The Interested Parties Respond

~ jtimothyhoward

The Federal Housing Finance Agency (FHFA) released its notice of proposed rulemaking on “Enterprise [Fannie Mae and Freddie Mac] Capital Requirements” on June 12. After the comment period closed on November 16, there were 77 entries on FHFA’s comment log. Half (38) were from individuals who wrote short comments ranging from one sentence to a few paragraphs expressing their personal points of view, and there were eight administrative-type entries (correspondence to and information or meeting summaries from FHFA).

The remaining 31 entries broke out this way: One each from Fannie and Freddie; 5 from private individuals—Myself, the team of Ed Golding, Laurie Goodman and Jun Zhu (who work at the Urban Institute but submitted their piece as individuals), and Andrew Davidson (who submitted three separate comments); 1 from an affordable housing advocate—The Center for Responsible Lending; 3 from private mortgage insurance entities—Genworth, Arch Capital, and U.S. Mortgage Insurers; 4 from Wall Street interests—Moelis & Company, Pershing Square Capital Management, Katz Capital, and The Structured Finance Industry Group; 5 from community lending groups— The Independent Community Bankers of America, The Community Home Lenders Association, The Credit Union National Association, The National Association of Federally-Insured Credit Unions, and Heartland Credit Union Association; 4 from large trade associations—The American Bankers Association, The Mortgage Bankers Association, The National Association of Realtors, and The National Association of Homebuilders; three from Washington think tanks—The American Enterprise Institute, The Housing Policy Council, and The American Action Forum), and four from multifamily interests—The DUS Advisory Council, Walker and Dunlop, NorthMarq Capital, and the National Multifamily Housing Council and National Apartment Association, commenting jointly.

For those whose interest is in multifamily lending I must offer an apology: from the start of the capital exercise I have concentrated almost exclusively on the single-family side, since that is where my expertise (and most of the controversy) lies. But multifamily lenders serve a critical segment of the housing community, and getting Fannie and Freddie’s capital right for these borrowers is just as important as it is in single-family. As soon as I can, I intend to dig into the multifamily comments, try to get up to speed on the issues there, and see if there is anything I can add to the dialogue that might be helpful.

Commenters on the single-family standard, as a rough generalization, fell into two groups: those whose primary concern was how the proposed capital rule could (or needed to) be improved in order to strike the desired balance between taxpayer protection and the provision of an ample flow of mortgage credit to as wide a range of potential borrowers as possible, and those whose comments were colored by a different objective—whether it be ideological (reducing the role of “government” in housing), competitive (engineering the capital rule so as to move business away from Fannie and Freddie to a preferred financing source), or something else.

The focus of this post is on comments intended to improve the FHFA standard. (If those who wish to use capital to constrain the companies end up carrying the day, the issues the former group is trying to get right won’t matter as much.) From this perspective, I found the most useful and constructive comments to have come from Fannie Mae, the team of Golding, Goodman and Zhu from the Urban Institute, The Center for Responsible Lending, and the three mortgage insurance entities (who had valuable insights into how the capital dynamics of insurers differ from those of banks). And even including the comments from the “we’re going to wind this thing [Fannie and Freddie] down, we’re going to kill it, we’re going to drive a stake through its heart, and we’re going to salt the earth so it can never grow back” crowd, the submissions as a whole revealed a number of areas of legitimate concern:

  • The lack of transparency of the FHFA proposal, which makes it difficult to understand it in sufficient detail to offer constructive suggestions for how to improve it (or to prevent unintended consequences);
  • Near-universal agreement that using current loan-to-value ratios in the standard creates severe problems of procyclicality, which need to be addressed;
  • The adverse effect on mortgage rates of layering conservative assumptions one on top of the other;
  • The need for FHFA to acknowledge the role of guaranty fees in absorbing credit losses;
  • A significant degree of overcapitalization of higher-risk mortgages relative to their historical performance;
  • Confusion as to how the minimum capital ratio, loss reserves, the going concern capital buffer, any systemic risk buffer (proposed by some) and excess capital relate to one another in the standard, and
  • Reservations about the proposed equity capital relief for securitized credit risk transfers.

Below are brief elaborations of each of these points:

Lack of transparency. U.S. Mortgage Insurers spoke for many commenters when it said, “The NPR does not provide sufficient factual detail to permit interested parties to ‘comment meaningfully’ on the proposal.” USMI said that, “FHFA has chosen to abandon the existing capital rule in its entirety…using instead as a foundation for this NPR the CCF [FHFA’s Capital Conservation Framework], which has not been publicly released.” USMI added, “The remedy is to treat this proposal as an ANPR [Advance Notice of Proposed Rulemaking], solicit further comments on the appropriate capital regulations for the Enterprises, and, in particular, solicit comments on whether an insurance company capital model is more appropriate in light of the fact that these entities are not banks.”

Pershing Square Capital and The Center Responsible Lending (CRL) believe FHFA’s current standard may be too complex to fix, and for that reason are prepared to support a simple 2.5 percent leverage ratio for all of Fannie and Freddie’s business.

Use of current loan-to-value ratios in stress test. This feature was almost universally cited as problematic, because of its strong procyclical effect. The Urban Institute’s Golding, Goodman and Zhu noted with understatement that, “It will be difficult for a GSE to manage to a requirement that can double in two years.” Several commenters (including Fannie, the Urban Institute team, Pershing Square, the ICBA and the ABA) supported moving back to the original LTVs used in the 1992 standard. Yet nearly an equal number (including Genworth, Arch Capital, the Housing Policy Council and the MBA) proposed sticking with mark-to-market LTVs but having FHFA adjust them for “fundamental housing values,” which would somewhat increase required capital in strong housing markets and somewhat reduce it in weak ones.

I was surprised that trying to offset current LTV volatility by attempting to estimate when homes are overvalued or undervalued had as much support as it did. Most obviously, such estimates of fundamental value always will be subjective. Second, this approach still would have the companies holding too little capital near market peaks and too much capital at troughs. And third, it leaves unsolved the problem of how to set guaranty fees when required capital is not known at the time of pricing. But given the number of comments in favor of this alternative, FHFA will need to examine it seriously.

Layered conservatism. FHFA says it “considers it prudent to have risk-based capital requirements that include components for credit risk, operational risk, market risk, and a risk-invariant going-concern buffer; that require full life-of-loan capital for each loan acquisition; that are calculated to cover losses in a severe stress event comparable to the recent financial crisis, but with house price recoveries that are somewhat more conservative than experienced following that crisis; and that do not count future Enterprise revenue toward capital.” Numerous commenters, including the community lending groups, wanted FHFA to quantify the effect this layered conservatism had on guaranty fees and mortgage rates. As the NAR noted, again with understatement, “the significant caution taken in creating a conservative rule mutes or may hinder the Enterprises’ ability to support their public mission.”

The Urban Institute group, CRL, Arch Capital, USMI, the NAR and the NAHB all called attention to another significant, but hidden, form of conservatism in the standard: since the 2008 financial crisis, the adoption of the qualified mortgage and ability to repay standards, improved appraisals, changes in underwriting and stronger capitalization of mortgage insurance companies all have reduced both the likelihood and severity of a similar crisis in the future, but none of these favorable changes are reflected in the stress loss percentages in FHFA’s look-up tables or risk multipliers.

In addition, embedded in Fannie’s comment is a subtle but important fact: FHFA has built all of these levels of conservatism into a stress standard that uses current value LTVs which, given the recent run-up in home prices, are near record lows. Were FHFA to switch to an original LTV-based standard—as it should—Fannie said its required capital under the FHFA standard would rise “by nearly $25 billion.” This would make Fannie’s capital requirement for its September 30, 2017 book not the 343 basis points estimated by FHFA, but well over four percent—much higher than almost all of the commenters on the standard are expecting it to be.

 Exclusion of guaranty fees in stress test. No commenter defended FHFA’s decision not to count guaranty fees in determining required stress capital (although a few suggested that some type of discount or “haircut” might be appropriate to account for the uncertainty in estimating the magnitude of those fees). USMI had perhaps the most cogent comment on this topic: “It would be highly ironic (if not irrational) to require higher fees based on capital needs, but not count those fees when determining capital requirements.”

 Excessive capital requirements for higher-risk mortgages. Both the Urban Institute team and CRL did extensive analyses of the FHFA proposal by loan attribute. The Urban Institute team wrote, “Our conclusion: the lower FICO higher LTV mortgages require more capital than is necessary relative to their less risky brethren.” CRL was more specific, saying, “The model would disproportionately place the cost of this systemic failure capital [capital required to pass FHFA’s stress test, plus cushions] on lower wealth borrowers, by a factor of as much as ten to one,” and it made the added point that “not counting revenues adds a further bias to high LTV low FICO QM loans” because these loans prepay more slowly during stress periods, and thus can cover a higher percentage of their losses with guaranty fees. CRL concluded its analysis by saying, “The proposal has greatly excessive capital demands. This will harm the housing market and overall economy, and it will place the heaviest unnecessary burden on working families of modest means.”

Interaction of capital components and loss reserves. Several commenters are concerned that FHFA has not thought through how the different components of its proposed capital standard relate to one other, or what each one’s purpose is, resulting in what USMI calls “a ‘mash-up’ of different capital concepts.” Genworth questions “the need for both a going concern buffer and a minimum leverage requirement,” while the criticism of USMI is more general: “It is not clear that the proposal takes into account the full extent of, and interactions between, loss reserves, the minimum leverage standard, the incentives provided by prompt corrective action for the Enterprises to hold excess capital and the market pressure for the Enterprises to hold even more capital.”

Fannie raised an important question about how the FHFA capital rule would be affected by implementation of the Current Expected Credit Loss (CECL) accounting method scheduled to take effect on January 1, 2020. Under CECL, a company will set its loss reserves based on the “expected lifetime losses” of its loans, rather than its “incurred losses,” as currently. The FHFA capital proposal states that, “The credit risk capital requirements in the proposed rule are based on unexpected losses (stress losses minus expected losses) over the lifetime of mortgage assets.” I had interpreted this to mean that as Fannie and Freddie’s loss reserves rose under CECL during a stress period (along with their expected losses), their required equity capital would fall by a comparable amount, since the total stress standard will not have changed. Fannie’s comment suggests it does not believe that will be the case. FHFA must clarify this relationship. For an insurer, loss reserves and capital serve the same purpose: to absorb credit losses. If an accounting change (CECL) can push up the companies’ total required capital, that is a flaw in the FHFA proposal that needs to be fixed.

 Too favorable treatment of credit risk transfer securities. Finally, numerous commenters questioned the cost-effectiveness of securitized CRTs, with most (including Fannie) focusing on their likely non-availability during times of stress, when they would be most needed. The Urban Institute team, CRL, Arch Capital and Genworth all said that the cost of Fannie and Freddie’s CRT securities should be deducted from any capital relief given to the companies when CRTs are used.

*                                                   *                                                                   *

 As should be evident from the above, enough questions about and serious objections to FHFA’s proposal were raised by those who commented on it that the agency almost certainly will need to rework and reissue it. This has obvious implications for the timing of any administrative mortgage reform that preserves the role of Fannie and Freddie in the secondary market. The companies cannot be released from conservatorship until they are recapitalized, and they cannot be recapitalized until they have binding regulatory capital requirements. Fannie and Freddie’s required capital will determine not only the dollar amount of new equity they would have to raise but also how they would have to price their business, which in turn will affect the volume and mix of business they could do (and, through these volume and loan quality impacts, their investment values as going concerns). A workable final FHFA capital regulation is at the same time an essential step on the path to administrative reform and a challenge that must be met to get there.

The Mortgage Bankers Association—which is solidly on record in favor of legislative reform that creates competitors to Fannie and Freddie rather than administrative reform that recapitalizes them—clearly sees the potential for protracted discussions over the risk-based capital standard to delay administrative action indefinitely. Its comment letter is not subtle about this. In addition to advising FHFA that a lengthy, “multi-round set of notice-and-comment periods would give FHFA the opportunity to fine-tune the proposed rule, benefiting from outside points of view, improving it in stages,” MBA told FHFA, “In fact, as can be seen from the structure of our comment letter, we find ourselves with more questions than answers with respect to many aspects of the proposed rule. We would ask that FHFA seriously consider the full set of questions posed when developing additional data and information to release prior to further rounds of notice and comment.” I counted all of the MBA’s questions and there were 86 of them—enough, should FHFA elect to address them all in detail, to keep the agency tied up for months.

FHFA, instead, should “get on with it.” By now it undoubtedly will have reviewed and categorized all the comments it has received. After analyzing them thoroughly, it should take the initiative to meet with the individuals or groups whom it believes have the best insights into or ideas for constructive changes to the standard, with the objective of creating a new less complex, more consistent, cohesive, transparent and defensible proposal that it can issue as a new notice of proposed rulemaking, with advance buy-in from key stakeholders. Supporters of administrative reform also need to engage on this. They have the most reason to get Fannie and Freddie’s capital right, and to get it right as quickly as possible.

239 thoughts on “The Interested Parties Respond”

  1. Height Capital Markets, Ed Groshans

    Crapo’s outline is in line with the Treasury Department, Groshans wrote in a note, adding that Height is keeping its odds at 85 percent that Treasury Secretary Steven Mnuchin and Federal Housing Finance Agency Acting Director Joseph Otting will initiate administrative actions to end the conservatorship of Fannie and Freddie.

    Groshans expects Treasury’s plan for the GSEs will be released this month, and that Treasury and FHFA will reach agreement to permit Fannie and Freddie to retain additional capital. This agreement could occur when Fannie and Freddie report fourth-quarter earnings or in conjunction with Treasury’s plan. He sees Mark Calabria being confirmed by the Senate in April, and expects Calabria, as FHFA Director, will amend the Preferred Share Purchase Agreements (PSPAs) and end the Net Worth Sweep (NWS), before the end of June.

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  2. Tim Mayopoulos, former Fannie Mae CEO, on CNBC today seemed to be reinforcing recap and release as a good idea. He threw out the $150-200m “general” recap requirement and that it would potentially increase mortgage rates. Seems consistent with Tim’s thoughts in this blog. I wonder if the new CEO shares that sentiment?

    https://www.cnbc.com/video/2019/02/04/former-fannie-mae-ceo-on-the-fate-of-fannie-and-freddie.html

    Cheers,
    Justin

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      1. Fannie and Freddie have $5.2 trillion in mortgages and mortgage-related securities on their balance sheets (and $5.4 trillion in total assets). Capitalizing the mortgages at 2.5 percent would require $130 billion. The lower end of the $150 – $200 billion range currently being kicked around by commenters is a capital percentage of about 2.9 percent, while the upper end of that range is 3.85 percent. As I’ve said previously, I believe Fannie and Freddie’s traditional business model of a diversified portfolio of mortgage guarantees priced, using cross-subsidization, to an average fee sufficient to earn a target return on invested capital will not work at a capitalization rate of 4 percent. If the companies are forced to hold that much capital they will end up with much smaller credit guaranty books of mainly higher-risk loans, with the lower-risk mortgages being retained in portfolio by banks at spreads to their cost of deposits made more attractive by the fact that Fannie and Freddie’s higher guaranty fees will get built into all mortgage rates, including the ones banks own. There is no mystery at all as to why banks and their supporters advocate “bank-like” capital for Fannie and Freddie.

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    1. This is a hybrid of the MBA’s and the Milken Institute’s plans, with all of the major elements the large banks have been asking for: multiple credit guarantors (including a privatized Fannie and Freddie), an explicit government guaranty on the securities backed by these private guarantors, which would be issued by Ginnie Mae, and the guarantors’ affordable housing goals replaced by a “Market Access Fund,” funded by a 10 basis point fee on loans financed in the secondary market (which allows banks to charge this fee to all homebuyers, but pocket it if they keep the loans in portfolio).

      The banks couldn’t get their secondary market “reform” legislation through the last Congress, and there are much higher hurdles to getting the Crapo plan passed in the current one.

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      1. Tim

        this article appeared today in American Banker by Alex Pollack: https://www.americanbanker.com/opinion/changes-to-capital-rules-should-be-part-of-gse-overhaul?utm_campaign=amerbanker-tw&utm_medium=social&utm_content=socialflow&utm_source=twitter

        curious as to your reaction, especially this paragraph: “If 4% is the right risk-based capital for mortgages [ risk-based capital requirement for banks to own residential mortgage loans is 4%], then the system as a whole should always have to have at least 4%. If the banks need 1.6% capital to hold Fannie and Freddie mortgage-backed securities, then Fannie and Freddie must have 2.4% capital to support their guarantee, or about 5 times as much as their previous requirement. If Fannie and Freddie hold the mortgages in portfolio and thus all the risks, they should have a 4% capital requirement, 60% more than their former requirement.”

        tia

        rolg

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        1. Pollack starts out his argument saying, “If 4% is the right risk-based capital for mortgages…” It’s not. The original Basel bank risk-weight for mortgages was fifty percent of banks’ overall 8% leverage requirement. Both the 8% overall bank capital requirement and the 50% risk-weighting for mortgages were “rough justice” figures, since banks can take a nearly endless combination of risks on all the asset types they are permitted to hold. Pollack’s argument thus can be reduced to, “If banks have to hold an arbitrary and unjustified amount of capital against their mortgages, then Fannie and Freddie should have to too.” That’s convenient for a staunch supporter of banks.

          Systemic parity among financial institutions holding or guaranteeing mortgages is a good idea, however, and if we are going to go that route we should first figure out what the appropriate capital requirement is for credit guarantors and portfolio lenders, then apply those requirements to all institutions performing these functions. FHFA is currently attempting to do that for credit guarantors, but at the moment nobody is working on the appropriate risk-based capital requirement for portfolio lenders (like banks) who fund 30-year fixed-rate mortgages with short-term deposits and purchased funds. Pollack likes to ignore this problem—since Basel doesn’t put any explicit capital requirement on banks for their interest rate risk-taking, then that’s the final word on that—but in my view this is both analytically and intellectually dishonest. You can’t properly compare risk-based capital requirements across institution types unless you account for all of the risks.

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          1. Tim

            apart from what is the right capital percentage to start from, I found interesting that the total capital to be held against a securitized mortgage includes not just the GSE’s capital, but the mbs holder’s capital required in connection with holding the GSE guaranteed mbs. does the fhfa proposed reg account for an mbs holder’s capital in coming up with the GSE’s capital? does this “two layers” of capital in the securitized mortgage system make sense?

            rolg

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        2. I wish there was a more efficient way to find answers to such specific questions on the blog. I believe Mr. Howard has answered that question. Yet I’ve been digging through the blog for days now trying to find it (again).

          I remember Mr. Howard stating excess capital affects g-fees and also, perhaps, excess capital acts a a surtax on the GSEs business.

          How does GSE surplus capital play out to its own disadvantage to mortgage loan originators?

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          1. For ROLG, there really aren’t “‘two layers of capital'” in the securitized mortgage system. Under Basel, banks have to hold 4 percent capital against the whole (or unsecuritized) mortgages they have in portfolio, but only 1.6 percent capital if the credit risk on those mortgage has been guaranteed by Fannie or Freddie (in the form of an MBS). The difference between those percentages, 2.4 percent, is the implied value Basel puts on the Fannie and Freddie guaranty. But as I noted earlier, (a) that’s just a “rough justice” number for the credit risk, and (b) nowhere does Basel attempt to set a capital percentage that purports to account for the interest rate risk involved in short-funding a 30-year mortgage with consumer deposits and purchased funds. The 1.6 percent Basel risk weight for banks’ holdings of Fannie and Freddie MBS is woefully inadequate for that risk–Fannie and Freddie are required to hold 2.05 percent capital for the interest rate risk on their portfolio loans, and they match fund them at time of purchase, and constantly rebalance them to keep the duration gap between the mortgages and the debt and derivatives funding them at zero.

            For Gordon, I can sympathize with your not being able to find some of the comments or answers I’ve made or given in the blog. I frequently can’t find them myself (for some, I do a “copy and paste” and put them a file so I know where to look for them). With the blog about to enter its fourth year, I was thinking I might do a “three-year retrospective” post that summarizes the main topics and themes I’ve addressed, and identifies which posts cover which topics. That might be a start.

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  5. Thanks for that. I also found the 2016 complaint, which calculated the balance due to Tsy (at that time) at 20 billion had the payments been recharacterized allowing for Sr. Pfds to be retired. That number comports with the current few billion surplus you note. (I’d be happy to donate it to the wall, fence, barrier (or whatever) if we get a favorable ruling.

    Tim’s clarification also addressed the implausibility / impracticality of a second way of looking at the payments. I’m clear.

    And for what it’s worth, I found the two judges concern to show deference to the past two presidents’ modus operandi as it relates to the sweep unsettling. Not sure what to make of all that.

    Time to read up on APA claim.

    Thank you.

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    1. @ron

      just to be clear, the APA claim if sustained by collins en banc would result in a more straightforward remedy, which should be identical in application to the backward remedy for the constitutional claim.

      rolg

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      1. Yes, I see that. Thanks for ensuring I do.

        It seems that you and Tim think the emails and memos from Sweeney’s court might help with the APA claim. I’d like to think so too. Oh, would I! Yet defense continues to make the case, with success, that intent and motive are legally irrelevant. I can’t recall how defense worded it this time but it was taken to the superlative. Judge Edith Jones wasn’t buying it. What makes you think things could be different here? The most indicting memos would’ve, I think, left Lamberth, Millet and Ginsburg unmoved due to this governing presupposition.

        Secondly, could have Lamberth or the DC court of appeals found that HERA had successfully insulated FHFA from eyebrow raising behavior yet also have ruled on the unconstitutional nature of the protection they *thought* HERA afforded? I thought not, but may this court?

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    1. I think it’s just a technical clean-up. There was no Executive Committee of the Board when I was Vice Chairman (or if legally there was, it never met, took any actions or reported on anything). The July 21, 2016 version of the bylaws says, “The Executive Committee, during the interim between Board meetings, shall have the authority of the Board, except that it shall not have the authority to take any of the following actions,” and goes on to list ten important or consequential types of action it can NOT take. The amendment removes the Executive Committee entirely, so now there is no subgroup of the board that is not allowed to take these critical actions between Board meetings. Uh….okay.

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      2. Tim –

        I saw the changes, read through them, and wondered what would drive this change.

        I went looking.

        FHFA OIG posted their list of open recommendations as of 1/1/19 (Compendium of Open Recommendations – 01/01/2019 [https://www.fhfaoig.gov/Content/Files/CompendiumJanuary2019.pdf]).

        There are a number of recommendations to change portions of their by-laws for better corporate governance. A number of the recommendations are due to a romantic relationship an executive had with a counterparty’s executive that gave rise to a potential conflict of interest. Excluding those changes, there are still a number of recommendations to alter the by-laws.

        Further, there is lots of discussion elsewhere about “can’t release them util they are *reformed*”. What does reformed mean? There are lots of opinions from various stakeholders. Deferring to the authority, FHFA, the impartial FHFA OIG has reviewed the actions FHFA has taken via OIG audits & reports and listed out where FHFA has failed to execute on actions to reform the GSEs, based on FHFA’s own statements, reports, analysis, etc.

        While it seems that the train is picking up steam for some sort of administrative reform, in my opinion, it would behoove any administration actor to button up the open items from FHFA OIG & use that as leverage with Congress & critics to say, “We thank the previous Directors for starting down this road. However, there was much work to be done. We thank OIG for showing where the final pieces of reforming the GSEs were and we have addressed all of their comments which are now closed. The entities are now reformed and we can move forward with the next leg of this administration’s plan of removing the GSEs from conservatorship. If Congress, in their infinite wisdom, would like to further reform the entities, they should pass legislation with the specifics, directing FHFA to carry out these specific reforms in the legislation Congress passes.”

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  7. Tim / ROLG,

    In the recent hearing plaintiff was asked about remedy to which plaintiff noted two parts, backward looking and forward looking. Backward looking entailed an accounting recognition of paid in full. Forward looking entailed no further sweep of profits. (Plaintiff generously threw in the warrants.) My question is, I heard no mention at that time of the overage paid back to treasury. Comments?

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    1. @ron

      upon a court finding that i) Ps have standing to bring the constitutional claim, and ii) the fhfa is unconstitutionally structured, backward relief would be vacating the NWS (and treasury writing down senior preferred), while prospective relief would be not to vacate the NWS nor write down the senior preferred but rather eliminate the for cause director removal requirement from HERA moving forward.

      rolg

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      1. Remedy (backward and forward) as noted between 23 and 24 minutes:

        1. Liquidation preference has been paid back along with 10%, which would eliminate liquidation preference.

        2. Enjoined from any further implementation of NWS.

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      2. ROLG, I think what you’ve defined as backward looking actually contemplates both forward and backward looking per the plaintiff’s oral argument between 23 and 24 minutes. But since we agree on those essential components of remedy (removal of Director isn’t important to me at this point), my question is, does anyone find it odd that there was no mention of accounting for the “98 billion” of the *overage* in the context of remedy? Was it tacitly thrown in with the sweetener of the warrants?

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        1. I’m seeing this exchange well after it took place (and have deleted a couple of the comments), but let me try to sort it out.

          There are three different categories of relief that are being discussed (and in some cases confused) here: relief in a finding for plaintiffs on the constitutional claim, relief in a finding for plaintiffs on the APA claim, and relief for other alleged violations of the law by Treasury.

          Let’s deal with the third category first. Ron mentions the warrants and the “$98 billion in overage” paid by the companies to Treasury (as dividends at 10 percent after-tax on the $187 billion of draws Treasury forced the companies to take). Plaintiffs don’t include these in their prayer for relief because the original terms of the conservatorship aren’t being challenged in the Collins case (or in any other of the net worth sweep cases). Only the agreement between Treasury and FHFA to re-characterize then 10 percent dividend as a sweep of all the companies’ future profits is at issue, and if the plaintiffs win on that–whether in the APA claim or the constitutional claim–the remedy plaintiffs are asking for is a reversal of the sweep, done retroactively.

          There are two ways to do it. The first is to characterize each quarterly sweep payment in excess of the 10 percent dividend that otherwise would have been payable that quarter as a reduction in the outstanding senior preferred stock of each company (and Treasury’s liquidation preference). Cooper & Kirk does this calculation for us in the appendix to their December 18, 2018 en banc brief. Following this method results in all of the senior preferred (and the liquidation preference) of both companies being paid down, and Treasury owing Fannie $7.1 billion and Freddie $9.1 billion at the end of last year. The second method for unwinding the sweep is to consider each quarterly sweep payment in excess of the 10 percent dividend as an amount owed by Treasury to each company, and cumulate all those “owed” payments (or, in some recent quarters, shortfalls when sweep payments were less than the scheduled dividend) and have Treasury write each company a check. I haven’t done the math on that, but I suspect the size of those combined checks would exceed $150 billion–but the companies still would have to pay the 10 percent annual dividend on their (un-repaid) senior preferred stock. While theoretically possible, this second method would balloon the federal deficit, making the first method of reversing the sweep the far more likely alternative.

          The possibility of “forward-looking relief” arises with the constitutional claim. There, if the en banc panel finds that it is not appropriate to retroactively nullify the net worth sweep as a remedy for the constitutional violation of having FHFA being headed by a director removable by the president only for cause at the time the sweep was entered into (which neither FHFA nor Treasury is contesting), it can grant plaintiffs forward-looking relief, as the Collins merits panel did. But in that event the net worth sweep would stand, and plaintiffs would get nothing (except a future FHFA director removable by the president).

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    1. I don’t see there as being that much distance from what acting director Otting was quoted as saying a couple of weeks ago and what the White House spokesperson Lindsay Walters is saying in the Bloomberg article you cite. Otting’s statements were over-interpreted as implying that the release of Fannie and Freddie from conservatorship had been decided upon and was imminent, whereas the Bloomberg article, along with a couple of other articles I’ve seen, contain editorial comments and third-party spin saying “not so fast.”

      Just what did Walters say today? According to Bloomberg, that “Housing finance reform is a priority for the administration,” and that “The White House expects to announce a framework for the development of a policy for comprehensive housing finance reform shortly. ” Nothing new here, other that Walters said “shortly” whereas Otting said “soon.” The reporter (Elizabeth Dexheimer) added, “Walters said no decisions had been made on any reform plan. [I suspect she meant final decisions.] The administration intends to work with Congress to formulate a proposal that fully addresses the risks to taxpayers and that improves the ability of creditworthy Americans to buy a home.”

      Note that “working with Congress” does not mean legislation; that remains a “bridge too far” in the current divided, partisan and dysfunctional Congress. And Treasury Secretary Mnuchin has repeatedly stressed his desire to consult with Congress on any administrative reform plan he proposes. As recently as December 18 of last year–at Bloomberg’s offices in Washington–he said, “I would like to get [Fannie and Freddie] out of conservatorship, My preference would be to do something that has bipartisan legislative support [note the use of the word ‘support.’] There are changes we will be able to make with a new director at the FHFA.”

      The letter to Otting from Maxine Waters and Sherrod Brown last week very likely did result in the renewed emphasis this week on the “working with Congress” aspect of the administration’s plan, but other than that I don’t see much sustantive difference between where we were then and where we are now. I think the pro-Fannie and Freddie crowd got a little too far over the tips of their skis last week, and the pro-bank side is now working to sell a counter-narrative. We should all take deep breaths, sit back, and wait to see what the administration actually comes up with.

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      1. Tim

        It would not be surprising for someone like otting to be candid (and truthful) in what he thought was a private setting, and for a potus spokesperson to be optically correct (and vague) in making an announcement to the press (that was clearly intended to be read by congress).

        which leaves us to still wonder what the admin plan will look like. we should find out soon, but I suspect the admin plan is some combination of GSE recapitalization along the lines of the moelis blueprint coupled with items requiring congressional legislation (mbs guarantee and additional charters for competitors), should congress wish to implement them. I also think that it will address emerging issues not necessarily on the front burner, such as Ginnie Mae guarantees of federal mortgages that are increasingly generated by nonbank lenders.

        if so, then one would hope treasury/fhfa would proceed to do what they can do on their own and not wait for congress. but I think the admin doesnt want to crater calabria’s confirmation, so seeking some bi-partisan congressional support for what the admin can do on its own with FHFA is likely….which will likely extend the timeline that otting seemed to have bee intimating, a reality of DC that otting, as more a business man and less a politician, may still be adjusting to.

        rolg

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        1. Anon 1234– Your attachment of Otting’s letter to Waters and Brown did not come through, but for those who have not seen it I found it to be a bit of a brush-off (which I would not have done).

          Otting states the mission of FHFA, then lists eight “statutory duties of FHFA [that] support this mission.” He ends with this two-sentence statement: “As the Presidentially-designated acting FHFA Director, I intend to carry out these duties and responsibilities and lead the agency in accomplishing its mission. As you are aware, my duties began January 7th, and as we begin the journey of evaluating the Enterprises and developing a framework for ending conservatorship, I would welcome your insight and perspective.”

          Both the content and tone of this letter suggest to me a different interpretation of the events of the last two weeks than I had made earlier. That is, it now seems possible that Mnuchin and Otting were fairly far down the track on an administrative proposal that they intended to announce they were considering. Otting, in what he thought was a closed meeting, gave his staff a heads-up on the goings on, and word of his remarks got out and was reported in the press. That led to the reaction from the Democrats in Congress (and others), and now this strategy of “get out there first with your idea, and let others react to it” is no longer feasible. Rather than “announce then receive input,” the approach now has to be “receive input then announce.” The latter of necessity takes longer, and also gives Treasury and FHFA less latitude.

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  9. Dear Tim:

    I recently re-read your September 11, 2018 prepared comment regarding FHFA’s proposed capital requirement rule for Fannie Mae and Freddie Mac; and, although I am not well versed in each facet involved in determining an appropriate minimum capital level, I can clearly see your, and former Federal Reserve Board Chairman Paul Volcker’s, logic that “Fannie Mae and Freddie Mac are not banks” and that “bank capital standards [are] not appropriate for and should not be applied to [the enterprises].”

    As you know, there are various proposed recapitalization plans floating in and around Washington, with the Moelis plan being the most discussed. But like so many, the Moelis plan mimics FHFA’s own flawed reasoning that the companies need considerably more relative core capital than they did prior to the crisis because of the huge financial losses they sustained between fiscal years 2008 through 2011.

    As we all now know, however, a majority of those losses were non-cash contrivances imposed on the companies by Treasury through write-offs of deferred tax assets and recordings of astronomical loan loss reserves (most of which never materialized). And it was all designed to make the companies appear to the public as being insolvent and “on the brink” of disaster and, thus, allowing Treasury and FHFA to begin the real dismantlement of these two firms.

    Moelis proposes a capital build of $167 billion over three years, which seems way too much given the capital standards prior to their conservatorships. Additionally, Acting Director Otting has stated that “based upon their business models today, [the enterprises will need between] $150 and $200 billion.” This approximate 300 to 400 percent increase in minimum capital standards can only be interpreted as yet another yoke to hang on the companies’ shoulders, and yet another effort to destroy the existing common and preferred shareholders.

    So, I was hoping to calculate a more reasonable minimum combined core capital for the enterprises using your methods and your experience with Mr. Volcker. I didn’t know, however, if it requires complex financial modeling or if this could be done simply through several formulas and the companies’ 10-k’s/10-q’s. I know you’re quite busy, and this isn’t a priority, but if you could offer any suggestions or guidance, I would be very much appreciative. Thank you.

    Best regards,
    Bryndon

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    1. Bryndon—I think it’s important for everyone to realize that updating Fannie and Freddie’s capital standards has both an economic and a political component. The economic component is actually the easier one, because it’s largely objective. The more subjective political component is where almost all of the uncertainty resides.

      Since you’ve read my comment letter to FHFA on its capital proposal, you know that I believe the agency effectively backed into its 3.24 percent capital figure for Fannie and Freddie by adding several layers of conservatism to the objective data they have on the credit losses the companies experienced on their December 31, 2007 books of business (which were the ones that went through the 2008 financial crisis and its aftermath). I and others have noted that FHFA’s “engineered” 3.24 percent capital number was virtually identical to the 3.25 percent average capital assumed for the recapitalization exercise done by the analysts at Moelis & Company in its June 2017 proposal, “Blueprint for Restoring Safety and Soundness to the GSEs.” Few believe this to be a coincidence.

      Which brings me to the Moelis capital number. Moelis is quite straightforward with where it came from: “These illustrative capital requirements…are broadly consistent with approaches applied to other large financial institutions, and represent reasonable estimates of capital standards for the Enterprises.” The “other large financial institutions” are of course big banks. But Moelis also gives itself some flexibility, saying, “Given the unique nature of Fannie Mae and Freddie Mac’s businesses, and particularly the scale of their mortgage guarantee businesses, FHFA may elect to implement a more nuanced risk-weighting system for mortgages, as compared to the fairly simplistic…approach applied to multi-product banks,” and it adds, “A more nuanced approach…could also help to broaden the ‘credit box’ that has historically excluded large groups of deserving Americans from obtaining a mortgage.”

      My interpretation of Moelis’ handling of the capital number hasn’t changed from the time I first read its blueprint. Prior to that proposal, “recap and release” for Fannie and Freddie had been anathema to the universe of (largely bank-centric) commenters who dominate the mortgage reform dialogue. I believe Moelis knew its plan would never get out of the gate unless it included a capital ratio for the companies that was roughly in line with what their opponents and critics were advocating. But Moelis conspicuously left the door open for a further refinement in that number, based on Fannie and Freddie’s “unique” business. FHFA now has the responsibility for making that refinement. Its initial effort, put out for comment last June, was “Moelis-like” in its result. It now has received the comments on that—which I summarized in the current post—and many of the objective analysts told FHFA that it was being excessively conservative, to the detriment of the companies’ ability to serve low- and moderate- income homebuyers. The ball is now in FHFA’s court to respond to those comments.

      As I said earlier, the economic part of this isn’t the problem. Ever-to-date, Fannie has had a 3.6 percent loss rate on its year-end 2007 book of business (Freddie’s has been somewhat lower). About half of those losses, though, came from products and features—interest-only ARMs, no-documentation mortgages, and risk layering—that now are prohibited by Dodd-Frank. And Fannie didn’t need to cover all of its losses with capital; it could (and did) cover most of them with guaranty fee income. I’ve calculated that with its current book of much higher quality business, Fannie could survive a repeat of the 2007-2011 home price decline with only about 1 percent capital. Of course, it should have more than that, including a going concern cushion to maintain investor confidence throughout a crisis. But it doesn’t need anywhere near 3.25 percent economically.

      I can’t handicap how the political component of Fannie and Freddie’s capital requirement will turn out. I’m encouraged, though, by the fact that under the sort of recap and release plan acting director Otting seems to be advocating, there is an alignment of interests among the companies’ key stakeholders—existing shareholders, potential new shareholders (who will supply the new capital they need), homebuyers and Treasury (as holder of warrants for 79.9 percent of Fannie and Freddie’s common stock). The further the political capital number strays from the economic capital number, the more capital will need to be raised, the higher the companies’ guaranty fees will need to be, the less business they will be able to do, and the less valuable they will be to ALL of their stakeholders. Those are powerful incentives to “get the capital right.”

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      1. Thank you for taking the time to get back to me; and thank you for the insight on the political component of the capital equation. I think I know now what to do to calculate a reasonable core capital amount that would be, in the spirit of Washington politics, a compromise. Thank you, again.

        Best regards,
        Bryndon

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        1. The concern here is that Otting might view 3.25% as the compromise, between the 2-2.5% that a purely economic treatment would recommend, and the 5% “big bank capital” that Calabria has espoused in the past.

          Tim is right about the politics being a large part of the debate. Many politicians, whose “knowledge” of the events of 2008 is simplistic at best and just plain wrong at worst, will be very uncomfortable with any capital standard that would not have withstood 2008, nevermind whether or not the companies actually needed all, or any, of the money they received. Trump does not have unlimited political capital to spend, and he might view a 3.25% standard as a small price to pay to get the companies released.

          The 3.25% capital standard is not set in stone yet, but it seems likely to be a politically-driven reality.

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          1. The advantage of having Fannie and Freddie’s capital determined in the context of an administrative reform process–rather than a legislative one–is that the people at the table working out the details will be knowledgeable about the economics of the companies. They will understand the impact of unnecessary excess capital on Fannie and Freddie’s guaranty fees, and thus the volume and mix of the business they will be able to do. (There would be little chance of those considerations coming into play in a legislative reform package.) Both in this blog and through other means, I will continue to stress these two points: (a) once the administration determines the stress environment it wants Fannie and Freddie to be able to survive, determining their economic capital requirement is not difficult, and (b) nobody except potential competitors to the companies will benefit from having them hold significant amounts of capital above the economic amount. In stark terms, this will be the political call: how much should homebuyers be required to pay (through higher than necessary guaranty fees) to subsidize the interest spread on banks’ portfolio holdings, or to give the private-label securities issuers a somewhat better chance of bringing that fundamentally flawed mode of financing back to life. In an ideal world that amount would be zero, but we do not live in an ideal world.

            Liked by 2 people

      2. UPDATE #3 : Trump Won’t Act Alone to Get Fannie, Freddie Out of Government Control; White House to work with Congress to overhaul mortgage-finance giants

        1:37 pm ET January 29, 2019 (Dow Jones) By Andrew Ackerman

        WASHINGTON–The Trump administration plans to work with Congress to overhaul mortgage-finance giants Fannie Mae and Freddie Mac , a White House spokeswoman said Tuesday—playing down the idea the administration will seek to unilaterally release the firms from government control.

        The White House also expects to announce a framework for comprehensive housing-finance changes “shortly,” White House spokeswoman Lindsay Walters said in a statement.

        The statement said no final decisions have been made on what will be contained in the proposal.

        For more than a decade, lawmakers have tried without success to overhaul Fannie and Freddie, which were placed in conservatorship during the 2008 financial crisis. Recent statements by administration officials indicated the government was reviewing plans to soon take the firms out of government control, sending shares surging .

        Some hedge-fund investors have bet for years that the government would eventually recapitalize and release the firms from government control, in lieu of a technically complicated and politically contentious battle to overhaul the mortgage-finance system. Tuesday’s statement suggests that the administration wants to work with Congress, at least for now.

        Joseph Otting , the acting head of the Federal House Finance Agency, said in a private meeting with agency staff earlier in January that the administration was preparing to end the conservatorship on its own. “The Treasury and White House viewpoint is that the [FHFA] director and the secretary of Treasury have tremendous authority and that they would act, I think, independent of legislation if they thought it was the right thing to do,” Otting said, according to a copy of the audio reviewed by The Wall Street Journal.

        The comments surprised housing-policy experts, who warned they could derail the pending nomination of Mark Calabria, a libertarian economist and aide to Vice President Mike Pence , to head the FHFA on a permanent basis.

        The Senate Banking Committee is preparing to hold a nomination hearing on Mr. Calabria as soon as February, but the release of a detailed plan could delay or even imperil Mr. Calabria’s confirmation chances, analysts said.

        Mr. Otting, who also serves as comptroller of the currency, also said a big part of the administration’s efforts would revolve around adequately capitalizing the firms. The companies currently operate with tiny capital buffers, but would need between $150 billion and $200 billion in capital to operate as fully private companies, he said.

        “I think that’s going to take some really heavy lifting and thought processes around that,” he said in the meeting.

        Fannie and Freddie are central players in the mortgage market, buying mortgages from lenders and packaging them for issuance as securities. The government effectively nationalized the pair in 2008 in a bid to stabilize the housing market as mortgage defaults mounted.

        In return for injecting about $190 billion into the firms, the government created a new class of stock—senior preferred shares—that paid an annual 10% dividend, along with warrants to acquire nearly 80% of the firms’ common stock. The Treasury revamped its bailout agreement in 2012 to require nearly all the firms’ profits be swept away as dividend payments on those preferred shares. Investors filed suit over the change.

        Write to Andrew Ackerman at andrew.ackerman@wsj.com

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    1. Although some of this is political, Waters’ and Brown’s “request that you [acting director Otting] provide our Committees a copy or detailed description of the mission that Treasury and the White House have outlined to which you referred no later than February 1, 2019” should produce a result that will be of interest to many others as well (including me).

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      1. Is there a chance that Fannie & Freddie will ultimately go the route of Sallie Mae? Privatized and their charters done away with?

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        1. That alternative can’t be ruled out entirely, but at the moment I would say it’s fairly far down the list of possible outcomes. For one it would require legislation, which is highly unlikely before the 2020 election. And if we get past 2020 with no administrative reform–and without a decisive ruling in favor of the plaintiffs in one of the court cases–I think you would need a Republican-controlled House and Senate, and probably a Republican president, for Sallie Mae-style privatization of Fannie and Freddie to get put on the table. And then it would need to pass and be signed by the president, which would require overcoming the objections that a fully private Fannie and Freddie would be much less effective (and much more costly) in financing mortgages for low- and moderate income homebuyers than the companies as they originally were chartered. Those are a lot of high hurdles to get over.

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  12. Otting’s comments from last Friday are expanded upon here.

    https://www.politico.com/story/2019/01/24/federal-housing-finance-agency-overhaul-1111874

    I don’t know if Politico will ever release the audio itself, which seems highly unlikely, but they seem to have gotten the important parts.

    As it pertains to this blog post: Otting’s capital requirement idea is in the $150-200B range. Doesn’t seem too far off ot Watt’s.

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    1. The bottom end of this range seems reasonable, given the risk characteristics of the companies’ current mix of business. The closer you get to the top, however, the more the challenges mount: not only will there be more capital to raise, but the businesses that will be raising it will be less valuable, because the extra capital will require them to price themselves out of significant segments of the market (particularly for higher-quality loans), which will slow their growth and reduce their earnings multiples.

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      1. Tim

        Moelis blueprint combined GSE capital is $167B when recap finalized: http://gsesafetyandsoundness.com/wp-content/uploads/2018/11/Blueprint-for-Restoring-Safety-and-Soundness-to-the-GSEs-Final.pdf

        so looks to me like otting is basing his talking point to staff estimate on that (indeed, the administrative plan may very well be based on moelis blueprint).

        otting also is reported to have said that their income is about $11B, which on a combined basis seems very light;; moelis blueprint projects combined GSE NI of $19.5B in 2020.

        so I am seeing that all of this reporting is directionally excellent, even if some details are murky.

        roll

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        1. The $11B of earnings was odd to me. The capital stats were clearly aggregate figures but $11B of earnings is too low to refer to aggregate earnings for the GSEs today.

          I wonder if Otting gave us a window into their projected GSE net income after reforms. Some obvious reform levers that would reduce earnings power: paying a fee for government security guarantee, lower G-fees, reduced footprint, more risk transfers, lower security/loan portfolios, or… paying a newly fixed rate on sr pfd!

          Or, perhaps he misspoke?

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          1. I also noticed, and wondered about, Otting’s reference to an $11 billion annual earnings figure. From the context of the quote in the Politico article, he clearly meant Fannie and Freddie combined. Eleven billion per year is a reasonable normalized earnings figure for Fannie alone (post-CRT expenses that have now reached $1.2 billion per year), but given their current business profiles Fannie and Freddie combined should be earning around $18 billion per year. It may have been a simple mistake: someone gave Otting the Fannie number, and he confused it with the annual earnings for both companies. But it also may be, as you say, a “window” into a potential conflict between two competing visions of Fannie and Freddie in the future: the “reduced footprint” version that a director Calabria might seek, and a less constrained Fannie and Freddie that would be more attractive to investors and thus easier to recapitalize. Even using the low end of the $150-$200 billion capital figure Otting cited, $11 billion in combined company earnings would result in an after-tax return on equity of only 7.3 percent per year, hardly competitive with the ROE’s of other financial institutions. And with capital of $200 billion, the ROE on $11 billion in annual earnings would be only 5.5 percent.

            If this was not a misstatement, Treasury will have to quickly figure out what sort of future it wants for the two companies it is pledging to recapitalize. If it is to have them constrained and overcapitalized, it will be in for a rude awakening when it asks investors to step up and provide the amount of capital required to successfully relaunch them as shareholder-owned entities.

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          2. @Patrick

            it is remarkable that an administrative plan seems to have been developed, at least in principle, that potus, treasury, otting and Calabria have all “signed off ” on, news of which has not leaked until this town hall meeting between otting and fhfa staff. and given that the town hall meeting was held to deliver the prospective “news”, one can assume that very few if any people among fhfa staff have participated in the plan. (unless one posits that they just pointed to moelis blueprint and said to each other, “let’s do this”)

            if this is right, then the plan may very well be somewhat barebones, in which case otting may have just misspoken…as it is hard for me to see how a reform scenario that yields a 50% smaller GSE pro forma combined net income (but also requires $150-200B in capital) could have been processed without significant involvement by fhfa (and GSE) staff itself.

            this is of course speculation on my part, but all of the financial reforms you refer to that would reduce the net income of the GSEs by about half would have to be carefully modeled and reviewed, and in my experience, when that kind of work is done, it is very hard to keep it a secret.

            rolg

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          3. I think Hanlon’s Razor is apropos here., but rolg did a great job of explaining why it was likely just a mistake.

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    1. interesting argument. Judge Edith Jones dominated most of the questioning (unmistakeable Texan accent), and she seemed clearly to favor Ps argument. But it is hard to assess how the other 15 judges will react given their relative silence. At one point Judge Willets I believe asked P counsel for precedent of retroactive relief in a constitutional for cause removal case, and P counsel pointed to Bowsher (which was comparable to for cause removal inasmuch as the wrong branch, congress, had the removal power). I thought this was important. treasury counsel did his best to color the APA use of “shall” for invalidating unlawful agency action, seeking to preserve equitable freedom for the court to refrain from revoking NWS. There was no follow up from judges, so hard to tell whether they thought his arguments had merit (I thought they did not).

      it is interesting to note that Judge Jones repeatedly suggested that the reason why the other circuits found the way they did on the APA claim was that they let fhfa/treasury control the factual narrative. not so with the collins complaint, which had the benefit of the fairholme discovery. Judge Jones stopped fhfa/treasury counsel when they were speaking as to historical acts which were not in the complaint as support for the NWS. you simply never saw that in the other circuit arguments.

      rolg

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      1. After listening to the recording, I think there is a good chance the Fifth Circuit en banc will invalidate the net worth sweep on the grounds that it violates the Administrative Procedures Act (APA). My sense on the constitutional claim is that even though nobody contests that FHFA was unconstitutionally structured at the time it agreed to the sweep, and even though I think plaintiffs had the better arguments on standing to bring the claims, the judges are likely to balk at granting the remedy requested by plaintiffs (vacating the sweep, which plaintiffs argued the court “is obligated to do”) because, as a couple of judges put it (paraphrasing), “two different presidents and four different directors of FHFA weren’t saying the net worth sweep should be undone,” and “undoing the net worth sweep would not be doing what the president wants.”

        The easier path, therefore, will be to rule on the APA claim. The argument there was notably one-sided. The woman judge (whom David Thompson of Cooper & Kirk called judge Jones) pounded both the FHFA and Treasury lawyers on their assertions that the net worth sweep was a reasonable exercise of a conservator’s discretion or judgment. Judge Jones had ample experience with conservatorships during the savings and loan crisis, and made the point that no conservator then (under a statute with language virtually identical to what is in HERA) had ever taken all of a company’s net capital for the government. She asked FHFA’s counsel to name a single instance in which this had happened, and he erred in citing a case from 1993, which, as judge Jones corrected him, involved a receiver, not a conservator.

        I thought it was very helpful for judge Jones to have raised the fact pattern assumed by judge Lamberth in the Perry Capital case, because that allowed Thompson to say that Perry was argued (and decided) pre-discovery, and that documents produced since that time mean “we now know what happened” concerning Treasury and FHFA’s motivations for entering into the net worth sweep. More than one judge bored in on the duty of a conservator to return their wards to a state of “soundness.” One judge (I didn’t note which one) asked, “How does siphoning off all of [Fannie and Freddie’s] net worth return them to a sound and stable condition?” The FHFA counsel made reference to the Treasury backstop as a substitute for capital, but judge Jones wasn’t having it. “Soundness means soundness,” she said. There was more along these lines, and no judge in the en banc panel expressed agreement or even sympathy with the FHFA counsel’s justifications for the sweep.

        Guessing how a panel of judges will rule after an oral argument in which most of the participants were silent is not easy, but for me the combination of the strong written dissent by judge Willett in the initial appeal, the fact that the Circuit agreed to hear the case en banc in the first place, the lack of verbal support for FHFA’s position on the sweep, and the uniformly skeptical reception of those who did speak to FHFA’s attempted defense against the charge that the net worth sweep is ultra vires leads me to expect a ruling in the plaintiffs favor on the APA charge. And now we wait.

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        1. Tim

          I agree with your assessment of the APA claim. The charge was led by Judge Jones, who is well respected (and who clearly has experience with federal conservatorships/receiverships), and there did not seem to be much judicial enthusiasm for the fhfa/treasury counterarguments…indeed, when they waded into the historical reasons why the NWS was not ultra vires, Judge Jones was quick to respond that these factual assertions go beyond the allegations contained in the complaint (and derived from fairholme discovery), which must be assumed to be true on a motion to dismiss that was granted by the district court.

          I wouldn’t let the pushback on standing/redressability regarding the constitutional claim lead you to conclude that claim is likely to be denied. there is scotus caselaw in P’s briefing that argues that this type of second guessing (“why didn’t Obama’s appointed director Mr. Watt revoke the NWS”) is not necessary. the collins court may simply ignore this caselaw, as did Judge Schiltz in the Bhatti case in the district court (now up on appeal in the 8th circuit), but none of these concerns led the collins merits panel get to the same decision regarding unconstitutional structure that now both fhfa and treasury also concede. it would be a strange result for two defendants to agree that fhfa was unconstitutionally structured and for the court to say that Ps cant do anything about it. collins was the first circuit court to hear the constitutional claim, and now it has heard it twice. Judge Willets certainly seemed interested in retrospective relief regarding the constitutional claim.

          rolg

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          1. Great commentary. I felt exactly as did Tim. So now we wait for them to rule. How long after an en banc does that normally take?

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        2. Thank you, both.

          Judge Jones -I think- was very alert.

          She brought up that the nws happened 4 years after (she actually said 5) trying to counter-arguing defense counsel as in understanding the very different circumstances and time frame under which it was signed.

          And neutralized government’s argument of heightened bailout risk which required an extreme arrangement (nws) saying the saving and loans crisis of the 80s/90s was just as bad with banks utterly punished but never depleted of capital to this degree.

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        4. Tim

          one more thought occurs to me based upon your reaction. the collins merits panel didn’t really write a majority opinion upholding the NWS under the APA, it simply referred to the reasoning of the Perry majority and the other sister circuit opinions. Now under Judge Jones’s thinking, those other decisions are suspect because they didn’t have the benefit of the fairholme discovery contained in the collins complaint. in effect, there is not much reason for the en banc court to look to the merits panel majority’s reasoning simply because there was no merits panel majority reasoning, and its reliance upon other circuit opinions has been brought underside pretty stiff scrutiny.

          rolg

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          2. Tim

            another reaction to the collins 5th circuit en banc oral argument.

            one might have thought before argument that after being rejected by 5 sister circuits, the APA claim would have been the “harder” claim, and given that neither fhfa nor treasury would defend constitutionality of fhfa structure, the constitutional claim would have been the “easier” claim. after listening to the oral argument again, the reverse appears to be true. at least one judge was hung up on redressability of relief regarding the constitutional claim, whereas with Judge Jones leading the charge, the conservator’s authority to agree to NWS was heavily challenged.

            IF the court finds for Ps on the APA claim, I expect the court will not address the constitutional claim since the relief required to be granted in the case of the APA claim is all of the relief Ps are seeking (revoke NWS). courts will avoid constitutional questions if possible. moreover, the court likely is keenly aware that All-American is challenging the constitutionality of the CFPB structure before 5th circuit (same basic constitutional claim as in collins), with argument scheduled in March as I recall. so no need to reach out to address the constitutional claim in collins if relief is to be granted on the APA claim.

            IF this is true, then the court could issue an opinion more quickly than one might otherwise expect, since it would be a more straightforward opinion, and the reasoning of Judge Willet’s dissent in the merits panel opinion is available to serve as an en banc majority opinion.

            rolg

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          3. I agree, and appreciate the irony here. What appeared going in to be the more difficult claim to win–because so many other judges already had ruled against plaintiffs on the same issue–now looks to be the easier one. Thanks both to judge Willett’s stinging minority opinion in the appeal and judge Jones’ intense focus on the bizarre fact pattern in the APA case (which had been deliberately misrepresented by the government in Perry), the way is wide open for the en banc panel to assess the merits of each side’s claims anew. When it does, I’m confident it will see both the strength of the plaintiffs’ pleadings and the weakness of the government’s defense. On the latter, the use of “may” versus “shall” in defining the conservator’s duties was in fact the only choice the drafters of HERA had; they could NOT have said the conservator “shall” conserve the companies, because that might not be possible–that’s why the option of receivership exists. And you can add to this the fact that even Treasury didn’t believe HERA permitted it to simply take all the companies’ net income in perpetuity; that’s why it went to such lengths to make up the “death spiral” story and try to sell it to the public. Now that documents giving the lie to that cover story have become public, Treasury’s has changed its position to,”well, HERA allows us to do it.” But switching to a backup story after your first one blows up usually is not a winning strategy.

            So, yes, I think the Fifth Circuit does what you suggest: rules for the plaintiffs on the APA violation, and leaves the issue of the constitutionality of a single-person director removable by the president only for cause to a less complex case, All American, which already is teed up for hearing in the same circuit. And I also agree that a ruling for plaintiffs on the APA violation won’t have to take the 3 to 8 months mentioned by the legal analyst for Bloomberg the other day.

            Liked by 1 person

          4. Tim

            one more thing to think about re collins 5th circuit en banc consideration of the APA claim. Ps have been arguing that NWS is “inimical” to the conservator’s mandate to restore GSEs to soundness. If a majority of en banc agrees with this claim, then it should issue a summary judgment in favor of Ps and vacate the NWS, and remand to district court to implement relief (the accounting adjustment to the senior preferred). under this theory, no set of facts could justify the NWS as an authorized conservator act since NWS could never lead to soundness.

            however, if a majority find that only if the Ps alleged facts are true is the NWS ultra vires, then the circuit court would remand for a trial on the facts…which would give defendants an opportunity to prove its death spiral narrative. while I sense that the en banc court was inclined to reverse the district court’s motion to dismiss, I am unclear whether it would grant Ps summary judgment.

            rolg

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          5. If the administration is indeed considering releasing Fannie and Freddie, I don’t know that a remand for a trial on the facts would be a bad outcome. The facts in this case are clearly against Treasury, and it knows it. Would it really want all of its “bad memos” from discovery (and others not yet made public) being aired at a trial? I very much doubt it. You could just as easily see how a ruling against FHFA and Treasury on the law, and a remand to trial on the facts, would give Treasury the political cover it needs to settle with plaintiffs and move forward with its plan to recapitalize the companies.

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          6. Tim

            to your point about treasury/fhfa wanting to avoid a trial if that is the order from collins en banc, I just wanted to post this email from stegman to miller well before the NWS, that I had never seen before, in case you had not seen it either: http://fanniefreddiesecrets.org/wp-content/uploads/2017/07/Email-re-Meeting-Recap-6-25-12.pdf. it came to my attention from another board. this evidence is even worse than the testimony of the fnma cfo just a few days before the NWS.

            I would tend to agree that treasury may very well have been looking for court cover (or any congressional action it would agree with) the past few years, and anything short of affirmance by collins en banc at this stage may be cover enough.

            rolg

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          7. Yes, I had seen that memo before. And I wonder how many similar or worse memos, emails or other documents have been produced in discovery but not yet released to the public.

            Through this string of comments and responses we’ve probably found our way to the right way to think about the most likely outcome of the Collins en banc hearing. If the panel affirms the appellate court’s ruling on the APA claim, it has to address the constitutional claim. But there, with both FHFA and Treasury agreeing that FHFA is unconstitutionally structured, the judges will need to decide on the remedy to grant plaintiffs, which at least some of the judges seemed reluctant to want to do. The Fifth Circuit has a “cleaner” version of the same constitutional issue in the All-American case coming to it in March. And it can get to that case without the complications in Collins in two ways: finding that FHFA violated the APA by entering into the net worth sweep, and reversing it, or ruling against the appellate court’s dismissal of the APA claim and remanding it to the district court for adjudication based on the facts. I think we both agree that the latter option is the more likely.

            Remand, though, may well be the “trigger event” Treasury needs to settle the net worth sweep case with plaintiffs, to avoid the embarrassment of a trial. (I would love to be an expert witness if the case does go to trial; as I’ve documented in the amicus I did for Gary Hindes’ case in Delaware and elsewhere, there is a compelling pattern of premeditation, dishonesty and misrepresentation on the part of Treasury in its dealings with Fannie and Freddie dating back to before the conservatorships.) And settlement, obviously, would put us on the path to recapitalization and release.

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          8. Tim

            “I think we both agree that the latter option[remand for trial as opposed to summary judgment] is the more likely.” analytically, no, but “politically”, yes.

            you have talked about “economic” capital and “political” capital regarding setting the GSEs capital requirements. I would add in complementary fashion that the en banc court will engage in “legal analysis” and “politicking” among the 16 mostly silent judges in choosing which option.

            in order to defeat the motion to dismiss, Ps have to get past the anti-injunction bar, by showing that, given the facts alleged in the complaint, the NWS is not within the conservator’s authority. In order to win on summary judgment, Ps have to show that under no facts can the NWS preserve and conserve assets and return GSEs to a sound operating condition. Frankly, there is not a significant analytical difference between these two positions.

            Once the court comes to the conclusion that the conservator has a mandate to conserve and preserve (which none of the sister circuits concluded, but which the collins en banc court seemed disposed to conclude, and which judge willets concluded in the merits panel dissent), then does the court simply reverse the dismissal, instructing the district court that it is not barred by the anti-injunction provision so that it can engage in a trial, or go what is really a small step further, and find that on its face the NWS is inimical to preserving assets and promoting soundness.

            and whether the en banc court travels the distance between the two steps is likely to be decided more by “politicking’ than by analysis.

            we can derive no clues from judge willets dissent in the merits panel, which simply was a dissent against the majority opinion to affirm the motion to dismiss. one cant tell whether judge willets would have voted for summary judgement in favor of Ps. see https://www.dropbox.com/s/724xoc5atlkr0wa/collins%20merits%20panel%205th%20c%20opinion.pdf?dl=0

            rolg

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          9. Tim

            on 1/24 the All American case (arguing the CFPB is unconstitutionally structured) was calendared by 5th circuit for oral argument en banc (to be argued 3/12). All American had requested an original hearing en banc, which is highly unusual, and the 5th circuit just granted it the day after the Collin en banc oral argument.

            did the 5th circuit collins en banc hold a conference after the oral argument on 1/23 and decide to rule only on the collins APA claim and not the constitutional claim (if so, necessarily in favor of Ps on APA claim if not deciding the collins constitutional claim)? and decide to defer any constitutional adjudication to an en banc hearing of All American?

            or is this a coincidence?

            rolg

            Liked by 1 person

          10. I doubt it’s coincidence. But it also could be that the Fifth Circuit en banc wants to hear oral argument in the All-American case before deciding how (or whether) to rule on the constitutional claim in Collins. If I had to guess I would say that’s more likely than that the panel already has decided to rule in favor of Collins plaintiffs on the APA claim (much as I may wish it were otherwise).

            Liked by 1 person

          1. If the administration is serious about recapitalizing the companies (and I believe that it is), it would make sense for Otting and someone from Treasury (probably Craig Phillips) to begin exploratory settlement talks with the plaintiffs in the net worth sweep cases, if they haven’t done so already. Whether they could reach a settlement that would preempt a ruling from the Fifth Circuit is another matter. Both sides have their “wish lists,” and FHFA and Treasury also have the political problem in settlement of being perceived as giving up over $15 billion per year in revenue from an action that has consistently been upheld in court. That doesn’t mean a pre-Collins ruling settlement can’t happen, but I would view it as a long shot.

            Importantly, though, for a recapitalization and release of Fannie and Freddie to go forward the net worth sweep does have to be eliminated, and the cases challenging it settled. Waiting until the Collins en banc panel rules would shift the terms of the settlement towards the winning side in the case, but it wouldn’t impede one. For me, therefore, a post-ruling settlement of the net worth sweep cases is the more likely outcome. As for the other cases—principally Washington Federal, which challenges the legitimacy of the 2008 conservatorship (and thus Treasury’s granting itself both the warrants for 79.9 percent of the companies’ common stock and a 10 per cent after-tax dividend in perpetuity on draws to offset net worth deficits it and FHFA created through accounting choices they forced on the companies)—I highly doubt the administration will settle those. Plaintiffs would have to be willing to finance their continuation in the hope that they ultimately would prevail in court.

            Liked by 2 people

  14. FHFA told the courts in both Rop and Bhatti cases that it will not defend constitutionality. Could either of those courts take that information, rule in favor of plaintiffs by default on constitutional grounds, and provide the relief in the form of reversing the NWS? That is, even if 5th circuit doesn’t do it after arguments tomorrow, could a ruling come from either of those cases? Would they just follow the 5th circuit precedent? I can’t remember the status of either one of those in terms of schedule. I have seen reply briefs, so I assume they are headed to oral arguments soon?

    Cheers,
    Justin

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    1. Again with the caveat that I’m not a lawyer, I would think that a ruling by the Fifth Circuit en banc on plaintiffs’ constitutional claims would be viewed as dispositive by the judges in the Rop and Bhatti cases, and that they would go no further. I do not know the likely timing for either of those decisions, however.

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    2. @Justin

      bhatti is on appeal at 8th circuit, rop still with a district court judge that apparently doesn’t want to touch case. nothing that the 5th circuit does will bind the 8th circuit, but an en banc opinion of a sister circuit always comes with a measure of respect. the principal issue in collins en banc will be whether the court grants Ps retroactive relief (void NWS) for the constitutional violation (single director for cause removal). when you listen to the recording of the oral argument, that will be the issue to listen carefully to. I will be most interested to hear whether the court considers Section 706 of the Administrative Procedure Act to require retroactive relief, as Ps have argued. there may also be some reference to the Bowsher and Lucia soctus cases, that Ps will argue are precedents for requiring retroactive relief. also a wild card is how and to what extent the court focuses on NWS as a violation of HERA conservatorship duties.

      rolg

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  15. Tim,

    Is there anything preventing Otting from executing on the “clear plan” set by Treasury?

    If so, it seems in the best interest of the Treasury to keep its cards close to its vest until Calabria is confirmed. Yet, as Otting said, a Treasury plan will be coming out “in a few weeks.” That tells me Otting will be implementing the plan; otherwise Calabria’s confirmation will be jeopardized by politicians who oppose Treasury’s plan, perpetuating the current deadlock.

    Otting also said, “If I can move that down the rails before Mark is confirmed, there’s a lot of things I think we can get done, and then Mark could come in and continue down the path of the mission that’s been laid out,” he added.

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    1. It seems to me that having Otting start implementing now is in their best interest. Congress will see little they can do to stop recap and release at this point regardless of whether or not Calabria is confirmed. If Demarco’s tenure is evidence, they can’t stop the path that the acting director is taking. They might feel compelled to get Calabria confirmed sooner rather than later if they oppose recap and release since the acting director is clearly implementing exactly that. At least with Calabria they have a shot at something somewhat different from straight recap and release that Otting is intending. This path is perfectly aligned with all the past court rulings to boot. To me, politically speaking, this is genius.

      Cheers,
      Justin

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      1. There are multiple moving parts here. Prediction as to how they all will align is complicated by the existence of a wild card—the court cases challenging the net worth sweep (most imminently Collins, in which oral argument will be heard en banc tomorrow)—and a contradiction: the nomination as director of FHFA of Mark Calabria, who is on record as stating that the securitization business of Fannie and Freddie Mac is a “false God” that should be replaced by deposit-based financing, and the appointment of an acting FHFA director, Joseph Otting (also Comptroller of the Currency) who recently has stated that Fannie and Freddie shortly will be released from conservatorship and allowed to recapitalize.

        What are we to make of this? The easy analysis is that Treasury Secretary Mnuchin has concluded that, given the results of the mid-term election, legislative reform of Fannie and Freddie in the next two years is a virtual impossibility. Thus, if he is to make good on his November 30, 2016 statement that, “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,” he has to do it administratively.

        Treasury’s traditional constituents, the banks, want to replace Fannie and Freddie with multiple credit guarantors that have access to government guarantees. But that requires legislation, which this administration now knows it’s not going to get. And here, I think, the banks and their supporters have made a serious tactical mistake. By going “all in” on the legislative alternative, and flatly opposing administrative reform, they’ve failed to come up with anything that works for them that can be done administratively. So as Treasury looks at how it can deliver on its November 2016 promise, the only path it sees is what I’ve called “TINA (there is no alternative) and the Warrants.” That is, Fannie and Freddie clearly have the best mortgage credit guaranty model, and if Treasury embraces that and facilitates the companies’ recapitalization, it can reap a substantial financial reward through the exercise and sale of the warrants it granted itself in 2008 for 79.9 percent of the companies’ common stock.

        Treasury knows the banks won’t like that, so it gives them something it thinks they WILL like: Mark Calabria as the nominee to head FHFA. (I think there is zero chance that Calabria’s nomination was made without Mnuchin’s approval.) But, knowing that Calabria’s nomination will take a while (and given the government shutdown and the general dysfunction in Congress, perhaps a long while) to reach the Senate floor for confirmation, Treasury then appoints Joseph Otting—a colleague of Mnuchin’s at One West—as acting director of FHFA, putting him in a position to set the release and recapitalization of Fannie and Freddie in motion. If that gets under way before Calabria becomes head of FHFA, he enters his job under a very different set of circumstances than he might have expected. With Treasury (and the acting FHFA director) having decided that the future secondary mortgage market should be built around a reformed, recapitalized and released Fannie and Freddie, will Calabria really feel (or be) free to hobble them and make them less efficient and less valuable to their stakeholders, who now include not only homebuyers and existing shareholders, but also Treasury? I very much doubt it.

        I may not have this analyzed correctly, but at the moment this is how I see this seemingly disconnected and inconsistent set of circumstances getting resolved.

        Liked by 3 people

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        1. Thank you for the rundown, Tim. I have two questions. First, I don’t recall any of the big names actually mentioning recap, only release. Did I miss something, or is recapping the companies the only thing logically consistent with what has been said? Second, do you believe that the companies will have to be fully and adequately capitalized before they are released? If so, that puts the recap on a timeline. To me, it seems hard to justify releasing the companies before they meet all applicable capital standards.

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          1. Fannie and Freddie won’t be released from conservatorship until, at a minimum, they have an agreed-upon capital target and a feasible plan to achieve it. I could see a scenario where they could be released from conservatorship after attaining a certain percentage of their target capitalization, then remaining under enhanced supervision (with restrictions on certain activities) until they reach the status of “adequately capitalized.” But, yes, recapitalization is assumed whenever administration figures talk about the “release” of Fannie and Freddie.

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      1. I don’t have the right expertise to evaluate the legal merit of the arguments the current (exclusively Democratic) members of Congress are making here about the constitutionality of the FHFA director, nor am I able to assess how those arguments might be received by the 16 judges who will be discussing the case on Wednesday.

        What did strike me about the amicus is that even Democratic members of Congress–who when I was at Fannie were strong supporters of its mission and management–have completely bought into the story about them and their role in the crisis peddled by the companies’ opponents since that time. I won’t recite the “list of horribles” included in the amicus, but one claim particularly resonated with me: “it was discovered that [Fannie and Freddie] employees had long ‘manipulated accounting and earnings to trigger bonuses for senior executives’.” Really? I was one of the Fannie executives accused by FHFA’s predecessor, OFHEO, of accounting fraud. That claim was litigated in a civil suit for eight years, and ultimately found to have had no merit (OFHEO had made up the charge to gain political and then regulatory leverage over the company, which it succeeded in doing). But even this disproven charge now is repeated as fact by historical allies and supporters of Fannie, along with the other fictions in the amicus. This reality distortion is the main reason I have been skeptical of getting any constructive legislation on Fannie and Freddie out of Congress–they just “know too many things that ain’t so.”

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        1. Tim

          these amici briefs are retread copies of what was filed in All-American (CFPB) case before 5th circuit. they realized that collins will be argued first. they all focus on an issue that neither fhfa nor treasury will contest in collins, the constitutional merits of single agency director for cause removal. so they are superfluous (if not absurd). judges are not going to find for fhfa and treasury on an issue these parties will not assert, notwithstanding anything a non-party amicus says. the parties will contest P standing and repressibility, and P retrospective relief, with respect to the unconstitutionality of the single agency director removable for cause claim, none of which amici have addressed.

          rolg

          Liked by 1 person

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  17. Tim,

    I’m not too clear on the rules surrounding this, but why are Fannie and Freddie not designated as non-bank SIFIs? They seem to fit the definition.

    If it’s because they are in conservatorship, would you expect such a designation post-release? And if so, Fannie and Freddie would then be subject to US Basel III non-bank SIFI capital standards, which, by my limited understanding, are more strict (higher) than even those proposed by Watt.

    In that case, the Basel III standards would become the de facto capital standards, and all this wrangling over Watt’s proposed capital rule becomes largely moot.4

    Do you have any thoughts on this angle? Is it even worthy of consideration when it comes to Fannie’s and Freddie’s future capital standards?

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    1. FHFA’s proposal for Fannie and Freddie capital put out last June did not contain any SIFI-type supplement or override, and I personally think that was the correct call. The Financial Stability Oversight Council (FSOC), which has the authority to assign the designation of “Systemically Important Financial Institution” (or SIFI) to both banks and non-banks, has not had success in coming up with a workable concept for a non-bank SIFI. In fact, all four institutions which at some point have been given the non-bank SIFI designation—GE Capital, AIG, Met Life and Prudential—found the associated capital requirements to be so misaligned with their business that they took steps to restructure themselves to escape the consequences of the designation. The FSOC clearly does not have the right answer to the non-bank SIFI question.

      And for Fannie and Freddie, there is no need to subject them to an artificial and cumbersome Basel III-type capital standard to keep them from being systemically vulnerable. With the strict limits now placed on their on-balance sheet portfolios, they essentially are in one business: guaranteeing residential mortgages. And in this business they have no liquidity risk, no interest-rate risk, and their losses are statistically predictable. That is, if you know the risk characteristics of the loans they guarantee, and also know the type of economic and financial stress you want them to be able to protect against, it is possible to set a capital requirement that will produce that result. I know of no other financial business for which this is true, and it obviates the need for the SIFI designation.

      I believe FHFA is on the right track with its proposal for a true risk-based capital standard for Fannie and Freddie. As I said in my comment on the proposal, there are some corrections and enhancements that need to be made to it, but the basic concept is sound. If it is properly implemented, Fannie and Freddie will be able to achieve the stress protection sought by the SIFI designation, without the associated negatives that drove GE Capital, AIG, Met Life and Prudential to seek to escape it.

      Liked by 2 people

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      1. Thanks Tim, I always learn a few new things regarding the GSEs reading your posts! I’m not sure if this is the forum, so my apology ahead of time if it isn’t, but at some point I thought I read in 2020 the GSEs will adopt FASB current expected credit loss accounting. If that’s accurate, how may that impact the accounting going forward?
        Thank you, Jack

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        1. With current expected credit loss (CECL) accounting, Fannie and Freddie, and also banks, will change the way they determine the size of their loan loss allowance, or loss reserves. Today the companies’ policy is to add to their loss allowance when they believe a loss is probable, or when a loss has been incurred. Under CECL, which is scheduled to be implemented in 2020, they will be required to set their loss allowances at a level that approximates the losses they expect to incur over the life of the loans they own or guarantee.

          That will be a big difference. Today the actual loan losses on Fannie and Freddie’s post-2008 books of business are very modest, and their loss allowances are falling because both companies were so grossly over-reserved (at the direction of FHFA) through the end of 2011. For the last three years Fannie has averaged around $600 million in credit losses on its $2.9 trillion books of post-2008 business, a credit loss rate of 2.1 basis points. In 2020, CECL will require the company to estimate the lifetime losses on those same books, and add that to its reserves. How much will that be? Hopefully Fannie will give us some guidance during the course of this year, but if it estimates those losses at 20 basis points, CECL would require it to add $5.8 billion to its reserve, which would run through the loss provision and thus be a deduction to net income, cutting Fannie’s 2020 profits by over one-third compared with what they would have been without CECL. In the following year, however, Fannie only would have to add to its reserves the estimated change in the lifetime losses of each quarter’s book relative to the previous quarter’s book—a much smaller number.

          In sum, I would expect CECL to have three effects on Fannie’s and Freddie’s net income: (1) a one-time transition-year addition to the loss allowance that will reduce their pre-tax net income by somewhere around 40 percent, (2) much more modest negative effects on net income in the subsequent few years, but then (3) when a downturn hits, considerably more net income volatility going into the downturn (when CECL pushes the loss allowance sharply higher, and net income lower) and then coming out of it (when CECL pushes the loss allowance back down, and net income back up). This third, procyclical, aspect of CECL has attracted the attention of the banking industry, which is hoping the FASB will make changes to the rule that will mute this effect. We’ll have to wait to see if that happens.

          Liked by 2 people

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          1. Tim,
            Great analysis. Can the extra profit from lower corporate tax balance this extra $5.8B reserve?

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          2. In my view, no. The lower corporate tax rate is independent of the addition to the loss allowance–i.e., it’s already benefitting the companies, so you can’t call it an “offset.” If Fannie adds $5.8 billion to its loss reserve, at the 21 percent corporate tax rate its after-tax net income (and, if by then it is allowed to rebuild capital, its addition to retained earnings) will be $4.6 billion less than it would have been otherwise, full stop.

            Liked by 2 people

          3. Tim, per your reply, is it reasonable to believe that the GSEs and banks would, or should be, in similar positions? By that I mean, during or before first quarter 2020 they should be “educating” ,through press releases or 10Q, to the shareholders the anticipated impact from CECL? Your explanation is excellent. I’ve had a sense that not a lot of folks are talking about the impact it will have on earnings and it may come as a surprise to some, at least temporarily.

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  18. Tim,

    I have found your knowledge and understanding to be exceptionally high quality and authentic. I have been trying to get hold of Michael Lewis to see if you and he could collaborate on a book detailing the current situation. I know your book was in 2013, and with the additional twists and turns, it is time to add more to the story. Mr Lewis has the public forum and similar background as you to explain the truth to the public, and possible help to balance the decision-making to come.

    If you two could connect and begin the process to consider such an undertaking, the announcement of this would have enormous influence on the political and public sphere to keep fairness on the table and try to limit the back room dealing. Then with the publication, the entire public would be able to finally understand what was perpetrated upon these companies.

    With all due respect to you and your knowledge and your reach, we all would be better served to have you and Mr Lewis working together. The book concept could be bigger than “The Big Short”.

    If anyone out there has clear access to Mr Lewis and believes as I do, please contribute to making this happen.

    DrJohn

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    1. First of all, there is someone—a published author of both nonfiction and fiction—who now is working on a book about the current situation with Fannie and Freddie (although I’m not at liberty to give that person’s name). I have met with them, and we have an ongoing dialogue, by email and phone. (This person also talks about writing a “Michael Lewis-style” book.)

      Second, I highly doubt Mr. Lewis would wish to co-author a book with me—he does quite well with those he writes on his own. I also suspect that for him even to consider the subject, he’ll want to know how the drama resolves itself, with a view to doing the “inside story” on it

      Liked by 1 person

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    1. I saw that, but am not sure what to make of it. The first paragraph in the story says Otting told employees that “the regulator will announce a plan within weeks to take the government-sponsored enterprises out of conservatorship,” but cites no source for that statement. In the second paragraph the reporters state that this plan “will soon be announced, according to an attendee of that gathering,” without saying what “soon” means. And the third paragraph says a spokesperson for the agency “denied there was any talk of timing or details.” We’re left with having to choose among three different versions of what was said, with no help from the authors of the story (or their editor, if they have one) in reconciling the discrepancies.

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      1. net, net, there is an administrative plan, and the plan is to get the GSEs out of conservatorship. and fhfa staff heard it straight from Otting. none of this has been denied

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          1. Tim

            I have been thinking about treasury’s reticence to affect how DOJ defends the GSE cases (assuming of course that Mnuchin might want to have it otherwise). news broke yesterday about a reversal of interpretation by the office of legal counsel in DOJ regarding a statute relating to online gaming (apparently at the instance of a memo written by Cooper & Kirk and financed by Sands Casino/Mr. Adelson). trying to influence DOJ is something of a third rail, certainly for “lobbyists” but also for federal agencies themselves (imo because the next question asked is which lobbyist has “gotten” to the head of the federal agency).

            so it makes perfect sense for any administrative plan that deviates from a full-throated defense of the NWS to come from Otting at FHFA in the first instance, and for Treasury to keep clear of the process until it is released.

            rolg

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          2. That’s quite possible. In any event, I don’t think that since Otting became acting director of FHFA he has said or done anything that did not have Mnuchin’s approval, nor do I think Otting will take any future action without it. So it certainly could be that Treasury’s wishes will first be learned through FHFA’s statements or actions.

            Liked by 1 person

  22. Tim

    the surprises just keep on coming with this collins en banc hearing.

    an amicus brief was just filed by law professors arguing that the single director removable only for cause structure is constitutional. these same professors also filed a similar amicus in the All American case with the 5th circuit, which will be argued some two months after collins. (there were also an amicus brief filed in All American written by professor wurman that it is unconstitutional (wurman wrote highly accessible and brilliant book, “a debt against the living: an introduction to originalism,” which is highly recommended)).

    this is an absurd amicus filing inasmuch as neither treasury nor fhfa will be arguing in favor of the constitutionality of the structure. I have no idea what these law professors are doing since an amicus cant advance an argument that is not advanced by the parties in interest. puts academia to shame.

    rolg

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    1. Professor Ilan Wurman is a member of the Federalist Society and has worked for Senator Paul and Senator Cotton as well as clerking for Judge Smith – US Court of Appeals for the FIFTH CIRCUIT

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    2. @Paul

      article III of the US constitution states that the judicial power extends to cases and controversies. this is understood to involve disputes between parties in interest, parties who have “skin in the game” to use a Taleb meme. there is no constitutional controversy between Ps and S in collins en banc as it relates to the constitutionality of the single agency director removable for cause provision. Ps win on this point and the question goes to whether retrospective relief is available.

      the professors’ amicus brief amounts to wind whistling among the leaves.

      rolg

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  23. Tim

    collins has filed a motion to file a reply brief (appendixes to motion) to treasury/fhfa’s briefs. the en banc court’s calendar does not authorize this reply brief filing but the motion makes clear why Ps should be allowed to do so. not opposed by treasury and fhfa is silent. this is top notch lawyering by Cooper & Kirk.

    https://www.dropbox.com/s/p8ajp58h37g2xhh/collins%20en%20banc%20reply%20brief%20motion.pdf?dl=0

    rolg

    Liked by 1 person

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    1. In addition to being top-notch lawyering, I found this brief to be extremely well argued: the points it makes are simple, clear and compelling. Nobody disputes that FHFA is unconstitutionally structured; FHFA’s and Treasury’s last-minute arguments that plaintiffs do not have standing to bring this case are unpersuasive, and there is ample precedent, including from last year’s Supreme Court ruling in Lucia v. SEC, that backward-looking relief for plaintiffs’ damages is required. Bravo.

      I also was pleased to see that Cooper & Kirk finally came out swinging against the government’s continued fictitious rendering of the facts in the case. After making the point that the en banc panel should address the APA claims first (since a finding in favor of plaintiffs on these claims “would clearly require vacatur of the Net Worth Sweep,” thus avoiding the need to get into the constitutional claims and the issues of remedies), C&K adds this pithy summation:

      “Tellingly, neither Treasury nor FHFA is willing to stand up to the facts alleged in the Complaint. Instead, they devote multiple pages of their en banc briefs to a counternarrative of the events that led to the imposition of the Net Worth Sweep. But the Court should make no mistake: a ruling in Defendants’ favor on the statutory claims would be a ruling that Congress authorized a government money grab designed to wipe out the Companies’ private shareholders and prevent the Companies from ever emerging from conservatorship as sound financial institutions as others did following the 2008 financial crisis.”

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      1. Tim

        quick thought:

        why did C&K suggest in reply brief that 5th Circuit en banc could simply decide APA claim in favor of Ps and invalidate NWS (cribbing from J. Willets dissent in the merits panel) and avoid the question whether to give retrospective relief for the unconstitutional structure claim? while courts generally prefer to avoid constitutional questions if possible, and ruling for Ps on the APA claim would provide Ps all of the relief Ps are seeking, some courts (DC Circuit court in PHH merits panel) have decided in favor of Ps on both statutory and constitutional grounds (of course DC Circuit later reversed this holding en banc).

        my suspicion is that C&K knows, that the 5th Circuit knows, that the All-American case (CFPB) is docketed and briefed in the 5th Circuit (and a P request for original hearing en banc has been received but not yet decided), and so the separation of powers single director removable only for cause claim will necessarily be heard by 5th Circuit (there is no All American statutory claim to keep court from deciding the constitutional claim). so the 5th circuit may well decide to put off the Collins constitutional analysis for another day, soon to come.

        this again is smart lawyering by C&K. my sense, however, is that 5th Circuit seems to really want to hear the constitutional claim in Collins (the letter of advisement sent to counsel shortly after deciding to rehear Collins en banc focuses on constitutional remedy, and the constitutional claim has become much easier to decide with no party arguing in favor of it on the merits). one might look to the en banc questioning at oral argument to indicate whether the court likely will decide both claims.

        rolg

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        1. rolg,

          let’s assume that P’s win and are able to get the NWS reversed. So what? How does this help the shareholders if the GSE are still in conservatorship? I can’t see how the P’s can get the GSE out of conservatorship unless there is administrative action.

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          1. @zd

            imo, if the NWS is vacated, the GSEs will not only be highly profitable but also become readily able to be recapitalized. the premise for retaining the GSEs in conservatorship disappears. so yes administrative action is necessary, but it becomes feasible as well.

            rolg

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    2. ROLG / TIM,
      Can you clarify something for my concerning the en banc hearing in the Collins case. My understanding is that there is a panel of 11 judges. Of the 11 judges, are the 3 judges in the original appeal on this panel, and if so does that mean we start off down 2-1 and there fore can only have 3 more judges on the panel vote against us in order to win the majority?

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        1. @rolg,

          I know Senior Judges can participate in en banc rehearings as well, but I’m under the impression they rarely do. Is that correct? Do we already know all 16 judges will be involved…is that stated somewhere in the filings? Has anyone recused/eliminated themselves or will we just find out who actually shows up on the 23rd? Also, do you know what happens if the 16 judges end up in a 8-8 tie…back to the previous majority (3 panel) ruling?

          TIA

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          1. @gb

            a senior judge who participated in the merits panel can participate in rehearing en banc. no senior judge participated in Collins merit panel. 16 active judges will participate en banc.

            rolg

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  24. the explanation of the legal strategy is great and all but at the end of the day why does this matter to this blog unless its good or bad for the Ps

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  25. Tim

    I have noted that 5th Circuit en banc rehearings are rare, but haven’t found quantification until now: https://twitter.com/Alec_Mazo/status/1085241775961235456. 8 out of over 7300 appeals in 2018.

    now what do we take from this? just focusing on the separation of powers claim for a moment, the merits panel found the single agency director removable only for cause to violate the separation of powers doctrine, but provided no retrospective relief (vacate NWS). a majority of 5th Circuit judges must vote in favor of rehearing en banc and it occurs about about .1% of the time. either the 5th circuit wants to review the ruling that there was a constitutional violation or it wants to review the denial of relief.

    given the treasury and fhfa briefs, the finding of a constitutional violation will not be argued by treasury, nor by fhfa if the en banc court finds that Ps have Article III standing (injury in fact), which the merits panel found. all this tells me that the focus in the en banc hearing will be whether retrospective relief should be given. the 5th circuit’s letter of advisement to the litigants makes this clear: https://www.dropbox.com/s/63ewbjp8dfz2xoq/collins%20letter%20of%20advisement.pdf?dl=0

    rolg

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      1. @jerry

        the APA claim will also be reviewed en banc. what’s interesting here is that willets wrote a bravura dissent, and the majority was one sentence, saying essentially we agree with the Perry majority. I don’t expect the en banc majority opinion on the APA claim to be one sentence.

        rolg

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        1. I am eager to read the transcript of the January 23 en banc hearing when it’s released (although very likely others will have read it before I see it, and someone will have identified the key takeaways….). My guess is that the focus of the panel will become evident early in the session, and that not too long afterward the inclination of the majority also will be apparent. Having monitored the various legal proceedings from the outset, however, I wouldn’t even think of hazarding a prediction about the outcome. On verra.

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    2. ROLG, does it matter that the Collins plaintiffs are a combination of both junior preferred and common stock holders? I’m thinking as the Collins plaintiffs gain some power here post en banc that any relief to the plaintiffs might have to balance the interests of both junior preferred and common stock stakeholders. Do you have any thoughts on this?

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      1. @biv

        nothing in collins differentiates claims made by junior preferred and common Ps. both would benefit from the relief sought (vacate NWS). in any recap, hard to predict how that might look, though the Moelis blueprint offers one view.

        rolg

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      1. @ 2.0. can’t tell from website. last cases’ recordings posted having hearing dates of 1/9 and 1/10, but I cant tell when the mp3s were posted. court rules don’t provide guidance

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    1. This decision has little implication for the constitutionality cases involving Fannie, Freddie and FHFA. The article itself explains why: “The appeal was a long shot because it would have forced the court to hear the case shorthanded. Justice Brett Kavanaugh took part in the dispute when he was an appeals court judge, precluding his participation at the Supreme Court…[Solicitor General Neil] Francisco pointed to three pending appeals court cases that he said raise the same issues.”

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      1. @mark

        no treasury maintained that position in the merits panel brief; it is being consistent. it just doesn’t want to grant P’s any retrospective relief. and it would be consistent with prior briefing if fhfa agued that there is no separation of powers violation in the en banc brief, not yet filed (or at least docketed). but the question is whether having a trump appointee in Otting will cause fhfa to switch gears and align itself with treasury. I am not holding my breath but it is a possibility.

        rolg

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          1. oops, my bad. I had just read table of contents of the fhfa brief for the previous comment, which indicated no diversion from a “normal” fhfa brief. but then I read this in the introduction:

            “Under prior leadership, FHFA petitioned for rehearing en banc seeking consideration by the full Court of the Panel’s holding that FHFA’s structure, in particular its leadership by a single director removable only for cause, unconstitutionally limits the President’s ability to supervise FHFA. As of January 7, 2019, FHFA is led by a new Acting Director, who has reconsidered the issues presented in this case. For the reasons discussed herein, it remains FHFA’s position that it is unnecessary for this Court to reach the constitutionality of the Housing and Economic Recovery Act’s (“HERA”) for-cause removal provision in order to resolve this case and affirm the dismissal of Plaintiffs’ claims. To the extent the Court concludes it is necessary to reach the constitutional issue, FHFA will not defend the constitutionality of HERA’s for-cause removal provision and agrees with the analysis in Section II.A of Treasury’s Supplemental Brief that the provision infringes on the President’s control of executive authority.”

            so Otting got a half of loaf…fhfa lawyers say, in essence, that Ps don’t have proper standing to raise separation of powers claim. but if the collins en banc court decides otherwise (as did the collins merits panel), then fhfa will stand down and agree that fhfa is unconstitutionally structured (as does Treasury).

            but fhfa will still argue that Ps don’t deserve retroactive relief (invalidate NWS): “Nevertheless, that issue provides no basis for awarding any relief to Plaintiffs in this case. Therefore, the Court should affirm the District Court’s judgment dismissing Plaintiffs’ claims.

            Liked by 2 people

  28. apparently Otting just made his first on the record comment about GSEs: OTTING in Politico Pro: “Our goal is to be able to complete the release of the GSEs but at the same time make sure that it supports the U.S. housing market.”

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    1. Full text:

      Otting: ‘A lot’ can get done during acting FHFA tenure

      By Victoria Guida
      01/10/2019 12:45 PM EDT

      Joseph Otting, who took over as acting director of the Federal Housing Finance Agency this week, said today there’s a lot he can accomplish to further housing finance reform during his tenure at the agency, despite the temporary nature of his position.

      Otting, who is also comptroller of the currency, will be in charge of the agency that oversees Fannie Mae and Freddie Mac until a permanent replacement is confirmed. President Donald Trump has nominated vice presidential aide and libertarian economist Mark Calabria for that position.
      “There’s a clear mission that’s outlined by the Treasury and the White House, what they want to accomplish,” Otting said in an interview this morning inside the building that houses both the OCC and FHFA.

      “If I can move that down the rails before Mark is confirmed, there’s a lot of things I think we can get done, and then Mark could come in and continue down the path of the mission that’s been laid out,” he added.

      Otting echoed Treasury Secretary Steven Mnuchin by saying that “ending conservatorship is a priority,” and maintaining the 30-year mortgage is important.
      He declined to go into detail about his views on what type of reforms might be needed to the mortgage giants, often referred to as government-sponsored enterprises.

      “We have to look at the capital and liquidity requirements of the GSEs,” he said. “But by all accounts … I think the GSEs can be commended for the way they have repositioned their business models and the way they are serving the market.”

      He said he was still getting his bearings in his new role, but added: “Our goal is to be able to complete the release of the GSEs but at the same time make sure that it supports the U.S. housing market.”

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      1. This is a very positive statement. By my recollection it’s the first time any senior official at either Treasury or FHFA has made an unambiguous commitment to “release the GSEs,” and Otting goes beyond that by adding the explicit goal of ensuring “that it [the release] supports the U.S. housing market.” Otting further indicates that he is unlikely to make any dramatic moves at FHFA prior to the confirmation of a director by the Senate (which doesn’t surprise me).

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        2. If Otting gets started with a thing or two it’ll make Calabria’s confirmation easier because path will seem inevitable. If he sits on his hands, there will be an impression that stopping his nomination can prevent certain outcomes. So I’m going with the former.

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        3. Otting is moving before Calabria is confirmed. He stated there is a clear direction from the White house and Treasury, and doesn’t state Calabria. He also mentioned Mark can “continue” that mission which means Otting will be the initiator.

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          1. which leads me to think he will be more a policy implementer and less a policy formulator (rendering much of his 1950s mortgage market musings irrelevant)

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          1. Tim, would you please share with us your opinion on what motivates David Stevens to write article after article pushing the “billionaire hedge fund” narrative wrt the GSEs? I tend to think accusations that he is “bought by the banks” are nothing more than conspiracy theories, but the fervor and persistence of Stevens’ smear campaign makes me wonder if I am being naive.

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          2. Dave Stevens up until recently was the president of the Mortgage Bankers Association, whose largest and most influential (and largest dues-paying) members are the big commercial banks. His job there, literally, was to do whatever he could to help them get what they wanted, in Congress or administratively. One thing the big banks have wanted since the late 1990s is to reduce (or eliminate) the competitive power of Fannie and Freddie in the secondary mortgage market, to banks’ benefit in the primary market.

            The MBA and other opponents and critics of Fannie and Freddie, however, never have had strong arguments for replacing them with a bank-centric alternative. The companies have the best business model for their primary activity—guaranteeing the credit of residential mortgages—and their performance during and after the financial crisis was provably far superior to any other source of mortgage finance. So where do you go if you’re Dave Stevens (or another opponent or critic of Fannie and Freddie)? You invent things—“Fannie and Freddie caused the financial crisis”—you make vague negative statements about them—“they have a flawed business model”—or, as we’ve seen recently, you find a boogeyman to attach to them—“greedy hedge fund managers” who want to make money by bringing the companies (undeservedly) out of conservatorship.

            These were the weapons Dave wielded as president of the MBA, and it’s no surprise that he’s still using them. And by now he may even have convinced himself that he’s on the right side of the argument. I do wish, though, that he would stop saying that Fannie and Freddie caused the financial crisis. He knows that’s not true, and he diminishes himself by repeating a known falsehood.

            Liked by 3 people

          3. Ooh, he mad. I bet every penny that the share prices rise causes his blood pressure to go up a point.

            This is the most bald-faced expression of his disdain for hedge funds that we have yet seen from Stevens. It’s clear that he will go to any lengths to try and deny current shareholders any price increase in their shares. In fact, it’s starting to seem like his primary concern, with the future state of the country’s housing finance system only being invoked as cover.

            To his first point, Trump, Mnuchin, and Trump’s picks for FHFA (Otting now, Calabria later) actually do have a sense of urgency. Trump and Mnuchin might be out of office in 2021, so anything they do will have to be done in the next 2 years. By the standards of a recapitalization of this size, that’s pretty fast. It’s also ludicrous to say that a recap and release benefits shareholders at the expense of taxpayers, then turn around and claim that it’s preferable to have the companies rely on taxpayer money (Treasury’s credit line) in the case of a downturn rather than loss-absorbing equity capital from private investors.

            To his second point, the administration has been rather clear that they want the companies released by the end of 2020. Release means recap, and recap means ending the NWS. While this is a worse deal for the government from a pure income perspective, it also allows Treasury to finally cease its funding commitment, a large source of taxpayer risk.

            To his third point, a recap and release will certainly NOT “only serve to bolster the shares of the two companies”. Cementing the changes that the SPSPAs and Watt have put in place (reduction in retained portfolio, the CSP, etc) is a primary goal of releasing the companies.

            His second-to-last line also betrays a clear misunderstanding of the purpose of getting the companies out of conservatorship. That purpose is minimizing taxpayer risk, which remains sky-high given the companies’ lack of capital and Treasury’s funding commitment.

            It’s comforting to know that Otting is in power and Stevens isn’t.

            Liked by 1 person

          4. from Stevens: “I was surprised to read the comments from FHFA Acting Director Joseph Otting as articulated by Politico. If accurate, the idea of retaining capital prior to real reform is striking in its vulgarity.”

            it is striking that the most prominent historical lobbyist against the GSEs is reduced to characterizing the current FHFA director’s ideas as vulgar. the man doth protest too much.

            rolg

            Liked by 2 people

      2. Key point: the GSEs can be commended for the way they have repositioned their business models and the way they are serving the market.

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    2. Tim(and perhaps ROLG)-

      FHFA sought and obtained an extension of the deadline by which it must file a supplemental en banc brief in the Fifth Circuit because, FHFA says, “[t]his case raises significant issues of interest to FHFA’s new leadership [and] FHFA’s new leadership requires additional time to review the issues presented in the case and to evaluate FHFA’s positions.” The filing is now due on Mon., Jan. 14, 2019. A copy of today’s request is attached to this e-mail message. The Court entered a paperless order granting the request. 17-20364-00514792607

      Do you believe this request for an extension is just another delay tactic(it’s only one day I believe), or something greater? Do you think FHFA would have a change in position at this point? I believe that with a new director the position has in fact changed, but would the courts be the place to verbally change that position? Wouldn’t they just keep delaying until they implemented their plan? Curious of your thoughts and I may be thinking too much at this point. Thank you as always for your time.

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      1. A one-day delay is certainly not a “delaying tactic.” To me it indicates two things: first, FHFA’s new leadership is appropriately focused on this case, and second, the Fifth Circuit intends to stick to its timetable for the en banc hearing on the 23rd (hence the only one business day slip in the deadline for FHFA filing its response).

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        1. I did have a scenario play through in my mind when I read this fhfa motion for delay to file until 1/14.

          the clerk of 5th circuit wrote into the docket that all filing deadlines were to be strictly observed, as all 16 judges are being kept away from their own 3 judge merits panel cases, and as Tim mentions, the oral argument is in only two weeks. while the motion was unopposed, the clerk did fhfa a solid by granting an extension given its prior admonition.

          now, usually counsel files the brief on the last day permitted and completes it very soon before filing. I imagine fhfa counsel (Arnold & Porter) would send briefs in the past to fhfa director watt as a courtesy and watt never read them. I also imagine that fhfa counsel did likewise with fhfa acting director Otting and found out much to its shock and consternation that Otting wanted to read it. this is what successful ceos of large banks do, they read documents that are submitted under their name. hence the delay for Otting (or his designee) to read it over the weekend.

          will Otting red-line the brief and change content? no, I don’t expect the fhfa brief will contain any admissions or surprises when filed. while Otting may very well be proactive, I wouldn’t expect him to initiate action through the vehicle of a legal brief. but I imagine some lawyers at Arnold & Porter had visions of their careers passing sadly before their eyes.

          rolg

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          1. I can’t help but believe that yesterday’s interview and today’s court delay during Otting’s first five days are indeed setting a tone of quick action.

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          2. It is going to be fascinating to watch the legal situation play out over the coming weeks and months. Mark Calabria, the nominee for FHFA director, is one of the authors of the Housing and Economic Recovery Act of 2008, and he has made clear in his writings that he believes the net worth sweep is in violation of HERA. The new acting director of FHFA, Joseph Otting, knows many of the plaintiffs in the suits against the net worth sweep, and through these contacts understands that Fannie and Freddie were not “rescued,” they were nationalized by Treasury for policy purposes, and that what Treasury and others have called their “bailout” was in fact a cynically engineered strategy to saddle them with temporary or artificial book losses in order to load them up with non-repayable senior preferred stock, at a 10 percent after-tax dividend, intended to prevent them ever from emerging from their Treasury-imposed captivity. Now Otting has said, unequivocally, that FHFA is committed to releasing Fannie and Freddie from the conservatorship it and Treasury forced them into in the first place. Treasury has remained silent on its intentions for the companies. How will Treasury, and FHFA, address all these issues from their institutional past? The drama is about to unfold.

            Liked by 1 person

          3. Tim

            when Mnuchin became treasury secretary, one might have considered whether treasury under mnuchin might have an effect on the DOJ’s representation of treasury in the NWS litigation. in short it hasn’t, and the reason likely is because of the dynamics of how DOJ represents the federal government. DOJ is totally in charge of things legal, and for the DOJ to even consider changing its course of legal action, someone at treasury would likely have had to get approval at DOJ’s office of legal counsel. not happening.

            different case with an independent agency, such as fhfa. here, the agency director is in control and gets to choose agency counsel and supervise its legal course of action. to Demarco’s credit, for example, fhfa used the law firm Quinn Emmanuel in all of its rep and warranty putback litigation against tbtf banks, which was a brilliant choice netting fhfa tens of billions of dollars in recoveries (and Quinn Emmanuel likely tens of million of dollars in fees). as to the choice of Arnold & porter to represent fhfa in the NWS litigation (which was also a Demarco pick as I recall), this was also a very good choice of a very fine firm, but with Otting (and eventually Calabria as director), legal oversight can be exercised by the fhfa director in ways that are simply not institutionally possible in the case of treasury and the DOJ.

            again, I expect to see an unexceptional fhfa brief filed Monday in collins en banc, but this fhfa client/lawyer dynamic bears watching.

            rolg

            Liked by 1 person

        2. The most plausible scenario to resolve this expeditiously is for the 5th circuit to invalidate the NWS en banc. That would quickly set in motion administrative release options and this whole cluster of a saga would be over.

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          1. ROLG,
            How quickly do you expect a decision from the 5th Circuit en Banc after oral arguments on the 23rd ?

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          2. @jerry

            hard to say. 5th circuit en banc rehearings are rare. on one hand, 3 judges have heard this case via the merits panel, and the other 13 judges have read their opinions, so they all have a leg up. on other hand, having 16 judges deciding a case may require more time than a 3 judge merits panel.

            the merits panel issued two well-reasoned opinions that the en banc court can build on (or respond to), but P’s claim for retroactive relief under the separation of powers claim (vacate NWS) will have to be decided and opinion written, and this is the biggest focus of the case, at least for me.

            rolg

            Liked by 2 people

  29. Hello Tim,

    I find the timing of this interesting and maybe the decision is an idealogical one for Mr. Bright.

    I wonder if, given the failed agenda to shrink or eliminate Fannie and Freddie’s business, i.e the Milken Institute think tank and the Corker-Warner bill, that maybe he is admitting it’s time to move on. He probably was also hoping that Fannie and Freddie’s business would be moved to Ginnie Mae (somehow).

    Are you familiar with Maren Kasper?

    https://www.housingwire.com/articles/47884-michael-bright-abruptly-steps-down-from-ginnie-mae

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    1. Mr. Bright’s seemingly sudden decision to leave his position at Ginnie Mae (telling HUD he would “institute an orderly transition process” in the week between the January 9 date of his resignation letter and his stated departure on January 16) is consistent with him having learned from some source that his vision of a future secondary residential mortgage market with Ginnie Mae firmly implanted at its center was not in the cards. I have no inside information on this, but perhaps Bright’s reason for leaving will become more apparent either from a future statement he makes or once we learn where he is going (that is, the “where” may reveal the “why”.)

      I do not know Maren Kasper.

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      1. He’s going to become president of SFIG (Structured Finance Industry Group):

        https://www.bloomberg.com/news/articles/2019-01-09/key-ginnie-mae-official-is-said-to-quit-to-join-industry-group

        These are the guys who, at their recent NY conference, urged members and attendees to join them in lobbying the government to cut back F/F market share and allow use of the CSP for PLS, not understanding that it’s fundamentally faulty product and not GSE competition that is preventing mainstream investors from buying their securities and restoring their market to what it was pre-2008.

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        1. Interesting. When I said in my current post that comments on the FHFA capital proposal for Fannie and Freddie were divided into two categories, “those whose primary concern was how the proposed capital rule could (or needed to) be improved in order to strike the desired balance between taxpayer protection and the provision of an ample flow of mortgage credit to as wide a range of potential borrowers as possible, and those whose comments were colored by a different objective—whether it be ideological… competitive or something else,” my “poster child” for the second category of comment, had I chosen to name them, would have been the Structured Finance Industry Group, where Mr. Bright is headed.

          The SFIG made no attempt to downplay its position that FHFA’s capital rule for Fannie and Freddie should be designed to make it easier for private-label securities to re-emerge as a significant source of funding in the future mortgage finance system, saying, “SFIG continues strongly to believe that reinvigorating the non-agency private label mortgage-backed securities (“PLS”) market should remain an important priority for both the FHFA and for the broader housing finance industry.” The SFIG said it believed Fannie and Freddie should not be accumulating credit risk (which is what a single-family mortgage credit guarantor does), and not only did it advocate a “level playing field” for capital that would produce this result, it went further, adding, “Thus, g-fee policy and other limits on Enterprise activity may still be required, even with a level playing field for capital, to limit risk at the Enterprises and maintain competitive equilibrium across the spectrum of mortgage industry participants and products.” (I’ll confess that when I read the SFIG comment the image that came to mind was the lawyers for Lizzie Borden asking the judge to place her with foster parents.)

          Mr. Bright should fit right in there.

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  30. as a general matter, potus cannot expend funds that have not been appropriated by congress. Obama did that to reimburse insurance companies under ACA and a federal district court held that was invalid.
    however, some scholars believe that potus has inherent executive power to take action in matters regarding national security, which would include the expenditure of funds available to treasury (such as if treasury recaps GSEs and sells shares). this would be contested in court. and more to there point, this cant be done soon.
    what potus may do soon regarding the wall is take advantage of an existing statute that authorizes potus to reallocate defense budget funding previously allocated for defense construction to new construction priorities in the event potus declares a national emergency regarding the border. no court has ever denied potus the right to declare a national emergency (there are over 30 national emergencies in effect now). courts have denied potus the ability to do certain things in the event of a national emergency (Truman couldn’t take over steel mills to avoid labor issues), but trump would have a clear enough statute that authorizes defense construction of his choosing in the event of a national emergency…unless some court finds that the border wall is not a defense construction project.

    rolg

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    1. No, not with respect to the Secretary’s possible actions affecting Fannie and Freddie on mortgage reform. These “kudos” are in my view a purely political reaction to an increasingly unpopular action–the government shutdown–that is starting to stick more to the Republican administration than to the Democratic leaders of the House and Senate. As a good soldier, Mnuchin is doing his part to help out.

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      1. I see it as completely political, but I find it rather interesting that he’d use this unfortunate standoff of the government shutdown as an opportunity to praise the work of the GSEs. Not just praise them but praise them for assisting individuals experiencing hardship, which aligns nicely with the GSE charter yet is somewhat contrary to the charter of big banks (or even One West). Maybe I’m reading too much into this but it…

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    1. There is nothing in this piece that surprises me, given the positions the Milken Institute has taken on mortgage reform previously. Milken says it opposes “releasing the GSEs from conservatorship without fixing the critical flaws in the GSE charters,” which Milken says only can be done through legislation. What are those flaws? “Most notably,” says Milken, “the privatizing of profits and socializing of losses.” I’m sure this diagnosis will seem puzzling to Fannie and Freddie shareholders, who have experienced massive amounts of book losses forced on them by FHFA and Treasury from the second half of 2008 through the end of 2011, and then had the cash profits their businesses generate seized in perpetuity by the net worth sweep in 2012–precisely the opposite of “privatizing profits and socializing losses.”

      Once you rule out releasing Fannie and Freddie from conservatorship administratively, however, all of Milken’s recommendations for “administrative reform” become more understandable. Their goal is to reduce the companies’ effectiveness as credit guarantors, and weaken them financially, to the point that legislating bank-centric replacements for them, with an explicit government guarantee, seems less foolish and thus more potentially achievable. It’s a version of the “boiled frog” technique, but in this case I suspect the frogs would sense the heat being turned up on them, and call (or croak) for help.

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      2. Tim

        I would agree that as to substance, this paper is noxious and hubristic. but I wonder to myself why MI published this paper now.

        it seems to me that MI believes that administrative reform is coming and based upon whispers and peeks, it is fearful it won’t go the way it would like. on p.23 of the paper, MI lays out two options: the first is Moelis blueprint-like, and the second is their prescription, which MI admits is the harder path. why set up the first as a straw man unless MI fears it is actually the boogie man?

        why would MI agree to suspend NWS dividends (certainly a departure from their previous position), as part of its preferred option, if it didn’t fear something more definitive was possibly coming soon? I may be imagining things.

        rolg

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        1. I agree that the Milken Institute authors are worried that Moelis-style administrative reform that results in the recapitalization of Fannie and Freddie and their release from conservatorship may be gaining traction, and feel a need to try to head that off if they can.

          Milken’s suggestion that the net worth sweep be suspended to enable the companies to rebuild capital was curious. Their recommendation had two important conditions: that the sweep suspension “(i) is not a prelude to releasing the GSEs from conservatorship absent legislation to resolve serious charter flaws, and (ii) would not represent a compromise of taxpayer claims.” On the first, if you’re not going to release the companies, then what is the objective of having them (slowly) rebuild capital, at Treasury’s expense? Milken doesn’t say. Their second condition was linked to a proposed imposition of the “periodic commitment fee” in the senior preferred stock agreement that has never been charged, but that in Milken’s words “would continue to compensate Treasury for the hundreds of billions of dollars of taxpayer dollars that backstop the GSEs’ debt and MBS guarantees.” In a footnote, however, Milken notes that if Fannie and Freddie’s periodic commitment fees are less than the amount of the net worth sweeps that are suspended, it would be a “compromise of claims” that would “require the written approval of the Attorney General or his delegate.”

          In many of its court filings, the government has asserted (very unpersuasively in my opinion) that the periodic commitment fee referenced by Milken would be “incalculably large.” Milken appears to endorse that view, but it undermines their rationale for suspending the sweep. If the sweep is suspended but replaced by a periodic commitment fee that is of comparable size, that would be of no benefit to Fannie and Freddie in rebuilding capital. Yet if the periodic commitment fee is a lot less than the suspended sweep payments–which it should be–the Attorney General would have to explain why he or she were approving this “compromise of [taxpayer] claims,” which they are highly unlikely to wish to do. So what, exactly, is Milken proposing here? My take is that it’s pure optics–endorsing an action that seems to be a compromise on their part but that has no chance of ever being acted upon.

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          1. in my view the compromise of claims argument is ludicrous. treasury waived the imposition of a commitment fee for 4 years before the NWS. the commitment fee was never calculated such that its prospective imposition, which treasury supposedly gave up in exchange for the NWS, was never part of the supposed negotiation between fhfa and treasury. this is all post-hoc litigation argumentation. this is MI grasping at vanishing straws.

            Liked by 1 person

  33. Tim, would you please send a response to this nonsense editorial publlished by The Washington Post? I left a lengthy comment (part of which I stole from you … sorry) but I’m nobody who will be taken seriously.

    https://www.washingtonpost.com/opinions/trumps-nominee-to-oversee-fannie-mae-and-freddie-mac-could-provoke-a-needed-discussion/2019/01/01/f3d2229e-fe4e-11e8-862a-b6a6f3ce8199_story.html?utm_term=.bd403a194852

    Thank you.
    Jeff Wood

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    1. The Post has a 30-year history (at least) history of declining to publish op-ends, and even letters, favorable to Fannie Mae. I have submitted a number of them, and never had one published. Shortly after I published my book I tried to go in from the top. I asked a friend and former colleague to contact the Post’s editorial page editor, Fred Hiatt, to bring an op-ed I had prepared to his attention, and to make the journalistic case for why the Post should publish it. Fred sent a note to one of his editorial aides, who wrote me asking if I could send it to her (she said it must have gotten lost because she couldn’t find it.) I resent it, and the next day got the Post’s standard rejection notice: “The column was carefully reviewed, but the Post unfortunately is unable to publish this piece.” (They never give any reason that might be useful in tailoring the next submission.) Six months after this episode I sent another op-ed–on the Johnson-Crapo legislation, which the Post favored and about which it had published several positive pieces, including an op-ed–to the same editorial aide, and the next day got the same rejection email. Being pretty adept at pattern recognition I haven’t tried another one since.

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      1. LOL. Yes, no point in attempting to educate the willfully ignorant who insist on preaching to us. We all should have learned that lesson by now. Thanks for your response.

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        1. As an institution, the Post many years ago took the position that Fannie and Freddie were bad public policy choices. I personally think it was because this was the insistent contention of what I call the Financial Establishment, whose members advertise in the Post’s pages (and on-line) and serve as sources for their many financial stories. But whatever the reason, even in the face of evident and provable facts to the contrary the Post has never acknowledged, or informed its readers, that there might be two sides to the controversies surrounding Fannie and Freddie. You only hear one side from the Post, except in an occasional letter to the editor. I wish there were something I or others could do to change this, but the Post has the final call, and it doesn’t appear to be willing to budge on its posture on the companies.

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      2. I went back and left the following in the WP comments for this story. Maybe some intern will read it and follow up with the PTB there.

        “To my knowledge, at least since the financial crisis in 2008, The Washington Post opinion section has refused to publish any letter or op-ed supporting the “other side” of the Fannie and Freddie story, the side that claims the shareholder-owned companies were unnecessarily nationalized and the investors’ money stolen by the government under the guise of “protecting taxpayers.”

        “I realize the editorial board is under no obligation to be fair or balanced in their writing. But for an organization that preaches “Democracy Dies in Darkness” to deliberately keep the public in the dark, for decades, about one entire side of this story is shameful.

        “Shame on you, Washington Post. You are not worthy of the public’s trust.”

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          1. Gary Hindes gets the credit not only for getting his letter published, but also given a prominent position in the Sunday Outlook section of the Post’s print version. I do know that Gary’s initial contact at the Post was at an even higher level than Fred Hiatt (whom I had contacted), and perhaps that helped.

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        1. Erin: I checked the comment log, and saw that on December 22 a post from you was submitted for approval asking the question, “Assuming a recap n release how do you see commons fairing out? all I see is dilution dilution dilution.”

          I’ve never quite understood why some posts get submitted for approval and others are simply posted. But as I’ve noted from time to time, I have guidelines for what types of posts I accept or allow to stay on the blog. If a post falls outside those guidelines I either don’t approve it (which is what happened in your case) or I delete it.

          I generally do not accept or approve comments that merely state a poster’s personal view, without adding any insight or information that I feel might be of use to other readers. (The majority of the posts I delete fall into this category.) I also apply this same “interest to a wider audience” standard when deciding whether to accept or answer questions from individuals seeking to inform themselves on a particular topic.

          Your question fell into a third category: topics I don’t address in the blog. One of those is the value of or outlook for Fannie or Freddie common and preferred stock. While the blog does provide information and analysis that might be helpful to readers in determining how to value the companies’ shares, I do not give investment advice myself, nor do I speculate on how various reform alternatives might affect the prices of Fannie or Freddie’s preferred or common stock.

          I know it may seem a little harsh (or judgmental) to have a comment not accepted or deleted, but posters should try not to take it personally. It is, I’ve found, the only way I can keep the content of the blog focused on the topics I believe are of the most interest to my readership, thus preserving the value of the site for them.

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          1. Tim

            I have followed and read your writings for so long and appreciate your knowledge and help, sorry if this question has been asked to you over and over, as I see it now FnF aren’t going anywhere now the rhetoric is what form they will be released, raise capital, how much capital etc. Assuming a recap n release how do you see commons fairing out? all I read is dilution dilution dilution.

            Thanks in advance, happy holidays

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    2. Calabria is a human rorschach test. he is against the NWS and, oh by the way, the GSE model to boot. I have no idea what he will do as FHFA director but the question you have to ask yourself is to what extent will he formulate rather than implement policy. I have read his writings, many quite polemical, and noted that he is a diehard Grateful Deadhead (as am I). I suspect that he will take direction but, given this administration, who knows when or if direction will. be given.

      rolg

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  34. Tim,

    Good morning. You are probably aware by now that Joseph Otting was named interim director of FHFA. With all of the choices available, it seems that the Otting appointment is signaling Mnuchin is in full control and plans to make an immediate administrative move. Why appoint someone like Otting as opposed to a more seasoned public servant to head FHFA temporarily unless you are about to have him maneuver as you see fit? The speculation is that this administration has had 2 full years to meet with everyone under the sun as it relates to GSE reform. Why wouldn’t they have a plan fully developed and ready to deploy by now?

    Bloomberg Quint had this to publish this morning: “Treasury’s Phillips has indicated in meetings with lobbyists, trade groups, academics and other administration officials that he would be amenable to parts of the Moelis plan, said the people who asked not to be named because his remarks weren’t public.”

    Thanks!

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    1. By statute, the president’s authority to appoint an acting director of FHFA after Mel Watt’s term expires next month is limited to either (a) one of Watt’s current deputies at FHFA or (b) an individual who has previously been confirmed by the Senate. As Comptroller of the Currency, Joseph Otting meets the second criterion, and this, together with the fact that he worked with Mnuchin at One West Bank and is familiar with the mortgage business (One West was the entity created by the FDIC when Indy Bank failed in 2008), made him the obvious choice to be FHFA’s acting director at FHFA. I wouldn’t read any policy implications into it.

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  35. Tim

    a curiosity.

    in FSOC’s 2018 annual report (just released), p.12, it states: “The Enterprises are now into their eleventh year of conservatorship. The Council reaffirms its view that housing finance reform is urgently needed to address the conservatorships, codify existing reforms, and implement a durable and vibrant housing finance system.”

    Click to access FSOC2018AnnualReport.pdf

    in FSOC’s 2017 annual report, it states: “Fannie Mae and Freddie Mac are now into their tenth year of conservatorship. The Council acknowledges that, under existing regulatory authorities, federal and state regulators are approaching the limits of their ability to enact regulatory reforms that foster a vibrant, resilient housing finance system. The Council therefore reaffirms its view that housing finance reform legislation is needed to create a more sustainable system.”

    Click to access FSOC_2017_Annual_Report.pdf

    2018 report leaves out the word “legislation” that was in 2017 report. could be an omission, could be an intention.

    rolg

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    1. Given all of the other subtle changes in tone from administration officials in their statements and writings on mortgage reform recently, the absence of the word “legislation” in the FSOC’s report this year is unlikely to have been inadvertent.

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      1. I also found the 2018 language, “codify existing reforms”, in the absence of the use of the word, legislation, to be interesting…perhaps administrative action that is intended to be comprehensive and requires no further legislation.

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        1. sorry, one more thought. look again at the 2017 language: “The Council acknowledges that, under existing regulatory authorities, federal and state regulators are approaching the limits of their ability to enact regulatory reforms that foster a vibrant, resilient housing finance system”. in other words, FHFA has done all it can and more is needed…through legislation. 2018 language doesn’t refer to need to go beyond existing regulatory authority, but rather simply “codify” existing reforms already achieved by regulatory authority. codify is a capacious term that certainly includes legislation, but by omitting the word legislation in this context, it would seem to indicate that codify includes fhfa rule making as well.

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          1. Thanks ROLG. I agree with you that was a strong argument. The difference here is the warrant actually says the words to purchase. They don’t own 79.9% currently. Also, until they exercise the warrant, there is nothing to challenge in court. I always thought Treasury May have realized this and the NWS was the only way for them to be compensated. Maybe some of the redacted docs in the Washington Federal case hint at this.

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  36. The treasury Secretary speaks (again): https://www.bloomberg.com/news/articles/2018-12-18/mnuchin-hints-at-fannie-freddie-changes-to-end-federal-control

    “Mnuchin didn’t specify on what Treasury might do unilaterally, though he indicated that securing Senate confirmation of a new Federal Housing Finance Agency director will be key to the administration’s efforts.”

    one might recall that Mr. Watt continually testified to congress that it was up to congress and not the fhfa director to reform GSEs.

    rolg

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    1. I saw that. First of all, Mnuchin’s comments make clear that he has no objection to Calabria as head of FHFA. Second, the careful phrasing of his statement, “My preference would be to do something that has bipartisan legislative support” indicates that he has shifted his efforts from a legislative solution to an administrative one, and referring to bipartisanship as his “preference” also suggests that he would be willing to take an administrative reform path that the Rs like but the Ds do not. The affordable housing advocates would be well advised to turn their Treasury lobbying efforts up a notch (or more).

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      1. He may not (legally). Whether he *can* or not is a question that pertains in part to repercussion, not legality. So far, our government has shown that without repercussion they can do many things that they may not do.

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        1. TY. In that case, stands to reason an acting FHFA Dir would suffice as well as a permanent one, assuming similarly empowered, that is.

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        1. The key word in that sentence from Mnuchin is legislative “support.” Legislative support is different from the legislative majority (a simple majority in the House, and a 60 percent majority in the Senate) required to get a bill passed in Congress. I interpret Mnuchin’s use of the word “support” as indicating that he would like Congress to approve what he does, but that he does not intend to wait for Congress to pass a bill before he develops and recommends an administrative approach that ends Fannie and Freddie’s conservatorships. If that interpretation is correct, the focus now would shift to looking for clues as to what this administrative approach might look like–and how Treasury is thinking about ending the net worth sweep and the associated lawsuits in a manner that will allow administrative reform (whatever its details) to proceed.

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          1. I think the recently passed sentencing bill is instructive in the sense that if anything gets passed during the next two years, it will have to be consistent generally with D policy goals; if this is correct, then it is hard to conceive of passage of a GSE bill that would get the necessary senate votes. hence the need for administrative action. and as Tim said, Mnuchin has just told us as much.

            while it is hard to say what that administrative path looks like now, it is clear that it will not include items needing congressional action (like an MBS govt guaranty which, at least according to the MBA, is important to the creation of additional competition int he GSE space).

            if administrative reform boils down to making permanent (whether by agreement or regulatory rule) the GSE reforms achieved to date during conservatorship (eg lower loan inventory) and doing a deal to raise more private capital, this is something an ex-Goldman Sachs mortgage banker feels competent to do, and moelis has provided the blueprint. it may also involve raising GSE fees, which the tbtf banks will likely appreciate.

            so it looks to me like dj Mnuchin is going to spin TINA and the warrants, and fhfa director watt did not want to dance to any particular tune, hence the need for a new fhfa director. and keep an eye out for the 5th circuit en banc in collins.

            rolg

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          2. To the “ending lawsuits” point, when does treasury start talking to plaintiffs to organize a settlement? After the new director is confirmed? What clues can we look for to see if settlement talks are happening?

            Might be a ROLG question.

            Cheers,
            Justin

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          3. @Justin

            if I were advising treasury, I would first point out that it faces a collective action problem. lots of different Ps who need not act collectively. one may wonder whether there are fewer litigation funders than Ps so before any talks begin in earnest, treasury would need to find out who are the real Ps having the financial interest supporting the litigation (it may already know). I would surmise that this would be relatively small group, but still subject to a collective action problem.

            I would also point out that if treasury has a definite view as to its objective re GSE reform then it should just proceed and let the litigation be a second order issue. if that objective entails eliminating the NWS and the senior preferred stock since it has been paid off in respect of the original terms of that stock, then this result solves almost all of the litigation…it provides the relief the Ps are asking for. I say almost because there is the amended Washington Federal complaint that seeks some $40B of damages suffered by Ps in 2008, and voiding the NWS does not provide that P the relief it is asking for.

            but generally, if treasury has a strong view as to what the administrative path should look like, then I would advise it just proceed full speed ahead. when you ask someone else what it wants, you may not be able to accomplish what you want.

            this process would avoid any leaks of negotiations simply because there would be no negotiations, and that would be another benefit of the strategy. assuming financial advisors would be retained in connection with any negotiations, and those retentions provide for success fees, one can expect one or more financial advisors to leak in the hopes of increasing the likelihood of settlement (leaks increase the stock price of the financial parties in interest among Ps, which increases the cost of not reaching settlement).

            rolg

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          4. The two critical components of an administrative reform proposal are settling the litigation and recapitalizing the companies. I see the nomination of Mark Calabria as head of FHFA as clearly facilitating the first (he does not believe that the net worth sweep–which the agency he has been nominated to head has been defending aggressively in numerous judicial venues–is legal), but complicating the second. Calabria has made no secret of his belief that Fannie and Freddie should have smaller roles in the residential mortgage financing process, and that depository institutions should have larger ones. The easiest and least controversial way he could accomplish this would be to have FHFA, as Fannie and Freddie’s regulator, require something close to “bank-like” levels of capital for the companies’ credit guaranty business, in spite of the fact that the normalized credit losses of this business are one-tenth those of commercial banks (with their very broad range of lending powers). But that will make the challenge of recapitalizing Fannie and Freddie all the more difficult.

            Saddling the companies with excessive capital requirements will have three important results: (a) it (obviously) will mean that Fannie and Freddie will need to raise a much larger dollar amount of new equity to meet their new capital requirements (at which point they will be able to reinstate dividends to their existing preferred and common shareholders); (b) the companies will have much less favorable prospects for doing business going forward, since they will be forced by their excessive capital requirements to price their credit guarantees far too high for the economic benefits those guarantees convey, and finally (c) the investors who will be asked to buy the new equity in these companies will know (or if they don’t know, will be constantly told by Mr. Calabria) that the companies they are being asked to invest in are decidedly NOT viewed favorably by the administration that is attempting to get them recapitalized.

            I can see how Secretary Mnuchin might deal with the first “critical component” of administrative reform; I am less clear as to how he will deal with the second.

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          5. Tim

            if with Calabria as new fhfa director the first step of the process is to cancel the NWS/senior pref stock, that goes a long way to settling litigation AND establishing a new pricing equilibrium for the common and junior preferred stock of the GSEs. my thought is that the market will be a very interested “third party” in the process going forward. the dynamic between being able to raise additional capital, and how much, and what level of “footprint” and capital the administration steers towards, will be a pull and tug reported upon daily by the market. one would think that trump/mnuchin might be mercenary enough to have the valuation of the warrants play an important role in their analysis.

            rolg

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          6. Tim,

            I believe Calabria is in an ideological dilemma. I don’t see how he can be true to himself if he continues to decry the NWS while seeking to saddle the GSEs with bank like capital strictures. To do the latter would be to act contrary to his laissez-faire ideology. He’d have to artificially manipulate things in order to let the free market have its way. Seems a bit hypocritical to me.

            So, how do you think he can alleviate this tension? Or maybe Mnuchin handles the percentages (2-5%?) and Calabria does the other?

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          7. An additional wild card in all this is the court cases. I’m thinking particularly about the en banc hearing in the Fifth Circuit on the Collins appeal, scheduled for the 23rd of January. According to the Fifth Circuit website, this court agrees to only one of every 100 requests to hear a case en banc. They took this one, and as I’ve noted in an earlier comment the plaintiffs did a masterful job of presenting their case in a way that will make it hard for a majority of the justices to rule against them. I can easily imagine one of the Justice Department lawyers saying to either Secretary Mnuchin or his deputy Craig Phillips, “You know, we could actually lose this.” To date Treasury has had a convenient reason to keep postponing action on Fannie and Freddie, since the net worth sweep payments have been flowing into Treasury’s coffers quarter after quarter. The now very real possibility that this stream of income might soon end likely is what’s behind the sudden flurry of interest by the government in administrative reform–as well as all of the articles from opponents of this reform (the latest being the piece in The Hill by DeMarco, Parrott, Stevens, Zandi, Holtz-Eakin and Ranieri) arguing against it.

            IF Treasury is now beginning to focus on the value of its warrants on Fannie and Freddie’s common stock as a substitute for the potential loss of its sweep income, this puts the conflict between Calabria’s apparent vision for the companies (smaller, less efficient and overcapitalized) and the goal of getting at least $100 billion in value from the warrants (by configuring Fannie and Freddie not to just limp along but to succeed by operating in a manner similar to how they did prior to the conservatorships) at center stage. It will be very interesting to watch how this conflict gets resolved.

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  38. Tim or ROLG,
    Tim, Thank you again for your insights. I read the Collins 5th Circuit en banc Brief. I am not a lawyer, but it seems well put together and mentioned several of three Justices’ cases in the brief: Thomas, Scalia (former Justice), and Kavanaugh. I suspect that this was either in preparation for appearing before the Supreme Court, or to come to a conclusion via the suggestion of a conclusion before going to the Supreme Court. What was your take on the Brief? Thank you again.
    FNMA Supporter1

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    1. I thought the brief was exceptionally well done: clear, persuasive, and most importantly in my mind, comprehensive. The brief properly begins with a discussion of whether the finding of the Fifth Circuit appellate court that FHFA is unconstitutionally structured requires it to then grant plaintiffs “backward-looking relief” by voiding the net worth sweep (which the appellate judges declined to do). I thought Cooper and Kirk did an admirable job of laying out the evolution of judicial thinking on this topic, citing recent decisions involving justices Scalia, Thomas and Kavanaugh, as well as judges on the Fifth Circuit itself, that all supported the view that the judges in the Fifth Circuit en banc MUST grant such relief. Cooper and Kirk went on to explain (prompted by a letter from the clerk of the court asking it to do so) that relief could be granted in a way that not only did not interfere with FHFA’s duties as conservator or regulator, but in fact freed FHFA to carry those duties out in the way HERA intended it to, by allowing the companies to return to a safe and sound condition through recapitalization. It was also important for C&K to explain that the net worth sweep could be unwound without it resulting in any dollar outlays by Treasury, and that granting plaintiffs relief in the net worth sweep case did not invalidate other prior actions of a FHFA director acting in violation of the Constitution’s separation of powers (which would need to be litigated separately).

      C&K then tied the constitutional and the APA violations together neatly and cleanly. In discussing the APA aspect, C&K zeroed in on the two glaring weaknesses of decisions of other courts that have upheld the sweep as consistent with HERA: these courts’ reading of the word “may” as being discretionary rather than permissive, and the fact the same courts, in grasping at the clause that said FHFA may “take any action…that [FHFA] determines is in the best interests of the [Companies] or the [FHFA]”, ignored the fact that the same sentence adds the qualifier, “as authorized by this section.” This section, of course, is called “Incidental Powers,” so it limits FHFA’s powers to act in its own interest, rather than (as other courts have wrongly said) expanding them to allow FHFA to do whatever it wishes in any aspect of its conservatorship or regulation of the companies (which would render the precise wording of the rest of HERA meaningless). Being able to quote the strong dissenting language of justice Willett–who is a Fifth Circuit justice and will be a member of the en banc panel–on both of these points added heft and credibility to plaintiffs arguments.

      The tying together comes from pointing out that even if one (wrongly) concludes that the prior courts got it right on the APA violation, the judges still have to deal with the constitutional issues raised earlier in the brief. The remedy for both the APA violation and the constitutional separation of powers issues is the same (unwinding the net worth sweep), but finding in favor of the APA violation would allow the Fifth Circuit judges en banc to (if they wish to) decide the case without having to get into the issue of severability and the more complex potential remedies associated with that.

      I will be very interested to learn how the judges react to plaintiffs arguments, and the defense’s counter arguments, at the en banc hearing on January 23. The quality and thoroughness of the C&K brief gives me reason for optimism.

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      1. Tim and f1

        that was an excellent summary, Tim!

        I would only emphasize that Cooper & Kirk pointed out that even if the circuit found a violation but was not inclined to grant vacateur relief for the separation of powers claim (and the brief provided many reasons and precedents why it should), nonetheless since this case arises in connection with agency action governed under the APA, the APA (section 706 as I recall) is an additional basis for granting relief for a “violation of a constitutional right”, so that a constitutional violation should give rise to relief under two theories, constitutional and statutory, belt and suspenders.

        another interesting point in the brief is n.5, which can be explained by this hypothetical: say on the 16 judge 5th circuit the judges split 8 in favor of the separation of powers claim (and would grant relief under this claim), and the other 8 in favor of the APA NWS exceeds conservatorship authority claim (and would grant relief under this claim); you would have all 16 judges voting to grant relief without a majority voting in favor of either claim. the footnote points out that relief must be granted if a majority of the circuit votes for it, even if for different claims. another two bites of the relief apple.

        the circuit has scheduled oral argument only two weeks after the fhfa brief submission deadline. it is eager to hear this case (as am I).

        rolg

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  39. Tim,
    I read your blog from the very first day. You deleted my comments many times. I don’t blame you because I was rude and unkind with the anti-GSE community. In fact you have been a gentleman not blocking me in advance before reading my comments.
    Today I made a commitment to not read or write anything else about GSEs. It has been extremely stressful over five years specially reading the malicious lies out there.
    In this last comment I want to expose my KISS ( keep it simple solution) idea. Many will laugh, maybe for someone will make sense:
    1) A fourth amendment suspending the NWS for ever.
    2) Extend the Treasury 200B backing commitment for 10 years in exchange for a fee.
    3) Exercise the warrants in exchange for the payment of the Senior Preferred.
    4) Retain profits for capitalization until the desired capital is accumulated.

    and that is it. Government may start selling the warrants as they see the market price is convenient. The 200B commitment never was needed and never will be, let alone with current FnF.

    Thank you for honesty and good bye.
    Jerry

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  40. Tim,

    Good morning. Paul Muolo with Inside Mortgage Finance published a short article today titled-

    Headed into Receivership: Fannie & Freddie? It goes on to say the following: “Federal Financial Analytics, a Washington-based consulting firm, in a new report said it believes the Trump administration will use its statutory authority to convert the conservatorships of Fannie & Freddie into receiverships. FFA calculates the trigger will be pulled by mid-2019. The firm, run by the consulting veterans Karen Petrou and Basil Petrou, predicts this could happen absent Congressional action or an all-hands crisis.”

    This seems to go against what we have heard from not only the Administration but from Calabria himself. Do you have thoughts or comments on this development?

    Thank you in advance.

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  41. Not if the OTCs are being manipulated by dealers to keep the price low for purposes of court cover on the low ball settlement offer from the gov’t.

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    1. I don’t know about DeMarco, but I know that at least three of the authors of this piece know what they’re saying about the causes of the housing and financial crises is not true. But they want bank-centric mortgage reform, and believe the best way to get it is to stick with a known false story that makes it seem justified. This has been going on for ten years.

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      1. Tim – why do you think these people keep lying and why do you think no one in the press does anything to counter their lies? It’s beyond pathetic at this point.

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      2. I thought you had commented on this before. Can Treasury sell warrants in a piecemeal approach? I believe not, as they own 79.9% of remaining at any point of time, so 100% of them must be utilized at once. Can you confirm?

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        1. Treasury must convert the warrants before they can sell the resulting shares, and it may convert them either in whole or in part. I believe that if Treasury ever does convert the warrants it will do them all at once (while reserving the right to sell the shares over time),.Unconverted warrants will be a strong disincentive for Fannie or Freddie to issue new equity, since any percentage of the warrants Treasury has not yet converted would give it the right to that same percentage of the new equity issue as well, which the companies will wish to avoid.

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          1. Tim,
            I believe the warrant was equal to 79.9% of all common shares previously issued pursuant to the warrant. So any additional common shares issued dilutes Treasury % also.

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          2. Eric: Rereading Treasury’s warrant fact sheet (which I hadn’t done in a while), you are correct. The number of shares to which Treasury is entitled by contract is defined by the “Fully Diluted” description as the amount of Fannie or Freddie’s common stock outstanding “immediately prior to the exercise of this Warrant (or a portion of this Warrant)”. That would mean that Treasury would have to exercise only some of the warrants before Fannie or Freddie could raise more common equity without giving Treasury the right to 79.9 percent of the number of new shares they just raised.

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  43. The Conservatorships of Fannie Mae and Freddie Mac: Actions Violate HERA and Established Insolvency Principles

    By Michael Krimminger and Mark A. Calabria
    February 9, 2015

     Demonstrate that the conservatorships of Fannie Mae and Freddie Mac ignore that precedent and resolution practice, and do not comply with HERA. Among the Treasury and FHFA departures from HERA and established precedents are the following:

    o continuing the conservatorships for more than 6 years without any effort to comply with HERA’s requirements to “preserve and conserve” the assets and property of the Companies and return them to a “sound and solvent” condition or place them into receiverships;

    o rejecting any attempt to rebuild the capital of Fannie Mae or Freddie Mac so that they can return to “sound and solvent” condition by meeting regulatory capital and other requirements, and thereby placing all risk of future losses on taxpayers;

    o stripping all net value from Fannie Mae and Freddie Mac long after Treasury has been repaid when HERA, and precedent, limit this recovery to the funding actually provided

    o ignoring HERA’s conservatorship requirements and transforming the purpose of the conservatorships from restoring or resolving the Companies into instruments of government housing policy and sources of revenue for Treasury;

    o repeatedly restructuring the terms of the initial assistance to further impair the financial interests of stakeholders contrary to HERA, fundamental principles of insolvency, and initial commitments by FHFA; and

    o disregarding HERA’s requirement to “maintain the corporation’s status as a private shareholder-owned company” and FHFA’s commitment to allow private investors to continue to benefit from the financial value of the company’s stock as determined by the market.

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    1. Hi Tim,
      With Mark Calabria being the top candidate for FHFA, would you care to share what your views on him are?
      -he is quoted jun 17th 2015 “To my GSE shareholder friends, it is possible for you to have been screwed over & for the basic GSE model to be bad public policy.”

      -also being quoted in 2017 saying that the Trump admin will get the GSEs out of Cship before the next admin takes over. but it will not be an easy task

      so with his Free Mkt small gov philosophy, yet also being a believer in the law: How do you think this pans out? more Model changes before being released? Do you believe he will try to shrink their foot print?

      Anyone else that knows Mark, or his views I encourage you also to enlighten us on this topic

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      1. Calabria was one of twenty individuals (including myself) or teams who submitted recommendations on housing reform to the Urban Institute’s “Housing Finance Reform Incubator” series in the spring of 2016. Based on the essay he submitted, if Calabria in fact is nominated to head the Federal Housing Finance Agency when Mel Watt’s term ends, and if confirmed, he would be yet another appointee of the Trump administration who does not support the mission of the agency he has been selected to lead (whether one thinks that is a good thing or not).

        In his Urban Institute essay Calabria was highly critical of the securitization model for housing finance, although oddly he made no distinction between private-label securitization, which failed disastrously, and securitization by Fannie and Freddie, which had far lower credit losses than loans from lenders (mainly banks) who followed the “originate and hold” model Calabria said he advocates. In spelling out his vision for reform in the Urban Institute article–which essentially is a return to the depository portfolio-centric system we had from the 1950s through the 1980s (and which ended with two systemic failures within a decade, the second in 1989)–Calabria said, “There may well be value in a smaller secondary market and in the current GSEs. To retain whatever value there is, the current GSE charters should be converted to national bank charters, and the GSEs reorganized as bank holding companies (BHCs).”

        That, of course, would take legislation, which is unlikely (particularly with the House soon to be in the hands of the Democrats). So the “smaller footprint” idea for Fannie and Freddie that often has been associated with Calabria’s name would appear to be a fairly good guess as to what his intent might be as head of FHFA. As always, though, it’s best to wait to see what he says himself.

        It’s also true that Calabria has been highly critical of the conservatorships, and the net worth sweep. But that issue is being driven by Treasury, and I believe Treasury will continue to call the shots on it after a new FHFA head is in place.

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        1. Tim, regarding the last paragraph of your response, if Mnuchin moves to Chief of Staff, then what? Obviously, who knows for sure? My unspoken questions have been, does Mnuchin share Trump’s vision on ending the conservatorship? Does Trump even have thoughts on the GSEs?

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          1. Treasury’s having the lead for the administration on issues related to Fannie and Freddie is institutional rather than personal. As everyone knows, Secretary Paulson didn’t bother to check with FHFA director Lockhart when he decided to force the companies into conservatorship (and then, after he learned that FHFA had just issued a letter deeming them to be adequately capitalized, had little difficulty getting the agency to do a quick 180 and support what he wanted). And even before that, prior Treasury secretaries during my tenure at Fannie did not take FHFA (or as it was then called, OFHEO) seriously as a financial regulator (one making little effort to hide his scorn for the agency and its leaders). Should Mnuchin leave, I think whoever succeeds him will assume responsibility for the issue of what comes next after the Fannie and Freddie conservatorships. I doubt Calabria (again, if nominated and confirmed) will challenge the new secretary, and have even greater doubts that if he does he will succeed.

            Of course, if there IS a new Treasury secretary we will need to wait to find out what ideas he or she has on mortgage reform, if indeed they have any at all. Which leads me to the president. I have yet to see any credible evidence that he has thought about the future of the residential secondary mortgage market for one moment, and I personally doubt that he has. Since just after the election Mnuchin has been the person who has talked about it being an administration priority to “get [Fannie and Freddie] out of the government…reasonably fast,” and the fact that for more than two years now nothing has happened suggests strongly that Mnuchin has not been able to get the president to engage on the topic, let alone make it a priority.

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          3. That issue currently is being litigated in Bhatti and other cases. Ed DeMarco was acting director of FHFA for four and a half years, which plaintiffs argue is far too long, and thus a violation of the Appointments clause of the Constitution.

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        3. Tim , good morning ,
          Can M Calabria start his office as an acting director immediately while he awaits confirmation? or have to be another person the acting director until he is confirmed?

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          1. I’m not sufficiently familiar with that aspect of the HERA statute to give you a confident answer. I believe the president has more flexibility to appoint an acting director after the term of the current director (Watt) expires in early January than he does today, but I don’t how much more flexibility.

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  45. Tim

    very informative as usual. thanks!

    what are your thoughts regarding an insurance company insurance model, per USMI (and requesting comments as to that)? isn’t the GSE guaranty essentially an insurance function? how would things change?

    rolg

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    1. While I don’t call it that, an “insurance model” is what I advocated in my comment to FHFA. I began it by saying that Fannie and Freddie aren’t banks—they’re single-product companies whose one risk, mortgage credit risk, has produced historical loss rates one-tenth those of commercial banks. (And I also suggested that FHFA get a copy of the letter from Paul Volcker to Fannie’s David Maxwell, in which Volcker discussed at some length why bank capital standards were not appropriate for and should not be applied to Fannie and Freddie.) I then went on to recommend that FHFA’s revised capital proposal have only three elements: (1) a straightforward (i.e., transparent, with no fudges) stress-based capital requirement, by risk category (although with far less granularity than FHFA has now—you don’t need that much); (2) a modest cushion to account for model error or the possibility that the next stress environment will be worse than the last one (although as I note in the current post, several commenters made the opposite point—that because of all the positive changes made since the crisis, having to protect against a repeat of the 2008 collapse is too extreme a standard), and (3) a going concern buffer (and here, too, some commenters argued that this isn’t needed: the combination of a minimum leverage ratio and FHFA’s prompt corrective action authority will serve the same purpose).

      An “insurance model” would have other features, but it’s basically what I just described. And calling it that should give it more credibility—there are real regulatory schemes for insurance-type entities, and they differ from the regulatory regimes for banks for a reason. Genworth had a very good quote on this that I didn’t have the space to use: “Basel applies to depository institutions that, among other things, are subject to a possible ‘run on the bank’ that would curtail new revenue. As a result, bank capital requirements focus on equity capital to meet prescribed ratios, while most insurance frameworks are primarily focused on ensuring liquid (available) assets are sufficient to pay claims under stress.”

      What caused the banks to need bailouts in 2008 were flights of short-term purchased funds (or so-called “hot money”) and withdrawals by depositors. The only way a bank can protect against this—given their funding mismatch and their leverage—is to have a mountain of capital big enough to convince mutual funds and depositors to keep their money there even during a crisis. It’s not really “loss-based” capital, it’s “confidence-based” capital. Insurance companies (and Fannie and Freddie) are different. Their losses, when they happen, happen slowly; they don’t have (much) short-term funding that can run away, and their revenues (guaranty fees) are linked to their long-term assets (life-of-loan credit guarantees). I’ve never understood how the notion of “bank-like capital” for Fannie and Freddie ever could have taken hold the way it did.

      So, yes, an insurance model would be the right one for FHFA to adopt.

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        1. This is a legal article (discussing the mechanics of a receivership), not a financial one (discussing its feasibility or practicality). As the authors note at the end, “As a general rule, FHFA must wind up an LLRE [limited-life regulatory entity, charged with liquidating Fannie and Freddie’s assets] no later than 2 years after it is established. However, FHFA may extend the life of an LLRE for up to 3 additional 1 year periods. Thus, an LLRE has a maximum life of 5 years.”

          So, query: If in receivership an LLRE is going to be running off, defeasing or unwinding all of Fannie and Freddie’s $5.0 trillion worth of credit guarantees over a maximum of 5 years, what entity or entities will step up to replace them? Oh, there isn’t anything? Well, maybe receivership isn’t such a good idea.

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      4. Tim

        thanks for thoughtful reply.

        you mention that FHFA has “prompt corrective action authority”. I think this bears emphasis. while it is always the objective to get a regulatory action right the first time, FHFA can always react and revise. So while I suppose nothing gets done until Watt’s replacement is in place early next year, it seems to me that FHFA has already revised much of the regulatory landscape for GSEs (eg positive changes re reduction in whole loan inventory, qualified mortgages etc), and this capital proposal actually is (or should be) less of a difficult job than FHFA seems to have set out for itself. Hopefully the comments it has received that you have summarized so well will help FHFA see that.

        as you say, lets get on with it knowing that this is a process that always can be revisited.

        rolg

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  46. Great info. From reading the comments on the FHFA website, I especially loved how all the anti GSE groups requested more time and info from the FHFA, and how they waited until the last day to comment.

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  48. Wow! This is deep – with lots of special interests. Thanks for following this so well and keeping us informed. It’s sickening, scary and frustrating to see what the government and courts have done to a basically good and needed system.

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