Waiting for Mr. Corker

~ jtimothyhoward

Early in December Politico, Bloomberg and the American Banker each published an article on the same day revealing that Senators Bob Corker and Mark Warner were circulating a draft of a revised version of their mortgage reform proposal from four and a half years ago, and also that House Financial Services Committee chairman Jeb Hensarling had dropped his long-held opposition to government guarantees on mortgage-backed securities to now join Corker and Warner in supporting them. The impression conveyed by these coordinated articles was that a new consensus had emerged around mortgage reform legislation that would make its chances of success much higher than the original Corker-Warner bill. Mortgage Bankers Association (MBA) president Dave Stevens, who very likely was one of the sources for the articles, expressed his enthusiasm and optimism to Politico, saying, “It’s exciting that this effort is finally coming to reality and there’s a lot of positive buzz about what may come out.”

The year-end burst of activity—and publicity—around reform legislation seemed to have been triggered by a confluence of factors: increased speculation that the director of the Federal Housing Finance Agency, Mel Watt, might allow Fannie Mae and Freddie Mac to begin withholding payments due to Treasury under the net worth sweep agreement in order to build capital buffers (which subsequently turned out to be true, although the buffers were limited to $3.0 billion for each company); passage of the tax reform bill, which cleared the way for Congress to consider other legislation, and perhaps most importantly the announcement in September by Senator Corker—who for many years has been the most active Senate proponent of replacing Fannie and Freddie with a bank-centric alternative—that he intended to retire when his term expires at the end of this year.

Following the Politico, Bloomberg and American Banker pieces numerous articles were written, papers released, statements made and speeches given about what might or should be in what quickly was dubbed “Corker-Warner 2.0.” And in mid-January FHFA director Watt weighed in with his views on reform. In a letter to the chairman (Mike Crapo) and ranking member (Sherrod Brown) of the Senate Banking Committee, Watt reiterated his “strongly held view that it is the prerogative and responsibility of Congress, not FHFA, to decide on housing finance reform.” He further told Crapo and Brown that in response to “a number of new or renewed requests” he was providing a seven-page paper titled Perspectives on Housing Finance Reform “for your information and for distribution to Committee members who have requested our views, and to others at your discretion.” When this FHFA paper was made public, advocates of all variants of reform alternatives predictably found elements in it that they contended supported their view of what was likely to happen next.

Then, on January 30, an actual draft of Corker-Warner 2.0—labeled “staff discussion draft 29”—appeared, apparently through a leak. While several sources said that draft 29 was not the most current version, and that changes have since been made to it, the fact that the leaked document was the twenty-ninth draft meant that it was the product of a considerable amount of time, thought and effort.

Draft 29 is an undisguised attempt to write the bill that the banks, and the MBA, have been asking for. The seven “Purposes of the Act” on page 1—adding an explicit government guaranty to mortgage-backed securities; protecting taxpayers with private capital and a guarantor-paid Mortgage Insurance Fund; ending “Too Big to Fail”; promoting competition through multiple credit guarantors; financing affordable housing with guarantor-paid fees; accommodating lenders of all sizes, and providing for a smooth transition to the new system—mirror seven of the ten principles in the MBA’s April 2017 proposal, “Creating a Sustainable, More Vibrant Secondary Mortgage Market.” And the three MBA principles that aren’t explicit purposes of the Act—a “bright line” between the primary and secondary market, preserving where possible the existing Fannie-Freddie infrastructure, and re-establishing the private-label securities market—are addressed in it somewhere.

Early reaction to draft 29 has been, to put it mildly, unfavorable. Affordable housing and civil rights groups, as well as community lenders, have been harshly critical of it, as was Senator Elizabeth Warren, who upon reading the draft put out the following statement: “I appreciate the dedication Senators Warren and Corker have shown to addressing this critical issue, but this draft isn’t even close to a solution that works for families who hope to buy homes. This draft bill would disrupt the housing market, raise mortgage costs, sharply reduce mortgage access, and create new, private Too Big to Fail institutions. This bill would end up creating more problems than it solves.” Yet the statement that best captures the failings of draft 29 is one made by novelist and Francophile Gertrude Stein more than eighty years ago: “There is no there there.”

The objectives of draft 29 are to create 5 or 6 new credit guarantors, require them to hold enough capital that the government can add its explicit guaranty to their securities without putting the taxpayer at risk, and then, once the new guarantors establish themselves in the market, put Fannie and Freddie into receivership and liquidate them. But it’s clear from the draft’s 82 pages of text that neither its authors nor those who have been advising them have yet figured out how to accomplish these objectives. Instead, they rely extensively on two techniques: offering a soup sandwich of provisions designed to reflect the wishes of different special interests without attempting to reconcile their obvious inconsistencies (as in the proposed capital structure), and delegating to FHFA, or in a few cases Ginnie Mae, the responsibility for overcoming the financial, operational, legal and market challenges of chartering and capitalizing the new credit guarantors, getting them established without jeopardizing market liquidity, meeting affordable housing needs, and liquidating Fannie and Freddie without triggering an avalanche of new lawsuits—all after the bill has passed (which, in light of this feature, it has no chance of doing).

So, how is it possible that a process begun almost a decade ago, which has had so many people working on it so intently for so long, could produce a result so empty and unimpressive? To understand this, you only need to know one thing: legislative mortgage reform is not, and never has been, about reducing the cost and expanding the availability of mortgage credit for consumers, or making the system safer for taxpayers; it’s about reducing the secondary market power of Fannie and Freddie to give more primary market power to the large commercial banks.

The Milken Institute, a staunch advocate of bank-centric reform legislation, inadvertently gave this game away in a late-January paper titled “Bringing Housing Finance Reform Over the Finish Line,” when it explained, “The multiple-guarantor model’s existential challenge is creating a system that ends the current GSE duopoly. Without new entrants into the guarantor space, the reformed housing finance system could end up further entrenching Fannie Mae and Freddie Mac’s dominance.” The authors of this paper could not have been more direct: the goal of the banks’ and the MBA’s multiple-guarantor model isn’t to make the system better or safer; it’s to reduce Fannie and Freddie’s market power.

Banks in fact have been pursuing this goal since the late 1990s, and to achieve it they and their supporters have repeatedly and consistently put out misinformation about Fannie and Freddie’s risks and benefits, about the true causes of the financial crisis, and about what needs to be done to reform the mortgage finance system. But this web of deception has consequences. To have any chance of getting what they want, the bank lobby has had to develop a public rationale for what they’re doing that they can say with a straight face (and if you’ve been paying attention you know this rationale has changed over time), and also come up with a mechanism that actually is workable. Neither is easy, but the second is exponentially harder than the first. The reasons banks give for needing to replace Fannie and Freddie are artificial, but the difficulties and risks of attempting to do so are real.

Banks’ most recent rationale for insisting that Fannie and Freddie be subjected to legislative reform—rather than simply released from conservatorship with more stringent risk-based capital standards and tighter regulation—is that only Congress can create the multiple guarantors with explicit government guarantees on their securities (and not the companies) that can solve “Too Big to Fail,” because the failure of one or even two of the new guarantors won’t collapse the entire system. But here the banks and their supporters fall victim to their own fiction. In their zeal to address a problem they mischaracterize, they make the system vulnerable to a more serious problem they overlook.

Critics and opponents of Fannie and Freddie suffer from self-induced amnesia about the sudden rise and spectacular collapse of the private-label securities (PLS) market. Their public story—which they’ve stuck to, despite readily available evidence to the contrary—is that the “failed business model” of Fannie and Freddie, and nothing else, is to blame for the financial crisis. Any serious student of the 2008 mortgage meltdown, however, understands and acknowledges the role played in it by the collateralized debt obligation, or CDO. It was the CDO that allowed Wall Street to become the buyer of otherwise unsalable tranches of subprime and other high-risk PLS tranches, which in turn allowed the PLS bubble to inflate by as much and for as long as it did. The CDO was alchemy, and what made the alchemy work was the insistence of the credit rating agencies that the performance of individual low-rated tranches that made up a CDO would be “independent, and not correlated,” and for that reason up to 80 percent of a CDO’s new tranches could safely be rated AAA/Aaa.

As we now know, this turned out to be wildly inaccurate. The performance of the low-rated tranches was not independent, and very large numbers of them failed together. In retrospect, there was no reason to have expected otherwise. Yet today we have the MBA and the large bank supporters making essentially the same CDO argument, only this time about competitive credit guarantors. We are being asked to believe that a group of 5 or 6 credit guarantors—which will have the same capital requirements, the same limited menu of products to guarantee, the same close regulation and supervision, and potentially the same regulated returns—will not have substantially similar financial performance during a downturn; that is, their performance also will be “independent, and not correlated.”

That, too, almost certainly would not be true. It is far more likely that a small number of very similar credit guarantors either all will perform well or all perform poorly together. And if they all perform poorly, the government will have no choice but to bail out the companies, to keep the mortgage market from imploding. Banks’ contention that it is possible to “guarantee the securities but not the companies that issue them” has little in the way of substantive argument to back it up.

But the need for multiple guarantors with government-guaranteed securities is the MBA’s and large banks’ latest cover story for their insistence on reform legislation, so that was what the staffers for draft 29 dutifully sought to create. The authors of the January Milken Institute paper knew this wouldn’t be easy, saying, “Ensuring adequate competition is a two-fold challenge: first, determining how to provide space for new guarantors to enter the market and ramp up market share in the face of the GSEs’ current market dominance; and second, determining how the GSE market share should be sufficiently ratcheted back to create space for new guarantors before these newcomers start guaranteeing loans without adversely affecting overall market liquidity.” Draft 29 makes clear that no one yet knows how to overcome either of these challenges, or indeed a number of others that emerge from the MBA’s April 2017 recommendations.

Given the truly dismal condition of the work product to date for Corker-Warner 2.0, one has to wonder if a final version of this bill can make it to the Senate Banking Committee at all. And Senator Corker may be wondering the same thing. In a Senate Banking Committee hearing on January 30, Corker asked Treasury Secretary Mnuchin, “What would be your options if we don’t act?” When Mnuchin gave Corker the response I’m sure he thought Corker was looking for—“There are certain administrative options that we have; these entities are very complicated; I would just say my strong preference would be to work with Congress on a bipartisan basis to reach a long-term solution”—Corker paused for a moment, then in a low, flat tone, said, “Yeah.” After another pause he added, “But in the event this great bipartisanship doesn’t survive, and we don’t get this done—it’s a very complicated topic—what are some of the steps that you might take?” To me, this sounded like a man who knew his baby was in trouble.

For nearly a decade, banks have been trying to pass self-serving legislation in the guise of mortgage reform, without success. The original version of Corker-Warner, made public in the summer of 2013, was the first bank-centric bill to be introduced, and it could not make it to the floor. Today the hill Corker-Warner 2.0 has to climb is steeper. One reason is that there now is a concrete, realistic and workable alternative in the form of the Moelis administrative reform plan, released last June, with which any legislative initiative inevitably will be compared. Another is that recently the community banking interests—led by the Independent Community Bankers of America and the Community Mortgage Lenders Association—have become much more open and aggressive in labeling Corker-Warner 2.0 a “big bank” bill, that would be bad for both smaller banks and consumers. Dorothy is pulling back the curtain.

The big banks don’t support the Moelis plan because it doesn’t give them what they want. But what they want they can’t come up with a way to do. Draft 29 is Exhibit A for that. The attempts by banks to pretend to do well something that shouldn’t be done at all no longer are fooling people. Legislative mortgage reform may limp along for another few months, but it looks as if it’s about played itself out. Once it finally has, and Corker-Warner 2.0 officially is declared dead, administrative reform will be back on the table, and we’ll learn how serious Secretary Mnuchin was when in December 2016 he said, “we gotta get [Fannie and Freddie] out of government control…and in our administration it’s right up there in the list of the top ten things we’re going to get done, and we’ll get it done reasonably fast.”

178 thoughts on “Waiting for Mr. Corker”

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    1. This is the first time I’ve participated in one of the Urban Institute’s on-line debate programs, so I don’t have any prior experience with the format. I was told that the way it would work would be that the moderator (Ellen Seidman) would pose questions, and the participants (there are nine of us) can respond at our leisure, as we log on to the site. So far we’ve just had the one question, and six of us have given our responses (which UI has asked we keep between 100 and 200 words); three have yet to “ring in,” and as of 3:00 pm EDT I’m the only one who’s made a reply to someone else’s comment– so I don’t plan to make another one until some of the other participants also start replying. The “debate” is scheduled to run through 5:00 pm EDT on Friday.

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      1. Tim –

        I noticed that Mark Zandi responded to your comment on Friday: (https://www.urban.org/debates/revisiting-housing-finance-why-federal-role)

        and only gave you about 5 minutes to respond to his paper here:

        Click to access 2017-08-02-who-bears-the-risk.pdf

        With the luxury of more than 5 minutes, I wonder if you wouldn’t mind either pointing readers to your prior responses to this report or address if there is anything in the report Zandi points to that would make you change your mind on the structural flaws you see inherent in the current CRT program?

        Thanks for doing all this work pro bono. Clearly your time is valuable to many.

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        1. I’m planning to do a post on the Urban Institute’s “Housing Finance Reform Policy Debate” sometime this week, and I’ll address my comment on CRTs, and Mark Zandi’s follow-up to it, then. Briefly, though, his one-line post at 4:55– linking a paper he’d published previously but not addressing the simple and direct question about CRTs I’d asked people to respond to–was typical of the reaction I’ve received from advocates of the CRT program to my criticism of it over the past couple of years: never addressing the criticisms directly, but instead putting out theoretical papers and making vague statements like, “these securities have transferred billions of dollars in credit risk to capital market investors (never saying anything about the remoteness of that risk or the cost Fannie and Freddie are paying to transfer it), and while there will be challenges issuing these securities during times of stress, we are confident those challenges can be overcome.”

          As long as the argument stays in the political realm, this sort of defense (ignore the criticism; repeat the talking points) works, and helps sustain what has become a very profitable program for Wall Street firms and capital market investors. So I unfortunately don’t think we’ll see it change any time soon.

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          1. Tim-

            Does the company Mark Zandi serves as a board member, MGIC Investment Corp, benefit at all from the CRT issuances?

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          2. No, although MGIC obviously would benefit from other types of mandatory risk sharing, such as “deep cover” mortgage insurance (MI) placed on new loans at origination, or “back-end” MI, which gives supplemental coverage at the pool level.

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          3. tim

            i was in one of these online debates and it seemed to be better structured. only two of us. each answered question. then each responded to other’s answer. then on to new question. structured to not have time gamesmanship. having 9 participants is way too unwieldy.

            rolg

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    1. Whether Larry Kudlow at the NEC would be a good thing for Fannie and Freddie depends on the issue. He clearly favors shareholder rights and has been critical of the net worth sweep. On the other hand, he historically has been a vocal opponent of Fannie and Freddie’s government charters and the role the companies play in the secondary market, and I doubt that he’s changed this latter position.

      Although it’s a bit long, I thought readers might be interested in the excerpt below from an early draft of my book, “The Mortgage Wars,” that didn’t make it into the published version. It discusses Kudlow, and also serves as a reminder of just how far back into the past the fierce ideological opposition to Fannie and Freddie goes.

      “The assault started with the Office of Management and Budget. OMB director Stockman had had a difficult first year. After having pushed for passage of the Kemp-Roth supply-side tax cuts, he began to have second thoughts about them once they were enacted. He expressed some of those misgivings in an interview he gave to a journalist named William Greider, who used it as the basis for a December 1981 article published in the Atlantic Monthly titled ‘The Education of David Stockman’. In it, Stockman was quoted as saying, ‘Kemp-Roth was always a Trojan horse to bring down the top rate,’ and that, ‘the supply side formula was the only way to get a tax policy that was really trickle down.’ Following the Atlantic Monthly article Stockman famously was ‘taken to the woodshed’ by President Reagan but left in his position at OMB. He then turned his attention to deficit reduction.

      Fannie Mae became part of those efforts in a roundabout manner. Stockman’s preferred policy objective for us was full privatization immediately. Absent that, he wanted Congress to remove our charter indicia piece by piece until all were gone. Congress, however, showed no interest in either. Stockman therefore came up with a backdoor way to effectively accomplish the same result. He would propose charging what was called a ‘user fee’ on the debt we issued to fund our mortgage purchases. The concept was that our agency status enabled us to borrow more cheaply in the capital markets than fully private firms, so the government ought to be entitled to attach a fee to our debt as consideration for the benefit of that status. A user fee would produce two results Stockman favored: first it would help reduce the deficit, and second it would put in place a mechanism for raising Fannie Mae’s debt costs over time to a level where eventually the cost of our debt and the debt issued by our competitors would be equal. Stockman put Fannie Mae user fees in the President’s 1985 budget, and gave the task of selling them to Congress to one of his deputies, a man named Larry Kudlow.

      Kudlow had been chief economist at the investment bank Bear Stearns prior to coming to OMB. I knew Kudlow from my days at Wells Fargo, and he was different from the chief economists at all of the other major investment and commercial banks. The other chief economists did mainly economic and financial analysis (as I had done), and when they brought politics into the mix they generally did so neutrally. Kudlow was much more political, and unabashedly opinionated and partisan. Kudlow actively sought influence with prominent Republican politicians and their advisors. He and Stockman had met when Stockman was a congressman, and found they shared many political views. When Stockman became Director of OMB, he asked Kudlow to come to the agency as Associate Director.

      Kudlow was even more opposed to Fannie Mae than Stockman or Regan, and he was passionately committed to getting user fees passed as legislation. We, on the other hand, viewed user fees as a mortal threat to our existence. We believed that if Congress ever accepted them in concept—even in small amounts—it would not be difficult for our opponents to convince future Congresses to raise them to a level that would jeopardize our business. Having just survived a brush with insolvency, we were not eager to repeat that experience.

      We took our case against user fees to our allies and Congress. Our best argument was a purely economic one: any fee added to our debt would cause us to raise the yield requirements on the mortgages we purchased. As such, it would be homeowners who ultimately would bear the cost of the user fees. To make that point clear, we began to refer publicly to user fees as a ‘homeownership tax.’ That proved to be very effective labeling. Kudlow seemed to realize it, and his response was to order Maxwell [David Maxwell, Fannie’s CEO] to stop lobbying Congress against the fees. Maxwell, of course, did no such thing. I recall being at a Fannie Mae senior management retreat in Myrtle Beach, Florida when a call for Maxwell came in from Kudlow. Maxwell took the call in a room adjacent to where we were meeting. He put the call on a speakerphone, and we all could hear Kudlow yelling at him. Kudlow had found out Maxwell had ignored his request not to lobby, and he was furious. ‘I TOLD you not to do that!’ Kudlow screamed. After the call ended, a slightly shaken Maxwell came back into the room we were in and said to no one in particular, ‘That man is crazy.’”

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      1. Someone on Twitter asked Larry Kudlow about the GSEs. As I remember it, he said “Take them private.” I’ve been unable to find the original tweet, though. I would ask him myself, but there are many different accounts on Twitter set up as Larry Kudlow, so I don’t specifically know who to ask.

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  6. Tim, this comment was posted a year ago in several forums, just FYI

    The Ginsburg-Wallison Reciprocation Issue

    This post is based on facts from discovery emails, AEI events, and two books: “Pursuit of Justices” by David Yalof and “Inluence: The psychology of Persuacion” By R Cialdini.

    Did Judge Ginsburg mislead everyone with his questions and quotes at April 2016 oral argument. –Yes. Did he make us think that he was against the Lamberth’s opinion? –Yes. Did he act so on purpose? Was he trying to avoid been objected as a panelist because of his close relationship with Peter Wallison. I don’t know. I am not here to “judge” Judge Ginsburg. I just want to state some facts.

    Wallison is not a passerby. In fact, he is the leading (paid) lobbyist against the GSE.

    He camouflages himself under the American Enterprise Institute, a so called think tank, that has been decades pushing the agenda of its funders (funders not founders) instead of interest of the people.

    He may be one of the intellectual authors of the NWS or at least he is the one that made public appearances in the media supporting the NWS and the illegal wind down of GSE.

    It is well known that Jim Parrot reported to him and other “fellow travelers” according with documents produced in discovery. Why Parrot had to report to him??

    Also it is clear and well known that Judge Ginsburg is a friend and intellectual contributor of the AEI because he has participated in few events in which the GSE has been criticized and targeted with all the lies that Wallison has been peddling since long ago. Such relationship sure has influenced the ideas of Ginsburg for years, so it is possible to consider that Ginsburg has made his mind against the GSE and in favor of wind them down long before the oral argument took place. Actually, the opinion of the Court seems to have been written by Wallison himself not by Ginsburg. Nobody is immune to the influence of his friends but a Judge should not write an opinion with a biased attitude. In fact the control of his own attitude is the most important skill a Judge must have. What good can be knowledge if the attitude is biased?

    Whoever wants to find out more about the relationship of these two friends should read the book “PURSUIT OF JUSTICES” by David Alistair Yalof , chapter six -The Reagan appointments. In this chapter of the book you will find, four familiar names: Charles J Cooper , Peter Wallison , Christofer Cox and Ginsburg.

    According with Yalof’s book, Cooper was a DOJ counsel and he was in charge of proposing the list of potential Justices to be recommended to Reagan for appointment of nominees. But Wallison, that was White House counsel, decided to scrap whatever the DOJ send him and created his own list of appointees. All the Justices appointed during the Reagan years were, in fact, “appointed” by Wallison. According with the author of the book , Reagan had always private meetings with Wallison in which the appointees were chosen. One thing is clear: Cooper from the DOJ did not appoint Ginsburg but Wallison from the WH did.

    The author also explain that Christofer Cox also worked as a lawyer in the WH counsel and Wallison was his boss. Holy Coincidence! This Christofer Cox is no other that the one that run the SEC from 2005 -2009 . It is no wonder then that the SEC never investigated the naked short selling of Fannie and Freddie nor the insider trading from the Eton Park meeting, in which Hank Paulson anticipated to his fellows the hostile take over of the GSE: “We had to ambush them” wrote Paulson in his book and “The first sound will be their heads knocking on the floor”, among other shameless phrases.

    Does Ginsburg owes his job to Wallison? According with the book of Yalof the answer is yes. Now let me tell you that “reciprocation” is one of the most powerful forces behind human behavior. That is why corporations and organizations all over the world have bunches of rules about trading favors. The shareholders of GSE may be victims of an act of reciprocation between Ginsburg and Wallison , and of course between Millet and Obama.

    If you want to learn more about reciprocation I strongly recommend to read the related chapter in the book “INFLUENCE-THE PSYCHOLOGY OF PERSUACION”.
    Reciprocation recognizes that people feel indebted to those who do something for them. It seems obvious and simple, however it may be very dangerous because it is mostly subconscious, and can go from being used to sell candies all the way to cause someone to commit horrible crimes.

    I write this with the hope that other Judges in this country become aware of this issue and never forget that their commitment is with the Rule Of Law and not with their emotional creditors.

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    1. I generally do not accept comments that focus on individuals involved in the issues covered in this blog–or the possible motivations for their actions or policy positions–but I’ve made an exception in the case of Rick’s contribution. I was the one who introduced the topic of the possible (I would say likely) connection between Peter Wallison and justice Ginsburg, and the comment above adds perspective and detail that I felt was worth sharing. And my broader reason for bringing up the Wallison-Ginsburg connection in the first place was to offer a readers a plausible argument for why what happened with the Perry Capital appeal–in which plaintiffs clearly were right on the facts and right on the law, but nonetheless had the appellate decision go against them–is not necessarily a predictor of what might happen in future cases (or appeals). For the reasons Rick and I discuss, the Perry Capital appellate decision was a “one-off,” and I thought readers should know that.

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      1. If the DC Circuit decision was only because of Wallison’s influence over Ginsburg — with the implicit assumption that no fair judge could have reached the same result — how do you explain the 6th and 7th Circuit decisions? Don’t get me wrong, I think Ginsburg’s decision was embarrassing, and the D.C. Circuit decision certainly gave cover to the 6th and 7th Circuits to just follow Perry Capital.

        Still, it isn’t clear how this theory accounts for the 6th and 7th Circuit decisions.

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        1. I’m neither a lawyer nor a legal analyst but, given the appellate decision in the D.C. Circuit, I was much less surprised by the decisions in the 6th and 7th Circuits, for the reason you mentioned: they dealt with the same theory of the law (violation of the Administrative Procedures Act) that the D.C. Circuit had just ruled on. That’s what the government argued in these cases, and I believe it did give the 6th and 7th Circuit judges an easy way to avoid ruling against the government in a $100 billion case that almost certainly would have been headed for the Supreme Court had there been dissenting decisions from two circuits in the same case.

          I also don’t want to tacitly accept your statement that “no fair judge could have reached the same result” as the D.C. Circuit. I did not say that. My reference to the Wallison connection was my interpretation of how justice Ginsburg could have gone from making solid legal arguments before the court in April of 2016 to co-authoring a decision in February 2017 that relied on contorted reasoning and in at least one case a literal misquotation of the statute to arrive at a conclusion that was starkly at odds with settled legal precedent (the mandated behavior of a conservator under the Federal Deposit Insurance Act).

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          1. Just responding to say you make a fair point regarding “I also don’t want to tacitly accept your statement that ‘no fair judge could have reached the same result’ as the D.C. Circuit. I did not say that. ” I struggled with exactly how to summarize that point, and did not mean to mischaracterize your statement.

            I agree there are a lot of problems with the D.C. Circuit decision, particularly in comparison to a FDIC conservator – an issue that should get more attention.

            It is striking how many courts appear to be confused about the FDIA (or more likely contorting themselves to reach a specific result), like the Sixth Circuit claiming that “HERA’s language—that FHFA may take action that it determines is in the ‘best interests’ of the Companies or FHFA. . . . is significantly different from the comparable language used in FIRREA, which states that FDIC may take action that it determines is in the best interests of ‘the depository institution, its depositors, or [FDIC]. FDIC is instructed to take into consideration the depositors to the failed bank in receivership or conservatorship.” When the use of the word “or” explicitly gives the FDIC an option (not to mention the D.C. Circuit’s construction of “may” that makes everything optional).

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        2. @bk

          with respect to the APA claim (NWS incompatible with conservator power), one might think that other circuits would “defer” to the DC circuits “superior experience” dealing with administrative law litigation.

          one might also wonder why gibson dunn (olson) and cooper & kirk (cooper) focused in perry on the APA claims to the exclusion of the constitutional claims (fhfa unconstitutionally structured and fhfa acting director unconstitutionally appointed); my own view is that they thought the APA claim was such a slam dunk that there was no need to argue constitutional claims.

          what you are now seeing in the collins 5th circuit argument and the rop and bhatti cases in federal district court is constitutional claims getting their hearing. this should have been done at the get go with perry (yes, monday morning quarterbacking).

          also helps to explain the scotus denial of cert in perry. this was “just” an APA statutory interpretation case, what does “may” mean in the statute, ho hum, not a (from soctus viewpoint) more important constitutional case.

          rolg

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          1. @ ROLG –

            Good points.

            In terms of the focus in “Perry on the APA claims to the exclusion of the constitutional claims (fhfa unconstitutionally structured and fhfa acting director unconstitutionally appointed),” I think some of it the timing of the cases.

            The arguments on appeal in Perry Capital were limited by what was alleged in the complaints. The complaints were filed in 2014. during the Obama administration.
            If the plaintiffs had won on those constitutional grounds during the Obama administration, the Obama administration could have responded “fine, we’ll modify the FHFA structure or appoint a new FHFA head (whatever the court ruled), and then we can agree to impose the Net Worth Sweep again.”

            With Trump’s election, the constitutional arguments had new force b/c of the assumption that the Trump administration would be unlikely to re-impose the Net Worth Sweep if it was ruled unconstitutional. (In addition, the passage of time and continued profitable operations of the GSEs would make re-imposing the Net Worth Sweep even less credible than it was originally — and it was weak to begin with.)

            Further, while asserting similar claims in multiple circuits can give the plaintiffs multiple bites at the apple, having those complaints in the different circuits differ a bit can be helpful in avoiding collateral estoppel (b/c the claims are, at least, somewhat different) and not having complete carbon copy complaints could make it easier for a subsequent court to rule in favor of the plaintiffs on a more nuanced basis than the first court screwed up. I do not know to what extent this was intentional and how much may have been happy coincidences.

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  8. Tim / ROLG,
    I just listened to yesterday’s oral arguments in the Collins case and thought that the plaintiffs were persuasive in the argument but so were the FHFA and Treasury arguments. I’m not sure how the judges will take this but one of the judges asked a number of questions about how the sweep was keeping with FHFA’s mandate to conserve and preserve their assets. That seemed fairly positive for our position.
    I was wondering if you had listened to this yet and what observations you had on the hearing…..

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      2. the most active questioner was judge willett, recently appointed by potus. it is not certain how to get a fixed read on judge willett (though i am inclined to say that judge willett seemed at least receptive to plaintiffs claims), but certainly much harder to get a read on the other two judges. one thing i would note is that you did not hear an active judge likely favoring defendants such as you had with judge millett in the perry case. so having said this, if the most active judge directs the direction of the panel, then there might be reason for at least some optimism.

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        1. I haven’t yet listened to the oral argument recording, but I can’t help but think back to my reaction to the recording of the Perry Capital appeal. That, to me, seemed to be a fairly easy read: Millett was clearly favoring the defense, Ginsburg seemed highly skeptical of defense counsel’s arguments and supportive of the plaintiffs, while Brown, who did not say much, also seemed favorable to plaintiffs.

          Between oral argument and the ruling, however, Ginsburg completely switched sides–going from making reasoned statements in support of plaintiffs at oral argument to making tortured ones to justify his finding for the defense in what became the majority ruling. None of us anticipated what almost certainly transpired between the two dates, which was the influence of Peter Wallison on justice Ginsburg. Ginsburg was appointed to the DC Court of Appeals in October of 1986 at the recommendation of Wallison, who was White House Counsel to president Reagan at the time, and prior to his appellate ruling Ginsburg had appeared at AEI conferences discussing Fannie and Freddie. We know that someone at AEI was communicating with the three appellate judges, because in her minority opinion justice Brown cited bogus AEI claims as fact (including the Ed Pinto invention that Fannie and Freddie bought or guaranteed 70 percent of all subprime loans leading up to the crisis, based on his own definition, used by no one else, of what a “subprime” loan was), which had not appeared in any previous motion nor was cited at oral argument, so could only have come from AEI directly. My strong suspicion is that Wallison went to Ginsburg and said something to the effect of, “You realize, Doug, that if you rule for Fannie and Freddie in this case they’ll be freed from conservatorship, and all of the good work we’ve done to get them under Treasury’s control will go to waste.”

          Hopefully nothing similar will happen in the Collins or other appeals.

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          1. tim

            it is interesting to speculate on the social dynamics of courts. at district court level, it is not obvious as the judge sits alone. however, many have higher ambitions and seem to take that into account. for example, judge thapar weaseled his way out of hearing a FnF case because his wife had a minuscule indirect investment in GSE (a mutual fund that owned 20 shares). he wanted to get appointed to a circuit court and didnt want to make any enemies with a controversial decision. he got his wish.

            on circuit court panels, one often sees an active judge questioning in a way that shows he/she is far more into the case than the others (as per willett with collins case). the question is to what extent does this judge create an impetus for the panel to go his/her way after oral argument. does the strong view push the panel in one way? it seemed that kavanaugh did just that in the panel decision in PHH, and judge garland had to get the troops reorganized by vacating and having an en banc hearing.

            sctous has its own dynamics as well which has spawned a whole commentary class of tea leaf readers.

            as for collins, the question will be whether they have an initial vote soon after the oral argument (which is scotus style), and whether (assuming i am right that willett seems to have a reasonably strong view and the other two judges are sort of up in the air) willett simply says to the other judges let me write an opinion and you see if you think that dog hunts. the other two judges may violently disagree with willett’s draft.

            who knows. as you intimate tim, this is all opaque to us, including the notion that wallison was the unseen “fourth judge” in the perry panel.

            rolg

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          4. Tim, do you think writing a post about Wallison, AEI and Ginsburg connection in Perry Appeal could be beneficial to, at minimum, increase awareness of TBTF interests & influence in the judicial branch? On GSE related issues, your blog reaches far and wide and simply making people more aware of the above could pre-empt AEI & other bad actors from illicitly influencing the judges behind closed doors, allowing them to rule on merits…

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          5. No, I don’t believe this issue warrants a separate post. For one thing, while I believe my view that Ginsburg was “turned around” by Wallison is well founded, it’s not proven. More important, though, I don’t think publicity given to this topic would deter similar behavior in the future. People with access to decision makers and opinion leaders–whether “bad actors” or otherwise– are going to use it to promote their interests. You might not think that’s fair, but it’s not illegal, and it’s the way the world works.

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          7. For the conspiracy theorists out there (and I am one of them), Wallison is a long-time member of the Council on Foreign Relations, and AEI is one of their captured think tanks.

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          8. Tim,

            Getting the GSEs under Treasury was in your estimation the “good work” they had done. But I have to assume they had an end game in mind. What was the telos that the good work was intended to serve?

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          9. To replace Fannie and Freddie with a secondary market system more to their ideological or competitive liking, which has proven much more difficult to accomplish than when they set it as an objective. They are like the dog who chased the car and caught it.

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          10. “like the dog who chased the car and caught it”

            Love it. Perfect! Have to use that next time I get a chance.

            Perfectly characterizes AEI and the fellow travelers who finally got a chance to do in the GSEs. They just didn’t know what to do when they got there.

            I also think Ginsburg’s connection to Wallison deserves more air time. We as citizens should not accept this kind of thing as a routine part of the government function.

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          11. So if one judge recused himself because his wife owned 20 shares, why didn’t the plaintiffs complain when a judge with known connections to Wallison/anti GSE groups stay on the case. Or was that not known at the time. At least you make it a point so that you can appeal it later.

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        1. So, we have Judges appointed by Clinton, W., and Trump, respectively. Safe to say, one D and two Rs. As Tim states above, the big question is: Do any of the Judges have indebtedness/ties to powerful anti-GSEers, as Ginsburg did with Wallison? When should we hear a ruling by the court? It should be interesting. Fingers crossed, yet again.

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  9. tim

    i raised the question awhile back whether the principal amount of any mbs guaranteed in connection with an MBA/corker warner-type housing finance proposal would have to count towards the debt ceiling. The federal debt ceiling statute (https://www.law.cornell.edu/uscode/text/31/3101) is unambiguous that federal guarantees of principal and interest are debt obligations that count towards the limit.

    i have found no authority that conditions inclusion for purposes of that statute on the form of guaranty (ie whether a guaranty of payment or collection, or whether there is additional credit support “in front of” the federal guaranty).

    it seems to me that the answer is that the federal guaranty would count towards the cap; it also seems to me that this has not been acknowledged or discussed by the proponents of mbs-federal guaranty proposals.

    rolg

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    1. I have not done exhaustive research on the topic, but my understanding also is that an explicit government guaranty on residential mortgage-backed securities would count against the debt celling. I have to wonder, though, if there isn’t some reason I’m unaware of why an MBA-type government guaranty (which could allow the government to classify its exposure as “extremely remote,” or something similar) might be exempt from that rule, for the simple reason that I find it hard to believe so many seemingly knowledgeable people would embrace and advocate for government-guaranteed MBS if they really would add $5 trillion to the national debt. But stranger things have happened in the reform debate, so it’s possible that explicit guaranty advocates are just “whistling past the graveyard” on this.

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      1. implementation of a fed guaranty is a tricky question and completely unaddressed by the MBA-type proposals.

        for example, if you guaranty all existing and outstanding mbs, then yes you have blown apart the debt ceiling by $5T. if you guaranty only newly issued mbs, then every institution (including those that are the intended beneficiaries of the fed guaranty) suffers a capital loss since newly issued mbs will be the preferred mbs holding and nonguaranteed mbs will go down in price.

        which policy is to be chosen is not addressed by MBA-type proposals, which leads me to think that they havent been carefully thought through.

        of course the MBA guaranty legislation can create a carve-out for mbs guarantees from the debt ceiling, but again nowhere has that been identified by the MBA-type proposals as a necessary component of the proposal.

        i worked some 30 years ago on FAA guaranteed programs (guaranteeing debt issued by the likes of air florida) and AID guaranteed programs (guaranteeing debt issued by foreign sovereigns and instrumentalities), and while the debt ceiling was not yet weaponized then, i can assure you that the treasury understood that its guaranty was backed by full faith and credit of US irrespective of remoteness of paying on guaranty.

        rolg

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        1. A question about F&F debt. F&F’s mortgages are said to not be listed as part of the national debt. That is what they are “private companies” and the gov only took 79.9% Ok, fine, but I was wondering how they list/calculate FHA/VA USDA etc loans. From a chart I looked at they combined are somewhere in between to total figures of Freddie and Fannie the past 10 years or so. So my point is, they ARE explicit government guaranteed loans yet I never hear anyone complain about “the government/taxpayers being on the hook” for their debt. Why not? The obvious answer is politics, don’t let the truth get in the way, but is there something else?

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  10. Mr. Howard, Inside Mortgage Finance is reporting strong demand for risk sharing securities.
    While for reasons you’ve stated previously they are not as effective as cash, do you believe demand and subsequent better pricing could make these less harmful or neutral for the GSEs?

    https://www.insidemortgagefinance.com/issues/imfpubs_ima/2018_9/news/Strong-Demand-for-Credit-Risk-Sharing-Deals-As-GSEs-Improve-Issuance-1000045025-1.html

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    1. Better pricing would, or course, make them less harmful. However, that isn’t the question. The question is, “Are the CRTs something that competent management would do?” The answer is no. The CRTs are designed to be a wealth transfer from FnF to give political cover for congress and FHFA by making it appear like congress and FHFA are doing something.

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        1. The “why are they doing them” question is easy. Their regulator is telling them to. And Wall Street and the investment community support them because they make a lot of money off them.

          I’ve just seen a good example of why few others call Fannie and Freddie’s CRT program into question. After the paper “Credit Risk Transfer and De Facto GSE Reform” was published by the New York Fed as a staff report, I wrote a note to the authors, sending them two of my blog posts and the blog comment I made last week about their paper on the program. They (collectively) sent back a note that I did not feel adequately addressed my criticisms, so I wrote the following (repeated in full despite its length, which I apologize for).

          “I am coming at this from the perspective of a former CFO of Fannie, who for fifteen years was responsible for pricing and managing the company’s credit guaranty business in a way that maximized its risk-adjusted return to shareholders.

          As you point out, CAS insures against unexpected risk, not catastrophic risk. Were I still Fannie’s CFO, I would not have issued any CAS since the inception of the program, because of my assessment that the interest payments on them (which, if not paid, would be retained earnings for my shareholders) are far greater than the dollars of credit loss I could hope to transfer to the buyers of the CAS tranches, given the quality of loans the CAS are insuring and the amount of the first-loss risk I still retain. As CFO of Fannie, all CAS would be doing for me is reducing my company’s earnings volatility (that’s what “unexpected risk” is); they won’t ensure its solvency. Paying huge premiums for insurance against a remote risk we (the company) are able to bear ourselves (earnings volatility) would be a very bad business decision, not a “success.” It’s that simple.

          The fact that Fannie and Freddie are in conservatorship doesn’t change this analysis. Today, the “taxpayer” gets all of the companies’ earnings. By issuing costly CAS and STACRs against high-quality books of business, the companies are reducing the payments to taxpayers now, in exchange for the possibility of being able to transfer modest amounts of credit loss (but far less than what they’re paying in CAS and STACR interest) to risk-sharing investors in the future. That, too, is a bad decision for taxpayers.

          In theory, this could work out differently over an entire business cycle. But the problem is that when the delinquency rates on the older books of business start to rise, CRT buyers will withdraw from the market, and not buy future issues. True “success” for an issuer of CRT securities is if it can transfer more dollars of credit risk to CRT buyers than it pays them in interest. But that same outcome is failure for the CRT buyer, and if they think there’s any chance of that happening they’ll run. The CRT issuer thus will end up paying more in interest than it receives in credit loss transfers on its “good” books of business, and bearing all the credit risk itself on its “bad” books. That’s also not “success;” that’s a badly flawed program.

          Briefly, in response to your four points:

          1. In your profit margin table, you’ve left out the expected dollar amount of risk transfers from the CRTs. Fannie and Freddie surely model that. When I was Fannie’s CFO we modeled our credit guaranty profitability over 500 different combinations of random home price and interest rate environments (with the most extreme being the threshold beyond which we had a “catastrophic” loss). Fannie and Freddie won’t tell us what these scenarios show, but I would be willing to bet that CAS and STACRs increase projected profits in fewer (and probably far fewer) than 10 percent of those scenarios. Again, that’s not “success;” it’s a waste of money.

          2. Overpaying for the insurance on your good books then not being able to get any insurance at all on your bad books makes the program worse, not better. And as I noted in the analysis I did for my post “Risk Transfers in the Real World,” even during a downturn CRTs issued against older books of business don’t help a company that much, because of their first-loss thresholds and the fact that the tranches can pay off before the credit losses hit.

          3. I didn’t say Fannie and Freddie are diversified across business lines (they aren’t; because of their shrinking portfolio business they’ve effectively become mono-line credit guarantors)—their credit risk is diversified across product types, regions of the country and origination years. This means that, at the entity level, they can use excess earnings from their good books to pay losses on their bad books, and remain solvent. That doesn’t happen if you try to manage risk just with CRTs. The fact that some investors made money on your 2014 CRTs doesn’t mean that others will be willing to lose money on the ones you want to issue in 2020. They won’t; they’ll walk away, and you can’t claw back the excess payments you made to the 2014 CRT buyers to help you cover the losses you’ll be stuck with on your 2020 book.

          4. I agree that CRTs are priced in a competitive market. My sole argument is that Fannie and Freddie (or other future credit guarantors) should be able to compare their potential guaranty fee pricing (or profitability) with CRT insurance and without it, and make the choice that is best for their shareholders (or homebuyers). That’s not happening now. With the companies in conservatorship, FHFA and Treasury have mandated that they issue CRTs. Once we’ve decided on what a reformed mortgage finance system should look like—and the credit guarantors in that system have been given updated and binding capital requirements—CRT issuance should not be mandatory; it should be based on economics, in which CRTs are assessed on the basis of their equity capital equivalency, and the guarantors are free to use them when they believe they will result in more efficient guaranty fee pricing, but in the alternative are not required to.

          I’d be happy to continue this discussion, perhaps through a conference call.”

          One of the authors quickly wrote back with this brief response: “Thanks again for your thoughts on the topic. At this point we would choose not to further discuss this given our different points of view, which seem somewhat ideological, and hence we likely won’t bridge the gap.”

          I found this answer curious. I had never heard anyone refer to a risk management technique as being “ideological”; it either is sensible and economic or it isn’t, for financial and analytical reasons that have nothing to do with ideology. So I Googled the authors and found out that two of them are executives at Annaly Capital Management. That made sense. Their answer sounded to me like, “we love these securities as investors because we make a ton of money off them and take very little risk, and choose not to discuss your criticisms of them.” The big surprise is that the NY Fed would publish a blatant marketing piece under its Staff Reports series. But that’s just where the reform dialogue is these days.

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          1. Yay you; their political naivety can be forgiven–although most serious observers can see everything about the GSEs has been tinged with politics and ideology for the past 25 years (starting heavily in the Reagan Administration)–but if “Fed researchers” are pumping financial products in the guise of GSE reviews, that’s a new low for the nation’s Central Bank and staff.

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          2. Thanks for putting them on blast. frbny has been doing the bidding for the companies that want the gse business.

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  11. Tim,

    HERA section 1367(a)(4)(A)(i) mandates that Watt put a GSE into receivership if “the assets of the regulated entity are, and during the preceding 60 calendar days have been, less than the obligations of the regulated entity to its creditors and others”. This means negative net worth, which happened on December 31, 2017, correct?

    If so, and if the profits over the last two months are not taken into account (i.e. the balance sheet is not updated more often than quarterly), then Watt would have to ask Treasury for the draw today to avoid forced receivership if I am reading this correctly. I have not heard news of Watt asking for the draw, which would be the first of his tenure.

    If the books really are recalculated daily then Freddie should not have to take a draw at all; their profits over 60 days should more than offset the $312M net worth deficit. Fannie would not have to draw the entire $3.7B either, though two months of profits is most likely not enough to cover the whole amount.

    Does this mean that we should expect real trouble if Watt does not ask for the draw money today? Or am I misunderstanding something here? Thanks.

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    2. Fannie’s (or Freddie’s) books are not “recalculated” daily; earnings are calculated on a quarterly basis. When I was Fannie’s CFO, we published our quarterly earnings as soon as we completed the calculations for all of the components that comprised the income statement and balance sheet, which typically took about three weeks after the end of a quarter, and four weeks or sometimes longer for annual earnings. Today the lag between quarter-end and the publication of earnings is even greater (Fannie’s full year 2017 earnings didn’t come out until February 14). You don’t know what a company’s net assets are until its earnings come out, so I would say that HERA’s 60-day period to cure a negative net worth would have started on February 14, and would run until mid-April.

      During the years 2008-2011, in which accounting-related expenses caused Fannie to post quarterly losses that eroded all its net worth, the director of FHFA typically didn’t request (and Fannie didn’t receive) a draw from Treasury until the end of the month following the release of the previous quarter’s earnings (i.e., for a loss in the fourth quarter of the year, typically announced in mid-February, a draw would be requested and made on March 31). I expect the same thing to happen this year, and this quarter. I believe there is virtually no chance FHFA will put Fannie (or Freddie) into receivership.

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  12. Mr. Howard

    I have been reading your blog for some years now. I wanted to post to thank you for the work you are doing. I have learned a great deal here.

    I don’t believe I can contribute here (on this level) so I will be in viewing-only mode.

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    1. This article by the Urban League and the Center for Responsible Lending is in response to a paper written by Jim Parrott, Michael Stegman, Phillip Swagel and Mark Zandi titled “Access and Affordability in the New Housing Finance System.” That “new housing finance system” is draft 29 of the Corker-Warner legislation, which, as I wrote in my current post, was so devoid of specifics that I’m surprised anyone would even attempt to say anything definitive about it, but Parrott, Stegman, Swagel and Zandi nonetheless did.

      An unfortunate reality of today’s debate on mortgage reform is that the loudest and most persistent voices are those of the advocates for large banks, many of whom have little or no practical experience in the secondary mortgage market and make assertions that are either wholly invented or based on assumptions with no basis in reality. In the Urban League/CRL paper, it was very satisfying to see the simplistic proposals of authors with only a superficial knowledge of the market they are proposing to re-engineer systematically dismantled by professionals who actually know something about their subject matter.

      It’s terrific that the Urban League and the Center for Responsible Lending are adding their objective and authoritative voices to this dialogue. I am in strong agreement with the arguments they make in this paper, which, for readers of this blog who haven’t read it, are summarized in three early paragraphs, which I’ve copied below:

      “The analysis claims to make an equal comparison of the current and proposed system, but it instead uses numbers and assumptions that substantially inflate the cost of the current system. It also makes overly optimistic assumptions about costs and benefits of the proposed system, and it omits other costs entirely. When these assumptions are corrected, it is clear that the cost of the proposed system would be far greater than the current system.

      Most important, the proposed legislation would jettison the very foundation blocks of the obligation of companies using government backing to promote the public interest, including: serving a national market, including rural and urban areas; serving all lenders equitably, including community banks and credit unions; promoting fair housing and increasing access to affordable mortgage credit for underserved borrowers; and meeting enforceable affordable housing goals and enforcement provisions. Under the proposal, these would be repealed and replaced with unenforceable aspirations and even explicit prohibitions on interfering with the ‘business judgment’ of those receiving and profiting from government backing.

      In addition, the comparison of the affordable housing assistance of the proposed system itself uses narrow scenarios and unreasonable assumptions that tilt the numbers erroneously towards the proposal, while a more neutral analysis shows that those promises are unattainable. When one looks behind the promises, it is clear that this legislation would be a historic setback for affordable housing and would harm the overall housing market. “

      Well done.

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  14. Good morning tim, with your extensive experience as a fannie mae cfo, can you give us an idea of how the raising interest rate by the Fed, will affect the earnings of the gse’s? On the other side, I have read the last lawsuit filed against the government in the U.S. Court of Federal Claims last week. in my opinion, this it is the strongest demand. Although it’s filed by preferred shareholders, do you think it can benefit the common shareholders? I have read in the third amendment that if a part of it is declared illegal by a judge, all the amendment will be annulled.
    This is the lawsuit:

    Click to access 18-00281-0001.pdf

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    1. Modest increases in interest rates should have little discernable impact on Fannie or Freddie’s earnings. Should rates rise enough to tip the economy into recession—which I do not foresee this year—I would expect both companies’ credit losses to increase, but not by nearly enough to offset the flow of earnings from their credit guaranty and (dwindling) mortgage portfolio businesses, and cause losses.

      I’ve now read the Owl Creek suit, and had both a general and a specific reaction to it.

      The general reaction is that the more these new lawsuits focus on the facts—particularly the true motivation for the net worth sweep, as revealed by the admissions of Treasury officials in documents produced in discovery for the Fairholme case—the harder it is going to be for the government to continue to pretend that FHFA was simply using its “regulatory judgment” as a conservator to act in the best interest of the companies when it entered into the sweep, rather than conspiring with Treasury in a manner that was ultra vires, or clearly outside of the bounds of the HERA statute.

      My specific reaction was to the power of the argument the Jones Day lawyers made in presenting Count IV: “Breach of Implied-in-Fact Contract Between the United States and the Companies.” The essence of this argument is that Fannie and Freddie, who were not in financial distress at the time Treasury and FHFA requested them to consent to conservatorship, did so with the understanding that FHFA would in fact act as a true conservator following that consent, and it did not, instead colluding with Treasury to take all of their net income in perpetuity. As stated in the complaint, “The Agency made no finding of insolvency, undercapitalization, or any other ground to impose conservatorship under § 4617(a)(3)(A)-(H) or (J)-(L)…. The Agency offered, and the boards of Fannie Mae and Freddie Mac accepted, a conservatorship that would aim to ‘preserve and conserve the [Companies’] assets and property’ and restore the Companies to a “sound and solvent condition.”

      There is no question that Treasury acted with premeditation and unlawfully in seizing Fannie and Freddie, and expropriating their assets for policy and financial reasons. The only question is which lawsuit will finally hit on the formulation that presents these deeds in a manner that resonates with the judges hearing the case and its subsequent appeals. The more cases that are filed, the more likely it is that one of them strikes that right chord.

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  15. tim

    the hindes/jacobs appeals brief just filed is quite good: http://www.gselinks.com/Court_Filings/Jacobs_Hindes/17-3794-0016.pdf

    it hammers at the point that judge sleet simply misunderstood the effect of HERA’s succession clause in mandating fhfa to exercise only those state law powers relating to corporate issuances that the GSEs themselves had…and no less than a scotus case (o’melveny) says that the conservator (addressed to FDIC under FIRREA, which HERA was modeled after) steps into the conservatee’s shoes in working through state law claims. in effect, by not benefitting from oral argument, judge sleet just whiffed on the core issue raised by hindes/jacobs.

    the third circuit’s rules do not require that oral argument be held but one would hope that given the prominence of this appeal the circuit court will decide to schedule oral argument.

    rolg

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    1. That’s excellent, and I’m glad to hear it. I’ll read the brief as soon as I can.

      I’ve always thought that Jacobs-Hindes was the “cleanest” and most straightforward of all of the cases challenging the net worth sweep. Let’s hope we get a better outcome from the appellate court.

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        2. I’ve now read the appeal brief and agree that it is very persuasively argued.

          I believe that in Perry Capital, first Judge Lamberth and then Justices Millett and Ginsburg determined in advance to find for the government, then did the best they could with the material they had to work with to justify their rulings (in some cases, having to misstate HERA or legal precedent to do so). In my view, Judge Steele’s appellate brief gives the judges in the Third Circuit few good “handholds,” should they be inclined to try do the same thing Lamberth, Millett and Ginsburg did.

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          1. Do we have any reason to believe that the Third Circuit will be any different? Or is the hope that eventually in one of the cases one judge, or two out of three as necessary, will finally buck the trend and examine the case from a neutral starting point?

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          2. @midas

            the hindes/jacobs claim is not a pure HERA statutory interpretation case like perry, but involves an analysis of whether delaware corporate statute defines the ambit of conservator’s power to isue securities under HERA…so it is a mixed HERA statutory analysis with a sensitivity to delaware corporate law. now as it turns out district court judge sleet was totally out of his element, not understanding the issues and the extent to which delaware corporate law was applicable…and he sits in delaware! the question is whether the third circuit court judges (some of whom would appear to understand delaware corporate law from their bios) might be more sensitive than sleet to the core claim that to understand the conservator’s power to issue securities, you need to go to the delaware statute.

            rolg

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      2. Hi Tim, with respect, given Mr. Corker’s upcoming retirement, wouldn’t an article titled ” Waiting for Mr. Mnuchin” be more apropos? Unless UST, the only Gov’t entity to actually verbalize intentions regarding GSE’s, has changed it’s mind due to DC ruling, isn’t the ball in the TS’s court, and only the TS’s court?

        Given the latest Congressional reform bill is a non sequitur of a non starter, Congress, and the retiring Senator, have as much to do with GSE reform as I do with this blog. This is all US Government at this point in time because a TS statement today that would read like, we’re just awaiting Congressional clarity on GSE would be more indicative of their disinterest in reform as much as their silence. Ergo, did the D.C. ruling derail GSE reform that was loosely slated for 1st Q post Tax Bill passage?

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          1. For readers, what Mnuchin said in a Bloomberg interview was, “We’ve talked about housing reform; I’m not sure that’s something we’ll get done this summer before the election, but we are determined to try to get Fannie and Freddie restructured in some format so that we don’t put taxpayers at risk.”

            This statement doesn’t surprise me, and I would view it as being moderately constructive. To me it suggests that Mnuchin does not expect Congressional action, and that given this he is content to wait (and continue to collect sweep payments, absent an adverse court ruling) until after the mid-terms, at which time he will go to work in earnest on an administrative reform initiative.

            Liked by 2 people

          2. No one seems to be discussing the $400 Billion elephant in the room which is how two Fortune 20 companies serving as the backbone of US RE industry that are apparently in dire shape could even repay a half trillion dollars in the first place. Leading to obvious questions of why they were nationalized after entering a contractual loan agreement no less, what exactly happened to them that required their nationalization, and simultaneously why do they require such drastic reform going forward. How you cure what ails an entity without first assessing the root cause of the sickness is beyond me, and Congress too.

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      1. briefly, there is no cause for receivership unless there is negative capital; fhfa could have put GSEs into receivership this quarter, but no one (other than AEI and other libertarian nutcases) even contemplated that. but as for litigation, yes receivership would be possible, the process would simply put a bracket around the litigated claims, and pay the claims off when amount owing is determined.

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  16. Mr. Howard,

    Have you seen anything from the AEI today that would convince you they have an actionable plan for mortgage market reform?

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    1. I will confess that I have not reviewed the tape of the AEI conference, because I have little expectation that I will learn anything new from it. But if by “actionable” you’re referring to the traditional meaning of that word-“giving sufficient reason to take legal action”– even without knowing what was said there I would respond by saying, “Most likely, yes.”

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    1. I don’t believe anyone contends this case is NOT “alive and kicking;” the question raised about it has been whether Washington Federal’s lead counsel has the intent and the wherewithal to see it through to trial rather than settle it, if given the chance.

      Separately, I understand that Fairholme also petitioned Judge Sweeney today for a two-week extension to file its amended complaint, so if these motions are granted the complaints won’t be filed tomorrow, but on March 8.

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      1. Hi Tim, when you say that the counsel in Washington Federal may settle the case, does it mean that they can settle for the benefit of those few that filed the claim and disregard the right of all other shareholders?

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        1. No. I meant that in the event the government offers a global settlement to all plaintiffs I expect Washington Federal’s counsel to accept it, rather than opting out and continuing to press their particular case on their own. I think there is a near-zero chance the government will offer the Washington Fed class plaintiffs a settlement of their own.

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      2. Tim–Have you read the recent paper on GSE credit risk transfers (CRTs), authored by three researchers from the New York Fed?

        I looked for your name in their footnotes, but–surprisingly–saw no reference to you or your multiple commentaris on the subject?

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        1. Yes, I did read the New York Fed’s paper on Fannie and Freddie’s CRTs—and no it didn’t reference any of the articles I’ve written about them. It also doesn’t address any of the major concerns I have about programmatic CRT issuance, which is my main criticism: it almost reads like a sales piece for these securities. It doesn’t say anything inaccurate, but it’s both incomplete and surprisingly superficial for work done by the New York Fed staff.

          The superficiality begins with the abstract, which says, “We argue that the CRT programs have been successful in reducing the exposure of the federal government to mortgage credit risk without disrupting the liquidity or stability of mortgage secondary markets.” That’s certainly true. But one side of the ledger can’t by itself determine “success”. In conservatorship, the federal government takes all of Fannie and Freddie’s profits and bears all of the companies’ credit risk. Yes, CRTs will absorb some of “the federal government’s” credit risk, but if the government has to give up more income in interest payments on those CRTs than it recovers through risk transfers, that’s not a “successful” program. The NY Fed, though, never looks at the efficiency issue.

          It does acknowledge the (obvious) potential for CRT investors to disappear when the economics of these transactions threaten to turn against them, when it says, “We note that the CRT programs have not yet been tested by an adverse macroeconomic environment, and we cannot be certain how CRT investor demand and pricing will evolve under such conditions.” But rather than try to objectively analyze what may happen in these circumstances, instead it simply states, “Careful management of the programs will likely be needed during such an episode.” Careful management? How does a credit guarantor “carefully manage” having the market for the CRTs it was hoping it could use to transfer credit risk dry up at the very time they could actually perform that function? The only “management” option left will be to hold the risk itself—and be less able to bear it due to the fact that so much of its revenues from earlier (good) loans will be eaten up in interest payments on CRTs that won’t end up transferring much risk. Shame on the NY Fed for dodging that issue.

          Elsewhere in the paper the authors retreat behind the cover of academic theory, as when they state, “Asset pricing theory would suggest that the ‘price’ of credit risk is the same regardless of which party owns that risk, and therefore that the GSEs (backed up by the Federal government) have no particular comparative advantage in bearing that risk.” In other words, since the market contains the best information about credit risk, CRTs have to be giving us the best price for it. But there are two big problems with this equivalency. The first is the one I just mentioned: for CRTs to be effective at absorbing risk they have to be available throughout the cycle, and Fannie’s CAS and Freddie’s STACRs almost certainly will not be. Second, Fannie and Freddie can diversify their credit risk across books of business—having income from their good books cover losses on their bad ones—whereas the CRT market does not and cannot do that. In asserting that Fannie and Freddie have no comparative advantage over CRTs in bearing credit risk, the NY Fed ignores both points.

          I expect much better work from them. The vast majority of people engaged in the reform debate have little practical experience with the subject matter they’re dealing with. They look to experts, like the New York Fed, for informed analysis and advice. Here, by oversimplifying and declining to do any serious analysis about the potential benefits and risks of CRTs used by credit guarantors, the NY Fed has let us all down.

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          1. Tim,

            Other than yourself, who is scrutinizing these products in an academic fashion? I’ve not found anyone doing so publicly and wondered if there IS anyone else doing it either publicly or privately.

            There seems to be a huge group of people pushing these but very few sussing out if they actually do anything or not. Which, after reading your critiques on them, appear to be very flawed at best if not outright fraudulent.

            Given that yours seem to be the only insights I’ve found, I worry that your scrutiny of these products is not getting disseminated anywhere other than here.

            Thank you again for your insights and as always, great work.

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          2. I may have something close to a unique niche in the mortgage finance field. I do this blog part-time and pro bono, because I believe my experience and expertise give me a valuable perspective on many of the issues at the heart of the mortgage reform dialog. Almost all of the other commentators I know either are paid to express an opinion, or don’t express an opinion because they’re NOT being paid. (This latter group is larger than you might think; I have spoken with many people at independent institutions and think tanks who’ve told me they agree with me but don’t weigh in on these issues because they can’t get the equivalent of “billable hours” for doing so–homebuyers don’t have anyone paying to advocate for their interests). So if I raise important issues or make good points in my blog, those who are being paid to take the opposite side of where I am won’t repeat what I’ve said, and indeed are most likely to ignore it. And the people who might agree with me don’t write to say so because, for a lack of funding to take up this issue, they’re working on something else.

            But that doesn’t mean I’m wasting my time. When I first started writing about CRTs, the Urban Institute’s “More Promising Road to GSE Reform”–which relied on the mandatory issuance of CRTs for the absorption of credit losses–was embraced by the Financial Establishment and endorsed by the MBA as the enlightened path to a new mortgage finance system. I believe my work had a lot to do with both the Urban Institute and the MBA moving away from mandatory CRT issuance towards endorsing the idea that CRTs should only be issued “when they make economic sense” (although they still need to do more work on WHEN CRTs are economically sensible), and giving capital credit for CRTs not dollar-for-dollar but on an “equity-equivalent basis.”

            If I still were CFO at Fannie, I wouldn’t be issuing the CRTs the company is issuing today; I’d be saving the interest payments (as capital) to use to cover loans made just prior to the next downturn, when I know CRT buyers no longer will be around to take those losses. But Fannie isn’t being run by its executives; it’s been run by FHFA, who in turn is being told what to do by Treasury, which still is operating on the “wind them down and then replace them” playbook given to it during the tenure of Hank Paulson. I won’t get Fannie (or Freddie) to stop issuing their CRTs, but hopefully, through the work I’m doing, I can help prevent the mortgage finance system of the future–whenever that gets developed and implemented–from assigning CRTs a role they can’t possibly carry out, and thus sowing the seeds of the next meltdown.

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      1. The general view is that a loss by plaintiffs in the Perry Capital case–which asserted that FHFA violated the Administrative Procedures Act in the way it implemented the conservatorship provision of the Housing and Economic Recovery Act of 2008–strengthens plaintiffs’ claims in their case before Judge Sweeney in the Federal Court of Claims, which asserts a regulatory taking. That is, if the government CAN legally appropriate all of Fannie and Freddie’s profits in perpetuity while claiming to be “conserving” them, that action constitutes a regulatory taking for which shareholders (both preferred and common) must be compensated.

        The Supreme Court’s denial of cert in the Perry Capital APA case also leaves alive several other courses of legal relief currently being pursued, including the breach of contract and breach of fiduciary duty claims remanded to the Lamberth court, the Jacobs-Hindes action in the State Court of Delaware (claiming that the net worth sweep is a violation of Delaware corporate law, and thus is void ab initio), and the actions in Collins, Bhatti and Rop, which raise issues related to the constitutionality of the FHFA director (independent of the executive branch) and the appointments clause (FHFA director DeMarco was not properly appointed to his position, and thus not empowered to agree to the net worth sweep).

        Of these, Jacobs-Hindes, Collins, Bhatti and Rop all challenge the legality of net worth sweep (under different theories of the law from Perry Capital), and if successful would (or should) result in the net worth sweep being unwound. The Sweeney case and the Perry Capital remands, on the other hand, would leave the net worth sweep intact but award shareholders damages, in amount to be determined by the court.

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        3. Tim, would you not expect the publication of the amended lawsuit in Sweeney’s court to be a turning point? Won’t this have references to the 1,000s of documents already handed over in quick peek which show “bald-faced lies” and “unambiguous” proof that UST lied to the US citizenry and perjured itself in multiple courts of law. This must be the beginning of opening up all the salacious material which can then be used in all the other cases?

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          1. We should have answers to these questions by tomorrow evening.

            Judge Sweeney’s “quick peek” order (issued almost four months ago) granted plaintiffs the right “to review the approximately 1500 documents dated May 2012 and later, which defendant is withholding pursuant to the deliberative process and bank examination privileges.” These documents must have been produced to the satisfaction of plaintiffs’ counsel, because they didn’t file any further motions with Sweeney to compel them.

            When plaintiffs file their amended complaint tomorrow, we should get a decent sense of both the scope and significance of any new revelations from these “quick peek” documents, based on the context of and the number of redactions in the complaint. I personally don’t expect there to be any bombshells, but I do think there will be more evidence of what we already know: that officials from Treasury and elsewhere in the government deliberately misled the public and the media about their motives for undertaking the net worth sweep, claiming that it was done for the benefit of the companies and the taxpayer when the real reasons were to transfer more than $100 billion of retained earnings from Fannie and Freddie shareholders to the federal government, and to keep the companies in conservatorship with virtually no capital until it or Congress could determine what could be done with them.

            If there ARE new documents of significance among this latest batch of 1500, they may not be released from their protective orders and made available to the public, but they very likely already have been shared with the courts hearing other cases related to Fannie and Freddie. In these cases they will be helpful, but in my view not dispositive. The really odd thing, to me, about the majority of the Fannie-Freddie cases is that the facts of what the government did don’t seem matter that much.

            The APA case in Perry Capital, for example, has been purely about the law. The government so far has claimed, successfully, that HERA allows FHFA to do whatever it wants with Fannie and Freddie in conservatorship, irrespective of its motives and the egregiousness of its actions. I continue to be stunned that this original (seriously flawed) ruling by Judge Lamberth was upheld by the D.C. Court of Appeals, and now won’t be reviewed by the U.S. Supreme Court. Even the government doesn’t believe what it’s saying in this case; if it really did think HERA allowed it to do whatever it wanted to with Fannie and Freddie, it wouldn’t have gone to such lengths of deviousness to hide its actions—it would have just taken their money outright and have been done with it.

            Similarly, Jacobs-Hindes is about what Delaware law permits, and Collins, Bhatti and Rop, post-SCOTUS’ decision not to grant cert in Perry, now mainly are about the constitutional issues of the independence and appointment process of the FHFA director. In these, “bad facts” about the government will be helpful to the plaintiffs, but not dispositive. The Perry Capital remand (breach of contract and fiduciary duty) and the Court of Claims case (regulatory takings) are where the government’s bad actions will be of the greatest value: the more blatant and obvious the government’s behavior with respect to Fannie and Freddie, the greater the damages that are likely to be awarded should plaintiffs ultimately prevail in these cases.

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          1. ROLG,
            ON the blog you referenced, the author does not mention our case on the “petitions to watch” from the Feb. 16th conference. That doesn’t sound promising, in my opinion, that our case was not mentioned on his list. I guess we will have to wait until tomorrow to find out.

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  21. There is some chatter about placing the gse’s in receivership. What would be the likelihood and process for this? How long would this take to resolve and would equity holders gain anything based upon current financials in this type of scenario?

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    1. The reason there may be “chatter” about putting Fannie and Freddie into receivership is that are two ways FHFA can respond to the net worth deficits the companies reported for the fourth quarter of 2017 ($3.7 billion for Fannie and $0.3 billion for Freddie)—it can either request a draw from Treasury to cover the deficits, or it can put one or both companies into receivership. Each time FHFA has faced this decision before (all of them between 2008 and 2011), it has requested draws for both companies.

      If FHFA were to put either company into receivership, the receiver would, by law, have to either restructure them or liquidate them. There is nothing close to a consensus as to what restructured versions of Fannie and Freddie would like, and liquidating the companies would leave our financial system without a functioning secondary market credit guaranty mechanism for conventional mortgages.

      Absent a plan for restructuring Fannie and Freddie, there is no way to evaluate how existing common or preferred shareholders would fare under such a scenario. In a liquidation scenario, the problem would be Treasury’s liquidation preference, which for Fannie is $121 billion (or over 3.5 percent of the company’s consolidated assets). Shareholders almost certainly would challenge that liquidation preference, but if it were upheld it is highly unlikely any preferred or common shareholder would see anything. Fannie calculates and publishes a fair value balance sheet each quarter—marking both their assets and liabilities to their estimated market values—and as of December 31, 2017 it calculated that the market value of its assets actually was less than the market value of its liabilities (by $19 billion). Fair value evaluations are notoriously conservative, but starting out $19 billion in the hole, then having to pony up another $121 billion to Treasury, would pretty much shut the door on anyone else.

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      1. Tim,
        Aside from our financial system without a functioning secondary market credit guaranty mechanism for conventional mortgages if they are put into receivership, what happens to the US $ 5-6 T MBS the GSE holds ?
        Thanks for your blog and knowledge.

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        1. I don’t know. I doubt Treasury would explicitly guarantee them, because then it would need to put them on the government’s balance sheet. I imagine it would simply say that Fannie and Freddie’s credit guarantees are still backed by the senior preferred stock agreement, but even so I imagine the MBS (and PCs) would suffer price deterioration from diminished liquidity.

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          1. tim

            “I doubt Treasury would explicitly guarantee them, because then it would need to put them on the government’s balance sheet.”

            which gets to the next point regarding calls for a treasury mbs guarantee going forward. even if it is “only” a last loss guarantee, wouldnt all fed guaranteed mbs have to go on the fed’s balance sheet? now of course, this would only cover newly-issued guaranteed mbs, but this will grow into a huge number. and with respect to all legacy outstanding nonguaranteed mbs, their price should logically decline (no explicit guarantee in the presnece of other mbs that are explicitly guaranteed calls into question the premise that there is an implicit guarantee that holders could rely on), which will create a major realized loss for a huge swatch of the institutional debt market, no?

            rolg

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          2. I am not an expert on government accounting, but I have to believe that the advocates of a full faith and credit government guaranty on MBS issued by “reformed” credit guarantors–which will be required to meet some defined standard of capital adequacy– have been told there is a reason those guarantees will not have to be put on the government’s balance sheet. Whatever that reason is, however, it can’t apply to the MBS of Fannie and Freddie today, which at most will have 10 basis points of capital backing them. And you’re right, if the government doesn’t explicitly guarantee Fannie and Freddie’s legacy MBS (because to do so would cause those MBS to move on the federal balance sheet) but then DOES subsequently guarantee the MBS of the reformed guarantors (with those guarantees being allowed to be kept off-balance sheet), then the legacy MBS would suffer a significant loss in value.

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    1. Ms. Petrou most likely is referring to a discussion in the 10K about FHFA’s “Conservatorship Capital Framework,” which are new capital standards the company said FHFA directed it to implement in 2017 that include “specific requirements relating to risk on our book of business and modeled returns on our new acquisitions.”

      In two places in the 2017 10K Fannie says, “In December 2017 and February 2018, FHFA, in its capacity as conservator, provided guidance relating to our guaranty fee pricing for new single-family acquisitions. FHFA’s guidance requires that we meet a specified minimum return on equity target based on the conservator capital framework. We must implement this target in the first quarter of 2018.” Then, when discussing guaranty fees on page 79, it adds this sentence: “We may be required to increase guaranty fees charged on some loans in order to meet this requirement.”
      That’s not “utility regulation,” though. Utility regulation implies a maximum return on equity, which keeps guaranty fees down. Here FHFA is insisting on a minimum return on (notional) equity, which Fannie says may push some 2018 guaranty fees up.

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      1. While utilities have a maximum rate of return (on equity presumably), don’t they also have minimum rates to keep investors in the fold? By my understanding those minima are not necessarily hard floors but are tied to the rates the regulator allows the utility to charge to maintain profitability.

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      2. tim

        thanks. seems to me that this is the opposite of utility regulation, in the sense that utility regulators usually seek to limit equity returns in order to promote customer affordability.

        rolg

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    2. Straight from the 10K. I believe this is what Karen is referring to which would imply a Utility scenario:
      —
      In January 2018, the Director of FHFA sent a letter outlining FHFA’s perspectives on housing finance reform to the Chairman and Ranking Member of the Senate Committee on Banking, Housing and Urban Affairs. The letter includes a number of recommendations for a future housing finance system, including:

      “providing for an independent regulator that retains FHFA’s existing authorities and adds additional authority. The regulator’s authority would include the authority to set a regulated rate of return for the secondary mortgage market entities.”

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      1. FHFA’s January 2018 “Perspectives on Housing Finance Reform” was a document prepared for the Senate Banking Committee that gave the agency’s recommendations for legislative reform; FHFA does not have the authority to cap Fannie or Freddie’s returns currently.

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        1. Tim,

          Good morning. I know Josh Rosner respects your work, as many do. He did have this comment earlier today. Do you have any insight as to the differing opinions? It seems like a worthwhile discussion. Thanks in advance.

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          1. I have no disagreement with Josh on this; the problem here is that my response was not well worded. I was referring to the powers FHFA would have as regulator, if and when Fannie and Freddie were released from conservatorship. As conservator, it clearly does have the power to regulate the companies’ returns, and–if you believe that the decision of the majority of the judges on the DC Court of Appeals in the Perry Capital case will be upheld–also to require that Fannie and Freddie finance a project to send people to Mars.

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          2. That was my tweet to Josh.

            Apologies if I misrepresented your statement Tim.

            I believe you two are the smartest people talking about the GSEs on a regular basis, so it is interesting when you see things differently. In this case, you both see eye-to-eye.

            Again, sorry for confusing the issue. There are lots of conversations going on in many different platforms. For us lay people, trying to fill the gaps between the conversations is challenging.

            I’ll take the liberty of speaking for many, but your blog & especially your follow-up in the comments has been really insightful. Thank you.

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  24. Tim – Lots of news out these past few days, in regards to the budget line items, draws on the Treasury, and OMB Director testimony.

    A question I have is about the MBA’s open letter to Congress. I know Dave Stevens said the MBA was going to press Congress to act in the next few weeks as this was window they saw closing quickly. Today, they sent an open letter: https://www.mba.org/mba-newslinks/2018/february/mba-newslink-wednesday-2-14-18/mortgage-bankers-post-open-letter-to-congress-on-gse-reform?_zs=SLkMC1&_zl=7AmI4

    It appears to rehash their earlier talking points, but, I hadn’t seen them push for “–A utility-style regulatory framework to ensure a level playing field and equal access to the secondary market for lenders of all sizes and business models.”

    While they don’t detail the ‘how’ this would be implemented, it is interesting they are bringing this into the conversation. Maybe they realize their members and other stakeholders (i.e. investors) will get on board if MBA has Congress’ ear for the moment.

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    1. The “utility-style regulatory framework” was an element of the MBA’s April 2017 white paper, and the only significant one that wasn’t incorporated into draft 29 of Corker-Warner 2.0. The MBA is still pushing for that, so it’s not surprising that some of its members wrote Congress in support of it.

      What I find surprising about it,though, is that the MBA either doesn’t realize–or thinks other people won’t notice–that utility-like regulation and returns for credit guarantors are incompatible with another reform recommendation the MBA is even more insistent upon: the need for multiple guarantors to create competition. Companies subject to utility-type regulation typically are allowed to be the only providers of that regulated product in the markets they serve. Open entry to competitors threatens the one aspect of their profitability utilities otherwise could count on: the volume of business they do. (You don’t see anyone claiming that there would be great benefits from giving consumers three or four power companies to choose among). Moreover, with regulated returns you would virtually ensure the performance alignment I discussed in this post, undermining the MBA’s (and others’) ability to claim that the federal government could guarantee the mortgage-backed securities of multiple credit guarantors without also implicitly guaranteeing the companies themselves. Multiple credit guarantors with the same capital requirements, regulated returns, close regulation and supervision and the same menu of products to guarantee would have financial performance that would be indistinguishable from each other. I’m beginning to think that the MBA and other bank supporters know this, but are willing to pretend it isn’t so in order to have a better story for why legislation that favors them also is good for everyone else.

      On the MBA members’ letter itself, there was one aspect of it that I found very odd. In arguing for the multiple-guarantor model the MBA supports, they claim that the current debate is focused on “two leading options,” the second of which is “an ‘issuer-based’ system that relies primarily on a handful of larger ‘lender-aggregators’ to originate and/or acquire mortgages from smaller lenders and issuing the securities themselves, after securing the government guarantee.” I don’t know who is pushing for that option. (The other “leading option,” I would submit, is releasing Fannie and Freddie from Treasury-imposed captivity.) But creating a straw man always is a good way to make a weak recommendation look better.

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      1. tim

        well put.

        in trying to think through what MBA’s bottom line would be, isnt the right answer simply an MBS level federal guaranty? even if structured as a last loss guaranty, wouldn’t this qualify the MBS they would hold for regulatory capital relief? what would be objectionable from MBA point of view if the GSEs continue subject utility regulation without those other competing guarantors which, one assumes, the MBA banks would control. i just dont see what is in it for MBA banks to have those additional GSEs if the existing GSEs provide a federal guaranty. they have a hard enough time managing their businesses as it is.

        rolg

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        1. What would trigger a federal payment on an MBS-level guaranty? Previous proposals have suggested you pick some extreme level of loss, say 10 percent (which would be 20 percent loss incidence and 50 percent severity), and have the government cover pool losses in excess of this amount. The problem with that approach is the government ends up making payments it can’t recover (unlike the “bailout” payments it made in 2008, which it did recover) for losses incurred on “outlier” individual MBS pools that the guarantor easily could have covered itself with revenues from its better-performing pools. I’ve never understood how pool-level government guarantees can be described as “good for the taxpayer;” they’re not.

          Alternatively, you could have federal guarantees of MBS triggered by a guarantor’s inability to pay them. But here you’re back to the “independent, and not correlated” argument the MBA is pushing. If both (or all) of your guarantors fail at the same time–as I argue they would, given their mono-line business and identical permitted activities, market and regulation–and during a crisis the government guarantees only the existing MBS, there would be no surviving guarantors to issue new ones, and the system would crater.

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          1. tim

            i appreciate your response but you are considering the effects of a mbs guaranty upon the taxpayer and the secondary housing finance system as a whole (which, i understand, is your touchstone). we can agree that MBA is concerned primarily with its members’ utility.

            viewed from that lens, what is the MBA definition of success here? in negotiations, i always try to understand the adversary’s definition of success, and sometimes exploring that leads to a shifting target.

            if you simply took the fhfa perspectives of utility regulated GSEs, recapitalized with sufficient private equity capital (and the moelis blueprint is absolutely the pathway for that) and a mbs level federal guaranty (of some sort, i agree with you that the devil is in the details but all the MBA is looking for is regulatory capital relief), why isnt that a done deal for the MBA?

            unless MBA is driven more by spite than self interest (which believe me i have seen before).

            rolg

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          2. I believe that, in addition to government-guaranteed MBS, the banks and the MBA also want secondary market credit guarantors that are weak enough that primary market originators can dominate them. New entrants, “bank-like” capital requirements that are unrelated to risk, and utility-like regulation all are a means to that end. The reason I like administrative reform similar to the Moelis plan is that–because of the warrants–it gives Treasury an incentive to reform and recapitalize Fannie and Freddie in a manner that makes them as efficient as possible, increasing the economic value of the warrants and at the same time their value to homebuyers. It may be that in order to get to an acceptable administrative solution Treasury will have to buy off the banks somehow, but I won’t be one of those suggesting how to do so–and it would come down to a negotiation between Treasury and the bank lobby in any case.

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      2. Unfortunately the President’s own budget includes the line “The proposal would help to level the playing field for private lenders seeking to compete with the GSEs.” as one reason for doubling the GSE guarantee fee surcharge. Even though you and I recognize that utilities and competition really don’t mix, the administration seems to at least leaning in the direction of introducing competitors to the marketplace.

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        1. @midas
          seems to me that increasing the g fee 10bps will also increase originating banks’ margin by 10bps when they hold their loans. that also has the effect of leveling the playing field.

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  25. Tim,

    Do you think Mnuchin had a lot of say in this budget? I ask because how does one square the release of the GSEs with counting the income from G-fees as income to the government for the next 10 years? Seems like the warrant value may be losing out to crony capitalism.

    “The budget proposes increasing the guarantee fees charged by Fannie and Freddie by 0.1 percentage point, a move the administration forecasts would raise nearly $25.7 billion over a decade”

    Hope to get your thoughts and thank you.

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    1. There are two issues here. The first is that until Fannie and Freddie are removed from conservatorship (or liquidated), or until the net worth sweep is declared illegal or cancelled, the budget document will show continued receipts from the sweep for the full ten years of the projection. There is nothing of any policy significance here; it’s just budgeting convention. As for the ten basis point increase in guaranty fees, unless there is some discussion about this elsewhere in the document (which I haven’t read, and don’t intend to), I would think that given the large amounts of red ink produced over the forecast horizon by the tax reform package and recent spending agreement, the budgeteers are looking for any credible assumptions they can make that will produce more revenue; every $25.7 billion they can put into their projections makes the projected deficit smaller.

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  26. Tim, Good morning
    As per Mortgage Finance News, Wallison and others who are anti GSE are planning to make a roundtable in Washington sometime end of February to talk about administrative options to get rid of GSE which does not need legislative actions. Have you heard of this and what is your take of this option?

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    1. No, I haven’t heard of this possible roundtable, but if the anti-Fannie and Freddie crowd is beginning to talk about non-legislative alternatives for doing away with the companies it would be further evidence that even the most ardent proponents of legislative mortgage “reform” now understand, post-draft 29 of the Corker-Warner legislation, that it’s not going to happen. As to how they think they might be able to produce the result they want administratively I have no idea, but I’m sure they won’t be shy about letting us know.

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        1. Hmm. PIMCO wants Fannie and Freddie to be nationalized (or, “folded into the government”), an explicit government guaranty on the securities they issue, a “continuation of [Fannie and Freddie’s] credit risk transfer programs,” and a gradual lowering of Fannie and Freddie’s loan limits coupled with reforms to the private-label securitization (PLS) process to help “revitalize” the PLS market. Any alignment of these recommendations with PIMCO’s interests as one of the world’s largest fixed-income securities managers is, we must assume, purely coincidental.

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          1. Tim –

            Unless I have not had enough coffee this morning, PIMCO seems to advocate one thing but proposes a solution that is at odds with what it advocated for. Effectively, they took no position on the issue.

            Advocate: “folded into the government” and “explicit government guaranty”

            Proposed Solution: “…we believe policymakers could thoughtfully and slowly shrink the government balance sheet…”

            On the fixed-income securities manager piece, I’ll just leave this: PIMCO Buys a Stake in First Guaranty Mortgage Corp., a $4 Billion a Year Lender (https://www.insidemortgagefinance.com/imfnews/1_691/daily/pimco-buys-first-guaranty-mortgage-corporation-1000033719-1.html)

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          2. The big problem with nationalization, or “fold[ing the GSEs] into the government”, is that their liabilities would count towards the national debt without being offset by their assets, amounting to an instantaneous $5T added to the debt the way it is currently calculated. This is political self-immolation when neither party will hesitate to (hypocritically) slam the other on reckless spending.

            Please correct me if I’m wrong on this, but I believe that was the rationale behind the warrants being for 79.9% of shares and not more, with 80% being the magic number for debt consolidation.

            Liked by 3 people

      3. What can admin reform do? G-fee? capital ratio? loan quality and limit? portfolio size? I guess not setting profit rate as utility which belongs to Congress.

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  27. Tim,

    Good morning. Would it not make more financial sense for Mnuchin and the Trump Admin to go ahead and exercise the warrants as opposed to continuing the sweep? It seems that a now 3 year window to recognize the larger windfall would be more beneficial for Treasury than the sweep. Maybe that is what is coming?

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    1. You’re getting far ahead of the story. The warrants won’t even be an issue unless and until Treasury decides it wants to preserve Fannie and Freddie in something close to their current form (a la the Moelis plan). At that point it will need to settle the outstanding lawsuits related to the net worth sweep (and the conservatorship itself)—which will end the sweep—and endorse a recapitalization plan. Then I’m sure it will work with investment bankers on a specific plan for exercising the warrants and selling the resulting common shares in a manner and at a pace that maximizes Treasury’s proceeds (and as a consequence the price of the stock held by existing shareholders).

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        1. As I noted in my previous answer, IF Treasury decides it wants to “get [Fannie and Freddie] out of government control” and restore them as shareholder-owned companies at the center of the secondary market–in spite of the fact that it currently is winning the lawsuits that claim it can continue to keep the companies in conservatorship and take all of their profits forever–it will have to settle the lawsuits. It won’t be possible to recapitalize them if the government at the same time is claiming in court (successfully) that it can force them into conservatorship, take all of their future net income, and be immune to judicial review.

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      2. That sounds like a favorable outcome, beneficial to all stakeholders. Afterwards, Congress could vote to re-charter the GSEs as utilities, as suggested by the Moelis plan. In that way, Fannie and Freddie would be, at least partially, free of political pressure and better able to regulate the mortgage market. I feel that many stakeholders, such as myself, would welcome such a practical outcome, but you know what they say about the devil in the details.

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    1. No, it’s hooey. And it shows that both sides of the reform debate are capable of coming up with, and pushing, nonsense. That’s why people need to do their own independent research and analysis of these issues, so that they’re less likely to be enticed into believing something that conforms with their priors, but isn’t true.

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      1. I totally agree with you on this point, but may I point out that the Inspector General did find over $500 billion in “accounting errors” on HUD’s balance sheets. I don’t know exactly what the “accounting errors” were, but I do believe there needs to be more accountability, honesty and openness in evaluating all players in the mortgage market.

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        1. Accounting errors are different from fraud. And the author of an article that has a section titled “Mnuchin Confirms GSE Sweep Money Used to Fund Obamacare” doesn’t check their facts carefully. Yes, there are many points the author makes that are valid, but because of its mix of fact and fiction the article overall is unreliable.

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        2. Brian, you might be referring to the numbers found here.

          https://www.usatoday.com/story/news/politics/2017/04/19/fact-check-ben-carson-didnt-find-hud-accounting-errors/100647342/

          The $500B number is the sum of the absolute values of the errors, not the sum of the errors themselves. The actual errors sum to only around $3M. That means there is no “missing” $500B floating around somewhere.

          The Valuewalk article is a mishmash of facts, errors, and wishful thinking. Example: claiming that FHFA had sued the list of banks for a total of $250B, settled for (a lot) less, and then saying that the balance of the money is still “owed” to shareholders is complete nonsense. The whole point of settling the cases is that there is no more liability going forward.

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  29. Tim , good morning, how long do you think that we will be waiting for Mr Corker?
    Are you aware of any time limit agreed with Treasury , or with FHFA or any other stakeholder?

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    1. Adding to Eric’s question, Watt’s term expires in Jan 2019, and Philips hinted that he wouldn’t pursue administrative action this year. What are your thoughts on the possibility of a new conservator replacing Watt pushing TBTF’s agenda? Is your “most likely scenario” based on the assumption that admin action will happen before then?

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    2. No, I’m not aware of any discussions as to what has to happen for Corker-Warner 2.0 to be declared “officially dead.” But I strongly suspect that having draft 29 become public–allowing everyone to see how far from anything remotely ready to be acted upon the C-W effort currently is–coupled with what everyone knows are the great difficulties for this Congress in getting anything passed at all (let alone something as controversial as a “why-not-give-it-a-try” total remake of a $10 trillion financial market at the heart of the U.S. economy), the air should start coming out of the legislative mortgage reform balloon pretty quickly. But it’s still going to be up to Mnuchin to decide when to initiate administrative reform discussions, and I have no basis for predicting that.

      On the issue of Watt’s successor next year, I know that some people are saying that a change in the director of FHFA could make a difference in the reform outcome, but I think that’s overstated, particularly as it relates to the TBTF banks. What they want requires legislation, and if they can’t get legislation (as I believe they won’t), that greatly limits the scope of their influence. And I also don’t believe the new FHFA director will drive administrative reform, no matter what his or her views are on Fannie and Freddie. Mnuchin has very clearly staked out mortgage reform as his territory, and Treasury (not FHFA) also is the entity that stands to gain financially from converting the Fannie and Freddie warrants to common stock, then selling it.

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      1. Hi Tim,

        It seems to me that administrative reform in 2018 is the most probable outcome, though I could be wrong! What are your thoughts on Hensarling’s and Corker’s suggestion to Democratic lawmakers that administrative reform and recaplitalization means risking affordable housing mandates? I find that hard to believe.

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        1. I hadn’t heard that Hensarling and Corker were telling Democrats that administrative reform “means risking affordable housing mandates,” but if that’s what the two are saying they’re using the term “affordable housing” in a specific and limited sense.

          When I was at Fannie, we used “affordable housing” to refer to the loans we purchased or guaranteed that had been made to people with low and moderate incomes who fell into one of several categories of “underserved borrower.” By the end of my tenure at Fannie, in 2004, over half of the total business we did satisfied affordable housing goals set for us by our program regulator, HUD.

          But that’s not the type of affordable housing Hensarling and Corker (and the big banks) are referring to. Both Corker-Warner bills (1.0 and 2.0) as well as Hensarling’s PATH Act include a provision requiring credit guarantors to contribute an amount equal to a certain percentage of their outstanding credit guarantees–typically between 5 and 10 basis points–to an “affordable housing fund,’ whose proceeds would be used to subsidize certain types of affordable housing programs. Guarantors, of course, would have to add this affordable housing fee to the guaranty fees they charge, so other homebuyers would end up bearing it. (Banks are big fans of this approach to affordable housing, because they don’t have to pay for it; the fee only gets charged when a loan is sold into the secondary market, making it in effect a tax on secondary market financing, from which primary market originators are exempt.) Fannie and Freddie currently have a similar fee–created by the 2008 Housing and Economic Recovery Act–but it’s set at a fixed 4.2 basis points. Corker and Hensarling are telling Democrats, apparently, that if they want more than 4.2 basis points per year going into an affordable housing fund they’ll have to pass legislation to get it.

          That’s true. But Corker and Hensarling are silent about the OTHER, much larger, aspect of affordable housing–the cost and availability of mortgages made to people with low and moderate incomes. The key to these is capital, and Corker and Hensarling both would require credit guarantors to hold large fixed, “bank-like,” amounts of capital, which would unnecessarily push up guaranty fees for millions of affordable housing borrowers. When you take into account both definitions of affordable housing, homebuyers would be much better off passing on legislative reform and pushing for administrative reform that includes a true risk-based capital standard, which would keep guaranty fees as low as possible while still providing a very high level of taxpayer protection.

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          1. Tim, thank you. Your ability to answer our questions here with easy to comprehend answers never ceases to amaze me. Thanks again your tutelage in Housing Finance and Reform 101 and beyond. You’d make a great high level educator.

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          2. tim

            there is also this below, fnma making equity investment in a housing fund financing homeowners who have trouble obtaining credit. i suppose there are housing tax credits involved too. this is a (relatively) small amount, but it chafes to hear a hypocritical criticism that a MBA structured housing guarantor system would out do GSEs in providing credit for low income housing.

            http://www.housingfinance.com/news/fannie-mae-announces-100-million-lihtc-fund_o

            rolg

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          3. This might be missing the point. The way I have interpreted the threats against affordable housing is that Hensarling and Corker are trying to scare Democrats into voting for their version of housing finance reform in 2018. The threat is that if no legislation can be passed and Watt’s term ends, Trump will appoint a far-right-leaning FHFA director who will unilaterally gut the affordable housing provisions currently in place. Therefore the Democrats should just take the little that Corker v29 offers so that the new FHFA director can’t undermine it.

            If enough Democrats understand and repeat Tim’s second sentence of the last paragraph: “But Corker and Hensarling are silent about the OTHER, much larger, aspect of affordable housing–the cost and availability of mortgages made to people with low and moderate incomes.” then those two will be forced to either stop their scare tactics or actually make meaningful provisions for affordable housing.

            It does beg the question: if a new FHFA director really was bent on destroying the GSEs and/or affordable housing mechanisms, how much damage could he or she do alone?

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          4. That’s exactly what Hensarling and Corker (and the MBA) are saying: “If you don’t pass our (awful) legislation this year, then next year a new FHFA director could do something even worse.”

            There are two problems with this tactic, however. First, it doesn’t change the fact that in its current state Corker-Warner 2.0 IS an awful bill. And second, in my view it overstates the likely ability of a new FHFA director to act in ways that are not consistent with what Secretary Mnuchin believes should be done with Fannie and Freddie.

            Even though according to the HERA statute FHFA is an independent agency not subject to the control of any other agency, from the day HERA was passed–and even before the conservatorship– the FHFA director has done whatever the Secretary of the Treasury has asked him to do, and nothing to which the Secretary has objected. I don’t see that degree of subordination or deference changing much when a new FHFA director is appointed. Mnuchin has made it clear that he sees Treasury as the lead agency in housing finance policy, and I can’t see a new FHFA director taking any major actions that run contrary to Mnuchin’s wishes. A logical extension of this view is that Mnuchin likely will have a strong say in who is appointed FHFA director next January, since he will want someone with whom he can work smoothly, and who he believes will not challenge him on policy issues. (A second logical extension of this view, though, is that if we get to next January without any moves toward administrative reform, and President Trump appoints a known “Fannie hater” as FHFA director, it will be a strong indication that Mnuchin intends to try to keep Treasury’s foot on Fannie and Freddie’s air hoses for as long as he can….)

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          5. Hi Tim, do you agree with Karen Shaw Petrou that the mortgage “market isn’t functioning properly” and therefore there is powerful economic incentive to resolve the conservatorship? If so, why doesn’t Mnuchin or Watt make a stronger case on this particular point, that each day in conservatorship further weakens the economy, and wouldn’t it be an easy case for Mnuchin to make that resolving the conservatorship along the lines of Watt’s proposed utility solution is not just a reasonable way forward but necessary? And finally, is there any connection, do you think, between the extended conservatorship and the stunning gap between home construction and household formation rates?

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          6. I haven’t followed the recent trends in either home construction or household formation rates, so don’t have any comment on that. And I agree with Ms. Shaw Petrou’s observations that the mortgage market isn’t functioning properly and that for this reason there is a powerful economic incentive to resolve the conservatorships; the problem is that the “powers that be” haven’t been able to agree on how to do this, so here we sit.

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          1. tim

            the biggest problem with this hensarling/corker/mba threat tactic is that it shows you have an empty hand by making an empty threat. what did buffett say about the guy who walks into a card game and cant tell immediately who the patsy is…?

            rolg

            Liked by 1 person

  31. http://www.scotsmanguide.com/News/2018/02/GSE-reform-bill-could-be-Congress–last-chance/

    “I read an interesting blog this morning that was filled with misinformation”.

    wonder what blog that could be. I notice he doesn’t go on to dispute any of it. These people, smartly, put out information in a vacuum where no one can commentate or critique it openly, like an open debate, because they’d have no factual basis to fall back on in their argument when pressed.

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    1. The Stevens piece you linked gives his arguments for why he thinks the goals draft 29 is trying to achieve are good ones. I don’t agree with much of what he says, but that’s really not the point. We’ve heard these arguments before, and here as in prior pieces Stevens says nothing about how you implement the new ideas in the legislation he’s advocating. “God is in the detail,” and as I noted in this post, draft 29 leaves virtually all of that detail to be figured out by somebody else at some later time. Why? What are they waiting for?

      Until somebody lays out their ideas for precisely HOW you get 5 or 6 de novo credit guarantors chartered, capitalized and up running to the point that FHFA can “certify that a competitive market exists” (which is essential to evaluating whether there is any realistic chance of raising capital for these entities), HOW they are to be capitalized (if you don’t know what their required capital is, you can’t possibly claim your new system will be effective at providing affordable housing for borrowers with family incomes at or below their area median), and HOW you navigate the legal minefield of running Fannie and Freddie through receivership before liquidating them, all of this is just lofty talk. The Moelis plan is a real plan, with concrete steps to achieve the recapitalization and release from conservatorship of Fannie and Freddie. In contrast, draft 29 is just an aspiration (or, dare I say it, a “half-as…piration”).

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      1. tim

        i have one simple word for MBA, the committee staff that took 29 drafts to accomplish nothing, and Corker: PRECEDENT.

        show us a precedent for the type of massive restructuring of a financing market by legislative fiat. show us a banking firm that would accept a mandate to advise on this legislative pipe dream. no serious investment banking firm would touch this mandate. it is not executable.

        the moelis blueprint is done by a serious investment banking firm and, as it makes explicit in the blueprint, it DOES rely on a precedent: AIG. moelis would accept the mandate set forth in its blueprint, as would every other investment banking firm on wall street.

        rolg

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  34. Tim – excellent article as usual. Thanks again for all your hard work. Small shareholders across the country are very grateful for all you do on this blog!

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  35. This article reminds me not of beating a dead horse with a stick rather of whipping the lead horse around a track that has no finish line. A newcomer to this saga might not think this article was referring to two Fortune 20 companies. Ironic how the supposed instigators of a financial crisis have self corrected themselves to sustainability and record profitability, all without the vaunted help of Congress. If the companies are far from broke then what exactly is Corker-Warner 2.0 trying to fix?

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    1. @paul

      instead of “fixing” GSEs by calling for a total revision of the secondary housing finance market and encountering all of the execution risk that this entails, congress could simply cause GSEs to reduce their mortgage loan portfolios and have GSEs become focused mbs guarantors rather than mortgage credit arbs.

      DOH! FHFA has already done that!

      rolg

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  36. tim

    great job as always.

    i suppose there is one additional factor to add why this corker draft will be unsuccessful: banker spite. spite at having been sued by fhfa (using an adept private law firm) and DOJ for wholesale financial fraud and misrepresentation in connection with the financial crisis, and from having to pay tens of billions of dollars in settlements and penalties.

    just another reason why corker wont get his legislative way is that banker spite masquerading as policy reform wont fly.

    rolg

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    1. I would think the long game of getting the mortgage market into the truly more expensive private sector aka the TBTF banks as described above, is a bigger driver here.

      The great thing that these corporations have going for them is that they never ever die. Unlike people who do, so their malfeasance in all things is eventually forgotten and the same mistakes are made again.

      Further, it makes even more clear that the REAL reason they’re all trying to sweep the GSEs under the rug thru a receivership conveniently sweeps under the rug the Bush, Obama and now Trump administration’s handling of this issue. Currently, they’re feeding all that money they make directly to the government because the court system refuses to rule on the merits of any of the cases because they’re also in on the take… which really lends itself to bigger issues, and for me, confirms the WHY a Trump could even get elected. People know the game is so rigged against them and for these ageless corporations they’re yearning to blow it all up and start over again. I keep saying this will end badly because it will. The biggest game changer is the fact that we can talk about this subject so easily. The transparency of the Internet will continue to take down these liars and there will, hopefully, be a peaceful transition to a more transparent world, which is possible since everyone is now constantly watched by our friends at the NSA!

      So yes I guess banker spite but no not really.

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  37. Thank you for the post, it describes the current situation and motivation of the players nicely.

    We might not even be able to call this bill Corker-Warner 2.0. From an Inside Mortgage Finance newsletter:

    https://www.insidemortgagefinance.com/issues/imfpubs_imf/2018_5/news/Sen-Corkers-GSE-Reform-Is-Complicated-Has-Yet-to-Attract-Democratic-Support-1000044641-1.html

    “However, the measure lacks the backing of Sen. Mark Warner, D-VA, who five years ago co-authored a GSE reform measure that eventually went nowhere.”

    and

    “When asked whether Warner approves of Corker’s draft, a spokeswoman was noncommittal, saying: ‘To get his support, any proposal would have to have strong affordability provisions, including enhanced assistance for first-time homebuyers.'”

    Perhaps Corker v1.29?

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