Assessing the FHFA Capital Rule

~ jtimothyhoward

A persistent theme of this blog has been the crucial role that a revised capital standard for Fannie and Freddie will play in determining how effectively and efficiently the companies will be able to carry out their traditional function of profitably providing large volumes of affordable mortgage financing to a wide range of borrower types in a post-conservatorship world.

Since the conservatorships, opponents and critics of the companies have insisted that any future version of them as shareholder-owned companies include the requirement that they hold “bank-like” amounts of capital. This demand has been couched in terms of safety and soundness (“more capital is better”), but in fact the goal of advocates of this approach is to burden Fannie and Freddie with capital requirements that are far out of proportion to the risks of the mortgages they finance, forcing them to raise their guaranty fees to levels that make their secondary market activities overpriced and less competitive, to the benefit of primary market lenders. As I’ve often noted, there is no economic or regulatory reason why Fannie and Freddie’s capital should be equal or anywhere close to that of commercial banks. Fannie and Freddie are not multi-product and multinational lenders; they are mono-line insurance companies, limited to a single asset type—residential mortgages—whose historical credit loss performance has been dramatically better than banks.

Last June, FHFA put a Proposed Rule for Enterprise Capital out for comment. I was among many who submitted one. While I didn’t say this in my comment letter, it was clear to me that in its specification of the risk-based standard mandated by the Housing and Economic Development Act (HERA), FHFA had used a combination of unrealistic structural elements and conservative assumptions to push Fannie and Freddie’s calculated capital requirement substantially higher, to 3.24 percent as of September 30, 2017. My comment addressed the elements and assumptions I thought were unjustified—including not counting guaranty fees as offsets to credit losses—and I suggested ways that FHFA could and should improve the quality and accuracy of its risk-based capital specification to align it much more closely with the risks of the mortgages the companies are guaranteeing and the way their business works. A number of other commenters made similar observations.

FHFA’s revised capital proposal is due to be released shortly, so it was with considerable concern that I read the recent spate of comments by the new FHFA Director, Mark Calabria, repeating the general (and insupportable) assertion that “Fannie and Freddie ought to operate under essentially the same capital rules as other large financial institutions.” These statements raised the possibility that he had chosen to side with the companies’ opponents on the capital issue, but I also thought he might not know the facts about the differences in risk between Fannie and Freddie’s business and that of commercial banks. So last week I wrote a two-page note for the Director and sent it to FHFA General Counsel Alfred Pollard, asking him to submit it both for the record and to Calabria. Here is what the note said:

“A recent interview with Fox Business News quoted you as saying, ‘I think our objective over time is that you have capital levels at Fannie and Freddie that are comparable to other large financial institutions,’ and that 4.5 percent capital was ‘kind of in the neighborhood of where we’re looking at.’

While I agree that Fannie and Freddie’s capital should be comparable to that of other large financial institutions, comparable is not the same as equal. Capital must be related to risk, and if FHFA engineers its risk-based capital standard for Fannie and Freddie’s credit guarantees to produce an average capital percentage equal or even close to banks’ Basel III risk-weighted capital percentage for residential mortgages of 4.5 percent, the companies’ capital standard would be far more stringent than banks’, because: (a) the delinquency and default rates of single-family mortgages owned or guaranteed by Fannie and Freddie have been less than one-third those of residential mortgages held by banks, and (b) bank capital also must cover the interest rate risk of funding mortgages in portfolio, whereas Fannie and Freddie’s capital standards treat credit and interest rate risks separately, and additively.

Historical data on single-family residential mortgage delinquencies and defaults for Fannie and Freddie versus commercial banks are readily available from the companies themselves and from the FDIC and Federal Reserve, and they tell a clear and consistent story.

During the time I was Fannie’s CFO from 1990 through 2004, the company’s rate of single-family serious delinquencies (90 days or more past due) averaged about 55 basis points, while over the same period the average serious delinquency rate for residential mortgages held on the balance sheets of commercial banks was 2.3 percent. Following the financial crisis both delinquency rates spiked, peaking in the first quarter of 2010—Fannie’s at 5.53 percent and banks’ at 11.54 percent. Both have since declined substantially, but banks’ 2.67 percent serious delinquency rate on residential mortgages in the first quarter of this year still was three and a half times Fannie’s 75 basis-point delinquency rate. In addition, Fannie now publishes its serious delinquency rate on the single-family loans it has guaranteed or purchased since the end of 2008, when it tightened its underwriting standards. These loans now make up 93 percent of Fannie’s total book, and their rate of serious delinquency in the first quarter of 2019 was only 33 basis points.

Post-crisis default rates tell a similar story. In the amicus curiae brief I submitted on July 6, 2015 for a court case involving Fannie and Freddie I noted, ‘Solid data now exist, and they show that, from 2008 through 2014, the average loss rate on residential mortgages owned or guaranteed by Fannie and Freddie was 0.45 percent per year. The loss rate for residential mortgages owned by commercial banks during this same period was 1.43 percent per year—more than three times as high.’

Most people are surprised to learn that single-family mortgage delinquency and default rates at commercial banks consistently exceed the comparable rates recorded at Fannie and Freddie, by a factor of three. I believe the primary reason is that banks finance a much greater percentage of home equity loans. But whatever the reason, banks’ much higher delinquency and default rates mean that Fannie and Freddie can provide an equal degree of protection against mortgage credit risk with one-third the capital that banks require.

A second critical consideration for determining what constitutes a level playing field on capital for banks and Fannie and Freddie is the fact that banks’ 4.5 percent Basel III capital requirement for single-family mortgages has to cover not just credit risk but also the risk of financing 30-year fixed-rate and capped adjustable-rate mortgages with consumer deposits and short-term purchased funds. Capital standards for Fannie and Freddie treat these risks separately; currently they have a 45-basis point minimum for guaranteed mortgages (now universally viewed as too little), and a 250-basis point minimum for mortgages financed in portfolio. The companies thus have to hold 205 basis points in interest rate risk-related capital for their on-balance sheet mortgages, even though they can and do match their durations with a combination of long-term debt and derivatives, and constantly ‘rebalance’ to keep those durations matched as interest rates change. Since banks have more interest rate risk in their mortgage portfolios than Fannie and Freddie, the capital required for the interest rate risk they bear should be higher as well.

A true level playing field on capital between banks’ on-balance sheet mortgage holdings and Fannie and Freddie’s single-family credit guaranty business, therefore, is nowhere near 4.5 percent. Banks’ 4.5 percent capital ratio properly applies to the companies’ portfolio holdings, making their credit risk capital no more than 2.5 percent (4.5 percent less at least 2.0 percent for interest rate risk), and the huge differential between banks’ and Fannie and Freddie’s historical credit performance should further reduce the companies’ required capital for their credit guaranty business—to a maximum of 1.5 percent, and arguably less.

For the above reasons, a very good case can be made for FHFA to set 1.5 percent as the minimum capital requirement for Fannie and Freddie’s credit guaranty business, and 3.5 percent as the minimum for their portfolio mortgages. More importantly, it would be a serious mistake for FHFA to employ layered conservative assumptions to push the capital percentage required by its risk-based capital stress test artificially high, in order to make it look more ‘bank-like.’ Doing so is unjustified, and would decouple the capital and pricing for the mortgages the companies guarantee from their true risks, making their services more expensive and less efficient for no good reason, to the disadvantage of the low- and moderate-income homebuyers Fannie and Freddie were chartered to serve.”

Once these facts about relative mortgage risks are known and acknowledged, it becomes obvious that it is incorrect to impose a bank-like capital standard on Fannie and Freddie. On top of that, as Fannie (and I) discovered more than thirty years ago, the correct way to specify a risk-based capital standard is nearly as obvious.

Prior to the early 1980s Fannie had done all of its business as portfolio purchases, funded with debt. Not long after I joined the company it began issuing mortgage-backed securities (MBS) using pools of newly-originated mortgages for which it bore the risk of loss, rather than having recourse to the originating lender. Fannie’s charter had been tailored for an entity that financed all of its mortgages on-balance sheet, so its new MBS, which for Fannie as well as Freddie were considered contingent liabilities and thus accounted for off-balance sheet, had no required regulatory capital. We had to determine how to capitalize, and then price, these credit guarantees ourselves.

The stress-test based approach we adopted was virtually identical to what FHFA should be doing to specify the risk-based capital requirement for Fannie and Freddie mandated by HERA. First, you use historical data to pick a defined degree of credit stress you want to be able to survive. (We initially picked a credit loss rate we deemed to have less than a one percent chance of occurring, later tightening that to a one-half of one percent chance; under HERA, FHFA gets to pick whatever loss scenario it wishes.) Next, you take your existing book of business with its fee rates, and break it into “buckets” of product types and risk combinations. Assuming no replacement business, you then simulate the performance of each of these buckets using different amounts of initial capital until you determine the exact amount of capital that, when combined with the guaranty fee income from the loans you project to remain outstanding during the stress period and allowing for projected administrative expenses, just allows that bucket of loans to survive the loss scenario you’ve chosen. Finally, you add a reasonable, clearly identified cushion of conservatism, and you have your required capital percentages. It’s that simple.

Unlike banks’ ratio-based standards, Fannie and Freddie’s stress-based capital calculations adjust automatically as the riskiness of their business changes, because they’re done at the risk and the product level. If FHFA wants to be even more conservative, it should pick a higher threshold of stress for the companies to meet (and defend that choice), rather than use unrealistic or unjustified elements to force the capital requirements higher. The latter break the link between capital and risk, and also affect Fannie and Freddie’s ability to attract a broad and profitable a range of business. FHFA’s decision in last year’s proposal not to count guaranty fee income in the stress test illustrates this problem. A properly designed risk-based standard permits the companies to trade off initial capital, guaranty fees and return targets to manage their mix of business, while remaining in capital compliance. For certain loan types it may make sense to charge a lower guaranty fee and compensate with higher initial capital (and thus accept a lower expected return); for other business a higher guaranty fee and lower initial capital may be the right choice. If guaranty fees are not counted in the stress test, however, this flexibility is lost. As a general rule, any significant distortions in the specification of the risk-based capital standard will constrain how the companies can do their business, sometimes in unpredictable ways.

There truly is a right and a wrong way to specify a risk-based capital standard, and the difference between the two is evident. When FHFA releases its revised capital proposal, therefore, there will be little doubt as to whether it has made a straightforward attempt to produce an accurate risk-based standard, engineered the exercise to produce a particular predetermined outcome, or tried to land somewhere in the middle.

Potential investors in a recapitalization of Fannie and Freddie should pay close attention to where FHFA comes out on this proposal, because it will be a window into the agency’s likely regulatory posture with respect to the companies post-conservatorship. At the one extreme, if FHFA makes only minor changes to its June 2018 capital proposal, this would strongly indicate that it intends to favor ideology and politics over economics in its future regulation, which should be a bright red light for any investor with a functioning memory. At the other extreme, a clean risk-based capital standard—which would result in the least amount of unnecessary capital, the lowest average guaranty fees, and the most flexibility to use cross-subsidization to broaden the companies’ product mix and support affordable housing—would be a green light for investment.

A middle-ground outcome on the capital standard, however, seems to be the most likely, and it will be the hardest for investors to evaluate. In this case, they will be well advised to closely examine the details of the proposed standard, assess the potential for any aspects of it to be used to their disadvantage, and insist that anything objectionable be remedied to their satisfaction before they agree to put new capital into the companies. Investors never will have as much influence in determining how the next version of Fannie and Freddie will operate and be regulated as they will prior to a first round of equity raising.

269 thoughts on “Assessing the FHFA Capital Rule”

  1. Tim

    a few next day thoughts on implications from the SBC hearing:

    1. we all knew congress would very likely not pass any GSE-related legislation. The big takeaway from the SBC hearing is that we now know that congress will not act to impede administrative reform. for those of us who remember corker’s jumpstart legislation, this is very important imo.

    2. mnuchin confirmed that he expects no SIFI designation provided GSEs raise the capital that fhfa decides is required. this indicates to me that he is thinking down the line to the capital raise, understanding that a capital raise would be a much heavier lift if the market anticipates SIFI designation. Mnuchin’s prediction re no SIFI can be respected since he leads FSOC. another indication that the SBC is off to the sidelines is that no senator confronted mnuchin on this prediction; the SBC held an entire hearing on GSEs and SIFI, so you would expect that no SIFI designation is not something SBC would expect/want.

    3. reading between the lines, mnuchin is driving the recap process, and he wants to maintain optionality (in the sense that Rubin preached at Goldman Sachs). so there will be a stopping of the dividend sweep in exchange for a commitment fee on the treasury line near term, likely by end of September. preserving optionality, no need to address the liquidation preference on the senior preferred now; that can wait for a global litigation settlement, which also will likely entail junior preferred offered an exchange into common program (with exit consents to force class conversion).

    4. logically the global settlement should come after fhfa promulgates its final capital rule. large junior preferred holders will want to know the capital rule before exchanging into common, and of course no capital raise can be done without the final capital rule. I expect Ds to petition scotus for cert in collins by 10/29/19, which is the date on which the mandate (ordering the district court to implement the invalidation of the NWS) will issue, which petition will stay the mandate. this will preserve for Ds a negotiating time period.

    5. as to the timeline and what needs to get accomplished before the 2020 election (from Ps and investors point of view), the global settlement/eliminating the senior preferred is the only necessary item; the capital raise doesn’t have to be done by then. I say this because even if a new potus is elected and seeks to nationalize GSEs (or something similar), investors’ claims with respect to any such action would be massive once the senior preferred is eliminated. the GSE recap train leaves the station once that settlement is done and inertia (bodies in motion staying in motion) will take over.

    rolg

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    1. I think this is an excellent analysis, and I agree with almost all of it. My only quibble would be on Treasury agreeing (with FHFA) to stop Fannie and Freddie’s sweep payments in exchange for their paying a commitment fee on the Treasury line. I think it’s more likely for Treasury to do a simple dollar-for-dollar addition to its liquidation preference instead. There is no reliable way for Treasury to price its line of credit without knowing the amount of capital that’s available to take the pre-catastrophic losses. This won’t be known until FHFA issues its final capital rule, and I doubt Treasury will want to price the commitment line twice (once for when the companies are in conservatorship, and again when they’re out).

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    2. Is there a legal reason why JPS has to be converted to common? Why can we not keep existing JPS the way they are like the commons and any future dividend can resume to JPS nd commons when companies start paying dividends?

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      1. @rb

        no legal reason. it is just that in most restructurings with a legacy capital structure, bankers like to “clean things up”. junior prefs carry high div rates that companies wont want to pay going forward for the privilege of paying the common a small div. selling common will be a whole lot easier (larger target investor pool) if common can get some div (after capital level reached).

        rolg

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    3. rolg & Tim

      Thanks for the summary. I actually find your 5th point (no pun intended) the most interesting and something I’ve tried to get my head around with respect to whether a RnR could persevere a new administration in 2020.

      I’m not sure if either of you had a chance to listen to the David Thompson webcast this morning, but if you did he described that a settlement may include that any overage (the post 10% moment, which he estimated at $25B now) would be in the form of a credit. It was my impression from previous discussions on this topic that this credit was framed as being in the form of a tax credit, but on today’s call Thompson described it in broader terms (or at least that was my impression) as a dollar for dollar credit that could be applied towards taxes or commitment fees.

      If you had an opportunity to listen to the call and care to comment I’d appreciate your thoughts.

      Thanks,
      Jack

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      1. @jb

        still a tax credit for the overage past 10% moment. the dollar for dollar reference was in answer to a request for injunction to bar treasury from more sweep dividends, and David said no need because if the sept sweep occurs and treasury increases preference then that just adds dollar for dollar the damages that would be sought by means of the tax credit.

        rolg

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        1. One clarification: David did not reference the “ten percent moment” at any point in the Investors Unite call. The “ten percent moment” is a concept popularized by Alex Pollock, in which he deems Treasury to be paid in full when the cumulative dividends from each company produce a ten percent internal rate of return on its draws taken from Treasury. David’s “dollar for dollar” approach references what the plaintiffs have asked for in the lawsuits: that each company’s sweep payments in excess of a given quarter’s calculated ten percent dividend payment be credited as paydowns of its outstanding senior preferred stock. Following this approach, both companies senior preferred would have been paid off completely last year, and today Treasury would owe each approximately $12.5 billion (a little more for Fannie, and a little less for Freddie). Using the “ten percent moment” formulation, Treasury today would owe the companies considerably less, if anything at all. (I’ve not attempted to replicate Pollock’s calculation.)

          David did say one thing that was new to be about the credits from Treasury on today’s call, which was that they could be used to pay a commitment fee on the Treasury line of credit, as well as be applied against Federal tax payments owed.

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  2. Hi Tim or ROLG,
    Is it okay for Mnuchin to be commenting that “we are planning to appeal”(on CNBC before the hearing), when in fact the Treasury did not lose in the en-banc decision. I thought there was supposed to be an “arms-length” provision between the FHFA and Treasury. So why is the MOOCH speaking for the FHFA re: pending legal issues. Thank you for any guidance on this point.

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  3. SBC hearing highlights: 1. Sen. Crapo urges the administration to act on administration reform as opposed to waiting on congressional action, and 2. the NWS will end very quickly, meaning that the September 2Q dividend likely wont be made (while the treasury line will remain in place in exchange for payment of commitment fee). doesn’t mention status of existing senior preferred. 3. per Mnuchin, no SIFI designation expected if the GSE capital rule amount is raised.

    rolg

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    1. Reading between the lines,Mnuchin seems to want congress to change the GSE charters. From what I hearing in the hearing, they want high capital requirements, broaden the players for the explicit government guarantee, reduce the GSE footprint, and make the capital requirements similar to banks. So, basically strip the GSE’s of their value. How do they expect to raise new capital like that? I am confused.

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    2. For ROLG: I heard something different on point 2. Mnuchin said that Treasury and FHFA were discussing how “taxpayers should be compensated” for giving up the net worth sweep, with the alternatives including an increased liquidation preference and a commitment fee for continuing the line of credit. That certainly sounded as if Mnuchin hasn’t yet conceded that the en banc Fifth Circuit ruling means the NWS is gone without any compensation for taxpayers. If the net worth sweep gets unwound through a paydown of the outstanding senior preferred (which is more likely than Treasury writing Fannie and Freddie checks of over $100 billion, and keeping the senior preferred stock agreement in place), Treasury’s liquidation preference goes away. And without the NWS, the discussion over a commitment fee for the line of credit from Treasury–in lieu of an explicit government guaranty–becomes one of economics rather than taxpayer compensation: given the capital requirement imposed on the companies, what is the fair economic value of the Treasury line? I don’t know how Treasury prices the line of credit without FHFA first specifying the capital requirement. So how do they end the sweep? My guess is that FHFA will allow Fannie and Freddie to not make their September sweep payments but increase Treasury’s liquidation preference by the amount of the foregone payments, while leaving the broader issue of a long-term resolution of the sweep to be determined after Treasury decides what to do about the Collins decision, and FHFA decides what to do about Fannie and Freddie’s capital.

      For Fabian C: To be fair, I think Mnuchin feels he has to support the administration’s position on legislative reform (which is the Crapo outline), and he’s comfortable doing so, knowing it’s not going anywhere. The question about how do you advocate much higher capital requirements for Fannie and Freddie (unrelated to the risks of their business), a reduced footprint for the companies and giving away their intellectual property or assets–as Treasury does in its administrative reform proposals–and still expect investors to put new money into the companies was Senator Brown’s point, and it’s a good one.

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      1. Tim

        from my POV I thought it was very helpful that Sen. Crapo exhorted mnuchin to proceed with administrative reform. my biggest fear re this SBC hearing was that he would try to convince mnuchin to hold off to give congress time. no jumpstart legislation as per corker this time! as well, I thought Mnuchin’s and calabria’s willingness to work with congress re a utility model, in reply to Sen Smith, was very interesting. a utility model, as opposed to multiple additional guarantors, has a glimmer of a chance for bi-partisan support imo, and it would certainly keep the SBC tied up in knots while administrative reform proceeds.

        rolg

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        1. I completely agree with you on the exhortation of Chairman Crapo to Secretary Mnuchin to proceed with administrative reform without waiting for Congress to act. But I had a different reaction to what Mnuchin and Calabria were saying about the utility model. I’ve often noted that the term “utility model” means different things to different people. Both Mnuchin and Calabria described it as meaning “regulated returns and pricing,” which it does, so it’s not surprising that they would be in favor of that. But a true utility model includes benefits as well as restrictions. My version of the utility model for Fannie and Freddie would allow FHFA to regulate their returns (and thus pricing) in exchange for FHFA’s agreeing not to advocate for the chartering of competitors, and for Treasury agreeing to price the PSPA commitment on an actuarily fair basis, instead of asking for an explicit government guaranty on the companies’ securities. I wonder if THAT would be acceptable to Calabria and Mnuchin. If so, there might be a basis for a sensible legislative compromise.

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          1. Tim

            as to the utility model and additional guarantors, it is clear to me from Sen. Brown’s comments in prior hearings that he views the utility model as an alternative to chartering additional guarantors (and I think sen. smith was picking up on that, though she didn’t say that explicitly), not something that could be layered onto additional guarantors. so perhaps mnuchin and Cambria were talking past sens brown and smith in thinking that additional guarantors could be a part of a utility regime…which might explain their willingness to discuss with congress in future. though one would really have to be insane to start up a new guarantor to compete against two Goliaths AND have regulated returns.

            rolg

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          2. You put your finger on the issue that, for me anyway, the Senate Banking Committee hearings highlighted. Discussions about the nature of the problem (yes, Senator Kennedy, I’m talking about you) and some of the solutions proposed for it were completely uninformed by readily available facts and practical reality. That’s not going to cut in an administrative reform, where the “fix” will actually have to work in the real world. Director Calabria’s performance today–including his enthusiastic “Yes, I agree’s” to all of Senator Kennedy’s erroneous, “hair-on-fire” claims about imminent disaster–suggest that he is not going to be the one to lead us to a sensible outcome here. Senator Brown made the obvious point about the conflict between imposing unnecessarily high capital requirements on the companies, reducing their “footprints,” and giving away their assets and intellectual property to competitors and ending up with entities that investors will be willing to put new money into. It apparently will fall to Secretary Mnuchin–assisted mightily, one hopes, by the investment bankers Treasury retains–to inject a sense of realism into this exercise before too much more time has passed.

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          3. Tim

            the market always ends up having its way. I just hope both fhfa and treasury hire financial advisors sooner rather than later so that some financial reality creeps into the mise en scene.

            rolg

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      2. Tim

        as to your point re NWS, my takeaway was that mnuchin and calabria are negotiating the end of the NWS (meaning sweep of dividends) currently and expect that it will stop very soon. what was not addressed is the capital structure represented by the outstanding senior preferred, which precludes any capital raise. as a quid pro quo for stopping the sweep, mnuchin insists on a commitment fee for the outstanding line. I dont think we disagree.

        rolg

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        1. 1. I can wrap my mind around the fear of “imminent disaster” (appreciating that some truly might not see that the failed business model narrative was a false narrative). It’s at least feasible. It’s not a logical contradiction for one to be misinformed. (Not that I think Calabria is misinformed!)

          2. What I find harder to grasp is how Calabria really thinks that competition would drive price down in the GSE world. (Someone asked for analytical data on that claim.)

          3. What I find impossible to reconcile is a attracting new investors to companies that Calabria threatens with a reduced footprint. If we assume he sees the irreconcilable dilemma of his own making, then we can begin to answer, why is he doing it?

          Care to speculate, Tim? I hope it’s a reasonable question for your blog given that he’s not stupid.

          I think 3 has to be some sort of political bargaining chip. It makes no sense to me otherwise. Whereas 1 and 2 could be just a means to create fear so that the competition prong of 3 can be justified. And with a smaller footprint due to competition, the other prong of 3 (not as many investors) isn’t as essential.

          In a word, rather than saying these guys are clueless, can you offer an opinion as to what’s behind the staged lunacy?

          Thx

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          1. I’ve never said (and don’t think) that Calabria is stupid. He is, however, ideological (with my preferred definition of an ideologue being a person who knows the answer to your question before you’ve asked it), and he has limited practical knowledge and no working experience of the mechanics of Fannie and Freddie’s business. For him to equate an increase in Fannie and Freddie’s average LTVs (offset by much better credit scores) with the excesses of the mid-2000s is preposterous. Then, the market was awash with no-doc lending, interest-only adjustable rate loans, risk layering, and widespread lender fraud (either ignoring or lying about the risk features of the loans that were being delivered to third-party guarantors)–none of which is going on now. Fannie and Freddie’s current delinquency statistics reflect the reality: loans originated since 2008, which make up 93 percent of Fannie’s book, have a serious delinquency rate of only 32 basis points, less than half the delinquency rate of the companies’ “golden origination years” of the early 2000s. Imminent disasters don’t arise out of nothing. Calabria, though, doesn’t seem to follow the data.

            As to “why he’s doing it,” I answered that with my definition of an ideologue: I think he truly believes that if you follow theoretical free-market principles it will lead to the best possible outcome. That’s also what Alan Greenspan thought, when he declined to regulate either subprime lending practices or the “everybody-except-the-gullible-investor-can-profit-from-the” private label securities market. That didn’t turn out too well.

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  4. Interesting interview with Mnuchin this morning. Seemed to say all the things we would want from him. Wants legislative action, in particular for explicit guarantee (though not required it is something they would ‘like’), 3-6 months allowed for legislative action or they will do reform administratively, retain earnings hopefully before Sept. sweep date, no mention of adding competitors (that was Kudlow in the plan then), smiled when staring ‘no comment’ regarding investors or court cases. Mnuchin is planning Moelis. Anything else is Calabria and/or Kudlow.

    https://video.foxbusiness.com/v/6084640350001/#sp=show-clips

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    1. I thought the interview was positive as well. The one negative to me was the 3- to 6-month waiting period for legislation, but we may get an idea of whether that will be real or not after tomorrow’s Senate Banking Committee hearing. If it becomes apparent that there is no appetite pre-election for taking on the sorts of sweeping changes to the secondary market Treasury proposed as the legislative component of its reform plan (which basically is the Crapo bill), then perhaps we can move straight to the administrative reform piece. And I may have been hearing what I wanted to hear, but I got the sense that Mnuchin was resigned to losing the net worth sweep.

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        1. Calabria has been “pushing for higher reserves,” i.e., more capital, since he became director of FHFA. What he hasn’t done is worked with Treasury to cancel the net worth sweep, or even allow the companies to defer their June sweep payment to build capital while still owing the money to Treasury (by adding the deferred payments to Treasury’s liquidation preference). He may have his reasons for that, but it’s been his show since April. Now that we have the Treasury reform plan and the Fifth Circuit en banc ruling, maybe we’ll see some concrete steps taken soon–although Calabria gives no hint of that in his prepared remarks to the Senate Banking Committee.

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          1. His comment mentions that the Dodd Frank stress test results show a decline in home prices of 25% (which is consistent with the decline in prices of 27% during the last downturn) would result in combined losses of $43.3B. On page two he says that he will act to build capital consistent with their risk profiles. Wouldn’t it make sense that he base his proposed capital rule on the figure he references of $43.3B since it’s based on their current risk profile? Maybe a multiple of it and not bank-like capital? I know you have mentioned that the validity of the test might not be the best, but it looks like Calabria puts some value in it.

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          2. I did note the mention of the stress test results, and wondered if Calabria knew how favorable they really were. And the $43.5 billion is overstated, because it includes the assumption that a $25.3 billion reserve is set up for the companies’ deferred tax assets, which (a) none of the Dodd-Frank stress tests for banks do, and (b) isn’t appropriate because with only $12.8 billion in projected stress credit losses, each company would be viable as a going concern, and GAAP would neither require nor permit a deferred tax asset (DTA) reserve to be set up under those circumstances. Take the DTA reserve away and Fannie and Freddie’s combined stress losses are only $18.0 billion, or about 35 basis points of their total assets. I do hope, though, that the FHFA staff instructs Calabria both on the workings of the Dodd-Frank test and the stress test mandated by the Housing and Economic Recovery Act. That might help get him to move away from his insistence that the companies hold “bank-like” capital; they don’t have anything close to “bank-like” losses.

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          3. Tim, in the past you have said that you want FnF’s capital requirements to be countercyclical, so that they are not forced to build lots of capital in an environment where doing that is difficult or impossible.

            In that case, shouldn’t they try to build as much capital as possible right now since conditions are good? Good in that the present book of business is pristine in regards to risk. Logically, that would lead me to believe that a good risk-based capital standard would be based on the worst stress test result over a preceding period (10-20 years?) rather than just the previous year’s. 35 basis points of risk is likely the best-case scenario, when capital standards are designed for the worst-case.

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          4. A couple of quick points on this comment. First, the 35 basis point loss figure comes from the Dodd-Frank stress test, which is stylized (it uses an instantaneous 25 percent drop in home prices) and simplified. The stress test specified in HERA, which is what FHFA is using for developing Fannie and Freddie’s required capital, is much more realistic, and really IS a worst case. Second, I believe that Fannie and Freddie’s capital requirements should be the same throughout the credit cycle–as opposed to the pro-cyclical design of the June 2018 FHFA proposal, which has them low during good times and rising dramatically during bad times–but that their EXCESS capital should be pro-cyclical. That is, they should be building a cushion of excess capital(over their statutory requirement) during good times, to give them a buffer to absorb unexpectedly high credit losses that may occur during bad times, while still meeting their overall requirement for capital.

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    1. I’ve now finished reading all seven of the opinions (consenting and dissenting on three separate issues) in this 123-page filing. My “summary judgments” on them are:

      (a) Very strong opinion by Judge Willett on the net worth sweep being a violation of the APA. Coupled with the weak dissent written by Judge Haynes (that still leans heavily on improperly applying the authority granted to FHFA in the “incidental powers” section of HERA to take actions “in the interests of the agency” to the statute as a whole), it now seems very likely that plaintiffs will get the NWS reversed by the Supreme Court, if indeed it even comes to that–the government may take this ruling as the impetus they needed to settle the suits with shareholders and move forward with a recapitalization quickly. To me this en banc decision explains the main anomaly of the administration’s reform report released on Thursday: the fact that it was silent on both the lawsuits and any details on the approach or timing of the path out of conservatorship for Fannie and Freddie. I believe it’s a virtual certainty that the administration knew this ruling was coming, and was waiting for its political cover to say or do anything more on this front. We may learn more about this at the Senate Banking Committee hearing on Tuesday.

      (b) The losses on Count II (Treasury exceeded its securities purchase authority) and Count III (Treasury and FHFA’s adoption of the net worth sweep was arbitrary and capricious) were on technical grounds–the shareholders bringing these claims were not within the “zone of interest” that legally allowed them to do so–and are of no consequence, since plaintiffs prevailed on Count I (the APA violation).

      (c) The important aspect of the ruling on Count IV, having to do with the constitutionality of the FHFA director, was that the majority agreed that the director as currently structured is unconstitutional. If upheld by the Supreme Court–as I suspect it will be–that should act as an important check on the director’s independence to implement policies that affect Fannie and Freddie that are approved neither by Congress nor the President. My other big objection to the reform report was the seeming intent to impose burdensome capital requirements and regulations on Fannie and Freddie; having presidential oversight will be a safety valve against this (particularly should a new president be elected in 2020).

      (d) I thought all of the opinions on the remedy for the unconstitutionality of the FHFA director were well done and quite interesting. To me, there are strong arguments on both sides (it’s a complex issue, with few direct legal precedents and multiple important considerations). The fact that the majority ruled in favor of a prospective remedy (changing the provision of the statute that has the director removable by the president only for cause) is a loss for plaintiffs on paper, but it shouldn’t matter given that they won on the APA claim, which as I mentioned is likely to be upheld at the Supreme Court, should it get there.

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      1. If you had your way, what questions would you have the Senate Banking Committee ask of the Treasury Secretary, Steven Mnuchin and the FHFA director, Dr Mark Calabria, with regards to the Fifth Circuit ruling? ROLG, same question.

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          1. That’s perfectly fine. I wouldn’t have it any other way. Thanks for all you do to intelligently inform us about the GSEs and promote a stable housing market, Tim. And if I may, I just wanted to say hooray! Judge Willett and the fifth circuit for giving a just verdict.

            Liked by 2 people

      2. Sir, Any thoughts on how this might affect the taking claims. Might this ruling speed Judge Sweeney to make a decision on dismissal. Seems now plaintiffs of other cases will want to leverage this ruling to benefit their cases.

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        1. Sweeney isn’t ruling on a motion to dismiss; she’ll be ruling on whether her court has jurisdiction over the takings case brought to it by the plaintiffs. I don’t believe the decision by the en banc Fifth Circuit will affect the timing (or the outcome) of that ruling.

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          2. My understanding is that this is an oral argument originally scheduled for late last month, and now “confirmed” for mid-November (I put confirmed in quotes because Judge Sweeney’s deadlines have a tendency to slip). It is for Sweeney to decide whether plaintiffs’ suit should be dismissed on the grounds that Sweeney’s Court of Federal Claims does not have jurisdiction to hear it. I expect Sweeney to rule for the plaintiffs in this matter (i.e., to say her court DOES have jurisdiction over the regulatory takings alleged in the suit). If she does the case then would proceed to discovery and hearings on a motion for summary judgment by the plaintiffs, in which they ask to be granted the relief they seek without trial.

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    2. Notwithstanding the APA decision. Doesn’t the invalidation of the for-cause provision actually make it problematic for the administrative plan?

      If the for-cause provision stood, Calabria would have stayed on for full 5 years and seen the recap plan through. Even if Trump got voted off in 2020. With it invalidated, the next administration (possibly Biden with the likes of Parrot and Sperling in tow) could have fired Calabria and bring the administrative plan to a halt.

      I thought this was why the current administration flipped on the provision several months back. No?

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      1. I don’t know that a Democratic president and his or her Treasury Secretary would be opposed to a recap of Fannie and Freddie, but if the current administration is truly concerned about that it would be well advised to get its recapitalization initiative under way quickly.

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        1. One would think so (that a Democrat would let the GSEs recapitalize). But it was under Obama that the 3rd amendment came to pass after all. Perhaps he was too green and let his purported “experts” advisors run amok. And yet still, the rumors of Parrot and Sperling advising Biden’s campaign give me pause.

          Anyway, the APA reversal is what really matters.

          Thank you so much, Tim!

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          1. I try to keep partisan political comments out of this blog (lots of heat, relatively little light) but I’ll comment here that adversarial treatment of Fannie and Freddie has been spread fairly evenly between the two parties over the past couple of decades. The first overt attack on the companies (testimony by an undersecretary of the Treasury in favor of the repeal of a key element of their charters—Treasury’s $2.25 billion “backstop” facility) came during the Clinton administration; their takeover masquerading as a rescue came in 2008 during the Bush administration, while the net worth sweep took place under Obama. The common denominator in all of these actions is that what I call the Financial Establishment was in favor of them. It still does favor hobbling the companies, to the benefit of the banks.

            What I hope is changing is that policymakers are becoming more influenced by facts about Fannie and Freddie and less by the myths created about them by their adversaries (many of which were on display in the just-released Housing Reform Plan from Treasury). But we’re about to have a test of that, as Treasury and FHFA embark upon their long-awaited program of recapitalizing the companies and releasing them from conservatorship.

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          2. Imo, aside from delayed RnR, you’ll be deleting many more partisan posts were the warrants to stand. After en banc, also imo, not a court in the land allows their exercise. Virtual impossibility. I bet lawyers jumping at chance to argue that. Way past usurious. Attorneys never addressed them because prior to win they were moot. Now, hardly so, in fact one might say as easily quantifiable as they are unjustifiable. Good luck with those. Either it all stands or it’s all fruit from tainted tree. Gl,

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          3. I don’t view the warrants as a partisan issue. What to do with or about them will fall to Treasury and its investment advisors to determine and decide. It’s one of a number of complex issues they will have to address on the path to a recapitalization of the companies.

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          4. as to warrants, they are solid from a legal perspective (though Washington Federal may get a little settlement gelt). but I know how investment bankers think, and I am sure they will go to treasury and say, give me a little help here, cant we figure out a way to make this capital raise just a little easier? bankers are highly paid professionals, but they are always looking for an edge or some easier path (bless their hearts)

            rolg

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    1. I’m still reading Collins, some 120 pages, but by i) 9-7 majority, 5thC en banc reversed the dismissal of the APA claim and remanded to DCt (meaning the Ps can go to trial to prove that the conservator did not have authority to adopt NWS), and ii) by a separate 9-7 majority, ruled that the single fhfa director removable for cause only provision was unconstitutional but that Ps are entitled only to prospective relief (so NWS not invalid as a matter of constitutional law).

      both parties will likely appeal.

      needless to say, this is a big win for Ps and I nominate Judge Willett for Great American of the Year!

      rolg

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        1. @bird

          first, this decision is an order that merely vacates a the district court’s dismissal of the complaint. so P’s ultra vires claim is simply back alive. but if I am wrong that it doesn’t curtail the conservator’s power for purposes of the SPSA, then second, this SPSA provision provides treasury a right to rescind agreement, which Treasury wont exercise.

          rolg

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          1. Hi ROLG,
            Thank you for spending your time and offering your analysis to us laymen. So, is this basically just another huge disappointment for those of us who are invested in the GSE’s, much like many are considering the release of “the plan” last evening. The timing of these events is very coincidental, and seems very fishy. And fishy doesn’t usually smell too good. The judicial branch seems quite connected to the executive tree.
            Thank you again for your time and insight.
            And I would be remiss to not thank Tim H. for his time, knowledge, insight, and the wonderful blog he has created for us.
            Paul

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          2. @pj4

            this is a huge win for GSE shareholders. Justice Willett has written a bravura opinion regarding the fhfa conservatorship powers that will play well at SCOTUS if it ever gets to that.

            how this affects the dynamic between fhfa and treasury in connection ion with the recap plan is something that I am contemplating but haven’t reached any firm suppositions about.

            rolg

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          3. Thank you. It looked to me like going back to the original court and just getting another kick at the can, only to have the judge kick sand in your face again. I like your reading of it much better.

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          4. @pj4

            put another way, the DCt said with respect to the APA claim that taking the Ps factual allegations as true, Ps lose. en banc majority essentially says taking Ps factually allegations as true Ps win.

            now are Ps factually allegations true? that is for the DCt to decide on remand.

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          5. It would be interesting to see how the en banc ruling will affect the SBC hearing next Tuesday, mainly the questions and responses (or avoidance)?

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          6. I’m just seeing this news now. It’s very welcome, and the timing of the ruling and the release of the administration’s reform plan cannot be coincidental. I’ll need to read the ruling first, then I’ll think about how the interaction of these two developments may affect the near-term course of the reform effort.

            By the way, this is how Washington works. Little happens in July and nothing happens in August, then everything starts happening at once right after Labor Day.

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          7. @jerry

            “…I would have thought that the opinion that FHFA exceeded it’s authority would have been the decision and Judge Atlas grants relief based on the opinion…”

            this is absolutely true. the DCt must apply the law set forth in the en banc decision, but it first needs to find that the allegations in Ps complaint are true before it applies that law. but I expect SCOTUS to take this case on cert.

            rolg

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          8. @mann

            yes thanks for that. recall language in majority opinion that the holding that NWS (assuming the facts in P’s complaint are true) is invalid is based upon “statutory interpretation, not business judgment”. there is not much that fhfa can do to avoid summary judgment at the DCt. recall the emails from Parrott that Judge Willett relied upon prominently? what is fhfa going to do, argue at DCt that Parrott didn’t send those emails? that his account was hacked?

            also remember that even if en banc granted summary judgment on APA claim, this holding would have been stayed pending SCOTUS consideration of cert petitions which will be forthcoming (and parties have 90 days to file petitions). so in the short term, there is no real difference between this reversal and remand, and summary judgment. the big deal is that this was a bravura opinion by Judge Willett that gave Ps an APA victory finally!

            rolg

            Liked by 2 people

        2. ROLG,
          So what you are saying is, the case just continues on as it would have before the dismissal? How does the written opinion that FHFA exceeded its authority play into this? I would have thought that the opinion that FHFA exceeded it’s authority would have been the decision and Judge Atlas grants relief based on the opinion, not the beginning of a trial. When might a trial start and are we looking at 1-2 years for a decision?

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          1. Judge Atlas can go for trial or summery judgement based on following quote from En Banc:

            “When we reverse the grant of a motion to dismiss, the district court may decide if fact issues require trial or if summary judgment should be granted.”2

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      2. Kudos to Tim for calling remand back in Jan and to Rolg for how they’d do it via piggybacking Willett’s dissent. Don’t stop now, Gents! Clarity and parity for the people! Gl,

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  7. Tim

    I agree that this treasury plan is the work product of a committee and not just a single person (Phillips). but I do not share your negative reaction to the plan. there are two themes to this plan: i) recommendations to congress, and ii) the administrative reform process. I choose to consider them separately.

    going forward, if you separate the treasury plan into these two segment themes, these two themes will progress on two very different timeframes and pursuant to two very different processes.

    the congress recommendation segment will in effect be delivered to congress (SBC) next Tuesday and dropped there (I have seen no mention yet that the HFSC has scheduled a meeting to review the plan recommendations, and I find this to be diagnostic). I suspect treasury will leave it up to congress to take up or not. I wouldn’t think treasury will spend a lot of time trying to help congress work through these recommendations inasmuch as congress has raised most of them as trial balloons at the SBC in the past and they have gone nowhere (and are even more likely to go nowhere now). So if I am right, this whole congress recommendation segment will soon be inconsequential.

    then there is the treasury/fhfa recap segment, which is the most encouraging part of the plan, and which will go into action mode now (assuming as I do that POTUS gives it the go), though likely much more slowly than we would like. since treasury doesn’t control fhfa and will soon enter into negotiations with fhfa that they will want to appear to have been arms-length, it is understandable that treasury didn’t want to presage in detail how it thought the recap would be conducted…though there is enough meat on the bone there to see that this process, as it said already under way, is being seriously pursued.

    as for tone, I ignored it, though I understand your objection to it.

    so net net, I am encouraged.

    rolg

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    1. Tim

      just to follow up on the HFSC, Chairwoman Waters has released a statement, and while alluding to a future hearing on the “Trump Plan”, it is clear that she is antagonistic, especially to the removal of the low income duty to serve requirement in favor of an access fund. https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=404261

      one more point. there is more than a whiff of a lawyer’s editing of this plan. there will be antagonists to the recap plan, and perhaps even litigation brought to stall or stop it. the negotiation between treasury and fhfa must be arms’-length and independent. if treasury went into precise detail regarding the recap I can imagine a lawyer might take exception. this plan appears to have a lawyer’ belt and suspenders treatment.

      rolg

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    2. ROLG: I appreciate your perspective. But I do think it’s a mistake to ignore the tone of the report. The more I review it the more I become persuaded that it was written by someone at the NEC (why else would a report allegedly done by Treasury make repeated recommendations as to what “Treasury and FHFA” should do?) And if that’s the case, it at least raises the possibility that Treasury lost an internal battle with the NEC over who should be leading the process for determining what should be done with Fannie and Freddie–or that Mnuchin concluded there was no upside for him or Treasury in fighting with Kudlow over this issue, perhaps because he knew he didn’t have the support of the president on it. Craig Phillips leaving Treasury when he did would be consistent with this interpretation.

      I’m not sure what’s going on here, though, and hopefully I’ll learn more from what the various participants in the reform process say and do about it in the coming days and weeks. But looking just at what’s in front of me, I view the reform plan as a step backwards on what at the end of 2016 appeared to be a clear path towards releasing Fannie and Freddie from conservatorship on terms that made economic sense for homebuyers and stakeholders, including Treasury as holder of warrants for the companies’ common stock.

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      1. Fwiw, which ain’t much unless forward movement but FHFA promoting Stacey Nahrwold to Dep Counsel last month could be timely given her 15yrs at SEC with an impressive resume primed for taking twins off otc exile. Ball is squarely in FHFA court and everyone knows it, which imo, is consistent and likely relevant. We’ll see. Gl,

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    3. @JoshRosner
      A proper reading of the @stevenmnuchin1 @USTreasury #GSE Reform plan: “We recognize #HERA directs @FHFA to recapitalize @FannieMae & @FreddieMac & reduce the risks to the public. @FHFA should do so. We recommend legislative actions but in the meantime must follow the law”. #FACT

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    1. Tim

      my take of the treasury plan is that there is a lot of treasury telling congress what it should do, that congress certainly can’t and wont do, in the next 18 months.

      there is very little detail of what treasury will do in negotiating the administrative recap plan with fhfa, which they will do in the next 18 months.

      so the stage moves to the SBC hearing next Tuesday, at which I expect some senator to say i) that the plan provides congress a lot of food for thought, and would the administration consider halting its administrative reform process while congress works though these recommendations, and also ask ii) what will the terms be of the administrative recap that is referenced very generically in the plan.

      I imagine that there is a fair amount of understanding between fhfa and treasury that has already been reached as to the parameters of that negotiation, and that none of this will surface at that SBC hearing…assuming that the senators even stiffen their backbones enough to ask

      rolg

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        1. @bird

          when negotiating a deal with another party that is subject to a litigation claim, especially in a case like here where fhfha will be seeking benefits that are also sought by the Ps, it is best to address the litigation at the last moment. treasury preserves its leverage. as well, inasmuch as I believe treasury and fhfa have a good idea what the large shareholders are seeking by way of an acceptable deal, by deferring the addressing of the litigation, I infer that fhfa and treasury believe that settling the litigation will be a to do item that will fall in line…as calabria once mentioned to a journalist.

          rolg

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        2. I’ve read this report carefully, and I’m searching to find anything positive to say about it. I’ve read hundreds of reports on and analyses of Fannie and Freddie, and this one is about as negative as any I can recall. Whoever wrote it REALLY does not like the companies (going so far as to say “there is some question as to whether the benefits of any subsidy conferred on the GSEs accrue to their shareholders instead of borrowers,” while quoting a discredited CBO report from 1996 that called them a “spongy conduit–soaking up nearly $1 for every $2 delivered.”) I was tempted to say that it reads as if it was outsourced to the Mortgage Bankers Association, but it actually is worse than that. I was very surprised.

          And I wondered how much Treasury had to do with the final product. There is a curious disconnect between the discussion in the summary about explicit guarantees and the way they are treated in the body of the report. The summary says, “Although Treasury does not believe a government guarantee is required, Treasury would support legislation that authorizes an explicit, paid-for guarantee backed by the full faith and credit of the Federal Government…” Yet repeatedly in the body of the study you read that Treasury “recommends” legislation to create an explicit guarantee for the securities of both existing and new credit guarantors. Supporting and recommending are not the same thing; I suspect Treasury’s position is what is stated in the summary, and that the report’s authors were the ones that turned that into an outright recommendation.

          But the biggest disappointment in the report is that there is nothing new or substantive about when or how Fannie and Freddie might ultimately exit conservatorship. The two sections that briefly cover these topics–“Preconditions for Ending the Conservatorships” and “Recapitalizing the GSEs” are, respectively, a rote listing of known steps with neither details nor timetables, and set of possible recapitalization approaches–again, all known–that ends with the unhelpful statement, “Each of these options poses a host of complex financial and legal considerations that will merit careful consideration as Treasury and FHFA continue their effort, already underway, to identify these and other strategic options.” And there’s not a peep about the lawsuits. We’ve waited six months for this?

          As I said, I’ll take a fresh look at this report tomorrow morning. Perhaps I’ve missed a hidden nugget.

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          1. Tim,

            You are probably right on the money. This is probably a report by committee, trying to mesh together ideas from many into a coherent framework. It failed to do that and it lacks the timeframes that Trump had said should be in it when he issued the memo. I suspect this is a little Mnuchin (the summary) a lot Kudlow, and processed through attorneys at DOJ who probably removed anything that would impact their cases before several courts. The result is flavorless and meaningless without reading between the lines and knowing who wrote what. I suspect there will be much speculation of that between now and the 10th. We might get a better idea as to who said what at that hearing. Too bad Kudlow wasn’t also called to testify.

            Cheers,
            Justin

            Liked by 1 person

          2. As I said, I’ll go through the report again this morning, to see if there’s anything I’ve missed. But before I do I’ll make one comment on its substance and one on its tone.

            On the substance, I think those who view this report as a further step towards ending the net worth sweep are misreading it. The White House already had made a non-specific commitment to that effect in its March 27 memo on Housing Finance Finance reform, when it asked Treasury to develop a plan to achieve a number of objectives, including “Ending the conservatorships of the GSEs upon the completion of specified reforms.” The conservatorships can’t be ended without allowing the companies to recapitalize, and they can’t recapitalize and leave conservatorship as long as the net worth sweep is in place. All that was said about this process in yesterday’s report was, “Pending that recapitalization plan, and as an interim step toward the eventual PSPA amendment contemplated by this plan, Treasury and FHFA should consider permitting each GSE to retain earnings in excess of the $3 billion capital reserve currently permitted, with appropriate compensation to Treasury for any deferred or forgone dividends.” That’s not ending the sweep. It’s no different from what Treasury and FHFA did when they allowed Fannie and Freddie to increase their capital from zero to $3.0 billion at the end of 2017: the companies were allowed to retain the extra capital, but they still owed Treasury the amount they were allowed to retain, in the form of an increased liquidation preference.

            On the tone, I’ll mention two points that I think encapsulate the policy orientation of whomever wrote it (my guess is someone within the National Economic Council, under Larry Kudlow’s supervision). In their recounting of the history of Fannie and Freddie, their review of the financial crisis makes no mention of the role played by the lack of regulation of subprime lenders or the private-label securitization process. Later on, as they discuss the importance of making changes to Fannie and Freddie’s regulation or operations in order to create a “level playing field for private market participants,” they address the impediments that exist to private-label securitization today (without mentioning memories of the disastrous losses inflicted on PLS investors during and after the crisis). One of these is the SEC’s Regulation AB II, which requires that “a PLS issuer offering SEC-registered MBS must disclose 270 elements for each of the underlying mortgage loans.” The authors note that “it is difficult to collect the required data for some of these fields.” Their proposed solution? “Requiring each GSE to conform its disclosure to Regulation AB II could help level the playing field.” Seriously? This sort of Harrison Bergeron-type thinking is present elsewhere in the report as well. One can only hope that its authors are not in a position at either FHFA or elsewhere where they can influence the administrative reforms FHFA intends to impose on Fannie and Freddie.

            Liked by 1 person

  9. Tim

    Layton on the GSE stress test results.

    https://www.jchs.harvard.edu/blog/the-2018-gse-stress-test-results-a-major-policy-success-and-its-implications-for-the-proposed-capital-rule/

    “Regardless of the specifics of what the FHFA comes out with in its capital rule, there is no denying that the stress test results are a credible reminder how de-risked the GSEs are today versus just five years ago. The stress loss, at just 0.8 percent of assets, is a small amount (and would only be 0.4 percent if no DTA write-down is assumed), especially when compared to the 3 to 5 percent loss ratio range that I have heard policymakers most commonly discuss as being generated during the financial crisis.”

    rolg

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    1. I’m glad Layton is making this point. I made similar points a few weeks ago in a couple of comments on the stress test results that start here: https://howardonmortgagefinance.com/2019/06/19/assessing-the-fhfa-capital-rule/#comment-11344

      With the implementation of the Current Expected Credit Loss (CECL) accounting rule next January, we shortly will have three up-to-date “real world” measures of relative credit risk for Fannie, Freddie and banks: the most recent 90-day delinquency rate on the loans they finance, their projected credit losses from the latest Dodd-Frank stress test, and the amount of lifetime credit losses they’ll be required to estimate after they implement CECL. As I noted in my comment cited above, if the required capital percentage as a multiple of these three metrics is much greater for Fannie and Freddie than it is for commercial banks, it will be a powerful argument that FHFA has set the companies’ required capital at an excessively high level, to the detriment of homebuyers who are paying the price of unnecessarily high guaranty fees and undue restrictions on the availability of mortgage credit.

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      1. I hope in next Tuesday’s SBC hearing someone from the committee would ask Mnuchin/Calabria to elaborate on GSEs’ capital requirement in light of the latest stress test result. The amount of capital required is one of the cores how the GSEs could be recapped/released.

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      2. Would a high capital percentage discourage the competition Calabriaia says he wants in the GSE market? If so, maybe talk of “competition” is a smoke screen.

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        1. There are many arguments against multiple credit guarantors. The multiple guarantor model is a free-market concept that is fundamentally incompatible with the business model of Fannie and Freddie as they currently are chartered and structured. I don’t know how we would transition from the current model to the one the banks are advocating (multiple guarantors of securities that in turn have explicit guarantees), which Calabria seems to support. The practical difficulty in making this transition is the major reason I do not believe legislation with these objectives can or will become law.

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          1. Tim – How does the current environment of unprecedented political polarization factor into your calculus regarding the lack of legislation passing in an election year?

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          2. Tim

            I would agree that the expansion of guarantor charters is a bad idea, as it wont accomplish the usual goal of improving consumer welfare by expanding competition. but I have been wondering why exactly? why would there be a race to the bottom?

            to my way of thinking, competition improves consumer welfare where the consumer can compare products, services and pricing and discern competitive advantages. with mbs guarantors, mortgage quality, credit analysis and underwriting prudence are far more opaque. new entrants would be able to free ride on the Fannie and Freddie brands, essentially saying that they were just like Fannie and Freddie without having first refined their business methods and systems, and infrastructure, and then essentially cut corners without being found out in an effort to maximize profits.

            would be curious your expanded thoughts one the matter, perhaps with a new blog post somewhere down the line.

            rolg

            Liked by 2 people

  10. Tim

    re the SBC hearing Tuesday 9/8, one would expect that it will focus on the Plan, reported to be released tomorrow, and since it is expected that the Plan will call congress to grant fhfa additional guarantor chartering authority, one may wonder, as Layton did recently, not only whether any new entrant would want to be a start-up David doing battle against two Goliaths, but also whether statutory duty to serve (DTS) obligations will be retained for GSEs and imposed on new entrants.

    I thought this is a good discussion of the DTS obligations of GSEs (and presumably any newly chartered guarantors as per congressional action), versus the elimination of these obligations in the Corker/Warner proposal and the latest Crapo 3 pager, in place of the creation of a market access fund. https://themreport.com/news/09-03-2019/a-different-perspective

    one should think this through. is it likely that congress will enact competing charter legislation and include the DTS obligations on new guarantors? if so, is it likely that those new guarantors will want to be subject to these DTS obligations, as well as compete against entrenched trillion dollar goliaths?

    if one thinks congress would strip the DTS obligations out of the new chartering authority (notice the fellow traveller origins of the market access fund), as per Crapo 3 pager, how likely is it that this would get bi-partisan support in senate from the likes of brown/warren, or any support in the House?

    imo, additional chartering authority passing congress is so unlikely it is laughable. but wouldn’t you think POTUS/mnuchin/calabria appreciate this? so apart from kabuki theater, what will this SBC hearing next Tuesday be all about?

    rolg

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    1. The reform plan we’re now being told will be released tomorrow almost certainly will contain both a proposed set of administrative reforms (which I expect will be more of an outline with an estimated timetable than a specific set of defined steps) and a list of recommended legislative reforms. The SBC hearing will be the first of at least two (the next one in the House) that will give the administration’s witnesses a chance to make the case for their legislative recommendations and respond to members’ questions and comments about both the administrative and legislative components of their plan. I won’t speculate on which particular items might be in the plan or the focus of attention for Senate or House members, since we should know the former tomorrow and we’ll know the latter on Tuesday.

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  11. Tim

    I think we can assume that the Plan will be released this week, as the big 3 are summoned to the SBC next Tuesday: https://www.banking.senate.gov/hearings/housing-finance-reform-next-steps (though I would love it if the Plan was delayed and they all marched over to SBC and queried, “what’s up?”).

    this will be a circus act imo, though I am eager to hear from Sen. Brown, who is on the record as saying that the best testimony he has heard over past couple of years related to utility-type regulation, as opposed to charter expansion.

    rolg

    Liked by 3 people

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  13. Tim

    with the prospect of an imminent release of the memo to POTUS re administrative action, there is some chatter about how such administrative action would “bypass” Congress. This is bogus.

    Congress acted when it created FHFA as an independent agency, and Congress acted when it made the fhfa director removable only for cause (putting aside the constitutionality of this provision). when the fhfa director negotiates with treasury regarding amendments to the PSPA, the fhfa director will be acting in Congress’ stead, implementing the legislation (HERA) Congress passed. when the fhfa director promulgates the final capital rule, this rule will be issued pursuant to congressional action and authority. without such prior delegation of congressional authority to fhfa, the fhfa rule would be invalid.

    when the administrative plan is implemented, congress will be acting through its designated administrative agent. if congress wants to do something different it can pass legislation. but congress has already passed legislation and this legislation will be implemented by fhfa.

    the GSE-haters need to wake up and understand that congress is sitting at the table at the calabria/mnuchin negotiation, and Congress specifically confirmed calabria to be there to implement Congress’s legislation (HERA). whining is never a good look.

    role

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    1. Within this current environment and open season on potus, who isn’t “hating’ on GSE’s is also significant. That Speaker Pelosi, a Squad member or one of the stumping, socialist horde haven’t touched on gse bounty even though they’re some 20% of econ says much more than a few disjointed, verbal drive by’s by Senator Brown and the odd journalist. Seems to me sh’s are being misdirected from both sides of the aisle. I’m guessing no vacation selfie showcasing a legal hunt? I do hope you land much, much bigger prey in the coming weeks. Gl,

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      1. @Paul

        fwiw, I find that GSE policy is like the tax code…generally, the only people in congress with an interest are, in effect, paid to have an interest by lobbyists. which is why the tax code is so complex, and why there were GSE “reform” proposals that were highly risky and convoluted, but not surprisingly benefitting the lobbyist paymasters if pursued.

        the simplicity of TINA will soon prevail, imo, although the capital markets equity raises will be a heavy lift.

        rolg

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        1. I’m now back from my nearly four weeks in Africa (which was spectacular), having missed nothing of substantive importance while I was away. Like everyone else, I now await publication of the administration’s reform plan, allegedly scheduled for shortly after Labor Day. The more reliable sources seem to think this plan will be short on details, which would disappoint but not surprise me. If that turns out to be the case, we may indeed need a favorable ruling from the Fifth Circuit en banc to break us out of the pattern of undelivered promises we’ve been in since Treasury Secretary Mnuchin’s pledge on November 30, 2016 to “get [Fannie and Freddie] out of government control…reasonably fast.”

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          1. Tim, do you think they will announce an end to the nws when they release the plan? That in and of itself would be substantial progress.

            Like

          3. @Craig

            an end to the NWS should be the product of a negotiation between treasury and fhfa. of course, there can be no recap unless the NWS ends, and the treasury plan likely will call for a recap in some form (likely with few details), so I think it will can be inferred with little reading between the lines. but the optics of the process would be improved if fhfa as conservator asks and gets it, rather than the treasury offers it, imo.

            rolg

            Liked by 1 person

          4. I can’t help but wonder if the en banc review has been waiting for the Administration’s Plan before issuing its ruling. If so, the core of the review is the NWS and if the Plan doesn’t lay out some sort of time line or process for ending the NWS soon, especially by most calculations the GSEs had paid back all the bailout money plus interest (even the en banc judges asked that question explicitly), then would en banc see how the government continues the delay and thus issue its ruling soon to make a point?

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          5. I’m convinced that the ruling by the D.C. Circuit Court of Appeals on the Lamberth decision was political, so I can’t rule out that politics might be affecting the timing or even the substance of the ruling by the Fifth Circuit en banc. But I think it’s more likely that the influence is running the other way: that is, Treasury can’t figure out how to unilaterally cancel the net worth sweep without incurring criticism from the large cadre of Fannie and Freddie critics who are well connected within the administration, so it’s been delaying publication of a plan that’s been substantively complete for some time in the hopes that the Fifth Circuit rules and it can tailor the implementation piece of that plan accordingly. If that indeed is what’s been happening, however, Treasury has about run out of time on that ploy. For that reason I think that unless the Fifth Circuit issues its decision in the next week or two it’s likely that Treasury will publish a plan that is short on details, including when and how to end the net worth sweep, which would be deferred until after the en banc decision.

            Liked by 1 person

          6. @Tim

            there was a statement during Collin en banc oral argument by a judge, perhaps Judge Dennis, that the 3rd A would not necessarily be ultra vires if it was followed by a 4th A that would in effect deem the senior preferred paid in full, and there was a lull at which point a judge, perhaps Judge Willett, responded to the effect that, well there certainly not any 4th A being currently contemplated.

            given that it is now more than 7 months after collins oral argument, the 5th circuit en banc has recently issued a contentious decision on sovereign immunity 3 months after oral argument (showing that it can deal with decisions having passionate majority, concurring and dissenting opinions with dispatch) and there is (and has been for a few months) the prospect of an administrative plan dealing with the 3rd A, it is not outside the realm of possibility that the en banc collins court is waiting on the administrative plan. imo, this would be a dereliction of judicial duty, as the legal validity of the 3rd A should stand on its own, but it seems at least one judge was interested in the possibility of a 4th A “rescuing” the validity of the 3rd A, and all it takes is for one judge to keep a decision from being rendered.

            rolg

            Liked by 1 person

          7. That, of course, is the most likely circumstance: as in the “Alphonse-Gaston” routine, each entity is waiting for the other to act. If that’s the case, I think Treasury is the more likely to break down and go first, since it’s the one that keeps setting deadlines, and has no good excuse for continuing to miss them.

            Liked by 1 person

          8. @Tim

            the issue with a 4thA “rescuing” the 3rdA is that unless treasury provides through negotiation with fhfa what the Ps are seeking in relief, such as deeming the senior preferred paid off AND providing some $20B payment into the companies to account for dividends made beyond the “10% moment”, the case does not become moot. it does, however, become easier for a judge sitting on the fence to award relief to Ps if treasury goes part of the way.

            rolg

            Liked by 2 people

          9. The courts would prefer to affirm a new policy rather than appear to force policy. Another argument en banc is waiting for admin.

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  14. Tim

    I was able to determine by inquiry with a reputable journalist that the “treasury plan” is really a single plan with contributions by treasury and HUD, and the treasury portion of the plan was completed in June, but that the HUD portion of the plan has been subject to revision until just now…when news trickled out that the plan has been submitted to POTUS for his review and for expected release in September. this journalist may publicize this clarification (as I suggested he should), but I am writing on background until he does.

    I think this should eliminate some doubt in the fannie-sphere as to Mnuchin’s intentions. it seemed to me that Mnuchin and Phillips were in synch and I doubted that the Phillips’ plan would need much post-hoc revision. of course, the proof of the pudding will be in the reading.

    rolg

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  15. Tim – care to comment on Sheila Bair’s appointment to Fannie’s BoD?

    Do you think she knows what the last BoD was threatened with when Hank came calling?

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    1. I’m not that bullish about Bair. In the years following the crisis, she was a high-profile critic of Fannie and Freddie, who drew on all of the bank-promoted misinformation about the companies’ business and alleged role in the crisis to justify her recommendations that their charter, structure and regulation be drastically changed in any new mortgage finance system. Perhaps once she gets on the Fannie board she will learn some actual facts about the firm and become an informed and constructive counselor to management, but that will depend on her.

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      2. until the GSEs are released from conservatorship a director is nothing more than a figurehead. so why bother to appoint her now? imo Bair appointment is a nod to the public financial markets. whatever one may think of her policy views, she is an experienced financial regulator and this is notice to the market that after release, there will be an adult on the board.

        rolg

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          1. well thanks, ff1. one may also consider the thought process from ms. Bair’s POV. one might expect that she had a conversation with calabria to the effect that she did not want to rent out her reputation for a GSE that was not going to be set up to succeed.

            rolg

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    1. You, and almost everybody else, are missing the context of these stress test results–both over time and in comparison to “other financial institutions” (i.e., banks)– because FHFA doesn’t give it.

      First the context over time. When FHFA published the initial Dodd-Frank stress test results for Fannie and Freddie in 2014, the credit losses it reported for the companies during the stress period totaled $94.2 billion, or 2.0 percent of the companies’ mortgages owned or guaranteed as of December 31, 2013. At that time, however, almost one quarter of Fannie’s mortgages had been purchased or guaranteed before 2009, with 12 percent coming from the disastrous 2005-2007 origination years. Since then, the size and influence of these very poor books of business have steadily declined. Today, only 4 percent of Fannie’s total book is from the 2005-2007 period, and the post-2009 loans have an exceptionally low 32 basis point serious delinquency rate. Freddie has seen a similar change in the composition of its book. This is the main reason the combined credit losses for both companies in the 2019 version of the Dodd-Frank stress test were only $12.8 billion, or 23 basis points of their total book of business as of December 31, 2018.

      You also can compare Fannie and Freddie’s stress credit losses with the credit losses of the large commercial banks that are subject to the same stress scenario. In 2014, the average credit loss rate for banks subjected to the Dodd-Frank stress test was 6.7 percent. In 2019, the average stress credit loss rate for banks was lower, but not by that much–it still was 5.7 percent of banks’ total loans outstanding, a decline of 17 percent from 2014. In contrast, over those same five years Fannie and Freddie’s combined credit loss rate fell by 89 percent. This meant that in 2019, Fannie and Freddie’s combined credit loss rate of 23 basis points was one-twenty fifth banks’ 5.7 percent credit loss rate. In spite of this exponential difference in stress credit loss rates, however–which is there for anyone to see–supporters of banks continue to insist that Fannie and Freddie should hold “bank-like” capital. It is ludicrous that so many people are making this claim seriously.

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      1. Hi Tim,

        I must not be seeing what you’re suggesting ROLG is missing. That the quality of loans has improved and 2005-2007 loans are less a factor, isn’t ROLG’s objective observation along with his subjective opinion still correct?

        There appears to be (objectively) $13B combined FnF credit losses through the adverse stress period, which, as a matter of (subjective) opinion, is small. Yes?

        Thanks!

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        1. Yes, $12.8 billion in credit losses during a stress test ($7.2 billion for Fannie and $5.6 for Freddie) is a very small amount. The context I was attempting to provide was to add that (a) that’s only 23 basis points of the companies’ total mortgages; (b) back in 2014 (the first Dodd-Frank stress test run for the companies) the credit loss rate was 200 basis points, but this was not a “normal” result because of the effect of losses from the very poor 2005-2007 books, while going forward stress losses are likely to be close to what we’re seeing now, and (c) Fannie and Freddie’s 23 basis points of stress losses are a miniscule fraction of bank’s 2019 Dodd-Frank stress losses 5.7 percent.

          Both the FHFA and Fed Dodd-Frank stress tests are stylized, but they nonetheless provide useful information about the riskiness of the entities that are subjected to them. And in the first quarter of next year we will get another useful risk assessment: banks’, Fannie’s and Freddie’s estimate of their lifetime expected credit losses, which is required by the current expected credit loss (CECL) standard mandated by the Financial Accounting Standards Board (FASB), scheduled to take effect on January 1, 2020. Taken together, the Dodd-Frank stress test results and CECL lifetime loss estimates will add an element of realism to the current discussion about the appropriate capital standards for Fannie and Freddie compared with commercial banks. As I’ve noted repeatedly, capital must be related to risk. If Fannie and Freddie are being required to hold ten times their average Dodd-Frank and CECL credit losses, while banks are required to hold, say, three times the same average losses, that will be a strong real-world argument that FHFA has set the former too high, to the detriment of the business the companies it regulates is supposed to be able to conduct for the benefit of the homebuyers they were chartered to serve.

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          1. The timing of the new FnF stress test results is interesting. Could it be a subtle way leading to the soon to be released administration’s “plan” that FnF wouldn’t need as much capital requirement as publicly stated before, and paving the way of retaining quarterly profits as early as the next quarter to build up the capital?

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      2. Tim

        compare the FHFA published 2018 stress test results:

        Click to access 2018_DFAST_Severely-Adverse-Scenario.pdf

        where there is set forth a projected draw amount on the treasury commitment (p. 6), with

        fhfa published 2019 stress test results:

        Click to access 2019_DFAST_Severely-Adverse-Scenario.pdf

        with no projected draw amount (p. 6)

        I wonder why the commitment draw line item is set forth in 2018 but not set forth in 2019? do you have a view?

        rolg

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        1. I hadn’t noticed that omission when I took a quick look at the 2019 results. In checking, FHFA included a highlighted section of PSPA funding commitment, Treasury draws required, and remaining PSPA commitment in each of the five previous Dodd-Frank stress test reports. It’s not in the 2019 report, but I don’t know why.

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          1. Tim

            this is speculation of course, but leaving out the commitment draw line item in 2019 stress test report is consistent with the notion that during this stress period (through 2021) the GSEs will be recapitalized and no draw will be required. clearly, if there is to be no recap and the GSEs capital level remain at $3B each, a commitment call would have been required and the line item presentation would have been proper.

            in the relative silence at fhfa/treasury since the treasury plan was (apparently) delivered in June, it is somewhat heartening to see this 2019 presentation. since I expect fhfa used the 2018 report as the basis for drafting the 2019 report, I suspect the omission of the commitment draw line item was advertent.

            rolg

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          2. The omission of the commitment draw line item clearly was advertent, and perhaps your speculation is correct. But FHFA wouldn’t need to just assume that Fannie and Freddie would be allowed to recapitalize during the stress period, it also would need to assume that they would successfully pull off equity offerings that would raise more than the $43.3 billion they are projected to lose in the scenario that has then establishing a valuation reserve for their deferred tax assets (less the $10.9 billion they had as shareholders equity as of June 30, 2019). Is it really reasonable for FHFA to assume that investors would put up over $30 billion in new capital just to have it consumed by stress losses? In addition, the timing seems off; Calabria recently has been talking about a fairly lengthy period of recapitalization through retained earnings before a new equity raise would take place. In a stress environment, there would be no retained earnings–more than all of the companies’ revenues would be consumed by losses. Having said this, though, I don’t have any other explanation for why FHFA would have omitted any mention of stress-related draws from Treasury.

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          3. @Tim

            “Is it really reasonable for FHFA to assume that investors would put up over $30 billion in new capital just to have it consumed by stress losses?”

            I don’t think this is the right way to look at it. The investors would be putting in money to make a return on it, presumably via ownership of two very profitable and safe companies. A risk of losing $30B would exist but the investors would just price that in during the offering. If that money was guaranteed to be lost, as opposed to being a “severely adverse” (and therefore improbable) hypothetical, it would be difficult to impossible to line up investors at all.

            Also, the more capital the companies have, the less risk to the companies losing that $30B represents. While you correctly point out that capital levels that are too high are bad for homebuyers and the economy, there should be a happy medium between the stress test results and Watt’s proposal that gives investors an incentive to participate.

            “Calabria recently has been talking about a fairly lengthy period of recapitalization through retained earnings before a new equity raise would take place.”

            I thought I had been following Calabria’s public comments closely, but I do not recall this one. Where did you hear or read about it?

            @ruleoflawguy

            I think there is another possible explanation for the omission of the PSPA draw stuff: the PSPA funding commitment might be gone by then! This is independent of the companies having enough capital to withstand the scenario, it could be either or both of these reasons.

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          4. @midas

            as I recall, there is no termination date for the treasury commitment. the commitment ends upon the occurrence of certain events, like full repayment, but there is no certain end date.

            because the treasury line is deemed appropriated by congress by express language in HERA, and it will be unrealistic to assume that congress will act to appropriate any other form of governmental backstop, I am most interested to see how the treasury plan deals with this existing commitment. I expect it will become an important backstop for the transition from status quo to restored private capital, although I also expect the commitment fee to be restored as well.

            as to the omission of the commitment draw line item, I think this is diagnostic. I simply think fhfa (and treasury) has reached a mindset where it wants to fund the GSEs with retained earnings/private capital rather than additional treasury draws. when you make a change to a 2018 document that you are using as a template for a 2019 document, you dont make this sort of change without consideration. none of this says anything about the ability to execute a recap, but I think it does say something important about the intent to pursue a recap. just my reading of the tea leaves.

            I concur that I haven’t seen calabria refer to an initial lengthy retained earnings period before capital raise…this was Layton’s contribution to the discussion. reading between the lines, I think Layton was insinuating that the capital raise will be harder than calabria might think if there is no prior substantial build up of retained earnings.

            rolg

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          5. “I concur that I haven’t seen calabria refer to an initial lengthy retained earnings period before capital raise…”

            ROLG,

            Not in so many words, but saying he isn’t under any time constraint – even five years, must mean something.

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          6. @ron

            I understood calabria to say that he was under no time constraint for the release from conservatorship, such that it is within his discretion as conservator to release companies at any point in time in the capital building process, or only after the capital level he has approved has been met, or perhaps even after some other reform has been implemented. when in this process new capital is raised is something that I hope is a financial markets decision, driven by advice he receives from retained investment bankers, and not a political decision.

            rolg

            Liked by 1 person

          7. ROLG,

            As I’ve noted now several times, I think it finally occurred to Calabria that (i) the capital requirements aren’t as severe as he thought and (ii) he can’t successfully secure investors given his “competition” mantra. I believe both those factors point to retained earnings. We’ll have to wait and see.

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          8. I am weighing in on this exchange a little late (I’m still in Africa, and spending even less time on blog-related matters than I thought I might), but I did want to clarify my comment about capital raising during a stress scenario.

            The reason I made this point is that I continue to be concerned about how realistic FHFA is being about the way the capitalization and capital management process for Fannie and Freddie works in practice. FHFA’s June 2018 capital rule tied their capital requirements to the market values of their loans, which would force them to raise tens of billions of dollars while stress events are occurring. That won’t be possible. As the 2008 financial crisis was unfolding, no financial institution raised a nickel of capital; a company needs to raise its capital before a downturn has become a crisis, or else it will fail (or need to be bailed out). I and many other commenters made the point to FHFA that it had to change this pro-cyclical aspect of its capital standard in the next version, but as of yet it’s given no indication that it will.

            It’s in this context that I’m assessing how FHFA might be treating capital in the most recent Dodd-Frank stress test. In its stylized scenario, sharp declines in GDP and increases in unemployment begin on January 1, 2019 and they continue through the third quarter of 2020. FHFA is writing about the results of this test in mid-2019, and Fannie and Freddie start the test with only $10.9 billion in capital. If FHFA really thinks that with this tiny amount of initial capital and the cascading losses assumed in the stress test the companies won’t need draws from Treasury because they’ll be able to convince investors to provide them with the capital necessary to cover their stress losses, this would indicate to me that at this late date it still isn’t thinking realistically about how the companies’ capital management process works. That would be very worrisome, and I hope it’s not the case.

            Liked by 1 person

          9. Tim

            The stress test is of course a pro forma exercise: what would the company results look like under the assumed stress scenario. I just find it interesting that fhfa added to the pro forma assumption of stress for two years beginning in 2019 a pro forma adequate capitalization to withstand the resulting losses. there is no other way imo to interpret the absence in the 2019 presentation of a line item treasury commitment call, as we know all previous stress tests did not assume pro forma adequate capitalization. what this implies is up for debate. safe travels.

            rolg

            Liked by 1 person

  17. Question for ROLG:
    What is the absolute longest period of time it can take for the 5th circuit to publish their decision regarding the Collins en banc rehearing?
    When do you think the decision will be published (tough question I know)?

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    1. @Daniel

      there is no answer to your question. there are 2 difficult claims, APA (NWS not within conservator’s authority) and constitutional (single director removable only for cause). if court finds constitutional violation, then will relief be granted (Ps cite to a SCOTUS case, Bowsher, and the APA Section 706)? there are 16 judges, so there are many possible majority, concurring and dissenting opinions to write on these claims. this is a high profile case and there “should” be an incentive for well-crafted opinions, which take time. and there may be jockeying over language for one judge to join a particular opinion…multiplied among multiple judges. I suspect the decision will be rendered “soon”…

      rolg

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    1. Layton (Executive Summary):

      “Summary: Over the past decade, Congress and most housing finance policy developers and commentators have overwhelmingly focused on reform of the government-sponsored enterprises (GSEs) in terms of comprehensive reform, meaning major changes in the design and structure of the housing finance system, which would require legislation by Congress. Because no such legislation has been passed, GSE reform appears, based on this expansive understanding of reform, to be the still-unfinished business of the 2008 Financial Crisis. But with a more limited concept of incremental reform – i.e., fixing the major weaknesses in the existing system of housing finance – the reality is that almost all of the major flaws of the pre-conservatorship GSEs have been successfully addressed while the companies have been in conservatorship. And these incremental reforms can easily be carried forward and completed to apply to the GSEs upon an exit from conservatorship, even if that exit is done only by administrative means. On this view, which I share, reform has been “mostly done” already, quietly and competently, during conservatorship, and so a program of “reform, recap and release,” if the administration pursues it, is very much in the realm of the possible.”

      rolg

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      1. I agree with Layton that there are no obvious “reforms” of Fannie and Freddie that need to be done before they can (and should) be released from conservatorship. I don’t agree with his assessment of the reforms that already have taken place, however (and note that he omits what I believe is the most significant one, that’s not limited to Fannie and Freddie–the QM and ability to repay standard), and I also was disappointed to see that in his discussion of Fannie and Freddie reform he makes a number of misstatements of fact and repeats several readily disprovable myths about the companies, which isn’t helpful in reaching consensus on the best way to complete the tasks of recapitalization and release that he agrees are now within reach.

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  20. Tim,

    Today, the Trump administration announced its intent to not renew the QM patch.
    https://www.foxbusiness.com/economy/trump-fannie-freddie-mortgage-lending

    The article notes both that the patch expires on the earlier of January 2021 and the end of the conservatorships, and that the Trump administration has expressed a commitment to end the conservatorships anyway (presumably during this presidential term while they have the power to do so).

    Is this news impactful, and if so how much and why? Is the patch expiration just a side effect of releasing Fannie and Freddie or is it a goal in and of itself?

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    1. The announcement by the Consumer Financial Protection Board (CFPB) that it does not intend to renew what is called the QM (Qualified Mortgage) Patch–which allows Fannie, Freddie and depository institutions with assets less than $10 billion to guarantee or hold mortgages from borrowers whose monthly payments exceed 43 percent of their income, while still retaining the legal protections of a Qualified Mortgage as defined by the CFPB–when the Patch expires in January 2021 is related only tangentially to the issue of removing Fannie and Freddie from conservatorship. First of all, this is an initiative taken by the CFPB, not FHFA, although Mark Calabria supports it in the name of creating a “level playing field” for mortgage lenders. (Calabria has not said anything that I’m aware of, however, about the fact that both the FHA and the VA still will be able to make QM loans with debt-to-income [DTI] ratios over 43 percent after the Patch expires, because they have a different definition of Qualified Mortgage than Fannie, Freddie and depositary institutions do.) Second, the CFPB hasn’t yet decided HOW to eliminate the Patch; it could decide to drop the 43 percent DTI restriction altogether, or to allow higher DTI loans to be QMs when these loans meet other specified requirements. Whether the elimination of the QM Patch has a negative impact on Fannie and Freddie’s business, or the mortgage market in general–and if so by how much–will therefore depend on how these higher DTI loans are treated in the future.

      I also will make one point about the QM Patch and the “level playing field” argument. Under FHFA’s proposed risk-based capital rule, unlike all depositary institutions (including the smaller ones to whom the Patch also applies), Fannie and Freddie would be required to hold more capital for loans that have higher DTIs. The June 2018 version of the capital rule defines a “normal” mortgage as one with a DTI between 25 and 40 percent. Loans with DTIs lower than 25 percent get a 20 percent break on required capital, while loans over 40 percent have a 20 percent capital surcharge. This, I presume, is based on historical loss experience–or at least it should be; and it’s also interesting that the “cut” on DTI in the FHFA rule is 40 percent, not the CFPB’s 43 percent. I wonder if Calabria is aware of any of that (I suspect he is not). In any event, this is yet another example of where Calabria seems to want to make Fannie and Freddie subject to bank-like rules and regulations, yet also give them unique, customized capital standards and regulations to which banks are NOT subjected.

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      1. Tim

        I found this thought useful, and I am almost embarrassed to say I read it in IMF: “Instead of avoiding the GSEs because of a high DTI ratio, lenders instead, could use 80-10-10 structures where a first-lien (under the 43%[sic] cap) could go the agencies with a second lien being originated and placed elsewhere. The possibilities are endless. Mortgage bankers are a creative lot…”

        in other words, if there are buyers for second lien paper on these high debt to income mortgages, then these senior mortgages can become QM, with some lenders taking a higher yield junior slice. just confirming, to your knowledge, would the GSEs take this senior piece with a junior lien underneath, and would the mbs market not be fussed with lurking junior lienholders (and is the whole premise correct, that the DTI is measured against only the senior piece to be bought by GSEs)?

        rolg

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        1. With the caveat that I haven’t been directly involved with the mortgage industry for almost fifteen years–and that lending and disclosure practices may have changed since I was–80-10-10 loans shouldn’t be a way around the DTI limit. An 80-10-10 mortgage is a loan with a ten percent down payment, an 80 percent LTV first mortgage, and a simultaneous 10 percent LTV second mortgage. Typically, 80-10-10s are used by borrowers who want to avoid paying private mortgage insurance, which is required (by statute) by Fannie and Freddie for loans with LTVs over 80 percent, and who are willing and able to bear the higher cost of the 10 percent second. They shouldn’t work to get around the DTI restriction, however, because borrowers applying for a first mortgage are supposed to disclose their indebtedness on all mortgages they have to the holder of the first (precisely so it will have an accurate assessment of the borrowers’ DTI, for underwriting purposes). Or at least that was the case when I was at Fannie.

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          1. Tim

            have a great trip!

            another quote from IMF that I thought you might clarify:

            “Meanwhile, Rob Zimmer, director of external communications for Community Mortgage Lenders of America, said just because the patch expires that doesn’t necessarily mean the GSEs can’t fund the loans. The patch currently accounts for as much as 30% of single-family mortgages purchased by Fannie Mae and Freddie Mac.”

            if non-QM loans and loans no longer protected by the “patch” are bought by FnF, what are the implications/consequences? thanks!

            rolg

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          2. The QM rule was designed to protect lenders from (a) lawsuits from borrowers who claim they were extended unsafe loans (if the loan is QM a borrower can’t make this assertion), and (b) requests from investors to buy back the loan, on the grounds that it was imprudently originated. The QM patch allows lenders to be protected against both types of claims if they make loans to borrowers with DTIs higher than 43 percent AND either Fannie or Freddie finance those loans.

            I’m speculating here (and perhaps there are lenders among the readership with more recent experience than I have), but if the QM Patch were done away with I imagine Fannie and/or Freddie still could buy the loans and give the selling lenders a special exemption from their buyback policies; lenders who make these now non-QM loans would remain subject to lawsuits from the borrower, however–although I wonder how significant that risk would prove to be. Also, it’s too bad that Twitter and the preference for sound bites have such a pervasive influence on the way people state their views today. Rob undoubtedly has reasons for saying that eliminating the patch wouldn’t “necessarily mean the GSEs can’t fund the loans,” but I suspect nobody asked him what those were, and, given that, he didn’t see any compelling need to volunteer them. (Let’s all play our favorite game of guessing what he might have meant, instead of asking him.)

            Liked by 1 person

          3. tim

            thanks for reply. as you know, after the FC, the GSEs recovered tens of billions of dollars from sellers on representations and warranties (while PLS sponsors were able to avoid significant recoveries for what were probably greater R&W violations). if FnF were to exempt originators on high DTIs from some elements of R&W exposure, I imagine that business would continue after patch expiry (though FnF’s underwriting algos would need to be effective).

            rolg

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          4. The majority of the rep and warranty violations that were occurring prior to the crisis, mainly with private-label security issuers but also with Fannie and Freddie, were deliberate violations of underwriting standards and were knowingly withheld. There always had been some fraud among originators–which the companies generally caught in their post-purchase reviews–but the scope and extent of the pre-crisis fraud was unprecedented, and went largely undetected by everyone until it was too late. If Fannie and Freddie were to give buyback waivers to lenders on non-QM high-DTI loans, they very likely would do so only on loans that had compensating factors balancing the risk from the higher DTI ratios, and they would retain the right to go against the lender for fraud.

            Liked by 1 person

          5. Tim

            right. in my reading, I am surprised at the number of financial journalists who believe that once the patch expires, no non-QM can be bought by GSEs, and since this is some 30% of current GSE originations, this will adversely affect GSEs etc. and of course, many dont appreciate that the patch might be amended (say, to a seasoning requirement such that all mortgages not in default after X length of time are deemed QM) as opposed to just left to expire. this is not even that complicated, but it is remarkable that these journalists seem to accept being fed by GSE antagonists rather than doing a professional job.

            rolg

            Liked by 1 person

      2. Top of the morn…….If bored by the sea, indulge us if you will in how UST might convert GSE’s to a utility model. Would also confirm TSY’s very public “no straight RnR” quote, as if to suggest someone actually asked him.

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        1. At the moment I am not “by the sea,” but this might be a good time to inform readers that on Thursday I will be leaving for three and a half weeks in East Africa, where (a) I will be spending a considerable amount of time away from the blog, and (b) when I do respond to questions or comments it will be in a time zone seven hours ahead of Eastern Daylight Time. My most likely reading and posting times during this period will be between 5:00pm and 9:00 pm EDT, and again in the early morning (before most people on the east coast are awake). I’m expecting that the summer doldrums and the typical August exodus from Washington will keep things quiet, but we’ll see.

          Different people seem to be thinking different things when they refer to a “utility model” for Fannie and Freddie. When I use the term, it refers to three combined characteristics: a limited number of companies providing a valuable or essential service; these companies having some sort of special charter or relationship with their regulatory agency, and there being limits on the returns the companies can earn. Fannie and Freddie currently have the first two, but not the third. In my version of a utility model, this would be added not by legislation but by a fourth amendment to the Senior Preferred Stock Agreement (SPSA), to which the companies would be parties, that also ended the net worth sweep. Others who are talking about or proposing a utility model for the companies need to be clear on what they mean by the term, what changes they view as necessary to achieve that status, and how those changes would be made. It’s not possible to evaluate the merits or feasibility of anyone’s “utility model” recommendation without those details.

          To answer your specific question, Treasury could achieve my version of the utility model by publicly endorsing the charters of Fannie and Freddie, making it clear that it views multiple credit guarantors as being inconsistent with the utility model it supports and thus a bad idea, and entering into a Fourth Amendment to the SPSA with FHFA, Fannie and Freddie in which limited returns for the companies were a component.

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          1. Certainly would seem to kill quite a few “tweeting” birds with one $5T stone, from shareholder concerns of future c-ships, to regulated, g’teed risk based mtg’s/returns, to gov’t oversight to name a few. Anyways, also as you noted, on verra. Thank you for all your time. Bon Voyage….

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          2. Tim,
            AIC Kijabe Mission Hospital in Kijabe, Kenya, is the Hospital I work at in Kenya (I am Stateside for 2 months, otherwise if you were in the area- and I was there -I would invite you to dinner. My wife is a great cook!). Should you have a problem, consider going there. It is 1-1.5 hours west of Nairobi. They will take good care of you.
            Jon

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  21. Seems to me, FHFA “wants” massive public offering. Of course that runs contrary to Treasury’s interest in maximizing warrants, which can only come to some degree through retained earnings. FHFA has also stated that they’d like to see Treasury reduce its stake in the GSEs.

    A “compromise” would appear apparent. Treasury agrees to reduce its percentage of warrants in exchange for a less “massive” public offering. Therefore, retained earnings bears more of the capital burden.

    The outcome will be a blend of Ackman and Moelis.

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    1. @ron

      there is to be a negotiation between calabria and mnuchin…calabria has even referred to it in his numerous interviews. this is the question I am asking myself: what does fhfa do if collins en banc decision results in some sort of P win? does it appeal to SCOTUS?

      a P win is adverse to treasury as creditor, although not necessarily adverse to its interest in reform of the GSEs to the extent that includes their recapitalization. is a P win adverse to fhfa?

      calabria has stated that his remit is to recap the GSEs…and pursue additional reforms. a P win in collins is an unmitigated benefit in seeking recapitalization (holding would improve his bargaining position, as it would eliminate senior pref so that he wouldn’t have to negotiate to remove it). why would fhfa want to appeal to SCOTUS?

      in effect, fhfa will have two constituencies, existing GSE shareholders who benefit from a P win (improving share price relative to the re-IPO price), and new investors that are required in order to execute the recap, which benefit from a P appeal and eventual P loss (which would depress price and afford new investors a higher proportionate interest in the GSE future cash flows).

      this is an odd situation.

      rolg

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      1. However, wouldn’t a P’s win in Collins potentially result in tax credit (the overpayment of 10%) for both Orgs? Wouldn’t that ultimately help any recap, as taxes paid could also be retained?

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        1. Yes, a win for the plaintiffs in Collins, if not appealed, would result in Treasury needing to refund net worth sweep overpayments to both Fannie and Freddie. I don’t have the exact numbers at my fingertips, but as I recall it would be about $10 billion to each as of today. It is most likely that these payments would be made not in cash, but as tax credits applied over time. Either way would help a potential recap, with a cash payment doing so immediately and a tax credit over three years or maybe a little longer (taking into account the likely effect of the requirement for both companies to implement the Current Expected Credit Loss accounting standard in 2020, which will lower net income that year).

          Liked by 1 person

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          1. Tim

            agreed. in effect a P win in collins promotes recapitalization (ignoring how existing and new GSE shareholders split the pie). treasury as creditor would have an optics issue not seeking appeal, but I can’t fathom how fhfa would want to appeal given its desire to recap, and Calabria’s personal historical views regarding NWS.

            rolg

            Liked by 1 person

      2. rolg,

        I found your perspectives above interesting. Regarding whether FHFA were to appeal if P’s win, my reaction to MC’s letter in the 5th a couple weeks ago defending fhfa’s constitutionality, I viewed it as a possible attempt by MC to “signal” the court FHFA would likely appeal if the P’s win on the constitutionality issue, but would likely not appeal if P’s win under APA or other remedies. Do you think that thought has any merit? Thanks for your, Tim’s, or others, replies.

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        1. @jb

          interesting take. yes, I could see Calabria preferring to lose on APA claim, if fhfa is to lose.

          as to requesting a writ of certiorari, there is a 90 day window after entry of judgment. so time enough to settle the litigation and avoid a SCOTUS hearing on fhfa’s constitutionality…but SCOTUS is hearing a separation of powers case in the Puerto Rico financing board that, if decided broadly, may affect fhfa’s single director removable for cause structure.

          rolg

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  22. Tim,

    Your post mentions future guaranty fees may warrant capital consideration. Would the same line of thought apply to balance sheet items, like the liability for net unamortized premium/discount of the trust liabilities?

    If my understanding is correct, this liability amortizes into revenue over time. It seems like this would have the same effect as future guaranty fees… Both would stand to bolster retained earnings (and therefore capital) simply with the passage of time?

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    1. If you’re talking about the treatment of guaranty fees in a risk-based capital stress test, then, yes, the stress test also should accurately reflect how purchase premium and discount would be amortized during a stress environment. But to be clear, amortization of purchase premium and discount affect net income (and retained earnings) in opposite ways: the amortization of purchase discount increases net income, while the amortization of purchase premium decreases it. Both purchase discount and premium are known numbers. What is unknown is how quickly each will be brought into the income statement as either income or expense; that depends on the prepayment rates of the loans with which the discounts and premiums are associated.

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    1. As I’ve said on previous occasions, I will wait to see Treasury’s housing reform plan and FHFA’s revised capital rule before drawing any conclusions about the likely course and timing of Fannie and Freddie’s journey out of conservatorship. Having said that, though, Calabria certainly seems to be sending signals that the way in which he intends to set capital standards for and regulate the companies is not likely to result in large numbers of investors wishing to put new money into them.

      I’ll also stick with my longstanding policy of not speculating on the impact of potential policy choices on the common or preferred share prices for either company.

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    2. My diffident take on that..

      “If I can end the sweep, reach some changes to the share agreement with Treasury, we can get them out of conservatorship, we can start to build capital” Mark Calabria

      We also know Calabria wants to initiate some sort of secondary offering of commons in order to recapitalize the GSEs.

      Yet Mnuchin enjoys the OI afforded him by the NWS (even though he noted the unethical opportunistic-nature of the previous administration in this regard.) He also wants to maximize warrants for future OI.

      The compromise is a much reduced IPO, allowing warrants to increase in value. Consequently, retained earnings will bear more of the recapitalization burden, hence the nod toward a possible five more years.

      Another feature could be ROLG’s idea of a new class of preferred shares, allowing for an immediate infusion of capital in exchange for some portion of the warrants. Obviously this would reduce earnings as it relates to commons pps, but it gets the Tsy out of the mix faster, eliminating any delay that would come with reaching some predetermined strike price.

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    1. I had high hopes for Layton’s ability to make useful and substantive contributions to the reform dialogue, but this piece was very disappointing in that regard. In it, he presumes to speak for Fannie as well as Freddie, but then goes on to give a simplistic and inaccurate description of the role and functions of both their on-balance sheet portfolio and off-balance sheet credit guaranty businesses. He also gives FHFA credit for “creating” an approach to pricing credit guarantees that balances risk and return, which I know Fannie did thirty years ago, and I’m sure Freddie had something similar.

      I never met Layton, but he came to Freddie as CEO in May of 2012, after a career spent at JP Morgan Chase. Not having worked in the trenches at Freddie, I now wonder if he ever really learned or understood the details of how its two business worked, or if he was able to gain an appreciation for the differences between the operating histories of his company and Fannie.

      Layton’s description of the two companies’ portfolio businesses–use cheap borrowing to make easy money by buying higher-yielding mortgages and your own company’s MBS–sounds like something you’d read in the Wall Street Journal. Doing the portfolio business improperly almost killed Fannie in the early 1980s. Before we could begin growing it again, we had to reinvent the agency debt market–introducing in the late 1980s option-based, or callable, debt that provided a much better match to the optionality of the mortgages we were buying. We only bought mortgages when the option-adjusted spreads between those mortgages and the blend of debt we used to fund them equalled or exceeded “bright-line” hurdle rates, and we constantly rebalanced our liability mix (using derivatives) to keep a duration match between the mortgages and our debt. Yes, the portfolio business was profitable, but our buying mortgages whenever their yields got too far above our debt costs also kept mortgage rates down for consumers. Treasury never liked our portfolio business, however, and when Fannie and Freddie were forced into conservatorship the first thing Treasury required of them was to shrink their portfolios by ten percent per year–even though at the time those portfolios were hugely profitable, and provided large amounts of net interest income that helped the companies absorb credit losses from their credit guaranty businesses. (Freddie, by the way, did not get into the portfolio business until the early 1990s–and then only because Fannie had developed the agency callable debt market, and showed them that this business could be done safely.)

      Fannie also didn’t run its credit guaranty business as an afterthought to the portfolio business, as Layton seems to think Freddie did (but I doubt it did either). We did compete with Freddie on price, but we did so knowingly. At Fannie, at any rate, we had a concept we called the “guaranty fee gap”–which was the difference between what our credit pricing models told us we should charge for the business we were doing, and what our single-family business managers charged their customers. We rigorously tracked the “gap,” and used it as a discipline against excessive price-cutting. The historical 60-40 market share differential between Fannie and Freddie that Layton cites wasn’t the result of aggressive pricing by Fannie; it was a consequence of the inferior payment structure of Freddie’s PC (which FHFA has now fixed by having both companies pay $2 billion to create a common security that makes Freddie’s payment delays to investors the same as Fannie’s). Duopoly pricing worked–it kept fees low for lenders (who passed them through to borrowers) and it didn’t lead either company to price foolishly. We don’t have to speculate about that. There is history, if remembered correctly.

      So no, Don, Fannie and Freddie before you arrived weren’t just watching the money roll downhill to them because of their favorable charters; Fannie, at least, had very sophisticated business operations and it ran those businesses well. The leaders at FHFA like to say that they’ve modernized the companies’ business operations, and Layton seems to agree with that. Perhaps they, and he, are thinking of the single security and securitized credit risk transfers (about which I’ve expressed my opinion many times). But on the basic credit guaranty business I don’t think FHFA has added anything, and if it puts too much conservatism in Fannie and Freddie’s new capital standards it will push that business backwards by breaking the link between the risk and the pricing of their credit guarantees, and restricting the companies’ ability to use cross-subsidization to attract a wider range of business.

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      1. Mr Howard

        You just stated: “Fannie, at least, had very sophisticated business operations and ran those businesses well.” My question is this no longer the case today, and if not, how can they be properly regulated going forward if only a small number of people truly understand their business?

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        1. I have no reason to suspect that the sophistication and quality of Fannie’s business management are any less today than they were when I was there. I was responding to what I took to be Don Layton’s characterization of them, which I believe is uninformed. Since he came to Freddie well after it was put into conservatorship (and only three months before the net worth sweep was imposed), it’s possible that he views himself as a partner of his FHFA conservators, and thus in order to make the decisions made by FHFA to which he was a party seem more important or consequential, he needs to present the pre-conservatorship Freddie as being more problematic or bumbling than it actually was. But facts are facts, and Layton’s opinions won’t change them.

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          1. Tim

            I have no doubt that you are right as to the historical issue, but what troubles me is that on the issue of competition v. utility-like regulation, calabria seems to have arrived at fhfa with a preconceived idee fixe that competition and additional charters is a solution to the risks presented by a duopoly, as opposed to utility-like regulation. Layton is simply pointing out Calabria’s tunnel vision, imo. as an aside, calabria will likely have enough regulatory power to put into place something that amounts to a lite version of utility-like regulation, and he may even come to realize that.

            now one can be cynical and posit that congress will do neither soon and so what’s the point of the discussion, but I believe it is possible that the idea of utility-like regulation will percolate so that at some point in time, congress may actually seriously consider it. just not holding my breath.

            role

            Liked by 1 person

          2. I’ll admit to not having read HERA from beginning to end, but I’ve read the critical sections of it and found nothing that gives FHFA the authority to set prices or return limits for Fannie and Freddie’s credit guarantees. FHFA does that now as conservator, not as regulator. So when people talk about FHFA imposing “utility regulation” on the companies, absent legislation I don’t know what they mean.

            I’ve long been an advocate of setting a limit on Fannie and Freddie’s returns, but in administrative reform this would need to be done by a fourth amendment to the PSPA to which the companies were parties. For Fannie and Freddie to accept a limit on their prices or returns, I believe they would need “consideration,” or something of value, in exchange. I know what I’d ask for if I were in charge of Fannie, but it will be up to the companies’ current top leadership to make that determination. Without either legislation or the companies’ concurrence, however, I don’t believe FHFA can put limits on their pricing or return targets.

            And this gets to the heart of what bothers me about the Layton article. Fannie and Freddie’s critics have been very successful in creating the impression that, if released from conservatorship, the companies won’t be capable of managing themselves properly without heavy regulation by FHFA. Layton seems to subscribe to that view, and his blog post is written in a way to justify it. I strongly disagree. FHFA should update the companies’ capital standards (to protect taxpayers), and set goals for the percentage of affordable housing loans they finance (to ensure the companies serve their target constituents), but leave HOW to meet those standards and goals to company management. I believe that one of the biggest deterrents to getting new capital into the companies will be the degree to which current FHFA leadership insists on appropriating for itself decision-making authority that other financial regulators properly leave to the management of their regulated entities, and that FHFA also should leave to Fannie and Freddie management.

            Liked by 1 person

      2. And what would the yield have been on FNMA debt if there was no implied government guarantee? I believe that is Mr. Layton’s point.

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        1. I hope that wasn’t Layton’s point; if it was it would put him in the same category as those who claim that Fannie and Freddie’s unique federal charters somehow make their business operations illegitimate. As to what the yield on the companies’ debt would have been without the implicit guarantee, that’s an unknowable hypothetical. So, too, is this question: “what would commercial banks have to pay private insurance companies to guarantee their consumer deposits, and what yields would consumers demand from banks if their deposits were insured by private companies, rather than the federal government?” The only difference between these questions is that the former is asked all the time, while the latter never is.

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          1. It’s weird that the same people who rail against the GSE charters never equate the banks’ FDIC backing isn’t it? It’s almost like they’re paid not to.

            Liked by 1 person

          3. From John Carney/Twitter:

            Weird that Howard says we don’t ask about the appropriate cost of deposit insurance. Gets asked all the time.

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          4. Carney, probably knowingly, misrepresents the point. I don’t question whether banks’ FDIC insurance is properly priced, and I know the correct premium to charge for this insurance is discussed all the time. The point I’m making is that FDIC insurance is an enormously valuable benefit granted to banks by the federal government, which supporters of banks refuse to acknowledge while at the same time claiming that Fannie and Freddie’s charters give them inappropriate or unfair advantages. Framing the FDIC insurance question as I did– how much more in premiums would banks have to pay for private insurance compared with government insurance, and how much higher an interest rate would bank customers demand on deposits insured by private companies rather than the FDIC–makes the inconsistency and hypocrisy of this double standard of government benefits being good for banks but evil for Fannie and Freddie apparent, and indefensible. Someone should ask Mr. Carney to respond to THAT point.

            Liked by 5 people

  25. Tim,

    I have seen some speculation that releasing Fannie and Freddie might be difficult because it could cause ratings agencies to downgrade the MBS, potentially shaking up the market ahead of election season. This seems to either ignore the fact that Treasury’s line of credit is limited to around $200B ($400B from the SPSPAs minus the amount already drawn), i.e. that there is not an unlimited government guarantee in place right now, or it makes the assumption that the government will make MBS holders whole no matter what while Fannie and Freddie are in conservatorship but might change their minds if the companies are released.

    As rolg has correctly pointed out in a Twitter response to Christopher Whalen, right now Fannie and Freddie have around $6B in capital ahead of a $200B line of credit with Treasury. If FHFA and Treasury are able to raise their desired level of capital while keeping the line of credit intact (with Fannie and Freddie paying a commitment fee for it, in keeping with the presidential memo), there would be $150B, or whatever number Calabria decides on, of private capital ahead of the same $200B Treasury line of credit. I fail to see how this would warrant a ratings downgrade. If anything, that would be cause for an upgrade! I would appreciate your thoughts on this. To me, it’s just another big bank false narrative with the aim of either slowing down or stopping recap and release.

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    1. If Treasury wants to release Fannie and Freddie from conservatorship there are a number of types of contingent support arrangements it could arrange with them–including a paid-for backstop facility, triggered by a loss of capital to some minimal threshold level–that would maintain the credit ratings on their debt and MBS as well as ensure that these securities remain eligible investments for international investors (as they are now). The “ratings-downgrade-if-released-from-conservatorship” is another hair-on-fire scare story cooked up by those who don’t want the companies released.

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      1. Gee, such a ‘contigent support arrangement’ (otherwise called an ‘explict guarantee’) would require Congressional action. Unless you beleive SecTsy can appropriate funds to the GSEs without Congressional approval.

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        1. Not necessarily. If Treasury were to endorse the new FHFA capital standards as making the risk of the companies losing all of their capital “extremely remote,” I believe a further layer of catastrophic insurance could be arranged with private reinsurance companies for a very reasonable annual premium.

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        2. @egar

          let’s be clear here. read HERA. it says that the current existing treasury backstop is “appropriated”. there is some $200B of remaining congressionally funded backstop for the GSEs THAT IS ALREADY IN PLACE. I do all caps because the MBA group (which may or may not include you) doesn’t seem to get it. congress doesn’t need to do anything!

          read the statue!

          rolg

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          1. @egar

            from Fannie’s 2018 10K: “As of the date of this filing, the maximum amount of remaining funding under the agreement is $113.9 billion.”

            there is a “savings provision,” in Section 1117 of HERA, that makes clear that all amounts drawn under the line shall be deemed appropriated by Congress (“Any funds expended for the purchase of, or modifications to, obligations and securities, or the exercise of any rights received in connection with such purchases under this subsection shall be deemed appropriated at the time of such purchase, modification, or exercise.”).

            now, this line of credit would have to be amended to provide a commitment fee and, presumably, make it clear that the securities issued to treasury in respect of any future draw shall not have a NWS. treasury and FHFA have authority to amend the line of credit in all respects except increase treasury’s maximum obligations thereunder.

            rolg

            Liked by 1 person

  26. Cooper & Kirk Lawyers
    A Professional Limited Liability Company
    David H. Thompson
    (202) 220-9659
    dthompson@cooperkirk.com
    Via ECF 1523
    New Hampshire Avenue,
    N.W. Washington, D.C. 20036
    July 15, 2019

    Lyle W. Cayce
    Clerk of Court United States Court of Appeals for the Fifth Circuit
    600 S. Maestri Place New Orleans, LA 70130-3408
    (202) 220-9600
    Fax (202) 220-9601

    Re: Collins v. Federal Housing Finance Agency,
    No. 17-20364

    Dear Mr. Cayce:

    It is no coincidence that since the current President took office the Department of Justice has had one position on FHFA’s constitutionality and FHFA has had three. FHFA’s latest switch, prompted once again by a change in leadership at the agency, only further underscores how this agency’s novel structure places vast executive power in the hands of a single individual who is wholly unaccountable to the President. Humphrey’s Executor blessed the FTC’s independence because in that case independence—combined with leadership from a commission whose members serve staggered terms—was thought to promote continuity and expertise at the agency. In FHFA’s case, independence achieves the opposite of continuity by leaving critical policy decisions up to the whim of whichever individual happens to sit atop the organizational chart of an agency that answers to no one. FHFA was right the second time, not the first or the third.

    Respectfully submitted,

    /s/ David H. Thompson

    Liked by 1 person

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    1. @Brian

      a particularly effective piece of advocacy, that points out that D’s conduct makes P’s argument for P.

      while I expect it is too late to affect the en banc decision making (though the argument could be tucked into an opinion before publication), Thompson’s point addresses a concern held by at least one 5th circuit judge (Higginbottom) that leans to the govt side. in the All American oral argument he asked P counsel (in context of the CFPB) where to draw line; is single director removable only for cause the constitutional flaw, or do you also need insulation from congressional appropriation etc. he said that if the court were to advise congress on where the constitutional line is to be drawn (which is not the court’s duty in the exercise of its Article III judicial power), what would be the answer.

      by pointing out to the court that the FHFA single director before the court switched positions two times in a full 360 spin during a single argument, Thompson is able to show the judges inclined to follow Higginbottom that the single director insulated from removal doesn’t produce the expertise development and continuity benefits thought to underlie the multi-member commissions in the original SCOTUS case examining insulation of directors from POTUS removal.

      rolg

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  27. Tim

    today we have two news pieces: https://www.bloomberg.com/news/articles/2019-07-12/trump-team-grows-wary-of-fannie-freddie-fix-before-2020-election and https://www.marketwatch.com/story/fannie-freddie-overhaul-could-mean-windfall-for-preferred-stock-analyst-says-2019-07-12?mod=mw_share_twitter

    the first is written by a partisan (anti-GSE) Bloomberg news organization that, I have read, pays more money to its Bloomberg journalists for moving markets. the second is written by a securities analyst who makes more money by making money for his firm’s clients.

    I dont know which article is or will prove more prescient, although I think you can find no better example as to how politics and finance are ill-suited dance partners than this comparison.

    rolg

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    1. I saw the headlines, but haven’t yet been able to read any of the stories. I’ll be traveling back to the U.S. today and won’t have have any informed commentary on anything until sometime tomorrow. In the meantime, I’ll remind readers that mere expressions of opinion (or frustration) about recent developments, without either new information or insightful analysis, will be deleted once I re-engage with the blog, so you may wish to consider saving time by not posting them in the first place.

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        1. Great update to that article 25 mins ago:

          ““The president earlier this year instructed the Department of Treasury to develop a comprehensive plan for bold reform,” White House spokesman Judd Deere said in an email statement. The National Economic Council, Treasury, Federal Housing Finance Agency and others “continue to work together on this presidential priority and anything to suggest otherwise is false,” Deere said.”

          Bloomberg seems to like to print things first from anon sources, only to have the parties involved correct them after the market has moved on their earlier reporting. Bonus achieved.

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          1. This clarification from the White House was helpful in clearing up the confusion created by the original Bloomberg article, but there are two cautionary elements in it. The National Economic Council (NEC), headed by Larry Kudlow who is no friend of Fannie and Freddie, is mentioned first in the list of those who “continue to work together on this presidential priority,” and consistent with that, the group’s efforts are described as developing “a comprehensive plan for bold reform.” The idea that you can’t remove Fannie and Freddie from conservatorship without a bold and comprehensive overhaul of the (“old, flawed”) system has been the pretext for keeping the companies under government control for over a decade. The NEC, at least, seems to be sticking with this playbook. We should know in fairly short order whether their influence prevails within the administration.

            Liked by 2 people

          2. Tim

            “bold” reform caught my eye as well. I concluded that if both admin and congressional reform was achieved (based upon Mnuchin’s desire for bipartisan congressional involvement and Calabria’s suggestions to congress), the result would be bold…including fed mbs guaranty and multiple charters. if just admin reform, less bold.

            rolg

            Liked by 1 person

          3. On legislation, Senate Banking Committee Member Mike Rounds was quoted this past Thursday 7/11 saying regarding congressional GSE Reform efforts, “I wish I could say it was going somewhere. It ain’t.” Per a Thursday 7/11 tweet from ACG Analytics (@ACGAnalytics). A google search indicates Rounds spoke that day at a Venable LLP Event. Interesting to hear this now from a Republican member of the Senate Banking Committee.

            Liked by 1 person

          4. No one expects legislative mortgage reform in the foreseeable future. The question now is: what form will the administrative reform piece take? If Mnuchin and the Treasury are driving the process, I would expect it to be consumer- and investor-friendly, and be designed to result in the removal of Fannie and Freddie from conservatorship in a manner that still could be described as “reasonably fast.” If, on the other hand, the anti-Fannie and Freddie forces within the administration, led by NEC Director Kudlow, have taken control, I would expect the process to be bank-friendly and take much longer, allowing for more opportunity for potential future legislative changes.

            What would pro-bank administrative reform of Fannie and Freddie look like? It would start with few significant changes to the capital standards promulgated by FHFA in June 2018, which were engineered to produce much higher required capital than warranted by the risks of the companies’ business. There then would be an agreement between FHFA and Treasury to cancel the net worth sweep, followed by Treasury’s conversion of its warrants to acquire 79.9 percent of the companies’ common stock. Next, FHFA would direct the companies to come up with plans to achieve their new required capital percentages, which when met would trigger their release from conservatorship. If, given the regulatory and capital requirements FHFA intended to impose upon Fannie and Freddie, investors were willing to put new equity into them, great; if not the companies would remain under FHFA control until they could achieve their target capital percentages through retained earnings, which would take many years but could be done more quickly by “shrinking their footprints.”

            I’m not predicting that this bank-friendly approach to administrative reform will be the one chosen—indeed I dearly hope it’s not. But I do believe there are strong advocates for it.

            Liked by 2 people

          5. Tim

            ex-Freddie ceo Layton just laid out that “baseline” in a WSJ article:

            “Four or five years of retained earnings, then do an IPO of more-likely digestible size that would be contemporaneous with the conservatorship ending and with the shareholders getting their full rights. That’s the baseline. I know a lot of people who would love to accelerate from that, but then they have to deal with all of these trade-offs. That acceleration is one area that’s hard.”

            https://www.wsj.com/articles/former-freddie-mac-ceo-plans-to-keep-hand-in-housing-finance-11562932800?mod=searchresults&page=1&pos=1

            but of course, if the first stage of the recap process can be a re-IPO at the beginning, then the process accelerates and disincentivizes MBA-moral hazard. can the re-IPO occur upfront while GSEs are still in conservatorship? Layton seems to be inclined to think not, but then again, the GSEs have generated >$200B in free cash flow while in conservatorship, so it would seem prudent to give it a shot.

            rolg

            Liked by 1 person

          6. I read the Layton interview. In the spectrum of outcomes I described in the current post for the upcoming revision of the FHFA capital rule–from a “straightforward attempt to produce an accurate risk-based standard,” to one “engineered…to produce a particular predetermined outcome” [favored by the banks], or an attempt to “land somewhere in the middle”–the scenario described by Layton would fall between the middle and the bank-desired alternatives.

            The administration SHOULD do the Fannie/Freddie capital and regulatory reforms in a way that meets rigorous safety and soundness standards comparable (but not equal) to those imposed on other financial institutions, while leaving the companies in the best position to provide the lowest-cost mortgage credit guarantees to the widest possible range of potential homebuyers. That would be best for consumers, the economy, and our financial system. But unfortunately competitive, ideological and political considerations all but rule out the optimum outcome. So now we wait to see how far from the “most homebuyer friendly” towards the “most bank friendly” end of the spectrum Treasury and FHFA elect to go. The point I’ve tried to make with my last few comments is that the amount of new equity supplied by investors will decrease, and the length of time it will take to complete the recap will increase, the further from homebuyer-friendly toward bank-friendly Treasury and FHFA’s “reforms” for Fannie and Freddie end up.

            Liked by 3 people

  28. Tim interesting comment from Paul muoulo
    pmuolo@imfpubs.com, bivey@imfpubs.com

    “If you’re wondering why everyone in the mortgage industry is waiting with bated breath for the new capital standards for Fannie Mae and Freddie Mac, it’s simple: Those standards, once cast in stone, will give the Federal Housing Finance Agency a powerful tool. One GSE observer who used to work on Capitol Hill told IMFnews those standards will give the FHFA legal cover to declare Fannie (or Freddie, take your pick) “critically” undercapitalized. Once that determination is made, the agency can move to terminate the conservatorship and enter into a receivership…

    The next step might be to create a limited liability regulated entity (LLRE) which would succeed the GSE. After that, the LLRE (once capital is raised) becomes a new company and the charter is sold to new owners. From what we understand, the FHFA has the legal power to sell the charter. We also understand that the Treasury Department under former Senior Counselor Craig Phillips was well aware of all of this. More to come in the weeks ahead.”

    Care to comment?

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    1. This is a nothing story. The option for FHFA to put Fannie and Freddie into receivership has existed since it and Treasury decided to use book accounting entries to exhaust all of their capital back in 2008, and it was kept alive when FHFA and Treasury agreed to the net worth sweep in 2012 in order to keep the income from the end or the reversal of those book expenses from becoming retained earnings (i.e., capital) at the companies. FHFA has not put Fannie and Freddie into receivership during all this time for one simple reason–neither it nor Congress has been able to come up with a replacement for them. The pending capital standards don’t change either FHFA’s options or its likely decision with respect to those options in any way. Another scoop from IMF (“Hold the back page.”)

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        1. Michael Bright, now at SFIG and the author of Corker’s legislation that called for receivership, is the only main GSE opponent left who used to work on the Hill.

          Some tigers never change their stripes.

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    1. I am not surprised that Calabria would reverse Acting Director Joseph Otting’s decision in January to withdraw FHFA’s prior assertion that the agency was constitutionally structured, reverting to the original position that FHFA’s single director removable only for cause IS constitutional. (Among other reasons, the current structure gives Calabria more power to do what he wants, for the remainder of his term.) But I AM surprised Calabria also also defended the legitimacy of the net worth sweep (if indeed he did; the Breitbart article says so, but I’ve not seen the actual letter). As a private consultant, Calabria had been consistently and forcefully outspoken about the illegality of the sweep. If true, this would be a striking example of the maxim “where one stands depends upon where one sits.” It also would not be a good sign for FHFA putting itself behind an administrative release of Fannie and Freddie from conservatorship, without a court invalidating the net worth sweep Calabria now says he supports.

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      1. Thank you Tim. I owe you a nice meal if you’re ever in the D.C. metro. You are incredibly insightful on this topic, and you are one of the good ones. Thanks

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      2. Tim,

        Supporting the NWS would mean (a) supporting an interpretation of HERA that allowed for the NWS. It could also mean (b) supporting the NWS decision as a solution, at the time, to end the “circular borrowing.” However, and as strange as it is for Calabria now to support the NWS in those two ways, I don’t think such support would make it inconsistent with (c) supporting putting an end to the NWS so that the GSEs can begin to retain capital.

        (a) is strictly a legal consideration.

        (b) pertains to a (dubious) practical concern during a state of affairs specific to 2012.

        Whereas (c) is justifiable based upon GSE reform giving way to recapitalization concerns.

        Thoughts?

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        1. These are plausible interpretations, but given everything else Calabria has said and done since he became Director of FHFA, it’s hard for me to view his letter to the Fifth Circuit judges as anything other than throwing more sand in the gears of administrative reform.

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      3. This is the correct reading (from Wiggins on COBH):

        It makes sense that Calabria would reverse direction regarding the constitutionality of HERA, given that he helped write it and he keeps an original dog-eared copy of it. In that sense, perhaps he is merely arguing that an unconstitutional structure cannot be a reason for the NWS to be invalid. A key sentence supporting this is: “At all relevant times FHFA argued and continues to argue the issue does not affect the Third Amendment’s validity.”
        I believe his prior arguments against the validity of the NWS were based on the fact that it does not fall within the power of a conservator, i.e. the APA claim. He doesn’t speak to this in this latest letter. Does anyone else see it this way?

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        1. first, this last minute about face by calabria on the separation of powers claim is completely amateurish and makes fhfa look foolish. the en banc 5th C judges have been twisted a full 360 degrees on this and must be laughing in their chambers. my bet is that the majority opinion(s) are written and the dissents are soon to be finished, so this embarrassing letter likely is to be given no weight by the en banc.

          second, calabria did not touch upon the APA claim. fhfa has always argued that no relief should be given for the separation of powers claim, first because removal of single director only for cause was constitutional, second because even though it was unconstitutional no remedy should be provided Ps, and third back to it was constitutional.

          why would Calabria do this? lots of possible reasons: make the deal with mnuchin look more at arms length between co-equal officials, protect himself and the recap/release beyond 2020 in case trump loses election, tell treasury that calabria has final say about capital etc.

          rolg

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          2. Another question, why deny the constitutionality of FHFA in the first place? Would Otting have presumed to make such a decision on his own (especially in his temporary capacity)?

            It’s all so bizarre. I can’t even attribute a calculated scheme to this given all the flip flopping, even accusatory remarks regarding funding Obamacare and other programs. At least the previous two administrations were consistent in their takings.

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          3. I’ve been traveling outside the country this week (returning tomorrow evening) and haven’t been able to follow either the most recent developments in the mortgage finance arena or the postings on this blog in anything close to real time. I finally read the letter Robert Katerberg wrote to the Clerk of the Court of the Fifth Circuit, and see that Breitbart did get the story wrong–Calabria did not reverse his position on the legality of the net worth sweep. That makes this filing less concerning, and for me at any rate merely curious, given that almost six months have passed since the oral argument before the Fifth Circuit and, as ROLG notes, the sixteen judges almost certainly have decided where they stand on the issues before them and why. Katerberg’s letter is unlikely to change any of that.

            Liked by 2 people

          4. @ron

            fhfa and treasury will soon, one hopes if not expects, be negotiating a deal to settle litigation, both against Ps, and to lay out the basis for a recap, fhfa in the capacity as conservator representing the GSEs as debtor and treasury in the capacity as creditor (though re senior preferred stock rather than debt).

            so fhfa and treasury optically should assume an arms’-length relationship, even as their interests are aligned…both want the GSEs out of conservatorship. yet the more treasury keeps the less the fhfa’s conservatorship wards retain, and so there is a diversity of interest as well. fhfa needs to assert independence at this point, so the thinking behind Calabria’s letter assumes, imo.

            Calabria’s letter is kabuki theater in courtroom setting.

            rolg

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        2. I agree ROLG, this seems ridiculous to submit such a letter this late in the game. We know the legal team for FHFA is not run by amateurs and Calabria has been working in Washington long enough that he’s no amateur. It seems to me he would know very well how the letter would be received by the en banc court (or would have been advised on how it would be received) and did it anyways. Who knows what his reasons are? It feels like throwing the fight to me. “Hey 5th circuit, at this late hour, please provide a ruling on our flip/flopping poorly argued stance on structure of FHFA.”

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  30. Tim

    Hamish Hume’s excellent article regarding how the recap must protect shareholders’ rights: https://www.americanbanker.com/opinion/recap-of-fannie-and-freddie-must-protect-shareholder-rights

    Hume points out that the overpayment beyond the 10% moment, which he calculates to be $18B, should be returned by Treasury to the GSEs, and he refers to how the reasonable expectations of GSE shareholders were violated by the NWS, which is the claim he is prosecuting in front of Judge Lamberth.

    Hume’s article tracks closely along the Moelis Blueprint, though Hume cautions against conversion of the junior preferred into common. On this I quibble with Hume. I expect some form of conversion to be proposed by Treasury and if 2/3rds of each class of junior preferred vote to convert, then there will be “exit consents” forcing the rest of the class to convert (as the consents will be to adverse amendments to the preferred). see section 7(c) of certificate of designation https://www.sec.gov/Archives/edgar/data/310522/000031052213000065/fanniemae201210kex415certo.htm. this coercive “force-along” provision will deprive any junior preferred holes of hostage or hold-up value, with the hurdle of getting 2/3rds consent being the protection for each holder that the conversion rate is fair.

    rolg

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    1. ROLG,the only reason the Moelis’ plan called for Junior preferred shares to be converted to common was because the plan called for no dividends to be paid until recap is achieved. If dividends are stopped the value of the preferred shares is diminished. There is a lot of rhetoric out there saying if commons are worth a penny preferred shares are worth par, but this is in a liquidation scenario. In a going concern scenario preferred shares can be worth more or less than par since their value is based on the dividend percentage that is compared to the Treasuries.

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    2. The only reason to convert the preferred shares to common will be to simplify the capital structure if the plan calls for recap issuing new preferred shares.

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    4. I agreed with almost all of what Hume said in his American Banker article. On the issue of how to reverse the sweep, Hume’s method of re-characterizing quarterly sweep payments in excess of a 10 percent annualized dividend on the then-outstanding senior preferred stock as paydowns of the senior preferred balance is what plaintiffs are asking for as a remedy for the imposition of the sweep, and I think it’s the correct way to do it. The “ten percent moment” is an internal rate of return calculation popularized by Alex Pollock, and it would result in substantially less than an $18 billion refund going to the companies, essentially rewarding Treasury for having entered into the sweep. If the sweep was illegal it should be unwound, full stop. And I don’t have a view about whether or how the junior preferred stock should be converted to common; I’ve said from the beginning that I’m content to leave that decision to the investment bankers and the major institutional investors who have more expertise and more of a stake in that decision than I do.

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      1. Along with his previous convictions?! “Where one stands depends upon where one sits” is a new proverb to me. I think I’ll keep it (along with Geritol).

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  31. Tim,
    If at some point in this process the senior preferred are deemed paid and the parties are unable to convert the junior preferred to common shares under a recap and release, would the junior preferred be considered part of the companies’ core capital?

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    1. Fannie and Freddie’s junior preferred is part of the companies’ core capital today. Fannie, for example, has shown $19.1 billion in junior preferred stock on its balance sheet since the end of 2011. (For the trivia buffs among the readership, Fannie had $21.7 billion in junior preferred outstanding when it was put into conservatorship in September 2008, but some of that was convertible. With the dividends shut off on all preferred stock–and it all being non-cumulative–holders of convertible preferred converted most their shares to common over the following three-plus years: $503 million over the balance of 2008, $874 million in 2009, only $144 million in 2010, and then $1.074 billion in 2011, before the conversion window closed. Some who converted may now wish they had not done so.)

      The reason you don’t see Fannie’s or Freddie’s junior preferred in the companies’ equity totals is that it’s offset by a combination of losses accumulated between 2008 and 2011 (which wiped out all of the companies’ capital, and more) and Treasury stock (common shares repurchased in pre-conservatorship years to boost earnings per share–which seemed like a good idea at the time, but in retrospect was not). Any who wish to know what Fannie’s equity account looks like–and how it changes from period to period–can go onto the company’s website and download any of its earnings press releases. At the very end all of them have a schedule titled “Condensed Consolidated Statements of Changes in Equity (Deficit).”

      Getting back to your question, if the senior preferred for each company were cancelled, their equity accounts would be unaffected: the component of their equity called “Senior Preferred Stock” would be reduced by the dollar amount of the cancelled senior preferred shares, and the “Accumulated Deficit” component would be increased (that is, made less negative) by the same amount. But then the companies could begin retaining earnings and raising new capital without fear of it being shipped to Treasury.

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      1. Tim – many believe that the fear would still be there as there has been no court ruling saying what was done over the course of the conservatorship was illegal or even ultra vires from the conservators standpoint. I still fail to see how fears of capital recapture would be abetted given that there seemed to be no legal recourse for the investors the first time around.

        Yes they sued, but their pleas all feel on deaf ears even when the facts were loaded in the plaintiffs favor along the way.

        Further, the secrecy with which the gov’t attempted to, and at least partly successfully, operated with would also make it neigh impossible to discern what actually occurred and make a judgement on whether or not it would be able to defend its invested dollars here going forward. My view is that they would have 0 chance given comments from plaintiffs attorneys in public forums “because of what that would mean.”

        Further still, the media was very obviously in on the take along they way – with the likes of wsj, fox biz, brietbart, cnbc, all abdicating any responsible role the 4th estate is ostensibly supposed to fill but has clearly failed.

        I fail to see how any rational investor managing billions is going to look at the history and say hit the bid given the reality of what happened and the ever shifting sands in DC.

        How does one get comfortable here?

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        1. @anon

          if I may, while I am sympathetic with this line of thinking, and indeed it formed the basis of the Perry amicus brief authored by Vartanian, also remember that the NWS was a conservator’s act, which (assuming it is not ruled authoritatively to be illegal) can only be repeated in conservatorship under HERA. once fhfa lifts conservatorship in connection with the capital raise, there would be no authority for fhfa or anyone else to repeat the NWS saga unless the GSEs were first put back into conservatorship. this may may be scant solace if there is no ruling by the 5th circuit invalidating the NWS…and even if there is, it is not likely that collins will be ruled upon by scotus prior to a release from conservatorship. a settlement is likely to be reached before that point.

          rolg

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          1. Thanks for your reply rolg.

            I appreciate that something similar to the NWS MAY only happen again under HERA if the GSEs (are ever released and then) re-enter conservatorship.

            However this brings up another question about bridges.

            Many say that at this point in the saga that it is a bridge too far to completely reverse the conservatorship. However, we now know that the impetus for the conservatorship was based on ‘creative accounting’ (read: fraud) and assumptions of catastrophic losses at one point in time that were used to justify the takeover and of course those losses never came to fruition. No, in fact the profits were so enormous that the same people who were publicly saying it was going to be a death spiral were privately discussing a golden age of profitability just a couple short years later after massive amounts of gov’t stimulus was required to shore up the housing market and save the banks from their own malfeasance of PLMBS issuance and cubed CDOs.

            I think it is a bridge too far to expect, with the publicly available history that now exits here, that money is going to come in given the systemic problem the gov’t itself has shown to be.

            Now as Tim points out, many of the competing firms are continuing to desperately try to hamstring them any way they can so they can swoop in and take over the market, killing the 30 year and making SFR biz model rule the land and we’re supposed to think that they are going to be released by a former alum of the same firm that whose prior alum had peoples heads hitting the floor. I find this all very convenient and suspect and I would wager that many others do as well, so much so that barring an adverse ruling on this entire fiasco cutting all the way back to the actions in 08, there will be few takers today.

            Would love to get thoughts on why that line of thinking is incorrect as well. Truly I would. I’ve not seen any to date.

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          2. ROLG, the companies were put in conservatorship while meeting all capital requirements imposed on them by their regulator. What guarantee do investors have the Treasury will not do the same takeover in the future and impose a new NWS? The plan in 2008 was to liquidate both companies and nobody was thinking how the Treasury actions would be interpreted by invesotrs, since nobody was thinking of recapitalizing the GSEs. Now it is catch 22.

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          3. @anon

            one observation and a suggestion for Calabria (who could use a little help from his friends).

            Greece within recent memory was on life support, and is now selling sovereign debt at rates comparable to the US. memories can be short in finance.

            Calabria should make clear as fhfa director, in connection with the settlement of litigation, that the NWS was not valid under HERA. a 3rd A that accelerated repayment of interest and principal to treasury with a sweep mechanism would have been, for example, so long as the sweep was extinguished when the sr. pref was paid off…something along those lines. he can do that in connection with a settlement and full releases all around…and he can do that because as far as I can tell he believes that. that might go a long way to addressing the market concern.

            rolg

            Liked by 2 people

          4. I don’t have much to add to this discussion (which I’m seeing late, since I’ve been traveling). I only would emphasize that in the discussions between senior officials at Treasury and FHFA, investment bankers and major institutional investors that will have to take place before any serious recapitalization plan can be formulated, the past actions of Treasury and FHFA with respect to Fannie and Freddie will be one of the top concerns raised by investors, and it will be up to Treasury and FHFA to come up with a way to address those concerns to investors’ satisfaction. I don’t know how that will be done, only that it will need to be for a recapitalization of the companies to go forward.

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  32. Tim

    as we await the treasury plan and the Collins en banc decision, I have tried to simplify the situation in my mind, and perhaps this might interest you and your readers. you can certainly weed out much detail when you simplify, and as well run the risk of dropping important details from the process. any feedback is appreciated.

    in my view, number one rule in finance (and business generally) is to try to engage in a course of action in which all parties to a transaction prosper. even better if that course of action is really the only feasible course of action.

    rule number two is that you almost never find transactions that satisfy rule number one.

    but consider this: the only way to raise $100B of GSE capital is to nuke the senior prefs. the only way to settle the lawsuits is to nuke the senior prefs. not saying this is sufficient, but it is necessary in each case.

    wow. it looks like we are pretty close to satisfying rule number one…nuking the senior prefs is the core course of action.

    now there are obviously a lot of details around this core course of action that need to be worked through, and i) fhfa will have its say (principally, capital), ii) treasury will have its say (how much more than the 10% return does it need from this saga…which affects whether the $20B+ it has received beyond the 10% moment will be put back into companies…remember that if treasury does this, it stands to gain 80% benefit from doing this through the warrants…and how much of the 80% warrants does it want to monetize…understanding that the more it monetizes the harder the capital raise), iii) the market will have its say because the market always has its say, iv) congress will have its say (but query if it will be more substantive than the usual grumbling, amounting to nothing), and v) the large junior prefs will have their say, given their prominent economic position (and the need to get 2/3rds of each class of junior preferred to convert into common as, I suspect, will be an aspect of the plan).

    so this will shake out slower than one might want, and since this is a dynamic non-linear process (one player’s move affecting the decision processes and moves of the other players), it will also shake out likely in a more unpredictable way than one might want. by simplifying one cannot make it more determinate.

    while this process is without precedent (no release from conservatorship/receivership of this magnitude before), which one might think adds to the uncertainty, I actually think this benefits the process insofar as decision makers will need to gravitate to the best solution on offer in the absence of precedent, and clearly the Moelis Blueprint is that roadmap. no other course of action that has been discussed over the past 7 years comes remotely close.

    now one culled detail that I want to reintroduce to the analysis is the tbtf bank effect on decision makers calabria and mnuchin. given the demise of SBC plans over the past few years that were neither well thought out nor feasible, it seems clear that Calabria’s suggestion to congress to pass a limited fed guaranty and charter competition is an accommodation to the tbtf banks. I feel certain this will not pass congress during the timeframe that calabria has discussed for the commencement of the administrative reform process. at some point once the administrative reform does commence, I believe the prospect of the tbtf banks being able to earn outsized underwriting/advisory fees will capture the attention of tbtf banks. nowhere but on wall street does money more focus the mind.

    rolg

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    1. I’m not as sanguine as you are on the potential for the banks and their supporters to back away from their opposition to having Fannie and Freddie return as shareholder-owned guarantors in anything close to their pre-conservatorship form. Put differently, I don’t think they’ll renounce a lifetime of opposition to the companies for a one-time (or maybe two-time) underwriting fee, no matter how large. In my view the bank lobby will continue to ask the impossible of Treasury and FHFA in administrative reform: smother Fannie and Freddie with structural constraints, including excessive capital, and intrusive oversight, then go out and convince investors to put $100 billion or so in new money into two companies that will have to struggle to achieve middling financial performance. I believe Treasury and FHFA will have to make a choice between what the pro-bank crowd wants and what will work in the market. I don’t know what they’ll do, so I’m just going to wait to see what the administration’s mortgage reform plan and FHFA’s revised capital plan look like. Then I’ll know, as will everyone else, and we can take our analyses from there.

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  33. Tim,

    Charlie Gasparino at Fox Business News reported today that JP Morgan held a meeting that included banks as well as FNMA FMCC top stock holders and Moelis today. I don’t fully trust his reporting, but he occasionally gets a truth nugget and this feels like one. Any thoughts on how such a meeting might have gone?

    Also, my sense is that rules of cooperative effects will soon start to take hold upon release of the administrations plan. At least one big bank will want the underwriting business of the largest public offering ever. That bank will need to support the recap and release against the will of the other banks. If this is imminent, wouldn’t they all start wrangling to be the chosen underwriter and thereby all start singing a new tune in support of recap and release? Or do you think that IPO is not enough business to warrant such a change in tone?

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    1. @juice

      if I may, this capital raise will be large enough to require all investment banks’ participation, and the fees will be large enough to guarantee this widespread participation. while there are tbtf banks, all of which have capital markets investment banking divisions, which may oppose the GSEs at the C suite level and have contributed to the MBA lobbying effort against the GSEs, there is no way any of these tbtf banks are going to make their investment banking divisions sit this one out once it gets started. all big investment banks will want to participate in the underwriting syndicate.

      rolg

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      1. I have no reason to doubt that the meeting Gasparino described did in fact take place. I would have liked to have been a fly on the wall there. (And, yes, I do know some of the people who were alleged to have attended, but I would not ask them about it, and if I did I’m sure they wouldn’t give me any details.) Breaking it into groups, you have the authors of the only public plan for recapitalizing Fannie and Freddie (the Moelis team), major institutional investors who will need to supply the capital that would make the recap a reality, and underwriters who will be responsible for structuring, marketing and pricing the deal. I doubt that any of these groups yet has a solid idea of what Fannie and Freddie are going to look like and how they will operate post-conservatorship, so my guess is that one key purpose of the meeting would have been to elicit the views of each party on the prerequisites for a successful capital raise, including the terms and context of a settlement of outstanding shareholder lawsuits, and what will be required from FHFA in the way of the capital rules and regulatory regime for the new companies to be able to successfully attract the volume of new equity needed to return them to shareholder ownership.

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        1. Tim

          my question is why did JPM hold this informational meeting? or put another way, if the Moelis folks were the main presenters, why didn’t Moelis hold the meeting?

          one answer is that JPM has many institutional investor clients who JPM thinks may have an interest in an upcoming offering, and JPM was just doing right by its customers. moelis wouldn’t have pulled in an equivalent audience. in my experience, however, someone in JPM’s position would usually also have some relationship with the prospective issuer, so that the investment bank is sniffing a forthcoming fee. without that relationship, the investment bank is just prospecting without a client. why help out an issuer if the investment bank isn’t retained? it’s the expectation of a fee that usually sets activity in motion.

          which leads me to believe that JPM has some obtained a mandate in connection with this deal…which is my speculation based upon my experience.

          rolg

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          1. I think there may be a simpler explanation for JP Morgan’s role in the meeting: JPM convened it at the request of one or more of the non-litigating shareholders who hired Moelis as their investment advisor, with the goal of trying to agree on how to structure and market a deal that will appeal to the much broader range of investors that will be necessary for a successful equity raise, but who are not nearly as familiar with what’s recently been happening with Fannie and Freddie as are the core group of litigating and non-litigating shareholders.

            The notion that JP Morgan already has been given the mandate to lead one or both companies’ capital raises at this early stage strikes me as a stretch. That mandate would have to have come from FHFA, acting for the companies it controls in conservatorship. Since FHFA has no experience in evaluating investment banks’ suitability for this role–and I doubt it would allow Fannie and Freddie’s management to make the choices–it will end up deferring to Treasury. That should indeed be what happens at some point, but I doubt it’s been done already. FHFA Director Calabria still is trying to exert influence over what the post-conservatorship Fannie and Freddie will look like, and in this regard seems at the moment to be more at odds than in alignment with Treasury on the recapitalization process. You don’t pick your horse (a lead investment bank) until you’re agreed on the size and type of the cart you’re going to ask it to pull, and FHFA and Treasury don’t appear to be at that point yet.

            Liked by 2 people

  34. Tim

    you and your readers might find this curious. this is a tweet by chris whalen to the effect that there can be no congressional passage of Calabria’s suggestions (charter competition and fed guaranty), based upon his attendance at a HFSC staff meeting, https://twitter.com/pgray41/status/1144608240501698560

    that tweet was then deleted. given that whalen holds himself out as a bank consultant, one wonders whether he was encouraged to delete the tweet by those who are eager to turn Calabria’s suggestions into roadblocks to delay admin reform.

    rolg

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    1. Your theory about the deletion of the tweet certainly is plausible. Whalen’s statement that legislative mortgage reform is “[n]ever gonna happen” is hardly news–any objective observer knows this–but as you point out the pro-bank crowd has to pretend to believe it could happen in order to justify slow-walking, or opposing outright, administrative reform. Whalen’s slip-of-the-tweet apostasy leaves the pro-bank forces with no argument for opposing what Treasury is trying to do other than self-serving obstructionism, so, poof, the tweet is gone.

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  35. Tim

    I watched the SBC hearing on SIFI designation for GSEs this morning. as far as I could tell only 6 senators showed up for it.

    why does Calabria continue to suggest that congress pass “GSE reform” when it is clear that the senate committee charged with GSE oversight has no interest in taking up the issue? the more calabria raises the issue of need for congressional action, the harder it is for him to supervise a successful capital raise.

    It is hard to imagine a regulator creating more harm (market perception of political risk) for less benefit (likelihood of actual congressional action). what started in my view as an intramural showing of respect by the executive branch for congress has now in my view morphed into a comedy of the absurd.

    rolg

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    2. there was one interesting comment by senator brown during this SBC hearing. he stated that he and the other members of the committee were surprised at the number of speakers invited to address the committee who argued for “utility ” regulation of the GSEs. see for example https://www.creditslips.org/files/levitin-senate-banking-testimony-3-26-19.pdf.

      this is a rather explicit rebuke of Calabria’s call for GSE charter competition. one speaker in this hearing, Prof Wachter made the further point that competition doesn’t become effective, assuming it could be effective in the case of mortgage guarantors, until there are some 30-100 competitors. but she believes that mortgage guarantor competition in any event would have negative effects on the housing finance industry.

      here is the video of the hearing: https://www.banking.senate.gov/hearings/should-fannie-mae-and-freddie-mac-be-designated-as-systemically-important-financial-institutions

      rolg

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      1. ROLG: I haven’t seen the SBC hearing video (and may have more to say if and when I do), but even without seeing it I’ll say that your two comments are related.

        The multiple guarantors idea is the latest in a long series of reasons invented by supporters of the large banks as a pretext for arguing that legislation “reforming” Fannie and Freddie is essential, and that anything less–including imposing sensible capital requirements and regulation on the companies–would be an unacceptable return to the “failed model of the past.” I won’t go over all the reasons why multiple credit guarantors is not a good idea–others have done that–but as you point out Congress simply isn’t going to give the banks what they want on this.

        Which brings me to Calabria. I had said from the time his appointment was announced that reconciling his ideological (and in my view uninformed) views about Fannie and Freddie with the facts and market realities of releasing them from conservatorship was a prerequisite to achieving the latter. I thought the way that most likely would play out would be for Treasury Secretary Mnuchin, his staff and financial team (including investment bankers) to essentially say to Calabria, “Your ideas about Fannie and Freddie may sound good in theory, but we won’t be able to get Congress to put them into practice, and even if we did they won’t work the way you think they would.” Calabria then would say, “Okay, so what should we do,” and the recapitalization process would begin.

        I don’t know what’s happened to change that, but my guess is it’s been the influence of the banks and their supporters within the administration. I strongly suspect they’ve been telling Calabria that his ideas on bank-like capital and multiple guarantors are absolutely on the money, and that he needs to see them through and not give in to what the greedy hedge funds want Treasury to do. And with Calabria digging in on these points, Mnuchin hasn’t yet come up with a way to overrule him without causing friction with the banks, who are Treasury’s historical allies.

        This is not a particularly optimistic reading of the current situation, but I fear it’s the correct one: Calabria is setting himself up as an obstacle to something that should and could happen (sensible recapitalization of Fannie and Freddie and their release from conservatorship) by becoming an outspoken advocate for something that shouldn’t and won’t happen (bank-centric legislative reform). Mnuchin has Treasury’s considerable institutional clout to draw upon in breaking this impasse, but so far he hasn’t seemed willing to do so. Perhaps a ruling from the Fifth Circuit in favor of the plaintiffs will give him the impetus he thinks he needs.

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        1. I don’t think that Mnuchin feels all that differently from Calabria. The public comments that Mnuchin has made indicate that he supports multi-guarantor model. His former top advisor Craig Phillips has also made similar comments:

          “The administration advocates ending the conservatorship of Fannie Mae and Freddie Mac and returning them to private ownership,” Phillips said. “Their charters should be removed from statute and their operations should be overseen by the primary regulator that has the authority to approve additional guarantors to introduce competition into the secondary mortgage market.”

          No high ranking official in Trump administration has publicly advocated for simple Recap & Release plan.

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          1. Mnuchin has always said he would prefer a legislative path to removing Fannie and Freddie from conservatorship, but the midterm elections effectively closed that off, leaving administrative reform as his only practical option. And we know from the leaked remarks made by Acting Director Otting to the FHFA staff in mid-January that there was an administrative proposal set be announced “in two to four weeks” that “really sets a direction for what the future of housing will be in the U.S.,” and that would require raising “probably somewhere, based upon their business models today, [in the range of] $150 to $200 billion.” Something happened to derail that plan, and I believe it was a swift and fierce show of opposition by the banks and their supporters. Perhaps we’ll learn the full story at some point.

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          2. @homebound

            this is a statement of aspiration by Phillips. I agree that this is the preferred end result for the administration. my question is how long will the administration dither with resect to implementing administratively that which it can implement, leaving congress to its devices. the administration could plausibly think that no large capital raise can be executed with the political risk posed by a congress that “might” do something…except that Calabria has stated that there is a roadmap and milestones to a release from conservatorship (including a capital raise), and congressional action (fed guaranty and charter competition) can be layered on top of that.

            there does not appear to be any interest in the SBC to move on Calabria’s suggested congressional action (if you watch the last SBC hearing, it seems that Sen. Brown is addressing both Sen. Crapo and Calabria with respect to his comment regarding the surprising support for utility regulation), and the HFSC is extremely unlikely to do so (and that is an understatement). my own view is that Mnuchin is preoccupied by trade at the moment with Phillips’ work product likely sitting on Mnuchin’s desk. this is a very thinly staffed administration and it appears to me that the only official who can green light the delivery of the Treasury plan to POTUS is Mnuchin himself. and so we wait for Mnuchin (and perhaps for the HUD memo to be finished as well).

            rolg

            Liked by 2 people

  36. Tim,
    Thanks for your coherent and cogent analysis. It’s absolutely refreshing to read commentary not designed for a 5th grader, using words greater than 2 syllables and with a terrific attention to detail. I am a “Mom and Pop” investor who is greatly interested in the outcome of the GSEs.

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      1. @BM

        no relevance to fairholme. elsewhere on the scotus front, scotus just granted cert on Aurelius, an appointments clause case that has some relevance to separation of powers claim in collins en banc (whether de facto officer doctrine/apparent authority bars P’s relief). will be argued in October. collins en banc enters its sixth month post oral argument, which is about the median time period for 5th circuit en banc rehearing rulings.

        rolg

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  37. Tim. Thank you for all you do. Do you think they would set a capital standard so high (such as bank like), that they know the GSEs will never be able to raise, for an ulterior motive? Set them up to fail?

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    1. I suspect there are some opponents of administrative reform within the executive branch who would like to see it fail, and requiring capital for Fannie and Freddie so excessive as to severely harm their business, and thereby scare off investors and make it impossible to raise that capital in the equity market, would be a way to produce that failure. I don’t think they’ll convince Treasury to sign on to that, though, because Treasury doesn’t have a “Plan B”. It knows Congressional reform is unlikely for the indefinite future, and it also knows the status quo of an indefinite conservatorship is not sustainable: the plaintiffs are likely to prevail in at least one of the upcoming court challenges to the net worth sweep, and the current director of FHFA believes the sweep is illegal, and I doubt he’ll support it much longer. And of course there is the value to Treasury of the proceeds from conversion of the warrants if it supports a successful recap.

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  38. Tim, Many thanks to you for the great public service as a private citizen when public servants are trying to rob the public for the benefit of their cronies.

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  39. Mr Howard

    Anyone reading this can’t help but come away knowing that you have left MC plenty of wiggle room politically and economically to implement what you propose. All concerned will never be able to repay you for your tireless efforts but universal gratitude I hope will have to do for now.

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  40. Continued endless thanks for all you, and other major contributors, do to shed light on the corruption, greed and outright theft we have witnessed. Also, between a possible favorable en banc decision, the specter of a debt ceiling fight and early 2020 maneuvering, I could see the gov’t feeling some pressure to lock in their $100B windfall. But main message is one of gratitude – Thanks!!

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  43. Potential new investors and investment bankers hired by the GSEs will eventually ask the same questions to make sure the GSEs are neither under-capitalized nor over-capitalized. GSEs and FHFA have to answer them.

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  44. Thank you Tim. Your ability to provide clarity on complex issues such as this is truly invaluable to us mom ‘n pop investors. I believe Bill Ackman is arguing for the same thing as you regarding capital standards. I’m not sure if you and he are in touch with each other but I sincerely hope you are.

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  45. “Finally, you add a reasonable, clearly identified cushion of conservatism, and you have your required capital percentages. It’s that simple.”

    If that is simply putting an extra X% cushion on top of a minimum risk-based capital calculation, what do you think would be a sensible range for the cushion?

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    1. No, the “cushion of conservatism” is applied to the calculated risk-based capital percentage, not the minimum– to account for model risk, among other things. The proper range for the cushion depends on whether conservatism has been built into some of the other assumptions that are needed for the parameters of the test; the more of that sort of conservatism exists, the smaller the cushion needs to be. The minimum leverage ratio also should be set at a level where one would expect the risk-based constraint to be binding most of the time.

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  46. Thanks for that. How about cc’ing Ken Moelis, too. Why only flavour the milk when you can also flavour the feed? Exclusively pitching FHFA is like erecting a fence around your burger so the cattle doesn’t wander off.

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      1. We surely hope so. Just as MSM loves to tout benefits of ex intel officers maintaining clearance to aid in those efforts, ignoring your advice should be viewed as needlessly reckless while shaping housing. Excuse my ignorant cynicism as the only voices that seem to have the mic are opponents. Nice to know your efforts are wisely being consulted and considered. Even Zuck consulted the twins when launching FB’s crypto. Expertise is just that and avoiding it is akin to inviting one’s own peril. Adding your experience to FHFA Dir’s intelligence should make FHFA a formidable ally to US Homeowners bar none.

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  47. Tim

    thanks for sending this letter to Calabria. as a professional economist, Calabria should be most interested in the data you have presented, and should either be persuaded by it, or be in a position to offer a rational, data-backed response to it.

    I would offer from my own experience an addendum to your thought at the end of the post that investors “insist that anything objectionable be remedied to their satisfaction before they agree to put new capital into the companies.” the investors’ cudgel is pricing, and if the capital proposal is set unrealistically high, the common stock will be priced correspondingly low, in order to consummate the capital raise.

    it is my expectation that fhfa and treasury are having (or should soon have) a conversation about capital levels, as the higher the fhfa sets the capital level the lower will be treasury proceeds from its warrant position. fhfa has no skin in this recapitalization game, while treasury has all of the skin in this game.

    so it would be my expectation (assuming treasury is pursuing its interest in the recapitalization) that treasury, more so than re-IPO investors, will bear the biggest burden, and therefore be in a position to make the most effective argument, with respect to an overly conservative, politics-driven capital level.

    rolg

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    1. As I tried to point out in the post, it’s not just the level of capital that’s important, it’s also the way the risk-based test is constructed. Specifications that divorce capital from risk at a disaggregated level can hamstring the business in ways that aren’t immediately apparent to the layperson, but can be significant.

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      1. Tim

        assuming that congress passes additional fhfa chartering authorization, would any of this capital analysis change for a new entrant? for example, do the sizes and operating histories of Fannie and Freddie affect them for purposes of capital in a way that is advantageous or disadvantageous when compared to how a capital analysis would be applied to a new and much smaller entrant without a past operating history?

        rolg

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        1. It would be up to FHFA as to whether there would be any different capital standards or charges for new entrants. The core risk-based capital numbers shouldn’t change, since those are keyed to the product types and risk characteristics of the mortgages financed, not the guarantor. One could make a case for some type of management and operations risk capital surcharge for a new entity with no track record of being able to do its business with operational or technical competence or reliability, but since FHFA is the one pushing for new entrants I suspect it would view such a surcharge as a barrier to entry and not impose it.

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          1. Tim

            my thought exactly, which in mind points to what I believe amounts to a conflict of interest on the part of fhfa/calabria. in my view, a new entrant without an operating history that is substantially smaller than Fannie and Freddie should have a more conservative capital analysis than Fannie and Freddie. whether Calabria’s ideological interest in seeking new entrants clouds this capital analysis for new entrants is something I hope we never have the opportunity to witness.

            rolg

            Liked by 2 people

          2. Tim and ROLG,

            Assuming that any capital standard applied to Fannie and Freddie would also apply to any new entrant, I would think FHFA would really want to get the standard right. If it hamstrings F&F, why would anyone else want to get into that business?

            Liked by 2 people

          3. I think this is a matter of theory and practice. Bank-like capital and multiple guarantors are ideological (and also pro-bank competitive) objectives, and most of those who advocate them don’t have the practical knowledge of the credit guaranty business to understand that they’re not compatible. FHFA got a lot of constructive feedback on their June 2018 capital proposal; we’ll see how much of it they incorporate into their revised proposal.

            Liked by 2 people

      1. I don’t see these as being in conflict. FHFA currently performs two roles: conservator and regulator. As regulator, Calabria believes that multiple guarantors would be better for the mortgage finance system. I disagree with him, but I don’t think his position on this conflicts with his duties as a conservator.

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        1. Tim “Happy Holiday,” very much appreciate your work and insight. Would you care to comment on the news of Bob Ryan, senior Policy Advisor, leaving FHFA? Could this possibly signal a major change in the regulation of the GSEs’ financial standards?

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          1. No. Bob joined FHFA to work with its then-new Director, Mel Watt, so it’s neither surprising nor significant that he’s leaving with Calabria having taken Watt’s place. (If anything, the surprise is that it took this long; Ryan’s fellow senior policy advisor to Watt, Eric Stein, left several months ago.)

            Liked by 2 people

  49. Thank you for your tireless work Tim! I check your blog every day to read any new comments (thank you for responding to everyone’s questions/comments) and responses from you. You are a vital advocate for the GSE’s and I thank you for that!

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