’s Politico interview, and didn’t see anything that worrisome in it. The statement he made about Fannie and Freddie only existing because of Treasury’s line is literally true: they have almost no capital (because Treasury has taken all their retained earnings) yet their credit guarantees are still valued by investors, because of the Treasury line.

            He does, in my view, have to wait for the budget and tax reform (or cut) legislation to “clear” before he, or Congress, can address mortgage reform. Since tax reform will likely drag into next year, mortgage reform will as well. When mortgage reform IS addressed, Mnuchin will have two broad alternatives: greatly restructure or replace Fannie and Freddie legislatively, or strengthen and preserve them administratively. I am betting on the latter, because (a) of the deep divisions and dysfunction in Congress that make any type of complex legislation very difficult to pass; (b) it will be easier to settle the plethora of lawsuits administratively than to try to dance around them in legislation, and (c) Treasury can harvest an estimated $100 billion if it keeps the companies, which it will lose if it eliminates them.

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    1. “we dont think they should be released from conservatorship absent reform”.

      i have read this refrain many times. i still dont know what it means, likely because the writers dont have a clear idea what they mean. this letter is nonetheless a welcome development, and i note the implicit dig at corker, when they say that retaining capital is not antithetical to reform. i guess they have an idea of reform that differs from corker’s idea.

      i have been around difficult projects and i would note that the longer the people involved used jargon and avoided specificity, the less likely anything was achieved.

      rolg

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      1. The administration could “reform” Fannie and Freddie by giving them updated (risk-based) capital standards, which essentially is what it did for the banks, whose crisis-period residential mortgage losses were triple those of the companies.

        This letter from Senate Democrats adds yet another voice advocating that Fannie and Freddie be allowed to build a capital cushion through at least a temporary suspension of their net worth sweep remittances, and the choice of September 29 as the date by which the senators would like Treasury to respond to their request indicates that they are focused on the third quarter payment.

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      2. Agreed. However, I wanted to point out that this is only a working paper and not the opinion of the IMF.

        Carisa Chappell, a reporter for IMFnews, had claimed that the

        “International Monetary Fund Favors a Fannie-Freddie Merger”

        However, Chappell failed to read the following opening statement:

        “IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ”
        As it turns out, The International Monetary Fund has not taken a position on this working paper.

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        1. I hadn’t seen the IMF paper, but don’t find it objectionable. I think it contains some good information, and while I don’t agree with some of its analysis and most of its conclusions or recommendations, it does meet its intended purpose “to elicit comments and encourage debate.”

          Its three “broad proposals” are (a) to merge Fannie and Freddie “as quickly as possible,” (b) to “level the playing field” between banks and nonbanks as originators, and (c) to “revamp” the “flawed structure” of Fannie and Freddie’s credit risk transfer (CRT) securities.

          The main argument advanced for having a single guarantor is that having two “sets the stage for a destructive ‘race to the bottom’ in terms of price competition between the two entities.” I think that’s way overblown. While Fannie and Freddie historically have competed on price (and underwriting), it always has been on the margin, with little visible effect on profitability and no effect at all on safety and soundness. Moreover, if FHFA ever does follow HERA and specify a true risk-based capital standard for them, one of the features of such a standard is that it will force each company to offset cuts in guaranty fee with additional capital (in order to pass the risk-based capital stress test).

          My primary reaction to the bank-nonbank level playing field argument and recommendations was how bank-centric they are. The author notes that banks have lost origination share to nonbanks (such as Quicken Loans) and that the FHA and Ginnie Mae have picked up share from Fannie and Freddie–and do a disproportionate share of business with the nonbanks. He clearly thinks those aren’t good developments, and advocates regulatory changes to rectify them. I have varying reactions to the policy changes he proposes, and don’t find any unifying thread behind them (other than to get more business for banks). If it were me, I would address these issues under two basic principles: (1) to avoid “regulatory arbitrage” that creates safety and soundness issues through favoring a particular type of institution, and (2) to make policy choices that favor lower costs for consumers over higher revenues to financial companies.

          Finally, it appears that the author’s main concern about Fannie and Freddie’s CRTs is that they are structured as derivatives rather than securities, which limits their marketability to many types of institution, and (because of their capital treatment) makes it expensive for banks to buy them. I have different concerns about Fannie and Freddie’s CRTs.

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          3. I have given my views on CRTs in a number of posts on this site, most recently in one titled “Risk Transfers in the Real World,” accessible in both the “Recent Posts” and “Top Posts” sections on the right-hand side of the blog. And I will be putting up another post on CRTs at the end of this month, following a conference call on the subject that I have agreed to do for the clients of a DC-based investment firm. (I will leave it to them to announce the day and details of the call).

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      1. @sch

        nafcu doesnt have a plan, rather a few bullet point principles. the “endorsement” was set forth in a tweet by a nafcu person, not corroborated, no quotes/context etc. moreover, one principle is explicit govt direct guarantee of mbs. mnuchin is on record saying that he prefers explicit paid-for over implicit, but is opposed to direct mbs guarantee unless there is alot of private credit in front of it. so like everything else on this subject, what people say, what they mean, and whether anything they offer is feasible is opaque. another nafcu principle favors gse capital build up. was phillips talking about that, or something else, or just said a few nice words about credit unions?

        rolg

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        1. @rolg

          This is from the NAFCU website:

          Craig Phillips, counselor to Treasury Secretary Steven Mnuchin, on Tuesday updated NAFCU Congressional Caucus attendees on the administration’s focus in addressing housing finance reform and on ensuring regulation does not impede credit unions’ and others’ ability to grow and strengthen the nation’s economy.

          Phillips said Treasury recognizes the critical role of housing finance, and particularly the importance of preserving a 30-year, fixed-rate mortgage. “Our goal is to work with Congress [to achieve] comprehensive housing reform,” he said. That overarching reform effort also needs to address bringing the government-sponsored enterprises (Fannie Mae and Freddie Mac) out of conservatorship as part of a long-term housing strategy, he said.

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    1. I was aware that Bloomberg was working on a story about the amicus briefs. On August 22 Joe Light sent me an email saying, “we’re working on a story regarding some of the amicus briefs filed in the Fannie-Freddie cases. It turns out there were briefs filed that were not actually authored by the parties whose names appeared at the top. In other examples, financial interests in the case were not disclosed.” He asked me why in my two amicus briefs I hadn’t disclosed either my shareholdings of Fannie Mae or my “consultant gig” with Fairholme, and told me that if I wished to respond he needed to hear back from me by Friday, August 25.

      The article published yesterday was written by Zach Mider, with Light credited for “reporting assistance.” (I never heard from or spoke with Mider, although he called the law firm I worked with on one of my amicus briefs and claimed he had spoken with me, which was not true.) From the time I first heard from Light to yesterday, the thesis of the article had morphed from what he originally told me (which apparently didn’t pan out when they looked into it) to: “Of the 14 [Fannie and Freddie amicus briefs] accepted by the courts, Bloomberg News has identified at least eight with ties to those [Fannie and Freddie] investors, some of which weren’t disclosed to judges.”

      I can’t speak for the authors of the other amicus briefs, but in my case I responded to all of Light’s questions. On my holdings of Fannie shares, I gave him information that showed these holdings to be de minimis, and told him in an email, “If you insist on mentioning my holdings of Fannie Mae in your article you must also mention this de minimis percentage, to allow your readers to put it into perspective.” (Mider did not mention my Fannie holdings.) I also wrote Light, “My reason for not mentioning my ‘consultant gig’ is that I do not have one.” I told him that in August 2014 Cooper & Kirk had retained me to assist in their review of documents produced in discovery in its Federal Court of Claims suit, but that this agreement never went into effect because the government was able to block my access to documents covered with the protective order. In full disclosure I told him, “I was paid one fee by Fairholme. In March of 2015, Fairholme asked me…to walk them through Fannie and Freddie’s financial statements. I agreed to do that, and they paid me an hourly fee. I’ve forgotten what the total amount was, but if it’s important to you I can go back and look it up (or ask Fairholme). It was a one time activity.”

      It’s revealing how Bloomberg handled this latter information. They still said, “[Howard] doesn’t mention that he had previously been paid for consulting work by Berkowitz’s firm,” and while they did say “his work for Fairholme was limited to one visit to the firm in March 2015 that wasn’t connected to the briefs,” they did not tell their readers what this work actually was (even though they knew). Bloomberg also learned how much I was paid to do it—they called Fairholme and asked them—but didn’t include that either. Omitting the fact that the “consulting work” was helping Fairholme understand Fannie and Freddie’s financials (which is about as neutral as a consulting assignment can be) as well as the amount paid for it (because it wasn’t very much) allowed Bloomberg to create the implication that I had improper “ties to Fannie and Freddie investors” that in some way tainted the amicus brief I filed. That was the story they were committed to write at the outset, and although it took them more that two weeks to come up with something they felt they could go with, that’s the story they ended up writing.

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      2. Do you plan on complaining to Bloomberg about this? It doesn’t hold a candle to Carney, but still.. I wish people would be held accountable for yellow journalism.

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    2. What’s glaringly hypocritical is attorneys are guns for hire, so why not authors of briefs? All this chatter by the opposition is designed to obfuscate the cogency of the arguments.

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  14. Just to clarify, (VIEs) Variable Interest Entities? Investments set up by a corporation but held off the balance sheets.
    Off balance sheet investments, at least in most cases, had tragic consequences to the corporations that held them during the financial crisis.
    I assume from what Tim has written so far, that CRTs could have similar risks that would be passed to the GSEs and to American tax payers, as was the case with off balance sheet transactions.

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    1. May I also add risk transfer with another party looks great at closing but what happens when trouble appears?Instead of concern about just one guarantor you now have to deal with multiple guarantors.VIE on balance or off just cloud the picture even more.So long as the government keeps the credit line open to the GSE’s they will not ever need VIE or CRT.Thats how I see it right or wrong.

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  16. HI Tim. With the current flooding in Texas and potential defaults and deferments, do you think this will impact Fannie Mae enough to get the government to refrain from sweeping the quarter profits? Or can the losses caused by the this flood cause Fannie to require a draw?

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    1. See web pages.

      Fannie (and I suspect Freddie) are offering up to 90 day mortgage payment relief to borrowers through their servicers.

      Standard historic response to major US natural disasters; wouldn’t have been offered without FHFA blessing.

      Who knows about what Watt will do if this causes some significant revenue shortage.

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      1. If “the banks are successful in substituting themselves for Fannie and Freddie as the centerpieces of the secondary mortgage market,” would it be reasonable for us citizens to believe those banks in the future would collectively provide the level of relief, and as timely, as the GSE’s just did?

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        1. From today’s Inside Mortgage Finance

          A One-Year Moratorium on Mortgage Payments in Hurricane-Ravaged Counties?

          By Paul Muolo
          pmuolo@imfpubs.com
          Fannie Mae, Freddie Mac and the FHA Tuesday issued a 90-day moratorium on all foreclosures and evictions for hurricane-affected areas in the Houston/Gulf region. Moreover, payment forbearance may even last up to a year under certain conditions.
          Freddie estimates that 167,000 of its loans reside in 18 impacted counties. Late yesterday, Fannie’s total was considerably lower at 36,583, representing $5.1 billion of loans. (No dollar figures were available from Freddie.)
          “We’re committed to ensuring that homeowners receive the mortgage assistance they need to overcome the devastating tragedy of Hurricane Harvey,” said Yvette Gilmore, Freddie Mac’s vice president of single-family servicer performance management. “Once they’re out of harm’s way, homeowners should contact their servicers … They may be eligible for forbearance on mortgage payments for up to one year if their mortgage is owned or guaranteed by Freddie Mac.”
          Meanwhile, some analysts are starting to take a close look at banks and lenders headquartered in the affected cities of Houston, Galveston and Corpus Christi. Cowen & Co. issued a report predicting that storm damage could “encourage consolidation.”

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      2. the harvey storm affects less than 1% of GSE’s guaranteed loans. this is not a material financial event given their size. may even be “worth” the servicing deferrals to derive the deserved goodwill.

        rolg

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        2. If I were one of many MBS guarantors, I would avoid areas with likely natural disasters like flood, hurricane, earthquake, and wildfire.

          If I were one of few MBS guarantors, I can afford to cover the whole country.

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        3. Good point. I’m sure Fannie Mae must set aside loss reserves for such events.
          By the way, is Tim taking a timeout? I was just hoping he was okay, since this question would have been best addressed by his experience & expertise, yet has not been answered.

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          1. No, I’m not “taking a time out;” I’ve been traveling in Europe for the past three weeks (and just returned yesterday afternoon).

            By the time I saw the original question Bill Maloni already had answered it, and my answer wouldn’t have been much different. At this stage it is difficult to estimate what Fannie and Freddie’s ultimate credit losses from hurricane Harvey (and soon, unfortunately, Irma) might be, because it will depend on as yet unquantified factors such as the extent and amount of state and federal aid to the affected areas. In general, though, I would expect the losses to be significant, and for both companies, once they have a handle on the rough amount, to reserve against them. The likely losses from Harvey and Irma, therefore, are yet another reason for FHFA to allow both companies to build a reasonable-sized capital buffer.

            Yesterday’s agreement to push the debt ceiling drama off until mid-December removed the most convenient excuse for FHFA to continue to talk about the possibility of allowing Fannie and Freddie to forego their sweep payments without actually doing it. This and the potential hurricane losses give FHFA as much political cover as it could reasonably expect for allowing a temporary suspension in Fannie and Freddie’s sweep payments, and I continue to think it will do so beginning with this month’s scheduled payment.

            Liked by 2 people

  17. Tim

    Could you comment as to whether or not you believe at this point in time Sec Mnuchin now has a better handle on the full set of facts surrounding the conservatorship? Additionally, do you believe he has begun to frame out a solution now that he has received and met with a variety of constituency with their respective vested interest?

    Thank you.

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    1. I have no good information about where Treasury Secretary Mnuchin stands in his process for “getting Fannie and Freddie out of the government.”

      I gave my general view on what I thought Mnuchin will do in a recent post called “The Path Forward,” and that view hasn’t changed. In this post I concluded that because legislative reform will be very difficult to achieve in the current political environment, and because the number and variety of lawsuits against the government for its handling of Fannie and Freddie in conservatorship make indefinite continuation of the status quo improbable, at some point Mnunchi is likely to lead an effort to reform Fannie and Freddie administratively. What I wouldn’t attempt to predict is when and how that might happen. To sufficiently clear the decks for Mnuchin to tackle mortgage reform, the administration will need to address the debt ceiling, pass a budget, and either succeed or fail at passing a tax reform package or a more limited set of tax cuts. How all of those are done, or not done, will affect not only the timing but also the political backdrop for future reform efforts in ways that aren’t possible to predict.

      I personally doubt that Mnuchin has done much more on mortgage reform than have an initial set of meetings with the affected parties, but I believe he does understand that the lawsuits must be dealt with in a way that encourages private capital to return to the system. Once he turns his attention to assessing alternatives for settling the lawsuits, he will again be meeting with plaintiffs who know what you refer to as “the full set of facts surrounding the conservatorship.” As I’ve said since Mnuchin first announced his intention to tackle mortgage reform, once you know the facts about the financial crisis and what really happened with Fannie and Freddie, the fiction peddled about the companies loses its power to persuade. That’s not to say that Mnuchin still couldn’t make a political decision to support the banks in their effort to take over Fannie and Freddie’s business for their own interest and at consumers’ expense, but my bet is that he won’t–if for no other reason than the value Treasury can extract from the warrants if it keeps Fannie and Freddie at the center of the mortgage finance system.

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    1. This is an article by former Chicago Federal Home Loan Bank president Alex Pollock, criticizing Treasury’s decision to direct Fannie and Freddie to continue to pay interest on the $13.5 billion in subordinated debt the companies had outstanding at the time they were put into conservatorship.

      I can offer readers a little perspective on this issue.

      I was intimately involved in Fannie’s decision to begin to issue subordinated debt (which I addressed in Chapter 8 of my book, in the section titled “The Voluntary Initiatives”). Treasury Secretary Summers believed that sub debt provided financial institutions with important market discipline, and advocated the mandatory use of sub debt for commercial banks. He wasn’t successful with the banks, but in 2000 both Fannie and Freddie voluntarily agreed to achieve and maintain a certain percentage of sub debt in their capital structures. We (at Fannie) were very clear with investors that we intended the principal of our sub debt to be at risk, and I in fact was astounded when I learned that, following the conservatorships, Treasury had directed Fannie and Freddie to keep paying interest on their sub debt outstanding.

      Pollack says in his article that because of covenants on Fannie and Freddie’s sub debt stating that the companies could not pay any preferred stock dividends if they did not make the interest payments on their sub debt, Treasury had no choice but to make their sub debt “money good.” That’s an excuse, not a reason. Had Treasury truly wanted to help Fannie and Freddie through the financial crisis, both it and the Fed had programs that would have allowed them to make repayable loans to the companies, fully collateralized by their ample holdings of agency MBS. Those interest payments could have been made even if sub debt holders were wiped out (as we and Freddie had intended them to be in such circumstances). But Treasury did not want to help out Fannie and Freddie; it wanted to take them over, and to do that it created a new type of instrument—non-repayable senior preferred stock, with 10 percent dividends paid in after-tax dollars—that could be used in conjunction with non-cash losses booked by FHFA to bury the companies under a mountain of non-repayable obligations. To get its senior preferred, Treasury had to bail out Fannie and Freddie’s sub debt holders.

      And there was a further benefit to Treasury to keeping the companies’ sub debt alive; it meant that to push Fannie and Freddie to the point where they had to start drawing senior preferred stock from Treasury, it had to burn through $13.5 billion less of their capital. Had Fannie and Freddie’s sub debt holders been wiped out, the companies now would have $174 billion in senior preferred stock outstanding, not $187 billion.

      Pollock’s version of the sub debt story is that it was yet another fraud perpetrated on the taxpayer by Fannie and Freddie (“Fannie and Freddie’s subordinated debt produced, and its holders experienced, zero market discipline. So much for the academic theories, at least as applied to government sponsored enterprises.”) My version of the sub debt story is that it SHOULD have produced its intended result, but that Treasury chose to override its market discipline for Treasury’s own purposes. Readers can decide which version of the story better fits the facts.

      Liked by 6 people

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  19. Why did Bill Ackman say:

    “We are fortunate that two of the most financially sophisticated Senators in Washington, Senators Corker and Warner, have taken the lead on housing finance reform and have suggested that they will put forth new legislation shortly to address this last remaining restructuring of the financial crisis.”

    You usually don’t get into this stuff.. but I think an exception is justified here. What is going on???

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    1. I don’t have any insight into this. If the suggestion that Corker and Warner “will put forth new legislation shortly” was made in a public forum I didn’t see it, and if it was made privately I haven’t heard that directly from anyone I deem to be reliable (which is not to say it may not be true; I just don’t know).

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      1. This is Tim’s blog and I try to refrain from putting my (many) opinions on it, but….I strongly doubt if you can look to either Corker or Warner to do anything super positive for the GSEs (or their invetsors).

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        1. this ackman quote was contained in pershing’s 2Q ’17 letter to investors. this is a carefully crafted disclosure, so this was not some off the cuff remark. i dont have anything to add except to say that while ackman swings and misses from time to time, he rarely is unprepared or not calculating.

          rolg

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  20. tim

    i thought this article by pollock was interesting: http://thehill.com/blogs/pundits-blog/finance/346392-fannie-and-freddie-face-a-moment-of-truth-on-their-taxpayer

    as i recall, pollock is no friend of the GSEs, but he advocates recap scenario along the lines of the moelis blueprint. i expect you will disagree with his capital requirement, but at least he sees the light that once the GSEs hit the “10% return moment” the NSw should expire.

    safe and enjoyable travels

    rolg

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    1. ROLG, I thought the same thing about the 10% moment, but the way he calculates it is not right. It should be calculated as if the NWS never happened, and that therefore back when the DTAs were reversed and the huge income resulting returned to treasury, thereafter, the outstanding principal amount costing a 10% dividend would have been reduced accordingly. So, the 10% moment happened long ago, we are not on the cusp as the author posits.

      Cheers,
      Justin

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        1. I do not agree that Pollock “advocates [a] recap scenario along the lines of the moelis blueprint.”

          Pollock is one of many anti-Fannie and Freddie commentators who insists on repeating the fiction that the companies were “broke” and needed Treasury “to bail them out with a ton of taxpayer money.” He then goes on to assert that because of this failure and the (in his words) “massive systemic risk they represent,” before they can be allowed to operate as private companies again they must be required to meet his definition of “repayment” of the interest and principal of preferred stock forced on them that they didn’t need, accept an arbitrary fixed-ratio capital requirement unrelated to the risk of the business they do, and also have “most of their economic rents and special government favors removed.” Then, according to Pollock, they “would have a reasonable chance to see if they could be successful competitors.” Gee, thanks, Alex. And what if, with all the burdens you’d have placed on the companies, they CAN’T be successful competitors? The banks would get the business? Who ever would have guessed that?

          Those who advocate for workable, fair and consumer-oriented mortgage reform need to have friends on our side, but we also must be careful not to label people “friends” who really aren’t.

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          1. tim

            i guess my sense was that pollock is showing movement in a directionally positive way. he is still an antagonist, but if pollock can contemplate an end to nws due to a “10% moment”, maybe even folks like hensarling might as well.

            rolg

            Liked by 1 person

        2. In my posted dismissal of “friend Alex’s” column, I pointed out had the GSEs only been given the 5% bank repayment rate and terms–rather than the 10% GSE rate, later heavied up by the infamous “Third Amendment–we would be having a different discussion today because everything advanced by the Treasury would long have been paid back.

          As an advocate of that earlier treatment, Alex has his hands all over the resulting unfair mess and isn’t an honest broker.

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          1. @bill

            i agree pollock is not an honest broker…which is why i find this blog post relating to a “10% moment” interesting. yes it should have been a “5% moment”, but for those who live in the present, this seems to be a welcome development.

            rolg

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  21. Tim / ROLG

    Wondered if you cared to weigh in on the latest documents released and what implications if any you think they would have on any of the court cases?

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    1. Not much new in these three documents, although the emails between two FHFA officials affirming their knowledge of discussions at Fannie and Freddie about the likely impending release of the reserves on their deferred tax assets are further evidence (if more was necessary) that Treasury and FHFA imposed the net worth sweep to prevent the companies from beginning to rebuild their capital through retained earnings.

      I was more interested, though, in the motion filed yesterday by Cooper & Kirk asking Judge Sweeney to again consider authorizing the “quick peek” procedure to help plaintiffs identify which of the 1500 documents the government continues to withhold might contain information relevant to their case. The earlier request for the quick peek made by plaintiffs in March was denied by Judge Sweeney as being “premature,” but given the government’s prolonged objection to and foot-dragging on further document production, I suspect Sweeney may grant the quick peek this time. If so, that would both speed up the document production process and significantly increase the possibility that more documents will be produced (with some made public) in the relatively near future that are helpful to the plaintiffs’ case.

      * *

      This is probably a good time to inform visitors to this site that on Thursday, August 17, I will be leaving for three weeks of travel in Europe, returning on September 7. During that time I will be checking this site much less frequently than normal, so responses to comments also may be considerably slower. (Fortunately, this is a fairly slow season, as many others appear to be doing something similar to what I’m about to do.)

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  23. Tim,

    FHFA announced the results of the GSEs annual stress test in an severely adverse scenario. The incremental treasury draws are projected to range between $34.8b and $99.6b depending on the treatment of deferred tax assets. The severely adverse scenario assumes a severe global recession where housing prices decline 25% in addition to other negative variables.

    Given the relevant discussion regarding what is the appropriate capital buffer required for the GSEs, doesn’t FHFA attempt to solve that question with this exercise and that number is ~$100b or ~2% according to them? This is much lower than some are advocating for. Curious to hear your thoughts. Thanks

    Link: https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2017_DFAST_Severely-Adverse-Scenario872017.pdf

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    1. also tim, further to sso’s question, could you please explain the DTA column in the stress test analysis. am i right to think that this applies to the ability to claim tax relief going forward from 2019 for the losses incurred 2017-19, as opposed to treatment of any current asset account valuation?

      put another way, if in 2019 the GSEs predicts future profits, much as they did in 2012 relating to its then DTAs, then wouldn’t the required capital under this stress test scenario be that much less (about $65B combined)?

      rolg

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    2. The 2017 Dodd-Frank Severely Adverse Scenario Stress Test Results for Fannie and Freddie were disappointing, not because of anything having to do with the companies—their operating results were extremely impressive—but because FHFA continues to put out misleading and indefensible information about their financial condition.

      We’ll start with the operating results. Actual stress credit losses for the combined companies were just $19.2 billion, $14.1 billion below their projected pre-provision revenues of $33.3 billion, and just 0.38 percent of their average mortgage balance. At 38 basis points, Fannie and Freddie now can cover their stress credit losses with one year’s worth of guaranty fees—and no capital. That’s a superb result.

      So where do the negative overall figures come from? FHFA is inventing non-cash expenses to make Fannie and Freddie’s numbers look worse. (It also did this last year, which I discussed in an August 2016 post titled “FHFA Fails the Stress Test.”)

      FHFA starts with booking a loss provision of $55.9 billion. Why? Stress losses are only $19.2 billion. Why an extra $36.9 billion added to the loss reserve? A stress test is supposed to be a worst case; what’s left to reserve against? You can contrast what FHFA did with Fannie and Freddie with what the Fed did with the banks it stressed. In the 2017 Dodd-Frank stress test for banks (the same as the one to which Fannie and Freddie are subjected), banks had $383.1 billion in projected credit losses, or 5.8 percent of their total loans. Banks’ projected stress loss provision was $420.9 billion, or less than 10 percent more than their projected losses. The Fed didn’t add excessive and unexplained amounts to banks’ loss reserves in their severely adverse stress test; why did FHFA grossly inflate the companies’ loss reserves, when as a percentage of assets their credit losses are one-fifteenth those of the banks?

      FHFA also subjects Fannie and Freddie to a “global market shock” and “counterparty defaults.” The Fed uses the global market shock on only 6 of the 50 banks it stresses, and those are banks with “large trading and private equity exposures.” Fannie and Freddie have neither, yet FHFA invents and adds a non-cash charge in this category. The Fed’s counterparty default component is used on only 8 of the 50 banks—those with “substantial trading, processing or custodial operations;” Fannie and Freddie don’t fall into any of those categories either, yet FHFA adds still more non-cash losses there.

      And then there is the deferred tax asset reserve of $64 billion. That would only be booked if there was doubt about the companies’ future profitability. Here there is none—on an operating basis the companies are projected to be profitable during the stress period, and even with FHFA booking the bogus other non-cash losses noted above the companies immediately would return to profitability afterwards. There is ZERO justification for showing this $64 billion charge as a legitimate component of the stress test, but FHFA does it anyway, to inflate the figure for possible draws from Treasury.

      That’s the disappointing part. FHFA, and Treasury, continue to pretend that Fannie and Freddie are doing much worse than they actually are. This is what I wrote about in the current post: Treasury and FHFA keep saying things about the companies they know not to be true, and that fly in the face of readily available evidence to the contrary. I keep hoping this will change in the current administration, but so far it clearly has not.

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      1. tim

        fhfa states this in connection with release:

        “4. WHY ARE THE CREDIT LOSSES AS A PERCENTAGE OF AVERAGE
        LOAN BALANCE AT THE ENTERPRISES RELATIVELY LOW COMPARED
        TO THE AVERAGE CREDIT LOSSES REPORTED BY THE FRB FOR THE
        LARGE BHCS?
        As a rule, the large BHCs charge off delinquent loans after 180 days, which
        results in higher credit losses during the DFAST planning horizon. The
        Enterprises typically do not charge off delinquent loans until disposition of
        the property, which generally requires a significantly longer time horizon
        resulting in lower credit losses during the DFAST planning horizon.”

        Click to access 2017_DFAST_Severely-Adverse-Scenario_FAQs_872017.pdf

        would you like to comment? thanks

        rolg

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        1. also in FAQ 1 fhfa seems to assume that there will be huge losses arising from MI bankruptcies:

          “For example, FHFA expanded the counterparty
          default component to include counterparties related to the Enterprises’ singlefamily
          and multifamily guaranty businesses. These include mortgage insurers and
          providers of multifamily credit enhancements.”

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          1. tim, one last point on this from me: having GSE counterparty default losses be a higher percentage component than bank’s doesn’t make sense. banks have huge counterparty risk given their structured products and derivative transactions

            Liked by 1 person

        2. I’m surprised by FHFA’s statement. When I was CFO we made an estimate of the loss on a foreclosed loan when we acquired the property, and charged that amount off immediately, then did a “true-up” of the final loss when we disposed of the property. If Fannie now is waiting to do ANY charge-off until it disposes of a property, that’s awfully aggressive (the opposite of conservative)–they know they have losses but aren’t booking them. I’ll have to look into that.

          I also note that in the 2014 stress test, Fannie and Freddie’s projected stress losses were $92.4 billion and their stress provision for loan losses was “only” $110.7 billion. Did the companies change their method for accounting for loan losses–again to be much less conservative–between 2014 and 2017, or is FHFA just being arbitrary with the amount it assumes to be added to their reserves, in order to produce a pre-determined result?

          As I mentioned in “FHFA Fails the Stress Test,” FHFA could avoid these non-cash entries entirely if it did a true, cash-based stress test, as Fannie did for years. You assume a realistic scenario for a home price decline–say 25 percent nationwide peak-to-trough, over a five year period–then project Fannie and Freddie’s income and expenses, by line item, in cash for as long as it takes to produce a peak in cumulative credit losses. That’s your required capital number.

          [Addendum to this answer, having just seen your comment on MI losses: That’s very interesting. Treasury and FHFA want Fannie and Freddie to do even more loss sharing with the MIs, so I guess they’ll tell them: “Oh, wait; the MIs don’t have enough capital to cover the loss sharing you’re doing with them now, so on that future loss sharing, none of it’s going to be any good. But we want you to keep adding to your MI counterparty losses regardless.” This makes no sense at all. Either FHFA is making up the MI losses in the stress test, or they are being grossly incompetent as a regulator in pushing Fannie and Freddie do more loss sharing with these entities.]

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      2. Tim,

        This sounds like a conspiracy against the GSEs with complicity even within the GSEs.

        1. Why isn’t anyone speaking out other than you?

        2. Do you think Mnuchin and Watt are aware of this accounting manipulation?

        Thx.

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        1. I’ve done some research on the explanation given by FHFA for why the increase in Fannie and Freddie’s loss reserves during their Dodd-Frank stress test is so much greater than what the Fed shows for banks in the same test.

          In its “frequently asked questions,” FHFA says that while “the large BHCs [bank holding companies] charge off delinquent loans after 180 days,” Fannie and Freddie “typically do not charge off loans until disposition of the property,” which takes much longer than 180 days, and therefore warrants a large increase in Fannie and Freddie’s loss reserves to account for this delay.

          In the response I made when I first heard about this explanation, I said I was surprised by it, because it didn’t square with how Fannie charged off loans when I was CFO. It turns out it doesn’t square with how Fannie does its loan charge-offs today, either.

          In Fannie’s 2016 10K, the company describes its loan charge-off policy this way: “For the majority of our delinquent single-family loans, we charge off the loan at the date of foreclosure or other liquidation event (such as a deed-in-lieu of foreclosure or a short sale). For a subset of delinquent single-family loans, we charge off the portion of the loans that is deemed uncollectible prior to foreclosure when the loans have been delinquent for a specified length of time and meet specified mark-to-market loan-to-value (“LTV”) ratios.” The “specified length of time” for these other loans is after 180 days of delinquency, as indicated in a rule from FHFA put into effect in 2015, which says, “A current assessment of value should be made before a single family residential loan is more than 180 days past due. Any outstanding loan balance in excess of the fair value of the property, less cost to sell, should be classified Loss when the loan is no more than 180 days delinquent,” adding, “Regulated entities should charge-off the portion of the asset adversely classified as Loss.”

          So—Fannie currently charges off its single-family loans either at 180 days or EARLIER, at foreclosure, not at “disposition of the property.” That’s at least as conservative as what the banks do. I have no idea why FHFA misstated the company’s charge-off policy in its “frequently asked questions.”

          I have brought the language in Fannie’s 10K and the FHFA advisory bulletin to the attention of Joe Light at Bloomberg, who wrote that I “misread that stress test” because I didn’t understand how the companies did their charge-offs. (I asked Joe if he thinks I missed anything, and have not yet heard back from him.) I also will send a note to a couple of officials at FHFA, bringing to their attention what I believe to be an error in their “frequently asked questions” about the Dodd-Frank test, and noting that because of this error the increase in Fannie and Freddie’s loss reserves during the stress test is both arbitrary and unreasonable, and in any event at great variance with what the Fed records for the banks.

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          2. Tim

            Seems to me there is either a big story here or an innocent explanation. Either way this should be cleared up. Thanks for making inquiries.

            Rolg

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          4. Tim

            It would be interesting to see how all of the CRT perform under the stress tests, whether and to what extent they perform their intended role. Fhfa “should” be transparent about this since CRTs are a new initiative mandated at fhfa’ insistence and the stress test is a real world scenario where their performance is very relevant to assessing their usefulness.

            Not sure how you can get that data but I would love to see your analysis of it.

            All best.

            Rolg

            Liked by 1 person

          5. I don’t know whether FHFA incorporates Fannie and Freddie’s CRTs into their stress analyses, although I would think they would. But the Dodd-Frank stress test scenario is not realistic, either for banks or for Fannie and Freddie–the time period is too short, and for housing the home price decline occurs much too quickly–and so the CRT results wouldn’t yield much useful information about their performance in an actual stress scenario. That’s one of the many reasons why I continue to recommend that FHFA do a customized, historically derived, cash-based stress test for Fannie and Freddie.

            Liked by 2 people

          6. Has the FHFA or Joe Light given you any type of confirmation to your response?Have they said that they would get back to you on the issue, in other words?

            Like

          7. It’s now been two weeks since I sent my note to the two FHFA officials. They have not responded, and at this point I suspect I won’t hear back from them. I did not expect to get any useful response from Light (and didn’t).

            Liked by 1 person

  24. Tim, this is from WSJ today and the author Ackerman (not to be confused with Bill Ackman) quotes FHFA officials.

    https://www.wsj.com/amp/articles/fannie-freddie-signal-possible-payment-delay-as-debt-ceiling-looms-1501795451

    ‘If Fannie and Freddie don’t make their payment at the end of September, they would be expected to make it at a later date. Any change in the payment arrangement would be designed to delay the dividend, rather than to allow Fannie and Freddie to begin to permanently retain their earnings, FHFA officials have said.’

    If the goal of retaining capital is to shore up the entities to avoid a draw if there is any earnings volatility and/or tax reform, what would be the point of delaying the dividend just to pay it later and put the companies in the same dire position again? Does this make any sense?

    thanks

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    1. I don’t subscribe to the Wall Street Journal and so haven’t read the article, but with that caveat I would say that this seems to be a fairly straightforward issue. Watt is talking about not making net worth sweep payments for a temporary period of time so that Fannie and Freddie can build up capital buffers sufficiently large to prevent a future draw from Treasury in the event of short-term accounting-related earnings volatility (and perhaps also in anticipation of a loss from write-downs in the companies’ deferred tax assets in the event of a cut in the corporate tax rate, although Watt has not mentioned that specifically). Fannie and Freddie still would technically “owe” any withheld sweep payments–and thus would “be expected to make [them] at a later date”–but as long as Watt felt the companies needed a capital buffer that “later date” would be pushed off indefinitely, or until the net worth sweep either was dropped as part of a settlement negotiation or ruled invalid by a court.

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    2. also tim, further to alec’s question, could you please explain the DTA column in the stress test analysis. am i right to think that this applies to the ability to claim tax relief going forward from 2019 for the losses incurred 2017-19, as opposed to treatment of any current asset account valuation?

      put another way, if in 2019 the GSEs predicts future profits, much as they did in 2012 relating to its then DTAs, then wouldn’t the required capital under this stress test scenario be that much less (about $65B combined)?

      rolg

      Liked by 1 person

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  25. “In a reform proposal Zandi and several partners released last year, the future Fannie and Freddie were envisioned as almost utilities, guaranteeing mortgages through a common platform for standardized, homogenized securities that allows them to share the risk with the private sector.”Mark Zandi
    Tim,
    What is your take on above comment “were envisioned as almost utilities ‘
    Thanks

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  26. From zandi: ““Here we are coming on nine years later, and they’ve done what they needed to do,” said Mark Zandi, chief economist for Moody’s Analytics. “That’s appropriate. Before the crisis these institutions were basically large hedge funds and now they’re mortgage guarantee funds. People think they’ve been standing still but they’ve evolved into what we want them to be.”

    http://www.marketwatch.com/amp/story/guid/01BE886A-785F-11E7-AA20-463FA534051F

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  28. tim

    i found this bill to mandate GSEs to use alternative credit scoring to be interesting: http://www.marketwatch.com/story/bipartisan-senate-bill-would-require-fannie-mae-freddie-mac-to-use-alternative-credit-scores-2017-08-02

    interesting not so much with respect to the merit of the notion that expanding beyond FICO scores may make sense, but rather that congress may end up “reforming” housing finance in one-off bits and pieces, like this bill, and not be able or willing to adopt what may be called an “obamacare” approach to housing finance reform, such as the massive overhaul that MBA is pushing for and that corker/warner may in their dark hearts be interested in.

    the more of these bits and pieces housing reform bills the better…

    rolg

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  29. Click to access 063017.pdf

    I noticed that FNMA in its latest monthly summary separated out delinquency rates for before and after the financial crisis. It demonstrates clearly the GSEs are holding high quality loans post-2007. If the GSEs were not really in financial trouble in 2008, with many no new-performing loans, how would they even get into any trouble now with almost all high quality loans?

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    1. I hadn’t noticed Fannie’s new delinquency disclosures; I appreciate your pointing that out.

      From 2003 through the end of 2016, Fannie had published its total single-family delinquency rate, then broken it into two components: credit enhanced (i.e., having private mortgage insurance or some other form of risk sharing) and non-credit enhanced (with Fannie holding all of the credit risk). This January it changed the delinquency disclosure slightly: it gave the total and non-credit enhanced delinquencies as it had done previously, but re-named the “credit enhanced” category– calling it “credit enhanced-primary MI and other”–and added a new column, “credit risk transfer,” which is a subset of the “credit enhanced-primary MI and other” column (that is, the loans that are used to calculate the “credit risk transfer” delinquency rate also are included in the “credit enhanced-primary MI and other” category).

      Then, in May, Fannie made two more changes to its single-family delinquency disclosures. The first was purely cosmetic: it renamed the total delinquency rate the “overall” delinquency rate (it’s still the same number). But it also added a new breakout of that “overall” delinquency rate, by groups of origination (or “vintage”) years: 2004 and prior, 2005-2008, and 2009-2017.

      On the vintage year breakout, Fannie is emphasizing how different the credit quality of its post-bubble books of business is from even the pre-2005 years (although at this point that’s a somewhat misleading comparison; only 4 percent of Fannie’s current book is from before 2005, and the reason most of those loans are still around is that they have credit problems, and can’t refinance). The more relevant comparison is between Fannie’s delinquency rate this year on its 2009-2017 book–which in the first half of this year has averaged 34 basis points–and the delinquency rate on Fannie’s total book of business in 2003 and 2004, just before the bubble began, which averaged 58 basis points. This comparison highlights how much better Fannie’s current book is even than the one it had at the end of 2004, before it added all the lower-quality 2005-2008 books that caused the bulk of its losses in 2008-2012.

      Finally, I’d note that the delinquency rate Fannie now is publishing on the loans backing its CRTs has averaged a minuscule 16 basis points this year. These are the loans Treasury and FHFA are requiring Fannie to insure against up to 400 basis points of credit loss, which is eight times the 50 basis point loss rates experienced by Fannie’s 1999-2003 books of business leading up to and during the financial crisis. As I noted in the current post, these CRT deals are just burning up Fannie’s revenues.

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      1. tim

        wouldn’t it make sense to do crt transactions on segregated pools of mortgages that for underwriting reasons offer the greatest risk of delinquency? the insurance will cost more, but you get what you pay for.

        rolg

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        1. The simple answer is that the issuance of CRTs should not be mandated—not by a regulator (as is the case currently) and certainly not by legislation. Making CRTs mandatory virtually guarantees that the majority of them will not be economic.

          The reason advanced for making Fannie and Freddie issue CAS and STACRs today is that they have no capital, and CRTs give them some protection against a severe credit loss scenario they wouldn’t have otherwise. The argument essentially is, “the CRTs may not be economic, but it’s the only way the companies can protect against a repeat of the last housing meltdown.” In my view, though, that’s just compounding an error. The government already has made a huge mistake by keeping Fannie and Freddie in indefinite conservatorship—even though they have returned to financial health—and confiscating all of their capital. To then force them to issue non-economic CRTS, which will cost them more in interest expense than they have any reasonable chance in recouping through reimbursed credit losses, only weakens their ability to absorb, through their annual earnings, the credit losses that do occur.

          In a reformed mortgage system, the context of CRTs will change. Credit guarantors will be given some specific amount of equity capital (which I hope will be risk-based, not ratio-based) that they will be required to hold. For a guarantor then to have any incentive to issue a CRT, two things would have to happen. First, the regulator would have to give the guarantor capital relief as an offset to the interest expense of issuing the CRT, which will require the regulator to determine the “equity equivalence” of the CRT structure being proposed (which is not an easy task). Next, given the equity equivalency from the regulator—e.g., for every dollar of face value of the CRT the guarantor will be relieved of xx cents of its equity capital requirement on the insured loans—the guarantor will need to determine whether that amount of equity capital relief makes economic sense, given the cost of the CRT in question.

          I don’t think there will be much of an argument about the framework for deciding on CRT issuance in a post-conservatorship world; the argument is over what Fannie and Freddie should be doing now. If it were up to me I would allow Fannie and Freddie to determine which loans, if any, they insure with CRTs, based on their assessments of the economics of the transactions. I doubt, however, that FHFA and Treasury intend to let them do that, at least not in the near term.

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  30. Tim,

    http://otp.investis.com/clients/us/federal_homeloan/SEC/sec-show.aspx?FilingId=12200956&Cik=0001026214&Type=PDF&hasPdf=1

    http://otp.investis.com/clients/us/federal_homeloan/SEC/sec-show.aspx?FilingId=12031567&Cik=0001026214&Type=PDF&hasPdf=1

    Note 15 on Regulatory Capital from this Q to last Q, a lot of different language but this stuck out “We are now working with FHFA on the implementation of the CCF” (conservatorship capital framework). Do you think this means anything? Or am i just trying to read into something thats not there?

    Thanks

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    1. I’ll have to do some research on the Conservatorship Capital Framework. The concept rings a bell but I haven’t been able to find any mention of it in any of the obvious places. My recollection is that it has something to do with Fannie and Freddie having common assumptions about the amounts of notional capital they should be using in setting their guaranty fees while in conservatorship, but I can’t recall what those assumptions are supposed to be based on.

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  31. Thank you. This sums things up nicely. Historically, the Fed, Treasury, certain members of Congress and the WH have been in an revolving door of monetary self favors through manipulation, fake news, deception, fraudulent accounting and well lets just say it ….frank corruption; with laws passed on false pretense to protect them (HERA, etc). The losers will be the small banks, the home owners, minorities and middle and lower bracket taxpayers. The winners, the big banks, certain lobbyists, select congressmen and likely post white house officials along with the ultra rich. Under the table and hidden in the “closets” and one would be totally naive not to assume this, would be bribery, collusion, threats and likely worse. In this atmosphere, can we truly believe that our current administration and Treasurer will do the right and logical thing (logic in terms of what is best for the country) or simply follow suit? This is our “banana” republic (judge Brown).

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  32. Tim, great piece perhaps we need two more items to make this work.
    1: access to Fed discount window in emergency
    2: legal victory with court cases to restore stolen capital

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  33. Tim,

    Thoughts on wording? I realize it would be speculative but we gotta pass the time someway.

    “If the Conservator declares a senior preferred stock dividend equal to our dividend requirement and directs us to pay it beforeSeptember 30, 2017, we would expect to pay a dividend of $ 2.0 billion by September 30, 2017.”

    Click to access 2017er-2q17_release.pdf

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    1. I believe based off the 3 new paragraphs added to the 10-Q filing today in the “CONSERVATORSHIP AND GOVERNMENT SUPPORT FOR OUR BUSINESS” section, it is clear they are discussing the possibility of not paying the dividend this Q, but nothing FIRM yet.

      In previous Q it was always implied dividend will be made. Watt (FHFA Director) made it clear in his last Senate hearing that the dividends don’t get paid until he declares them, and he can stop the dividends by simply not declaring them. Consistent with his view at the hearing, the language today (quoted above) implies that IF he doesn’t declare the dividends by 9/30/17, they won’t get paid. There is also new language describing in detail what were to happen IF the dividends were not to be paid, the amount will get added on to the UST’s liquidation preference: “If for any reason we were not to pay the amount of our dividend requirement on the senior preferred stock in full, the unpaid amount would be added to the liquidation preference, but this would not affect our ability to draw funds from Treasury under the Purchase Agreement.” Why add language about what happens in the event of FHFA not declaring the dividend if you plan on declaring it?

      Curious as to Tim’s insight on the language change.

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      1. This change in language in Freddie’s second quarter earnings release points the spotlight right at Director Watt. Based on this language, I now would expect him not to declare second quarter sweep dividends (payable on or before September 30) for either Freddie or Fannie. Watt has said that he is concerned about having the companies’ capital go to zero at the end of this year, and that he believes they should have a buffer of capital to protect against short-term accounting-related earnings volatility. He has the authority, in HERA, to create that buffer by withholding sweep payments for as long as he believes it will take to create a buffer of a size he deems to be prudent. And Freddie has just said, “It’s up to Director Watt.” (Freddie, in its release and as a disclosure, also reminds people that if Watt does allow it to forego any sweep payments, those amounts would be added to Treasury’s liquidation preference.) The only reason Watt WOULD make the payment is that Treasury wants him to, but HERA makes FHFA an independent agency not subject to the control or direction of any other agency (including Treasury). I know that since before the conservatorship both FHFA and Treasury have blatantly disregarded that provision, but in my view that’s all the more reason to adhere to it this time. We’ll see on September 30, but I’d now be VERY surprised if sweep payments are made then.

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        1. I hope Watt does the right thing and stops the sweep and starts acting like a real Conservator.
          However, I’ve just read this exchange from Freddie’s earnings call:

          “Joe Light
          Hi, good morning. I was wondering if you could walk through the changing language in the press release around the dividend concern: I guess why you guys decided to change it now, whether you received any indication that you might not make the planned dividend payment, and also to kind of walk through what happens in terms of the liquidation preference and all that if for whatever reason the full payment is not made this time.
          Don Layton
          Okay. You’ve asked two questions. The first one, the language is just being tightened up to be more technically accurate with the legal obligation. There is no implication about any change in that. If we were direct – we are directed to pay dividend or not by the FHFA, it is not in our discretion. If we were directed not to do so, under the existing terms of the existing PSPA, the amount not paid would be added to the liquidation preference, so we will just technically owe it at a later date.
          Joe Light
          Got it. So you’re saying you’re tightening up the leverage a bit, but I guess what you said would have been true any quarter, right? And the PSPA haven’t changed since 2012. So I guess what’s driving the change now?
          Don Layton
          Yes, the technicality is, we’re saying what our dividend will be; however, we don’t get directed to pay the dividends well past the date of the 10-Q or 10-K being issued. So we actually don’t know we’re supposed to pay it or not until we see that direction from the FHFA.
          Jim Mackey
          And we looked at that language last quarter. I think we tweaked a little bit then and we’re constantly looking at the press release and updating things and speaking them.
          Don Layton
          Okay. That was Jim Mackey, our CFO, by the way.
          Joe Light
          Got it. And I guess we’ll try this one last time, but what you just went through that was through any question, right? So are you saying that Watt’s testimony in May, for example, had nothing to do with it?
          Don Layton
          Correct. “

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          2. If nothing had changed then the language wouldn’t have changed. If nothing changed and the language needed to change then you are admitting that you got it wrong before. If Fnma has same language then I think fhfa must have been proactive. Guess we’ll see 9/30

            Rolg

            Liked by 2 people

        2. I think there’s a 50/50 chance the money is still paid on Sep 30 because 1) The debt ceiling may remain unresolved, 2) Watt is carefully ramping up in stages to fulfill his push on Congress to act, 3) The $5 billion RBS mtg fraud settlement will be part of Q3 earnings, which will be a much bigger amount to start withholding dividends at that point.

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        3. Thanks, Tim. So, it would seem that because Freddie cleared out a side for Mel to take it to the hoop, things look more promising. I’ll take it, but what a sad commentary on our state of affairs. 🙂

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        5. I must say, this sounds more like a short term concern. I’m patiently waiting for a long term solution and sticking with the GSEs no matter what Watt decides to do with the sweep.

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        6. Hi Tim,

          I may have it wrong (I am not a lawyer so maybe you or ruleoflawguy have more insight), but in my reading of the amended paragraph 2(c) in the amended PSPA, it appears to differentiate payments in-kind before and after December 31, 2012. It seems to allow in-kind payments at 12.0% by increasing the liquidation preference up to that date, and is then silent about it after that date. I presume the people that wrote that did not anticipate either 1. the GSEs still being around 5 years after they implemented the sweep, or 2. that there would be an instance whereby the dividend was not paid in cash since the purpose was to take all of the cash by January 1, 2018. Based on my reading, my first thought was that if FHFA decides not to pay the dividend, it violates the agreement. On further reading though, going back to paragraph 2(a), it seems clear that a dividend is only payable “if declared”, so I think the board/director can decide not to declare a dividend AND it does not accrue liquidation preference after December 31, 2012. I suspect that in that case, the only way Treasury can demand the money is to file a lawsuit claiming their right to the dividends was wrongly taken away. At that point, I am sure politics would create quite a fog. Thoughts?

          Cheers,
          Justin

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        7. Fannie Mae inserted similar “IF DECLARED” language into their 10-Q today. I would note that If Watt were to not declare the dividends, it would be per the terms of the SPSPA as Mnuchin mentioned on May 18. No changes in the agreement would be needed and Watt can do it without the consent of the Treasury.

          source: http://www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2017/q22017.pdf (Pages 8-9)

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          1. Still, Uncle Sam is facing debt ceiling by the end of September. It would be too tempted NOT to grab the $5B+ from Q2 (both Fannie and Freddie) to help our government’s credit afloat. A perfect storm is forming in front of our eyes. If Senate’s failure to pass any version of the healthcare reform (given that all signs pointing to the impossibility) was any guide, I am afraid that the government would wait for the last minute without a backup plan that might eventually rattle the market, and drag the GSEs resolution further to the future. On the other hand, Honorable Judge Sweeney’s court may also give us some unexpected news, if Fairholme decides the Discovery is done and can be moved to the next phase of judgment?

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          1. I have a different view– I believe the drama around the debt ceiling is something that is going to (and, because of the politics involved, really has to) play out irrespective of whether Treasury has Fannie and Freddie’s $5 billion or not. There is a coincidence of dates, but I don’t see the payment, or non-payment, of the SPSA dividends as having any substantive impact on what happens with the debt ceiling.

            Liked by 1 person

          2. Just for what’s it’s worth, take a look at the link below. $5 billion is quite a bit of money, even for the US government. Anyway, just as a basic financial matter. What company has ever announced a dividend without at the same time announcing it will be paid as a PIK? It seems crazy to even suggest the possibility that the September dividend won’t be paid in cash.

            “President Donald Trump himself is already in demand-making mode: On Tuesday, he threatened a government shutdown at the end of September if he hasn’t gotten money for his border wall (which Congress was unwilling to give him in April).” https://www.vox.com/policy-and-politics/2017/8/23/16112322/immigration-congress-trump

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          3. But how much time would $5B buy in terms of a government shutdown? A few days? Trump’s border wall will cost much more than that anyway.

            What *would* get that wall built is the ~$100B from the exercise and sale of the warrants in the Moelis plan. Just sayin’….

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      1. Every now and again the “draw would be good” assertion comes up. It wouldn’t be good, no way no how. It’s easier to squelch floundering companies than thriving ones. GSE bashers can spin the former scenario but not the latter one. Why else would’ve Corker tempted Watt to take a draw?

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    3. Fannie’s last declaration added the word “scheduled” to no avail. Ambiguous language aside, I’d suspect language shift is to show intentions emanate from FHFA as opposed to UST, or higher.

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  34. Tim

    Reading this post made me incredibly nauseous yet again in thinking about what has transpired here. Someone else just posted as well about HERA and this painful reminder that the government can do whatever whenever and have this successful roadmap now to strike again if needed. What a disgrace by public servants with no regard to a moral compass.

    You keep reiterating that the court process should put pressure on the administration but absent any court rulings in favor of the plaintiffs would you submit that at some point administrative reform will happen anyway since Mnuchin understands the game that was played here?

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    1. I take Mnuchin at his word that he still wants to get Fannie and Freddie out of government control, and that he won’t just passively accept the status quo. I have no insight into how well he “understands the game that was played here,” but he is knowledgeable about the mortgage business and has spoken to enough people about reform issues that I suspect he is aware of at least some of the problems with Treasury’s past stance on Fannie and Freddie that I mention in my post. Even so, I think a catalyst of some sort in one of the court cases will be necessary to get him to move on administrative reform within, say, the next year or so. If the government keeps getting victories in the courts, it will be tempting for Mnuchin to use the lack of action on legislative reform in Congress as a reason that it’s still premature for him to act administratively.

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      1. My point being, this large portfolio of mortgages will need to be held somewhere, even if the GSEs are replaced or reformed. This risk will still exist somewhere, needing to be safeguarded, regulated and controlled to prevent a future financial crisis. I don’t think Credit Risk Transfers would be sufficient to prevent any crisis, if strong credit and interest Rae standards are not in place.

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  37. Ok, let’s score this…

    As a running tally not only has the “death spiral,” third amendment (aka NWS) narrative been completely debunked – we may now no longer grant the benefit of the doubt that has come to be known as the initial “fog of war” decision to exile Fannie and Freddie.

    To add insult to injury, the perpetual refusal to allow Fannie and Freddie to retain capital can only corroborate the original intention of the Tsy not to allow the FHFA to function as a true Conservator.

    I believe Secretary Mnuchin has an affinity to the movie industry. I’d say he has a real doozy in this ordeal.

    What am I missing?

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    1. That refusal to allow a small capital buffer still baffles me just because it seems to have no logical purpose to further conservatorship, to push receivership, to help housing, to help taxpayers, or to help treasury if it was acting in the interests of taxpayers (I know they were not acting in taxpayers or homebuyers interests, but they have to at least be able to lie about it in a way that doesn’t make it obvious). Do any documents uncovered so far in Fairholme discuss what the thought process was in implementing the capital buffer reduction to zero? Why do it at all and why pick that date?

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  38. Mr. Howard,
    Great piece of revealing the truth. Tim appreciate if you will allow any one of us to send this as letters to editors of leading newspapers on behalf of your name or we send it ourselves quoting the entire article.
    Thank you.

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      1. Tim, unfortunately no one is listening to us and no one seems to care. The true facts are not heard at the top (Trump as an example). The hedge funds seem to have connection but I don’t think so: we are going in circles. No one seems to know that 18 banks paid huge fines to the tune of 100 billion to Fannie and Freddie accepting wrongdoing and over 150 billion has been paid to government in mortgage fraud. It is clear big banks (aka MBA) was at fault but they keep singing the same tune. How do you think the truth will come out and this is done correctly?

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        1. I think it would helpful if we get some mainstream journalists digging into this. Gretchen Morgenson is doing some of this at the New York Times, but we need more. The document releases are a good “news peg” for stories, and I hope they continue to come (only a very small number of the initially withheld documents have been unsealed and released so far).

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        2. To your point, I’ve often wondered how the former Treasury Secretary could unashamedly receive into the treasury coffers substantial settlements on nearly twenty straight(!) lawsuits against the TBTF banks yet not speak out against certain prominent pro-bank elected officials who would turn the entire mortgage industry over to these very culprits who falsified loan documents and all the rest.

          Still hoping the Trump administration distances itself from the former administration by setting ALL wrongdoings right. To do that they must drain the swamp as promised and be an example of ethical standard by REFUSING to profit from the egregious transgressions of their predecessors.

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  40. Tim,

    Would you be able to elaborate on any level of safety that even a small capital buffer would provide junior preferred shareholders as it relates to the contractual agreement in the stock certificates? If a small capital buffer was initiated, some are under the impression that junior preferred holders would at minimum be able to realize their stated liquidation value at a future point in time.

    This post isn’t meant to pose a speculative question, rather it is to understand the contract agreement as it directly relates to any type of modification to the NWS.

    Thanks.

    Liked by 1 person

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    1. If Mel Watt were to decide to withhold Fannie and Freddie’s scheduled net worth sweep payments in order to build a capital buffer against potential accounting-related earnings volatility at the companies (and some have speculated that Freddie’s second quarter earnings release, due to come out tomorrow morning, might have some wording that signals Watt’s intent in that regard), I do not believe it would have any implication for the value of Fannie or Freddie’s preferred stock, other than whatever meaning investors might read into that action.

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      1. @brian

        agree with tim. for the junior preferred to have value, either the NWS has to be invalidated or modified, or a court must have found that the junior preferred stockholders have suffered a corporate contractual breach or a constitutional taking by the issuance of the NWS.

        rolg

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  41. This post needs to be circulated among all of the major media outlets. It’s proof of the feeling that most Americans have had about the Federal Government that led to the election of Trump. That we are being lied to and that they are not serving us as elected officials but instead serving their interests at the expense of the Taxpayer.

    This is by far the most comprehensive analysis of the released documents, Tim. You’ve gone above and beyond to provide a comprehensive breakdown of what has really occurred. We have been lied to by two administrations for almost a decade. Two parties of “public servants”. If there ever was an argument for “draining the swamp” this post is it.

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  44. Thank you Tim for a well-written, well thought out piece. It still leads me to wonder … why the boards of Fannie and Freddie ever went along with this? Were they simply stupid and scared by the evolving crisis? Did they see the offer to lose any liability risk as a “get out of Dodge free” card and were solely interested in saving their own skin? It just seems incredible to me that Paulson could get these directors to sign off on allowing him to steal the company. What’s the point of having a board that’s the first to jump ship in a crisis?

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    1. I really don’t blame the boards for not fighting harder. Fannie’s board thought about fighting–and had the top banking lawyer, Rodgin Cohen of Sullivan & Cromwell, advising them–but they concluded that with Treasury’s determination to put them in conservatorship. which Paulson made very clear, and in the economic, financial and political environment they were facing at the time they had no chance of winning a fight against their regulator and Treasury. But, yes, I think the clause in HERA exempting them from shareholder lawsuits for “acquiescing or consenting in good faith” to the conservatorship made that decision easier.

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      1. Unfortunately, I think the boards’ consent means that the condition in section 1367(a)(3)(I) of HERA was fulfilled in regards to being able to place the companies into conservatorship.

        https://www.govtrack.us/congress/bills/110/hr3221/text

        Do we know if FHFA ever publicly gave its reasons for the conservatorship? More specifically, which of the twelve reasons did they cite? And do those reasons still apply given the information in the released documents?

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  45. Tim,

    Great post again! The evidence is becoming very clear and yet the end result is still so uncertain.

    What can/should the average shareholder be doing to help? It feels like we’re helplessly watching the court cases and writing my congressmen results in form-letter responses.

    Liked by 1 person

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  46. tim

    great piece as always.

    this piece should be part of a presentation made to senate banking committee in another round of hearings so as to put the corker/warner agenda into its proper historical perspective. a reality check, in other words.

    all best

    rolg

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  47. Hi Tim,

    Thank you for this excellent piece. The most important thing here is there’s no more guessing works, everything is laid out in the flesh. Which brought me thinking: what’s stopping the existing plaintiffs (or new plaintiffs) from going after Treasury and FHFA on the original conservatorship in the light of all these FACTS? Why continue to fight the NWS that can’t get around HERA and the powers of the conservator. Especially when it seems so blatantly obvious and I would even think it’s easier for the Judges to make a right call. I mean, this fraud can be easier to prove with the black rock reports and subsequently accounting abnormalities. And it’s a simple yes and no. Isn’t it?

    RF

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