The short week after Labor Day was full of developments of great significance to the fates of Fannie Mae and Freddie Mac. On Tuesday, September 3, we learned that the Senate Banking Committee had scheduled a hearing for the following Tuesday with Treasury Secretary Steven Mnuchin, FHFA Director Mark Calabria, and Department of Housing and Urban Development (HUD) Secretary Ben Carson as witnesses. That immediately sparked speculation that the administration’s long-awaited plan for housing finance reform would be released before this hearing, as indeed it was, on Thursday, September 5.

Treasury’s reform plan, however, was received with disappointment by followers of and stakeholders in  the reform process, because it contained little new information about how Treasury and FHFA were thinking about the process and timing of the recapitalization of Fannie and Freddie and their ultimate release from conservatorship, which Secretary Mnuchin and Director Calabria each repeatedly have said was a top priority. Combined, the two sections of the Treasury report titled Preconditions for Ending the Conservatorships and Recapitalizing the GSEs took up less than two of the document’s 53 pages, and contained only a broad list of known options, gave no indication of Treasury or FHFA’s preferences, and included no estimated timetables. And the section on recapitalization ended 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.”

The rest of the Treasury plan gave background on Fannie and Freddie and their history in the secondary mortgage market—much of which repeated the fictions about the companies created by their critics to justify curtailing their operations or replacing them—before detailing the administration’s many recommendations for legislative and administrative reform. And curiously, a number of the administrative recommendations were for “Treasury and FHFA” to take or consider certain actions, which suggested that the plan’s authors may not have been from Treasury but the National Economic Council (NEC), whose director, Larry Kudlow, had been responsible for the March 27 White House memo to Treasury requesting it to prepare the reform plan, and specifying the topics it should cover.

But the disappointment and puzzlement over the tone and lack of specifics of the Treasury plan was short-lived. On Friday, September 6, the Fifth Circuit en banc issued its rulings on plaintiffs’ claims that the net worth sweep was a violation of the Administrative Procedures Act (APA) because it exceeded FHFA’s statutory powers, and was in violation of Article II of the Constitution because it was approved by an FHFA director not removable by the president. Plaintiffs prevailed on both claims. On the APA violation the majority ruled that “the Third Amendment [authorizing the net worth sweep] exceeded statutory authority,” and emphasized that “We ground this holding in statutory interpretation, not business judgment.” On the Constitutional claim the majority said, “HERA’s for-cause removal protection infringes Article II. It limits the President’s removal power and does not fit within the recognized exception for independent agencies.” The en banc panel remanded the APA claim to the lower court for trial based on the fact pattern in the case (which does not favor the government), and on the constitutional claim granted plaintiffs prospective relief (severing the “for cause” restriction on removal of the FHFA director) but not the injury relief of voiding the net worth sweep plaintiffs sought. Plaintiffs’ loss on injury relief, however, was offset by their victory in the APA claim, which will void the net worth sweep if sustained and upheld, as is likely.

I do not believe the sequencing of these two developments—the vague and unsatisfying plan from Treasury for the removal of Fannie and Freddie from conservatorship, followed the next day by the announcement of the en banc Fifth Circuit decisions—was coincidental. In my view the administration almost certainly knew about the court decisions in advance, and believed it would benefit from being silent in its reform plan on the lawsuits and their possible resolution, then being able to cite the Fifth Circuit rulings as a pretext for giving up in an eventual settlement with plaintiffs the lucrative stream of net worth sweep payments it has vigorously defended as legal and valid up to this point. (Appealing one or both rulings to the Supreme Court, as Mnuchin has indicated Treasury may do, still would be consistent with this notion, as Treasury may feel this strengthens its hand in settlement negotiations.)

Those hoping to get clarification on the administration’s next steps in the housing finance reform process at this Tuesday’s Senate Banking Committee hearing came away with relatively little. Mnuchin did leave the impression that Treasury and FHFA would be able to work out some interim arrangement that would allow Fannie and Freddie to retain as capital the earnings scheduled to be remitted to Treasury as net worth sweep payments at the end of this month, in return for some form of compensation to Treasury. But he gave no indication of when, or how, the net worth sweep itself would be terminated. Chairman Crapo, on the other hand, prominently gave the green light to administrative reform in his opening remarks, saying, “Ultimately, only Congress has the tools necessary to provide holistic, comprehensive reform that will be durable through any market cycle. However, it is important for the administration to begin moving forward with incremental steps that move the system in the right direction.”

Nothing I heard at Tuesday’s hearing made me change my opinion that there is very little chance of any type of housing finance reform legislation passing in this Congress. But one episode in the hearing highlighted for me the major difference between an administrative reform process and a legislative one. Whereas in an administrative process hyperbole and misinformation invariably impede results, in a legislative process they frequently are the methods employed to produce them. The episode that brought this point home was the fact-free exhortation from Senator Kennedy (R-LA) for Congress to “put out the dumpster fire” of Fannie and Freddie because “we’ve spent $190 billion of the taxpayer’s money to bail them out, and we’re in worse shape now” because, according to Senator Kennedy, their underwriting standards are worse. Almost as disappointing was Director Calabria saying “I agree” after most of the wildly erroneous statements the senator made. Then, later on in the hearing, HUD Secretary Carson sought to assure his audience that the Federal Housing Administration (FHA), which is under HUD’s authority, had “made substantial progress” in recent years and “was doing well,” seemingly in contrast to Fannie and Freddie.

As Treasury and FHFA pursue the path of administrative reform, they must get a hold on the facts of the issues they will be dealing with, and do so quickly. Given the Fifth Circuit’s ruling on the constitutionality of the FHFA directorship, both Mnuchin and Calabria could have no more than fifteen months to complete the administrative reforms of Fannie and Freddie they’re contemplating. A good place for them to start in their fact-finding would be with the companion housing reform plan put out last Friday by HUD, which received almost no publicity. Reading this plan in conjunction with Treasury’s, it becomes unmistakably clear how far from economic reality the legislative discussions on Fannie and Freddie have strayed, and how useless they are as guideposts for successful administrative reform.

The Treasury report follows the lead of Fannie and Freddie’s opponents and critics in continuing to use commercial banks as the benchmarks for recommendations on Fannie and Freddie’s capital and regulatory oversight, even though banks take both interest rate and credit risk on a multitude of asset types with a wide range of risks, and can (and do) make loans in countries throughout the world, whereas Fannie and Freddie essentially only do credit guarantees on a single and historically safe asset type, residential mortgages, and only in the United States. The HUD report reminds us that there is a direct comparable to Fannie and Freddie, and it’s the FHA, which also does only credit guarantees on residential mortgages, with the same lenders and homebuyers as Fannie and Freddie.

In the Treasury and HUD plans, published on the same day, the same administration makes policy recommendations for three entities—Fannie, Freddie and the FHA—that do the same business with the same customers in the same market. Yet the recommendations of these two plans could hardly be more different, in tone as well as substance.

We learn in the HUD report that, “During the financial crisis, and after due to the policies of the previous Administration, FHA’s and GNMA’s balance sheets swelled, growing by approximately 350 percent and 400 percent, respectively, between FY2007 and FY2018.” Putting aside the political commentary, 350 percent growth for FHA loans outstanding in 11 years is astronomical. The growth percentage for Fannie and Freddie’s combined books of business during the comparable period, between the end of 2007 and the end of 2018, was only 9.6 percent. Stated more starkly, the average annual growth rate in FHA loans outstanding for each of the last 11 years—12.1 percent—exceeds the cumulative growth in business outstanding for Fannie and Freddie during that entire time.

There is only one plausible explanation for such a mammoth growth differential over such a long period: while in conservatorship, Fannie and Freddie have been overcapitalized and overregulated relative to the risks they incur, whereas the opposite has been true for the FHA. And the policy recommendations in the Treasury and HUD plans, if followed, would lead these capital and regulatory differentials to become even greater.

The FHA specializes in low-downpayment lending, so its book of business naturally will be riskier than Fannie’s or Freddie’s. But the gap in serious delinquency rates between the two is larger than one would expect based just on average loan-to-value ratios. In the second quarter of 2019, the FHA’s serious delinquency rate of 343 basis points was more than five times Fannie and Freddie’s average serious delinquency rate of 66 basis points. The HUD report also says, “Despite the current strong economy, the credit risk profile of the average FHA FTHB [first time home buyer] has deteriorated in recent years,” and goes on to note that several key risk factors—average credit scores, debt-to-income ratios, and the percentages of cash-out refinances and down payment assistance—have worsened in the last several years. For Fannie and Freddie, it’s been the opposite. Fannie now publishes its 90-day serious delinquency rate on loans acquired after 2008, and for these loans, which currently comprise 93 percent of its book, the serious delinquency rate in June was only 32 basis points, less than one-tenth the 3.66 percent delinquency rate of the pre-2009 book.

The equivalent to a capital requirement for the FHA is the Mutual Mortgage Insurance Fund (MMIF). Today the MMIF is set at a statutory rate of 2.0 percent. The growth in the FHA’s credit guarantees has been exponentially faster than Fannie’s and Freddie’s (helped by refinancings of conventional loans into FHA-insured loans, one-third of which take cash out), and the FHA has a serious delinquency rate five times that of Fannie and Freddie, a book of business that is getting weaker while Fannie’s and Freddie’s are getting stronger, and only a 2.0 percent MMIF standing between the FHA’s $1.4 trillion in loan guarantees and the taxpayer’s wallet. What, then, is the administration’s proposed response to these circumstances? According to the HUD report, “FHA should adopt a sound risk-based capital regime for the MMIF, well above the statutorily mandated two percent capital ratio, which will manage risk exposure to defined stress scenarios and ensure that FHA does not inappropriately compete with the GSEs or private capital.”

I don’t know what the right level of capital is to safely back the FHA’s credit guarantees. Here I’m citing the FHA’s situation mainly to point out the marked contrast between the casual and vague prescription of the administration for responding to the significant risk to the taxpayer posed by the FHA’s operations—saying only that it “should” (not must) adopt a sound risk-based capital regime, and raise its capital cushion “well above” the current 2.0 percent ratio (with no required percentage, or any guidance as to how to come up with such a percentage)—and the way the administration treats the same issues of taxpayer risk and capital in its discussion of the recapitalization and release of Fannie and Freddie.

The reasons for the vastly different approach to Fannie and Freddie compared with the FHA are, of course, politics, ideology, and the competitive desire of the commercial and investment banks to add unnecessary restrictions and impediments to the companies’ business in the secondary market, to the benefit of lenders in the primary market. Fannie and Freddie’s opponents and critics seek to create the impression that they are so risky, and pose such a danger to the financial system, that removing them from conservatorship must be done with extreme care, akin to handling nitroglycerin, with safeguards wrapped around cushions surrounded by micro-regulation. The reality is that Fannie and Freddie were the best-performing sources of mortgage finance before, during and after the crisis, and that reforms made to national underwriting standards since 2008 have made them even safer. And then there is the FHA, geographically located within 15 miles of Fannie and Freddie, operating in the same market, and being held to a completely different standard.

Secretary Mnuchin seems to be aware of some of this, at least conceptually. In an interview Monday morning with Maria Bartiromo on Fox Business, he said, “This is really housing reform, and we also are working with HUD in looking at reform of FHA. We want to make sure that if we fix Fannie and Freddie, we don’t put taxpayers at risk at FHA.”

Mnuchin’s acknowledgement of the broader scope of the exercise is a definite plus. It’s also a plus that in administrative reform the professionals who will be leading the execution of Fannie and Freddie’s recapitalization—including the investment advisers retained by Treasury—will be able to draw on their own knowledge about and experience with the capital markets and how they, and Fannie and Freddie, actually work, rather than having to rely on agenda-driven housing finance reform plans written by generalist career staffers at the NEC, Treasury, HUD or FHFA. With a fresh start, and a new cast of principals managing the process, fiction should more easily yield to fact, and political biases to economic realities.

During the Senate Banking Committee hearing, ranking member Brown (D-OH) noted that having FHFA boost Fannie and Freddie’s required capital, shrink their business and give away their assets and intellectual property to third parties would make it difficult to raise the amount of new equity required to bring them out of conservatorship. It’s an obvious point, which the investment bankers will understand. They also will understand that when they embark on a roadshow to pitch Fannie or Freddie equity as an investment, they will need to have a convincing answer as to why risk, capital and regulation are being treated the way they are at Fannie and Freddie, not compared with banks, but with the FHA.