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.
HOWARD ON MORTGAGE FINANCE 
SCOTUS granted cert petition re constitutionality of CFPB’s single director removable for cause structure. https://www.scotusblog.com/2019/10/justices-to-review-constitutionality-of-cfpb-structure/. This is an agency that is bringing numerous actions against parties that are interposing motions to dismiss claiming the action is without authority due to the agency’s unconstitutional structure. much more pressing situation than in case of fhfa. however, this case does not cleanly present the “backward relief” issue that Collins presents, and which is important for GSE investors.
it is not clear to me how this affects possibility of cert in Collins. but there are clear enough similarities between CFPB and FHFA to support reading through to the constitutionality of the structure of FHFA from the CFPB decision. hopefully SCOTUS grants cert in collins to address backward relief. at least in collins the FHFA would try to defend its constitutionality. with CFPB, scotus will have to rope in some amicus to argue on behalf of constitutionality since no party, not even C FPB, will do so. Decision likely summer 2020.
rolg
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Tim
one more point about the scotus CFPB case. scotus asked the parties whether if it finds the CFPB’s structure unconstitutional it can sever the director removal only for cause provision from the rest of the Dodd Frank statute. this last issue should be a close call. severability was adopted by then Judge Kavanaugh in the PHH case involving the CFPB (which was vacated by the DC Circuit en banc). severbility is a problem for Justice Thomas since he doesn’t think that scotus should be “blue-lining” statutes. the argument against severability is that it is clear that congress created CFPB as an agency independent from both POTUS (no potus replacing director at will) and congress (CFPB never has to go to congress for appropriations). to sever the potus removal provision only would create an imbalance of independence (still independent from congress but not from potus) that congress did not intend, and prior potus cases hold that severance should not apply to statutes that result in a statute that is inconsistent with the statute congress originally passed. but if no severance, then must the entire agency be invalidated? that is a hard place for scotus to end up, although no middle ground comes to mind.
the relevance for collins Ps is that if the CFPB structure is ruled unconstitutional but the provision is severed, then Collins Ps would still want to raise the question of backward relief, which seems not to be addressed in the CFPB case (severance is forward looking). however, if scotus doesn’t grant cert in collins, that issue may never be addressed. if the CFPB is invalidated however, then all hell breaks loose for FHFA.
if I had to bet, I would argue that scotus severs for cause (over a vigorous Thomas dissent), which makes it important for scotus to grant cert in collins on the backward relief question.
rolg
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Thanks for the update and analysis. While I’m hopeful that the appeal to the Supreme Court on the constitutional issue will bring a favorable verdict for the plaintiffs, I still think the en banc Fifth Circuit’s ruling on the APA claim gives us the best chance of ultimate victory, however long that may take.
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Tim
the fear is that when scotus granted cert in the CFPB case (Seila), it would focus only on the question of the constitutionality of an agency single director removable only for cause and, if unconstitutional, whether that provision could be severed from Dodd Frank (prospective relief). Seila’s cert petition simply did not focus on retrospective relief, which is odd since Seila is subject to a federal court order enforcing a CFPB civil investigation demand (essentially a CFPB demand which Seila resisted that could form the basis for CFPB to bring a subsequent enforcement action).
however, after some digging I found that Seila in a 10/4 reply arguing in favor of cert stated that “[t]his case will also afford the Court with the opportunity to consider the full range of remedial options in the event it holds the CFPB’s structure unconstitutional. Throughout this litigation, petitioner has consistently argued that the appropriate remedy is to “invalidate the CFPB as a whole,” or, at a minimum, to hold that the civil investigative demand is unenforceable.”
so it appears that in the merits briefing before scotus, Seila will argue for either an invalidation of the CFPB (which I think scotus will be unlikely to order) or the revocation of the federal court order enforcing the civil investigative demand (retrospective relief). whether retrospective relief will receive the prominence in Seila’s briefing that it would have had in Collins (assuming cert is not granted in Collins) is another matter.
rolg
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Well at least Doral proved optics won’t be an issue going forward, and here we were concerned about the visual of his one step removed profiteering friends. Wow, a G-7, I thought I had guts. This man is either flat-out insane or one of the coldest humans alive. That is a fact. Dealing with him particularly when he has leverage must be the stuff of nightmares. The man can justify literally anything. A very dangerous tendency. Gl,
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Regulator expects to hire adviser for Fannie, Freddie capital overhaul by November
By Pete Schroeder
WASHINGTON, Oct 16 (Reuters) – The nation’s top housing regulator said on Wednesday that he hopes to hire an outside financial adviser by next month to help the government devise a plan to remove mortgage giants Fannie and Freddie from government conservatorship.
Federal Housing Finance Agency Director Mark Calabria said he expects the adviser to help the regulator assess plans to overhaul Fannie and Freddie’s capital structure and raise billions of dollars in new cash.
He added that he also expects Fannie and Freddie to hire their own advisers ahead of potentially massive initial public offerings or other capital raisings that could prove to be a big payday for Wall Street firms that win the mandate.
“Fannie and Freddie will be the ones raising capital, but how do we allow them to set that path and how do we make sure that what they come up with as suggestions to raise capital are doable?” said Calabria at an event in Washington. “My expectation is that Fannie and Freddie are going to be able to get their own financial advisers, and we can start to work.”
The FHFA earlier this month posted a solicitation for an outsider adviser, and applications were due Wednesday. Calabria said the adviser will help the regulator assess capital plans put forward by Fannie and Freddie.
The pair, which guarantee more than half of the nation’s mortgages, have operated under a government conservatorship since being bailed out by taxpayers in 2008. The Trump administration has renewed efforts to release the pair from government control, issuing a report in September calling for them to be recapitalized and released.
Calabria on Wednesday emphasized that the pair will not be allowed to escape government control without raising a significant amount of capital. To that end, Calabria said he expects to announce in the coming weeks whether the FHFA will re-propose a rule outlining capital requirements for the pair. Analysts expect that regulation must be finalized before the pair could realistically exit.
“If Fannie and Freddie aren’t able to leave, then they don’t leave. Quite simply they have to be ready to get out,” said Calabria.
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Tim
The next big shoe to drop is the fhfa final capital rule. however, if the final rule is so different from the proposed rule, then fhfa will need to recirculate a new different proposed rule and go through an appropriate comment period. See https://twitter.com/KatyODonnell_/status/1184516975017562114
Calabria: “I should be able to announce within the next couple weeks whether we are going to re-propose” the capital rule.
certainly if fhfa is about to adopt as a final rule something that really doesn’t resemble the proposed rule, then re-proposal is proper. of course the whole purpose of the original comment period is to obtain public comment that fhfa believes would improve the proposed rule, so changes should be expected.
what is going on here sub silentio? any party “aggrieved” by the final rule has the ability to sue to enjoin promulgation of the final rule, arguing that it is so different from the proposed rule that it needs further analysis and comment. there would be a high bar for this suit to be successful (arbitrary/capricious). could GSE-haters be contemplating bringing this action, and could fhfa be considering this in connection with the analysis fhfa is currently conducting?
rolg
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I think having the financial advisors working with FHFA will be helpful in getting to a workable answer on the capital rule. If the goal is to ensure that Fannie and Freddie will be able to survive a future 25 percent decline in home prices nationwide, with a reasonable margin of safety, it’s not hard to figure out what that capital amount is. There are ample “real world” reference points, including the companies’ 2008-2012 loss experience, that inform that. The problem so far has been that the banks want a different answer, so that Fannie and Freddie will be hobbled to the banks’ advantage. If FHFA decides to accommodate the banks, Fannie and Freddie will be less attractive to new investors and have more difficulty raising the required capital, but it also will be obvious to informed observers–including the financial advisers–what’s going on, because the new Fannie-Freddie capital numbers will be obviously misaligned with these readily available real-world reference points.
I’ve begun working on a post on this point, which I should be able to get out next week.
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Tim,
In the past you explained why Fannie and Freddie report their statutory minimum capital standard as 0.45% of MBS assets; in 2008 when HERA was written, Fannie and Freddie did not include those MBS on the balance sheet. However, a few years later they were forced to put those on the balance sheet while HERA did not change.
HERA clearly states that the statutory minimum capital standard is 2.5% of *all* on-balance sheet assets plus 0.45% of MBS. How does FHFA justify continuing with the 0.45% standard, when HERA doesn’t seem to allow for such discretion? It conforms with the spirit of the law but not the letter. If Calabria sets a minimum capital standard that is below that of letter-of-the-law HERA, could someone hoping to delay recap and release sue FHFA over it? If so, would that give Calabria an incentive to set a 2.5% minimum capital standard so as to move the process along more quickly? And would that number be too high to attract investors?
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The idea when Fannie and Freddie’s revised capital standards were put into statute in 1992 was that off-balance sheet obligations of the companies that incurred only credit risk–their mortgage-backed securities–would be subject to a capital requirement of 0.45 percent, whereas their on-balance sheet obligations that bore both credit risk and interest rate risk would have a capital requirement of 2.50 percent. When the Financial Accounting Standards Board changed the accounting for Fannie and Freddie’s MBS to move them on-balance sheet, that didn’t change their risk, and for that reason FHFA (in my view correctly) did not change their required capital. I don’t believe there is any party that has either the reason or the standing to sue over that decision, so I doubt there is any danger of FHFA putting into effect the higher MBS capital requirement you’re concerned about.
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Tim and Midas
perhaps as background to Midas’ question is some recent speculation that calabria may be using the statutory capital level as the trigger to release GSEs from conservatorship into the “consent decree” phase (and presumably from the consent decree once the fhfa final capital rule is satisfied).
see https://twitter.com/pgray41/status/1184872171149103104?s=21
rolg
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I’ve seen the speculation that Fannie and Freddie’s current statutory minimum capital requirements might be used as triggers for releasing the companies from conservatorship under a consent decree–and also noted that the amount of capital they’re being allowed to retain by foregoing their net worth sweep payments is a few billion higher than these minimum capital numbers–but I’m not convinced this is what will happen. I find it difficult to imagine that Calabria will release Fannie and Freddie from conservatorship before their new capital requirements have been determined and announced, and these will include new minimums as well as the risk-based numbers. For the minimums, I think FHFA will go with “Alternative 2” in its June 2018 proposal– 1.5 percent of trust assets and 4 percent of non-trust assets, which would push Fannie’s minimum up to $59 billion compared with $22 billion under the old standard. The question I keep asking myself is, “How could FHFA justify releasing Fannie and Freddie based on hitting their old minimums after their new, much higher, minimums are known?” Maybe they’ll just do it anyway, but I’m not sold on that. An alternative would be for FHFA to make companies’ release point the attainment of their critical capital levels, which are half the minimum requirements. For Fannie under what I think the new minimums will be–and assuming today’s balance sheet size and composition–that would amount to little less than $30 billion in capital. As always, though, we shall see.
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Tim
I understand your thought process but I think there is less than meets the eye here. I see the “release” from conservatorship to be more formal than substantive as I would expect that the consent decree will strictly bind GSEs operations. what it will do is eliminate the Perry/Saxton line of cases argument that the conservator has power to do “anything”, which is anathema to new investors, since the GSEs will no longer be in conservatorship.
so the trigger for this conservatorship-to-consent decree event would imo be coincident with the time the GSEs are prepared to do their first offering, rather than any particular level of capital (understanding that one can expect the FHFA and the GSEs to want to do their first offering not before the maximum is built up under the recent letter agreement). the release from consent decree (or some subset of strictures therein) would trigger off of a precise capital amount, likely set forth in the capital rule.
rolg
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It seems we both agree that it’s unlikely FHFA has made meeting their current minimum capital requirements the trigger point for moving them from conservatorship to operating under a consent decree. Your view is that FHFA will take that step when it thinks Fannie and Freddie are ready to do a capital raise, and mine is that the companies won’t be ready to raise capital until they know what their capital requirements are, and those new capital requirements will render the old minimums obsolete. Similar conclusion reached by different paths.
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Tim
Bhatti was argued 10/15 at the 8thC. it was a messy argument, with one judge acting particularly bombastic (with all due respect). David Thompson was brilliant. I expect this merits panel will follow very closely to see whether scotus grants cert to collins’ petition, and if it does, Bhatti will go nowhere until a scotus decision. audio: http://media-oa.ca8.uscourts.gov/OAaudio/2019/10/182506.MP3
also yesterday, scotus heard oral argument in Aurelius https://www.scotusblog.com/2019/10/argument-analysis-justices-weigh-appointments-dispute-and-nature-of-puerto-rico-oversight-board/ (audio not yet posted: https://www.supremecourt.gov/oral_arguments/argument_audio/2019)
in Aurelius the 1st C found a violation of the appointments clause (no senate confirmation) re officers of the Puerto Rico financial oversight board but failed to provide relief under the de facto officer doctrine. this doctrine should not be applied in connection with constitutional deficits, as per prior scotus holdings, so scotus “should” affirm the finding of a constitutional violation and award backward relief…which would be an important precedent for Collins (albeit somewhat tangential insofar as it relates to an appointments clause rather than a separation of powers claim) in the Collins quest for backward relief. however, scotus may try to weasel out (a useful litigator’s term) of making this holding by finding that the whole Puerto Rico financial disaster is a local problem, such that the oversight board officers are local officers of Puerto Rico and not federal officers of the US, covered by the appointments clause. this seems quite wrong, but an all too convenient escape hatch.
rolg
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I finally was able to listen to the Bhatti argument, and came away with no sense for how the appellate judges might rule, should the Supreme Court not grant cert in Collins. Based on the history of prior cases, this ambiguity would seem to favor a finding for the defense.
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Tim
Layton and his history lesson on TINA: https://www.jchs.harvard.edu/sites/default/files/harvard_jchs_two_models_for_GSE_reform_layton_2019_0.pdf
rolg
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As I read the Layton paper, I was struck by how much a person’s individual perspective affects how he or she perceives, and recollects, what’s happening. I started following the reform efforts closely shortly after I published my book at the end of 2013, and view many of the events Layton discusses very differently than he does. To me, the Layton paper has a “prior to the conservatorships Freddie and Fannie had a lot of problems, and we fixed most of them after I got there” tone to it, and this colors his retelling of the evolution of the reform effort. I don’t see any benefit to listing or discussing the aspects of his retrospective review that I think he gets wrong (there are many of them); instead, I’d rather note that I agree with his conclusion that the reform dialogue has now coalesced around the idea of “fixing what works” (the title of an essay I wrote in March 2016 for the Urban Institute’s “Housing Policy Reform Incubator” initiative, in which I advocated “moving to a ‘utility model,’ with limited returns and a more focused business purpose”), and that the remaining issue is whether increasing the number of credit guarantors is either desirable or feasible. Here, I agree with Layton that it is neither.
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Tim
see https://twitter.com/ACGAnalytics/status/1182408443967221760?s=20 . “@FHFA
Director @MarkCalabria publicly indicated #GSEs could leave conservatorship before hitting top capital threshold and operate under consent decree.”
this confirms a leak of a talk Calabria had with fhfa staff some weeks ago, and I think this is important and frankly somewhat reassuring. it shows that fhfa/treasury have been thinking about how to “thread the needle”, how to raise large amounts of capital while not scaring off new investors by having the GSEs remain in conservatorship while doing these offerings. these offerings will be preceded by a period of earnings retention/capital build up so that these new investors will have the (cold) comfort of knowing that the cupboard is not bare before their capital contributions are made.
these are smart moves and they lead me to believe that fhfa/treasury have been in informal consultations with financial advisors relating to how to set the stage for the capital raises.
rolg
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Disputes with current shareholders would also have to be resolved as a condition, correct?
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@BIGe
no offerings without litigation settlement.
the timeline is interesting for litigation purposes. if fhfa puts the GSEs on earnings retention for next 4-6 Qs so that they build up the maximum capital levels permitted under the recent letter agreement before undertaking the first re-ipo offering (and release from conservatorship into consent decree operation), this would provide sufficient time for the slow moving litigation to more fully gestate…in particular, for collins to play out (see whether SCOTUS grants collins’ cert petition, and any SCOTUS decision; what district court judge atlas comes up with by way of remedy in collins), maybe even fairholme trials to be conducted before Lamberth and Sweeney.
now, fhfa/treasury have to consider how/when to negotiate settlements of the litigation. if they are willing to see the litigation play out as earnings are retained over the next 12 months or so, then they should either be confident that the results will be in their favor, or be prepared to settle with Ps on a basis that provides Ps the relief they are seeking (on assumption that the litigation results won’t be favorable to them).
rolg
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Very interesting. Thanks
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Tim, any comments on this would be appreciated: https://www.valuewalk.com/2019/10/gse-scam-net-worth-sweep/
Also, how do you envision the “global settlement” to be shaped to prevent the Treasury from declaring another “crisis”, force unwarranted accounting changes to the GSEs and this same situation happening again? Why would anyone invest in the post-Conservatorship GSEs if their money wasn’t safe from the same chicanery?
Thanks,
Paul
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I don’t share Dick Bove’s view that the agreement between Treasury and FHFA to allow Fannie and Freddie to retain an additional $22 billion and $17 billion, respectively, by not making their scheduled net worth sweep payments is a “scam,” or anything the agencies are trying to slip by investors. We know that Treasury and FHFA have neither amended nor cancelled the Third Amendment to the Senior Preferred Stock Agreement; they have merely agreed to allow the companies to add the stated amounts to their capital base, while Treasury’s liquidation preference rises by an equivalent amount. That’s quite straightforward, and I think investors understand it.
As for the accounting for the retained net worth sweep payments, we don’t have to guess about that, because we have a prior example to look to: the first quarter of 2018, when the companies were allowed to retain $3.0 billion in earnings by reducing the amount of their net worth sweep payment to Treasury. Then, “net income attributable to common shareholders” was reported at $3.32 billion, and shareholders equity increased by a comparable amount. Senior preferred stock outstanding did not increase as a result of the companies retaining their sweep payments.
In order for the companies to be released from conservatorship and returned to shareholder ownership two things will need to happen: the net worth sweep will need to be unwound or otherwise terminated, and Treasury’s liquidation preference will need to be reduced to, or close, to zero. There are two ways these can happen–either as a result of a final court decision invalidating the net worth sweep, or through settlement negotiations between the government and the plaintiffs in the lawsuits. I do not have any insight into what terms of settlement might be deemed acceptable by all parties; that’s what they will be negotiating. But I do agree that the settlement should include some form of reassurance to potential new shareholders that what happened to existing shareholders in the companies will not occur again.
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if you look at the moelis blueprint (https://gsesafetyandsoundness.com/wp-content/uploads/2018/11/Blueprint-for-Restoring-Safety-and-Soundness-to-the-GSEs-Final.pdf), p. 24, moelis posited an end to the sweep and an elimination of the senior preference at the same time (2018 Q4…yes, the end to the sweep is 3Qs later than forecast).
but why should that be so? doesn’t it make more sense, from Treasury’s point of view, to delay the amendment to the SPSA to the time when the GSEs are ready to settle litigation, offer to exchange common for outstanding junior preferred and issue new common? Treasury and FHFA appear to have made the decision to build retained earnings for at least a couple more Qs than moelis posited. but doesn’t this make sense, making it more likely that the first re-IPO offering is successful (so that the new common is buying into companies with some equity cushion rather than being the only cushion themselves at the time of the closing)? So the simultaneity of the two steps that may have been expected is now a sequencing of events…from Treasury’s point of view, for good reason.
sometimes if things don’t go in accordance with expectation, it isn’t a scam, especially when there is good logic to the way things are actually unfolding.
rolg
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It’s worth noting that the senior preferred stock on the balance sheet is different from the aggregate liquidation preference credited to Treasury. The two terms are not synonymous.
For instance, at EOY 2017, Fannie Mae reported senior preferred stock (equity) of $117.149 billion.
The 2017 10-K also states, “The December 2017 letter agreement increased the aggregate liquidation preference of the senior preferred stock by $3.0 billion as of December 31, 2017.”
This raised the liquidation preference to $120.149 billion.
The 1Q2018 10-Q has an aggregate liquidation preference of 123.8 billion, reflecting the $3 billion capital previously retained and the draw. This differs from the senior preferred amount of $120.836, reflecting only the draw.
Both the 2017 and the 9/27/19 letter agreements state that the liquidation preference is to increase by the increase in net worth. This is accomplished not by increasing the amount of preferred stock, but by increasing the liquidation preference.
The senior preferred stock certificates originally based the 10% dividend on liquidation preference.
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Tim
Would like your take on Donald Layton’s new paper out today regarding the GSE Capital Rule
https://www.jchs.harvard.edu/blog/what-the-fhfa-needs-to-get-right-in-its-gse-capital-rule/
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I’m about to fly back to the DC area from Southern California. I’ve downloaded the Layton paper, and will read it on the flight and give my reaction after I’m back on the east coast. Just from the summary, though, I can say that I agree with Layton’s position on the first three of his four “tough decisions”: (1) On bank SIFI rules (follow the spirit of the rule–to make sure Fannie and Freddie can survive a severe stress event, a 25 percent decline in home prices, with a going concern buffer left over–but do not force bank capital rules or ratios on the companies, because they’re not banks); (2) On minimum capital (use the minimums as back-ups to the risk-based standard, and update the minimum for credit guarantees–I thought the 150 basis point minimum FHFA had in its June 2018 proposal was reasonable), and (3) Whether to use original or current loan-to-value ratios in the stress test (this is not a close call–FHFA has to use original LTVs for a variety of reasons I’ve noted previously, and Layton concurs). Where I diverge with Layton is on his fourth “tough decision”: dealing with what he calls “the pronounced procyclicality of being a mortgage guarantor in terms of its impact on capital requirements.” Assuming FHFA moves away from using current loan-to-value ratios in the stress test, the remaining procyclicality of its proposed capital framework comes from the way it treats credit-risk transfer (CRT) securities, where it gives far too much capital credit for them. By allowing Fannie and Freddie to substitute CRTs for capital on a very favorable basis during good times, FHFA sets the companies up for severe capital shortages during times of stress, when CRT securities will not be available. Layton’s notion that this will not be a problem because “the market will price in how remote are the odds of a major stress event actually occurring” strikes me as overly simplistic. The right solution–which I know Layton, as a strong advocate of CRTs won’t like–if for FHFA to at a minimum deduct the cost of CRT securities from any capital credit it gives the companies (so as to not give them a non-economic reason to use too many CRTs in their capital structures during good times, only to have to scramble for equity during stress periods when existing CRTs don’t cover the right loans and new CRTs aren’t salable), or to devise a more sophisticated metric of “equity equivalent” credits for Fannie and Freddie’s CRTs.
More on this (perhaps), after I return to the DC area.
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[9:30 pm addendum to the above.] In reading the full Layton paper, I realized that in my quick scan of his summary discussion I misread his “Decision 3” on loan-to-value ratios, and also to some extent misinterpreted what he was saying about the role of CRTs. Layton favors using current loan-to-value ratios (CLTVs) in the stress test, arguing that original LTVs (OLTVs) are “a very poor choice for measuring credit risk on GSE mortgage guarantees over extended periods of time.” He’s right that OLTVs don’t accurately measure credit risk over time, but he’s missing a crucial fact about how OLTVs work in a risk-based stress test, and thus, I think, making a big mistake.
In an environment of steadily rising home prices, OLTV-based capital requirements on any year’s book of business become increasingly more conservative over time. That’s a good thing. The more home prices rise, the more systemically beneficial it is that the capital requirements on older books are overstated, because if home prices ever DO fall by 25 percent, this (overstated) capital on a company’s older books is what allows it to cover the (much higher) losses on its newer ones. If capital is based on CLTVs, rising home prices cause required capital on older books to fall, removing this countercyclical buffer. Making matters worse with CLTVs, when home prices fall not only do a company’s credit losses rise, but its capital requirements do as well (since the CLTVs fall). Who will provide that extra capital if home prices are falling and credit losses are rising?
Using OLTVs as the basis for the stress test creates the capital buffer Layton knows is necessary using CLTVs, but it (a) does so automatically, and (b) doesn’t lead to a company’s capital requirement rising at the worst possible time. Instead, with OLTVs the effective capital requirement on a book of business rises at the best and most manageable time—gradually, along with home prices, as the OLTVs increasingly overstate the current riskiness of these loans. I’m surprised that Layton misses this point, and it leads him to make a further mistake by thinking that increasing the “detachment points” on CRT securities (which the companies won’t be able to issue once home prices start falling, and probably well before then) is the solution to the CLTVs’ procyclicality. It isn’t; in fact it will compound the problem.
Nearly all of the analytically-oriented commenters on FHFA’s June 2018 capital proposal pointed out the dangers of using CLTVs in the stress test, and I thought that battle had been won. But Layton’s paper—and his statement that he’s been talking with the FHFA staff about the merits of CLTVs and trying to offset their procyclicality through refinements to CRTs—is cause for concern. This issue may merit bringing to the attention of FHFA’s investment advisors, once they’re named.
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Tim
my take on the Layton paper is that while it provides helpful background and explication, it appears to be an apologia for the continuation of and continuing reliance on CRTs. in a conservatorship regime where no equity capital could be built, CRTs performed a function. going forward in a regime where the GSEs will look to capital markets for equity capital (just like all other financial institutions), why should the capital rule be devised to preserve the CRTs’ utility (such as it is)? is it fair to say that this is Layton’s axe to grind (for whatever reason)?
I think about this capital rule issue with a high degree of simplification. but is it fair to say that it is not wrongheaded to view GSE capital requirements (at an admittedly high level of generality) as needing to satisfy i) the adverse stress scenario (25% reduction of housing prices) plus ii) a going concern buffer (to ensure confidence through the stress period), together with iii) some leverage backstop (for reasons i am uncertain of it if there is also a stress test)?
if so, then the 2018 stress test results show, on a combined basis, only $18B of stress test period losses ($43B with DTA write down, but if there is a capital buffer, then why should there be a DTA write down since isn’t the capital buffer there to ensure that the GSEs survive the stress period through to a new period of profits, which in turn should argue against a DTA write down?).
so I would hope that the final capital rule makes sense given this these impressive 2018 stress test results (ie a reasonable going concern buffer and a leverage ratio that in most cases would not be binding, given the risk profile of the guaranteed mbs). and to my mind, the 2018 stress test results make foolish any attempt to apply a bank-like % of assets test.
rolg
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Tim
one more thought. Layton states at p.32 that his approach “…is not a standard one used by other financial regulators. It is grounded in the specific and narrow business model of the GSEs and the availability (in all but the worst markets) of CRT transactions to lay off credit risk.”
this is a cavalier and totally unrealistic assertion. neither layton nor anyone else knows whether CRTs will be available in all but the worst markets…indeed, CRTs have been done exclusively to date only in good markets. my experience in the capital markets is that risk-bearing first quickly becomes too expensive at the outset of adverse markets, and then eventually become unavailable during the continuation of adverse markets.
rolg
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Tim
fhfa has put out an rfp for investment advisors to represent fhfa in connection with the recap/release:: https://www.fbo.gov/index.php?s=opportunity&mode=form&id=0c268c2f435189a7d727ecbd5c87a8a8&tab=core&_cview=0
the statement of work refers to two phases, development and implementation of the roadmap, and it appears fhfa is allotting a full year for the development phase, such that an actual capital raise may not be expected for another year at a minimum. this is a slow timetable, but at least it appears fhfa is getting serious about issuing a banking mandate to an advisor.
rolg
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A slow timetable creates a better negotiating position for the government versus the preferred shareholder plaintiffs. Said another way, if the government says they want to pursue a short timetable, this would strengthen the preferred shareholders’ negotiating position. Perhaps this is part of the reason the timetable is long here.
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@jim
there its that, and also it must be said that whenever any private party signs up a financial advisor, the engagement letter contains a termination date, usually out beyond the date that the principal wishes to conclude the transaction. so in addition to signaling probity to potential critics and patience to litigants who will need to settle, one might think that the one year for the development phase is not a minimum but perhaps more of a maximum time period.
rolg
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Tim
All American (Gibson Dunn counsel) has asked SCOTUS to hear its CFPB case before the 5thC renders its decision; the oral arguments in the All American case before the 5thC merits panel occurred a few months ago and the judges stated during argument that they were inclined to await the decision in Collins en banc before deciding All American. clearly, All American expects a result on its unconstitutional structure claim re CFPB similar to Collins re FHFA, that CFPB is unconstitutionally structured but no retrospective relief is to be given. so in an unusual cert petition, All American wants to hopscotch the 5th C and, in effect, have its case heard in conjunction with Collins’ recent cert petition.
while it is unclear whether SCOTUS will grant cert in either case, I believe that this petition by All American may increase the odds that SCOTUS grants cert in Collins (and perhaps All American too).
Click to access allamericanvcfpb–certpetition.pdf
rolg
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Thanks Rolg for all your insightful comments. Now a doubt from a European lay person. In case cert is given by SCOTUS to Collins for a retrospective relief, would this open the door to voiding conservatorship as well?
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@luiz
no.
rolg
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When do you think we expect the final capital rule? Weeks, months? Can we back into this date somehow?
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There is no way to predict when the final capital rule for Fannie and Freddie will be issued. We may get some indication from Director Calabria, since he speaks extensively to the media and in various housing finance forums, and covers a wide range of topics when he does. In one of those instances a few weeks ago he said he was still considering whether to scrap the June 2018 proposal entirely (he referred to it as the “Watt proposal”); if he does, the timeline for a final proposal would extend into 2020, and probably beyond.
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Hi Tim,
I discovered your blog recently and I think you are doing great work. I wholeheartedly agree with almost everything you say but there are a couple of points where I have questions.
1. The terms under which Fannie and Freddie were taken over were outrageous in my opinion, and I appreciate your view that they did not need a rescue, but I can also see how the US government might have concluded that something needed to be done. Agency MBS spreads had widened. There was fear this might worsen and trigger a more severe downturn. Was it unreasonable for the US to believe that something needed to be done to reduce agency MBS spreads?
2. You talk about non-cash losses, argue that these were not real, and highlight the reversals in 2012-2014. Reversals alone do not imply anything improper. One would expect 20%+ housing price increases to reverse a lot of losses on $5T worth of mortgages. Did the 2008-2011 charges violate relevant accounting standards?
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Mark—Your questions are good ones, and I’ll try to answer them fully but succinctly.
I’ve heard the wider spreads between agency MBS and Treasuries advanced as a reason for putting Fannie and Freddie into conservatorship, but this notion doesn’t hold water for three reasons. First, agency MBS spreads don’t affect consumers directly; while these spreads were widening before the crisis, the Fed also was lowering interest rates, and Treasury rates were falling by more than agency spreads were widening, so that MBS yields were declining (albeit irregularly) leading up to, during and after the recession associated with the financial crisis. Second, wider agency MBS spreads were not a threat to the solvency of Fannie and Freddie. What matters for the companies’ portfolio business is the spread between their debt cost and MBS yields, and THAT spread actually widened notably in the first half of 2008 compared with 2007 (i.e., the companies’ debt spreads to Treasuries widened by less than the agency MBS spreads), which was helpful to them. Finally, “wider agency spreads” was not one of the triggers in the 2008 HERA legislation (which Treasury sponsored) for putting Fannie and Freddie in conservatorship; Treasury did that on its own, without statutory authority and against the companies’ will.
We don’t know if some of the 2008-2011 non-cash expenses booked for Fannie and Freddie by FHFA violated accounting standards. This issue was litigated in cases against the companies’ auditors, but the Deloitte case was settled and the PriceWaterhouse Coopers case was dropped (which suggests to me that it was settled as well), and no information from those cases is available. For me, however, three factors suggest the non-cash charges were made to deliberately cripple Fannie and Freddie. The first is their scope—post-conservatorship, virtually every expense that could have been accelerated or booked based on an estimate was in fact recorded. This is the opposite of what happens at shareholder-controlled companies during times of stress. Second, most of the non-cash expenses were disproportionately large (relative to what other financial companies were doing), such as the loss reserve and securities write-downs, or poorly justified (the reserve for deferred tax assets). Third, and to my mind the most damning, was the unique mechanism chosen by Treasury for “rescuing” Fannie and Freddie: non-repayable senior preferred stock issued to remedy deficiencies in book net worth. It was no coincidence that non-cash losses—accelerated expenses as well as questionable estimates of incurred losses—spiked right after the conservatorship, and continued to rise (totaling over $300 billion) until by the end of 2011 Fannie and Freddie were required to pay a 10 percent dividend in perpetuity on $187 billion in senior preferred stock they didn’t need, didn’t want, and weren’t allowed to repay.
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Tim,
Thanks very much for the reply!
Regarding my first question, I should have clarified that I was asking only about general policy related to mortgage rates and availability. Your (second and third) points about the impact of spreads on Fannie and Freddie support the view that their takeover was wrong, something I agree with. Some of your other writings outline plans that I would call “solutions” so I think the answer is yes, you think it made sense to do something focused directly on mortgage rates, but I’m not 100% sure.
From year-end 2007 through the end of August, housing prices slid around 5%. According to Freddie Mac’s monthly data, 30 year fixed rates increased from 6.10% with 0.5 point in December 2007 to 6.48% with 0.7 point in August 2008 even though 10 year Treasuries dropped around 20 basis points over roughly the same time period.
These are not very encouraging statistics but they understate the palpable fear at the time. Subprime and Alt-A credit statistics deteriorated sharply during this period. There was legitimate fear of deterioration in well-underwritten mortgages. The actions taken were a bungled, illegal, and probably unethical mess, but I think it was perfectly reasonable for the administration to conclude that some type of action was necessary to reduce mortgage rates and mitigate the decline in housing prices. Would you agree?
To me it seems like this is a no-brainer question, but I have experienced too many cases where I thought the answer to a question was obvious only to realize someone very intelligent disagrees with me.
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If you’re asking if I agree that “some type of [government] action was necessary to reduce mortgage rates and mitigate the decline in home prices,” stated that way I do not. It would have to be a proper action, with a reasonable chance of success. What Treasury did was not proper, and many (including me) would say not legal: it took over two companies in full compliance with their capital standards, and meeting none of the criteria for conservatorship, because it wanted to use them as instruments of federal housing policy. That was well outside the boundary of possible actions it could (and should) have been considering to deal with the mortgage market problems it faced.
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Tim,
Why do you think that nobody has challenged, in court via a lawsuit, the imposition of conservatorship on the basis that the boards of directors were coerced into agreement? Many avenues of attack were tried against the NWS, and the most successful so far, Collins, seemed like a longshot to me at the time.
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Washington Federal HAS challenged that. Plaintiffs filed this suit in Margaret Sweeney’s Court of Federal Claims, where it’s “in the queue” behind the suits challenging the legality of the net worth sweep. The Washington Fed plaintiffs are asking for damages ($33 billion, or whatever the court deems appropriate), but many observers believe their counsel does not have the resources to pursue this litigation all the way to and through trial, which weakens their leverage in settlement discussions.
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@midas
oral argument on Washington Federal in front of J. Sweeney re govt’s motion to dismiss scheduled for 11/19/19. P’s counsel is a class action firm that normally would want to see a reliable pot of money at the end of a litigation in which it will not receive payment for its hourly fees as incurred. even assuming Washington Federal wins on merits that conservatorship was invalid because it’s board was coerced by the then Treasury Secretary, proving damages would involve the same sort of hurdles that Mr. Greenberg faced in the AIG case, also in the federal court of claims, where Mr. Greenberg won on the merits but was awarded no damages. so the fear for counsel is that this case is a long run for a short slide, and it has not been aggressively litigated.
rolg
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Tim,
I believe I was imprecise in my question. What I meant, more specifically, is why has nobody challenged the boards’ consent to conservatorship in a way to have it overturned, which would unwind all of FHFA’s actions since that date, all money sent to Treasury, etc.
The Washington Federal case only seeks money, not to overturn any events. It also only seeks money for shareholders as of the date of conservatorship, which might be scant comfort to those who bought their shares afterwards.
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A couple of large fund managers came close to challenging the conservatorships immediately after they occurred. I know this because I was indirectly involved in the process (even though I still was tied up in litigation over the accounting fraud charges at the time, and “off the grid” for this reason). A security analyst contacted me on their behalf to ask if I knew of a law firm to whom they might speak about the legal merits of such a challenge. I told the person I knew of a couple, and talked to principals at those firms to see if they were interested in a meeting on the issue. They said they were, and that point I dropped out of the discussion. A few days later, Lehman failed and the financial crisis ignited. I subsequently learned from the lawyers I’d spoken with that the firms who had wanted to sue Treasury decided against it, thinking it would not be good for their public image to be seen as suing, for their own benefit, the entity (Treasury) which along with the Federal Reserve was scrambling to save our financial system. Back then none of us knew the background facts about the takeover–as we do now–and perhaps had we known them the investment firms may have gone forward with their suit. But we didn’t, and they didn’t. And now, of course, it’s too late for anyone to bring suit on the issue: the statute of limitations ran out long ago.
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… Regarding my second question, your response was comprehensive and persuasive. Thanks again.
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Letter agreement is out!
https://www.google.com/amp/s/www.bloomberg.com/amp/news/articles/2019-09-30/fannie-freddie-permitted-to-boost-capital-cushions-by-billions
Cheers,
Justin
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The substance of this announcement was as I was expecting (as were many others), although I thought Treasury and FHFA might not wait until the last day of the month to make it. Fannie will be allowed to retain an additional $22 billion in earnings (up to a total of $25 billion, including the $3 billion authorized at the end of 2017), while Freddie will be allowed to retain an additional $17 billion (for a total of $20 billion). I also noted this sentence at the end of Treasury’s letter to each company: “The Enterprise and Treasury agree to negotiate and execute an additional amendment to the Agreement that further enhances taxpayer protections by adopting covenants broadly consistent with recommendations for administrative reform contained in Treasury’s September 2019 Housing Reform Plan, in further consideration for the amendment contained in Part I of this agreement.” I view this as a positive, since it means that “reforms” to the companies to be imposed between now and when they are released from conservatorship will be negotiated by the parties, rather than imposed by FHFA as conservator.
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Calabria talks about breaking up the GSEs like Ma Bell in the 80s, What a perfect analogy!
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Tim
no commitment fee yet…which is good, as that could be consideration flowing from the GSEsto treasury for the “big settlement” in which the senior preferred stock is nuked. while settlement of litigation is a big “get” for treasury, also getting the commitment fee is more support for treasury’s decision to eliminate the senior preferred. from a strategic point of view, I find this very helpful.
rolg
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As I’ve mentioned before, Treasury will need to know the capital requirements imposed on Fannie and Freddie before it can set the commitment fee for its line of credit, which will be less likely to be tapped–and thus command a lower fee–the more capital the companies are required to hold.
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Tim
disagree. commitment fees are typically charged based upon commitment availability and amount, not likelihood of usage. in fact, I recall mnuchin having referred to an imposition of a commitment fee at this stage, the suspending of the sweep. imo, non-imposition of fee at this stage is important.
rolg
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It’s fine to disagree. But I would emphasize that this “commitment fee” is not analogous to a fee for a bank line of credit; it’s a fee for providing catastrophic risk insurance. Cat risk is priced based on the estimated likelihood of occurrence, and in Fannie and Freddie’s case that is directly (and inversely) related to the amount of capital that has to be burned through before the catastrophic risk comes into play. I don’t know how else Treasury would price this–unless it does so politically, which I doubt it will.
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Does this entail a final capital rule then before settlement and amendment to SPSPA?
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I don’t believe settlement of the lawsuits is contingent on having a final capital rule in place, although it (the final capital rule) might make a settlement easier.
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Tim
you present nicely an interesting point: the treasury line of credit is to be used only at a time of severe stress, when the GSEs have eaten through their existing capital, and the larger the GSE capital cushion is, the more unlikely (and therefore more cheaply priced) the line of credit should be. typically, lenders are constrained in their own capital sources, and charge a commitment fee because of the opportunity its cost of not being able to allocate their lending capability represented by the commitment elsewhere. one can argue that treasury has no such sourcing constraint, as the line has been appropriated by congress (treasury’s only real constraint) and it can keystroke money from its account with the Fed, so the typical lender pricing considerations do not come into play.
rolg
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@ROLG even more interesting in that the draws that brought about the original situation were never really needed in the first place according to their regulator at the time of the takeover!
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Tim,
Does the consideration given to Treasury–namely the $39B in additional liquidation preference–concern you? Maybe I’m misinterpreting something, but it seems like they’re treating our retained capital like a draw from Treasury, adding to the liquidation preference that we will be forced to pay dividends on in the future. I suppose it’s possible that the court cases wipe out the liquidation preference, but treating our retained earnings like a loan from Treasury seems pretty abhorrent to me.
What are your thoughts?
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I think it was important that Fannie and Freddie be given the ability to begin to retain their earnings, and unless and until the net worth sweep is invalidated or canceled the only way this could have been done was by increasing Treasury’s liquidation preference by the amount of quarterly sweep payments due each quarter. I don’t like having the liquidation preference rise, but given that I believe it ultimately will be eliminated–either in a settlement with plaintiffs in the lawsuits or through a court-ordered re-characterization of sweep payments in excess of the ten percent dividend each quarter as pay-downs in the balance of senior preferred outstanding–I think it’s an acceptable price to pay for getting the companies’ recapitalization process started. If, though, for some reason the senior preferred does NOT get canceled, then having even more of it outstanding in exchange for retained earnings that are of no use to the companies will turn out to have been a bad deal.
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I’m thinking, as you may have mentioned before, that not eventually ending the liquidation preference would be a violation of the conservatorship agreement and would make it more difficult to raise capital on the open markets.
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Is anyone else nervous about the 5th En Banc getting remanded to the lower court for penalties? I mean they were the ones who got it wrong in the first place…If consistent with other court rulings, my gut tells me they will find a back door easy way out for govt….also, reminds me of when AIG won their legal battle but the courts ruled AIG gets nothing $$…
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@BIGe
Judge Atlas got the law wrong at her first go of it; she did not even get to the facts. Judge Willett’s opinion is clear enough on the law, and I dont see any legal wiggle room. NWS is inimical to the conservator’s duty; I didn’t find any caveats in Judge Willett’s opinion such as, well if the court below finds that there was indeed a “death spiral,” then the NWS can be consistent with the conservator’s duty. if there was a death spiral, then under Judge Willett’s opinion, it is clear that the conservator should have switched into receivership mode. but it didn’t go into receivership, so all of the govt’s allegations as to the death spiral are irrelevant. I dont see how Judge Atlas can excuse, for lack of a better word, the NWS as a viable conservatorship option under Judge Willett’s opinion.
so when Judge Atlas assess the factual allegations, and sees the govt’s answers, I simply can’t see how she can determine that the NWS complies with the conservator’s duty as elucidated by Judge Willett.
now as to damages, I dont see any wiggle room here either. unlike the AIG situation, Judge Atlas doesn’t have to divine what the shareholders’ holding would be worth if the NWS didn’t occur (as per the AIG case…and as Judge Lamberth and Judge Sweeney will have to do); she has a record of payments that the GSEs actually made as compared to what the GSEs’ dividends obligations were as per the pre-3rd amendment SPSA . those actual payments can be mathematically compared to the 10% dividend obligation, and the overage is the amount that treasury owes the GSEs. there is the fillip that under the PSPA, the senior preferred preference cannot be paid down, but treasury took and has retained all of the sweep money, so unless it returns the overage, paying down the senior preference is the only feasible alternative. the gov’t cannot stand by the terms of the agreement (no preference pay down) and keep the overage.
rolg
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Tim, and others,
The additional language in the letter agreement (re: future PSPA amendment which you quoted above) has me wondering…Why include this in a narrow agreement? What problem is it solving, or what purpose is it serving? It appears unnecessary and out of place.
Thanks,
AC
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@AC
every agreement in a contentious litigated situation has to be drafted with a view to defending the agreement against challenge…in this case, by some party that would not want the sweep to stop. you will notice that the agreement recites as consideration flowing to treasury for executing this letter agreement the covenant from the GSEs to enter into a future agreement that will contain covenants governing their future operations…which I believe will take effect once the conservatorship is ended (and I expect the conservatorship will end contemporaneous with the closing of the first public offering). so this is careful lawyering, and an indication that the legal (and other) merits of this step must be considered in conjunction with future steps.
rolg
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Do you believe that the warrants will remain intact at the time of the first public offering or will they have been dealt with already?
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The warrants will need to have been “dealt with”–exercised, amended or canceled–prior to any public equity offering by either company.
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@Tim Which of the 3 do you think will make the raise go well?
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The answer (as you know) is obvious. But if you’re asking what will Treasury do with the warrants, I have no insights into that.
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Collins through Cooper & Kirk have filed a petition for cert with scotus on the 5th C’s denial of retrospective relief in connection with constitutional claim: https://static.reuters.com/resources/media/editorial/20190926/fhfacertpetition.pdf
rolg
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I think that’s the right move. I know David Thompson believes that at least some of the SCOTUS justices agree that remediation of injury to the plaintiff is required in cases of unconstitutionality, so there seems to be little downside in filing this petition for cert. And SCOTUS might well take it, both to rule on the remedy and to settle the issue of the constitutionality of agency heads removable by the president only for cause, which is percolating through other courts as well, and needs to be settled.
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Tim
agreed. plus you have the strange situation that the 4 judges who would have found the single director removable only for cause structure to be constitutional all voted to deny retrospective relief…7 of the 12 judges who found a constitutional violation would have ordered retrospective relief. ripe for SCOTUS to set forth a definitive analysis and result.
rolg
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What do you think the timing is to get an answer from SCOTUS for something like this petition for cert?
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@big
totally up to scotus, but this is a case that Justice Thomas wants to hear.
rolg
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Does this bold legal move put FHFA and Treasury into a zugzwang position? It would seem to me that any reply by the government would weaken its opposing position.
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@Brian
thanks for incenting me to expand my vocabulary. FHFA may also file a cert petition seeking to uphold its structure, but it does so at the risk of having scotus both affirm to invalidate the structure and reverse to grant retrospective relief on the constitutional claim, so your chess-based intimation may be correct. FHFA may also want to have scotus reverse the APA decision, but since that was not a final judgement I dont think scotus will agree to hear that. treasury will sit this one out at the petition stage since the 5th Circuit constitutional claim results were exactly what it was arguing for (though if scotus takes P’s petition it will argue for affirming the 5th C). there is is some high level strategy going on and this signals, imo and as Tim alluded to, that Cooper & Kirk likes its chances for retrospective relief on the constitutional violation at scotus.
rolg
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@Brian
one possible fhfa strategy would be to argue to scotus that it should review the constitutional structure/relief claim and the APA claim at same time, and that it is premature to consider the APA claim (not a final judgment on the APA claim), so scotus should hold fire until the district court enters a final judgment on the APA claim. I dont see why scotus would agree that they must hear both claims together.
rolg
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Petition for cert almost certainly means still negotiating and Sep sweep made. Gl,
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Thx ROLG! You rule!
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Tim – You’ll be happy to hear:
Fitch Ratings has taken various rating actions on 1158 classes from 57 GSE Credit Risk Sharing (CRT) transactions issued between 2013 and 2019. Fitch has affirmed 441 and upgraded 713 classes. The remaining four classes were marked paid in full. After the review, 1091 classes have a Positive Outlook, reflecting an increased likelihood of upgrades in the near future.
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None of what Fitch says should come as a surprise to anyone following Fannie’s monthly summary information. Fannie publishes the average serious delinquency rate on its loans covered by CAS risk-transfer securities, and in June that delinquency rate was just 24 basis points. Fannie’s best six years for serious delinquencies were between 1998 and 2003, when its average serious delinquency rate was 50 basis points. That’s more than double the rate on the loans Fannie has covered with CAS since it began its CRT program. Had Fannie covered all of the loans it acquired from before 1998 through 2003 with the CAS it’s now issuing, not a nickel of credit risk would have been transferred to the buyers of these securities (and it would have made billions of dollars in interest payments on them). So, yes, I’d say Fitch is on pretty safe ground upgrading the credit ratings of the CAS Fannie has issued since it began that program.
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Tim
while we are all on Calabria/Mnuchin watch regarding the roll out of administrative reform, I just wanted to alert you and your readers that the Bhatti case will be argued before the 8th C. merits panel just over two weeks from now, on 10/15/19.
the principal claims are the i) unconstitutional structuring of the fhfa with a single director removable only for cause, and ii) the unconstitutional appointment of acting director DeMarco prior to the adoption of the NWS. In Collins en banc, Ps won claim i) 12-4, but lost on retrospective relief that would have invalidated the NWS 7-9. Bhatti will be another bite of the apple for retrospective relief on claim i). Collins did not consider claim ii), which is noteworthy for the following reason: SCOTUS has granted retrospective relief for an unconstitutionally appointed officer (Lucia). when it comes to ordering retrospective relief, circuit courts are wary to do so without explicit SCOTUS precedent (even though Section 706 of the Administrative Procedure Act would seem to require it). so with respect to claim ii) there is SCOTUS cover that may be available to the 3 8th C judges.
to avoid misunderstanding, if this 8th C merits panel did order retrospective relief for one of these constitutional claims, this would constitute a second judicial invalidation of the NWS. Collins en banc achieved invalidation of the NWS on statutory grounds, and simply awaits the district court to find that the incontestable facts in the Collins complaint regarding the NWS are, indeed, incontestable by the govt.
se https://www.dropbox.com/s/hr6xhqit9ffafoi/bhatti%20reply%20brief%208th%20C.pdf?dl=0 for Ps reply brief in the Bhatti case.
I am both a judicial realist, knowing that judges have judicial philosophies and are predisposed to certain arguments over others, and someone who has been surprised by judges veering from expectation. but I would point out that all 3 judges on the Bhatti merits panel were appointed by G.W. Bush and “may” have conservative dispositions.
rolg
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ROLG:
I was aware of the oral argument in Bhatti scheduled for October 15th, but appreciate the reminder for readers. This might ultimately result in another positive ruling for plaintiffs.
While we await word on what FHFA and Treasury have decided to do with the net worth sweep payments due from Fannie and Freddie on September 30, I should tell readers that if news on that comes out on Friday I’ll be away from the blog for almost the entire day. I have a morning flight to the west coast that probably won’t get me to my destination until around 5:00 pm east coast time, so I’ll miss any news that may come out before then, as well as any comments made about it on the site.
For what it’s worth, I expect FHFA and Treasury to do a version of what they did at the end of 2017, when they allowed Fannie and Freddie each to retain a $3 billion capital buffer, in exchange for adding a comparable amount to Treasury’s liquidation preference, and to have this be effective with this quarter’s scheduled sweep payment. I don’t see the addition to the liquidation preference as being problematic; no matter whether it stays at $191 billion or increases, it still will need to be dealt with–meaning eliminated–in settlement talks with plaintiffs, in order for recapitalization to proceed. I also believe they will announce a dollar amount of capital retention permitted under this agreement, which if I had to guess I’d put at $20 billion–enough to carry comfortably past the 2020 election.
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Tim, could you please explain “liquidation preference” as it pertains to this situation? David Thompson mentioned it in his 5th Circuit debrief as well.
Thank you,
Paul
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Interestingly enough, “liquidation preference” is not one of the (22) defined terms in the September 7, 2008 Senior Preferred Stock Agreement (SPSA). But section 3.3 of the SPSA states, “The aggregate liquidation preference of the outstanding shares of Senior Preferred Stock shall be automatically increased by an amount equal to the amount of each draw on the Commitment…”. In conjunction with the provision in the SPSA that draws by Fannie or Freddie taken under the Commitment only can be repaid with the consent of Treasury (which it has not given), the practical impact of the liquidation preference is that no matter what the dollar amount of payments to Treasury made by Fannie or Freddie under the net worth sweep, Treasury retains a senior claim on the companies’ assets (which is what the liquidation preference is) equal to the aggregate amount of draws made since day 1, which now total $191 billion. As long as Treasury’s liquidation preference remains in place, junior preferred shareholders would not receive anything from the companies in liquidation until Treasury had been paid $191 billion, and common shareholders would see no payments until Treasury had been paid AND the junior preferred holders received $33 billion. It’s for this reason that the liquidation preference must be eliminated—through a court judgment, settlement with plaintiffs, or voluntarily by the government—before any new money will be put into either Fannie or Freddie by investors.
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Ok, Very good. My next question is: if the “liquidation preference” is eliminated, does that eliminate the 79.9% Warrants that Treasury holds?
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No. The warrants would be unaffected by an elimination of the liquidation preference.
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There’s an entire document on the Liquidation Preference called the Certificate of Designation (aka “Stock Certificate”) also executed 9/7/2008.
Click to access certificatefnm2.pdf
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Thank you for pointing that out.
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How important is Pollock’s analysis?
https://www.realclearmarkets.com/articles/2019/09/20/have_fannie_and_freddie_paid_the_taxpayers_back_yet__103920.html
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Pollack’s “analysis” is fanciful, but more importantly, it’s irrelevant. The government is going to lose on the legality of the net worth sweep, and the remedy will take one of two forms: a recharacterization of the companies’ excess quarterly sweep payments as pay-downs of their outstanding senior preferred stock, or the government writing a check to each for the overages. Most believe the former is more likely, which would result in Treasury owing both companies around $12.5 billion each. There is no third alternative, and certainly no vehicle for Mr. Pollock to introduce his fantasy of a $9.9 billion annual commitment fee into the discussion.
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there was no commitment fee charged by treasury. full stop. GSEs did not owe a commitment fee for a line under terms of a transaction where no commitment fee is charged….”as every banker knows”.
why was no commitment fee charged? perhaps it was the rapacious dividend rate (10% for GSEs, at a time when tbtf banks were charged low single digits) and the rapacious equity kicker (79.9% of the common equity). maybe treasury was embarrassed to ask for more under the circumstances. it doesn’t matter. you live by the contract you signed….”as every banker knows.”
rolg
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Basically Mr Pollock wants to charge commitment fee on outstanding MBS that are in not in any way guaranteed by Gov instead of charging commitment fee on outstanding Gov SPS credit line.
How can a former President and CEO of the Federal Home Loan Bank have such weird views?
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Pollock is a loyal vassal of the Financial Establishment, and one of the foremost purveyors of its litany of misinformation about Fannie and Freddie. What he doesn’t seem to realize is that with the reform process having shifted to the administrative realm, the key participants in that process understand the facts about the companies: they’re the safest, not most risky sources of mortgage finance; they were not rescued by Treasury but taken over by it, and their $187 billion from Treasury wasn’t a bailout, it was, as I’ve said elsewhere, “senior preferred stock they didn’t need and you [Treasury] wouldn’t let them repay, whose purpose was to transform massive, temporary and artificial book expenses you’d created for them into massive, perpetual and real cash revenues you’re taking for yourself.” The plaintiffs in the lawsuits understand this even if Pollock doesn’t (and I suspect he actually may), so his draconian view of what is “fair” compensation for removing Fannie and Freddie from conservatorship–based on his false recounting of how they got there–will not be taken seriously by those who will be negotiating the terms of this task, and have no practical impact on them.
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Tim
one might expect mnuchin, who is a real banker, to refrain from negotiating for an economic position (pollock’s “you owe us a fictitious commitment fee”) that is not supported by the actual terms of the financial transaction; this is one reason imo why mnuchin has insisted that going forward from the execution of the letter agreement that is to stop the NWS, expected at end of this month, the commitment line will bear an actual commitment fee. mnuchin understands that fictitious entitlements are not enforceable.
rolg
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Tim,
Are there any lawsuits outstanding on these issues – the “stick up” and the rapacious dividend rate of 10%? The only one that I have seen are the ending of the NWS.
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Washington Federal challenges Treasury’s action of putting the companies in conservatorship, but while noting the 10 percent dividend does not specifically request damages from it (nor does it request damages related to the warrants). Plaintiffs’ Prayer for Relief asks for an award to “Plaintiffs and the Classes damages suffered by them by virtue of the Defendants’ taking and/or illegal exaction of $41 billion [the value Plaintiffs put on the aggregate common and junior preferred stock of Fannie and Freddie on the day prior to the announcement of the conservatorships], or some other amount to be determined at trial,” plus “Prejudgement and post-judgment interest, together with any and all further costs, disbursements and reasonable attorneys’ and experts’ fees.”
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I saw all I needed to see when Pollack says “as every banker knows”. It’s a biased article favoring big banks. Seems like desperation at this point.
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This will never end as far as the “banksters” and their ilk are concerned. It’s the old adage of repeat a lie enough times (and loudly) and at some point people start believing it. They have “access” to getting print in the media so they’ll just keep cranking out these opinion pieces and suggestions hoping something will stick.
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Tim – what is the best way for interested parties to recreate your analysis on the ineffectiveness of CRTs? Is your analysis publicly available anywhere? Has anyone else done it? It seems like there may be few parties with the expertise to do it that have interests aligned with the companies. Further, what does it say about who is really in charge today?
TIA!
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My two primary criticisms of Fannie and Freddie’s securitized credit-risk transfer (CRT) programs are that (a) they are too expensive relative to the credit protection they provide, and (b) they do not offer anything like “catastrophic” loss protection in a stress environment, leaving the companies to absorb the bulk of their credit losses on their own.
I’ve done quantitative analyses of each of these points using Fannie Mae data, which can be replicated by third parties provided they are familiar with the information Fannie discloses in its annual 10Ks and what it used to call its credit supplements (now called financial supplements).
My “too expensive” point is that because investors price Fannie’s (and Freddie’s) CRTs to earn comfortably more in interest payments than they expect to lose in credit losses, and can exit the market when they think the risk of CRT losses is too great, it’s extremely unlikely that over a full cycle Fannie ever will get more dollars of credit loss reimbursements than it pays out in CRT interest. To illustrate this, in a blog post titled “Risk Transfer and Reform” (September 27, 2017) I did an analytical exercise in which I assumed that Fannie had covered all of the loans it had on its books at December 31, 2007—just before the crisis—with its most popular type of CRT, the M-2, which provides credit protection for losses from above 100 basis points of a given pool’s initial loan amount up to 275 basis points. My analysis found that for Fannie’s pre-2005 loans it would have paid about $15 billion in interest on CRTs and received almost no loss benefit from them, while loss reimbursements on CRTs issued in 2005 would have exceeded interest payments by about $1.5 billion. If Fannie had been able to sell CRTs on its 2006 and 2007 books, they would have cost only $4 billion in interest and paid $20 billion in loss transfers—but with home prices beginning to fall in the summer of 2006 and falling further throughout 2007, investors would long have fled the CRT market. They would have pocketed the gains on the pre-2005 books, and left Fannie with the losses on the 2006 and 2007 books.
The analysis for my “insufficient loss coverage” point about CRTs appears in “Risk Transfers in the Real World” (March 20, 2017), which is a more technical post. Here, I assumed that Fannie had covered all its December 31, 2007 loans with both major types of CRT, the M-1 and M-2, which combined take losses above 100 basis points of a pool’s initial balance up to 400 basis points. The “takeaway” from this post is that of the $84.5 billion in credit losses suffered by Fannie’s December 2007 book, CRTs would have picked up less than one-third of them—again assuming Fannie could have sold CRTs in 2006 and 2007, which it almost certainly could not have—leaving the company to pick up the rest.
No one has challenged these analyses, but I also haven’t heard of anyone attempting to do them on their own. That may because the analyses are not easy, and one would have to know what credit loss data Fannie makes available, as well as how to use it.
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Tim
hopefully, CRTs will be a conservatorship/NWS historical curiosity, since once the GSEs are permitted to rebuild equity capital and exit the capital dungeon imposed upon them by the NWS, their usefulness (however useful) will no longer be needed. and certainly, if fhfa somehow encourages or mandates the GSEs to continue to use CRTs as capital is rebuilt, then the onus should be on fhfa to prove their utility. the best tell of the CRT’s inefficiency is the extent to which Urban Institute (employing Parrott as an advisor) extols them.
rolg
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The major concern I have here is that, in order to make its “headline” capital requirement for Fannie and Freddie look more bank-like (to satisfy the companies’ opponents and critics), FHFA will leave many of the cushions and elements of conservatism that were apparent in its June 2018 proposal in the revised standard, then allow Fannie and Freddie to reduce their required equity capital by issuing non-economic CRTs. While this arguably may work in a normal market environment, if and when we do experience true mortgage market stress, we will see investors exit the CRT market at the same time as homebuyers seek to refinance their mortgages (since mortgage rates typically decline during recessions). Under these circumstances Fannie and Freddie’s capital requirements on all new loans–purchase mortgages as well as refinances– will suddenly jump up to their full “headline” levels, given the unavailability of CRTs. In times of true stress it’s not likely the companies will be able to obtain this additional equity, forcing them to cut back substantially on their volumes of new credit guarantees. Fannie and Freddie’s essentially pulling out of the market just when it is most in need of the liquidity they were chartered to provide, with no obvious other sources of mortgage credit available to take up the slack, would greatly exacerbate the slump.
I understand why there is such a wide constituency for securitized CRTs–they are a huge, popular and profitable new asset class for investors and Wall Street issuers–but I truly hope FHFA thinks through the implications of institutionalizing in its capital proposal the use of noneconomic CRTs that actually would hinder Fannie and Freddie’s performance during periods of economic stress, thereby making our financial system less safe.
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I think your comments above are why.
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I’m very disappointed to see these comments from Josh Rosner, who should know better. I’ll send him a note.
The “back-and-forth” shown in the Twitter excerpt above, however, illustrates my main objection to this medium (and my reason for not being active on it): the response to any sort of criticism typically isn’t a substantive rebuttal; it’s a personal attack, often without any effort made to verify the accuracy of its content. For example, Josh says, “If I’m not mistaken the stock price of @Fannie Mae was about $123 when Tim became CFO & was about $49 as a result of his and Frank Raines stewardship.” Uh, no—and it’s a pretty easy fact to check. Fannie’s stock was in the single digits (adjusted for subsequent splits) when I became CFO on March 1, 1990, and $70.34 on the Friday before I was asked to step down. Josh also says, “he [meaning me] was exonerated from violating accounting rules & not from gunning the portfolios or lowering underwriting standards to boots [sic] executive comp.” The latter claim also is verifiably wrong. I was Fannie’s CFO for fifteen years. Over the first fourteen of those years—1990 through 2003—Fannie increased its share of total U.S single-family mortgages financed by an average of one percent per year, from 14 percent to 28 percent. In 2004, when private-label securitization began to dominate the pricing of all single-family mortgages, Fannie’s share of mortgages financed dropped by two percentage points, to 26 percent, because we didn’t like the underwriting, or pricing, on many of the loans being made. The fact is just the opposite of what Josh says. Look it up.
Finally, Josh twice takes gratuitous shots at the pro bono work I’ve been doing for the last several years, via the blog and private communications with key participants in the reform dialogue and the lawsuits, saying first, “That’s why he isn’t part of the DC debate,” then “Regardless of whether it is fair, he is generally viewed, in DC, as part of the problem not part of the solution.” I may not take part in the spats on Twitter (by choice), and I don’t seek publicity for what I’m doing (unlike some who shall remain nameless), but the notion that I’m not part of the debate or am viewed as “part of the problem not part of the solution” would come as a surprise to the many key insiders who have generously shared their thoughts and insights with me, and encouraged me to “keep up the great work.” And I intend to, personal attacks notwithstanding, because I believe we’re making real progress.
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Tim or ROLG,
Since the outstanding warrants obviously add complexity to recapitalization, would you think it is more likely Treasury would sell these back to the companies as opposed to exercising them and selling the shares? What would that look like if they did go that route since the companies don’t currently have funds to buy these back? Possibly an exchange of sorts based on the funds Treasury would owe them based on overpayment from NWS?
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We’re all driving at same point that understandably Collins didn’t address in keeping narrow NWS argument and is ahead of other two cases that just got exponentially brighter. Prior to the Fifth, cases weren’t viewed in aggregate(other than a bunch of losers) but now if one helps in Sweeney discovery and orals, Lamberth etc, then regardless if they join, the Gov’t risk still multiplies so behooves them to settle more than individual suits.
What would global settlement look like across the three cases? Gov’t keeps all money and GSE’s keep all equity, more or less? Which when you look at seems generous and appropriate for all parties, if overly simplistic. Given only the facts public to date, anything less on behalf of GSE’s seems an operational harm to which SCOTUS might agree. How much is enough for one company to illegally lose yet still maintain viability? Gov’t has yet to show their hand while trying to stop sweep as same time mounting an appeal. Ending Sep sweep seems elemental by comparison. I know we’re dealing with US Gov’t here but do they really want to make a Federal case out of seniors/warrants? Gl, (to them, too)
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there wil be a negotiation between litigating shareholders and fhfa/treasury. if both parties are smart, they will want a global settlement that settles all claims among all parties. each side has a good hand to play, analogizing to poker. treasury has massive financial claims, representing the existing senior preferred and the warrants. the shareholders have potentially massive litigation claims, including Collins, fairholme (2) and Washington Federal (putting aside for the moment Bhattil. notwithstanding these strong opposing hands, there is an alignment of interests since both parties want to recap the GSEs and set them on a path to release from conservatorship. everyone who needs to be at the table will be at the table, understanding that congress has no seat. while financial advisors wont have a seat at the table, their role will be important in advising as to what is achievable in the public markets…no sense for the parties to settle on a plan that is not achievable in the marketplace.
when there is an alignment of interest there usually is a settlement.
there may be a collective action problem among investors that fhfa/treasury have to deal with, since the investors may not have a common understanding of what constitutes their best interests and objective…which may prove a barrier to resolution for awhile, so the negotiation may be protracted.
any prediction as to outcome would be foolhardy.
rolg
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All great points, thank you, Gl,
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there is an alternative non-negotiation scenario that occurs to me, after having calabria today say for the second time in an interview that when fhfa/treasury conduct their negotiation, the plaintiff litigation will go away (“Looking to rebuild capital and once NWS ends which is part of our plan then a lot of these suits go away.”)
in this scenario, fhfa/treasury agree to a plan where Ps get some but not all of what Ps are asking for by way of relief in Collins en banc (ie something less than eliminating the senior pref and putting some $25B back into the GSEs somehow). fhfa/treasury can go into a period of retaining earnings and then implement their something-less-than-what-Ps-want deal, and do a stare down with Ps, asking whether Ps want to hold up the re-Ipo? if Ps dont settle (effectively on fhfa/treasury terms), then GSEs stay stuck in retaining earnings land and dont proceed to the next step of capital raises.
Ps then would have the choice of proceeding with litigation in order to try to get what they want, or saying good is good enough. hardball.
rolg
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today’s Calabria interview I was referencing: https://www.bloomberg.com/news/videos/2019-09-16/fannie-mae-and-freddie-mac-won-t-go-to-market-until-end-of-2020-fhfa-director-says-video (love the accent)
rolg
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rolg – I think that Calabria thinks that by using those words he is somehow not showing his hand (ie – using the “s” word, settlement, would be admitting the P’s suits had some merit and would be showing the Gov’s hand). It leaves an “out” for him if someone questions him later on….”I never said settle, I said go away which means the P’s lose their cases OR they are settled but I wasn’t passing judgment on the final outcome of the cases when I said that”.
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@distress
this gets to some of my concern regarding Calabria…who until conservatorship is terminated represents the GSEs’ interest (a conflict situation as fhfa must negotiate an end to litigation that calabria has claimed has merit as a private citizen). unlike mnuchin, who is a very experienced banker and investor, I am unaware that calabria has negotiated any financial or business transaction. calabria seems at once overly talkative and evasive with respect to a complex $100B recapitalization that would daunt the most experienced pro. I would feel a lot more comfort if fhfa had already announced the hiring of legal and financial advisors for the recap.
rolg
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the alternate theory seems super risky for govt….why play roulette
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@BIGe
agree. but I just find it curious that calabria has said on two occasions “these lawsuits will go away” rather than for example “these lawsuits will be settled”.
rolg
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Just thinking out loud…I wonder how the fact that Fannie and Freddie are cash flow-rich but capital-poor influences recapitalization. Can they use this to their advantage to raise capital on advantageous terms, maybe by offering dividends on common or coupons on a new series of preferred stock? Or is simply retaining the earnings the best option?
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@AC
GSEs are an outlier on the recapitalization playing field. I have never seen such cash flow rich companies requiring a recap in my >30 years on Wall Street. which is good.
there are risks to the GSEs, principally political and regulatory risk. no companies dont have any risks. but the biggest risk for companies generally is operational, can the companies create abundant cash flow, and the GSEs frankly dont exhibit this risk. which is very good.
now, one can expect the capital rule to require a huge amount of capital relative to current status, so execution risk of the capital raise is abundant. but there is a pathway if there is cash flow.
rolg
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Tim / ROLG,
In the en banc ruling, it was determined sweep was unconstitutional. Was it determined HERA allowed for the NWS, thereby HERA in that regard was unconstitutional, or did they determine HERA didn’t allow for the sweep. (The Epstein rule.)
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The Fifth Circuit en banc determined that the provision in HERA that made the Director of FHFA removable by the president only for cause was unconstitutional, but ruled that the remedy should be changing that provision prospectively, rather than granting plaintiffs the injury relief (voiding the net worth sweep) that they sought. The en banc panel also ruled that HERA did not authorize FHFA to enter into the net worth sweep, and that doing so was a violation of the Administrative Procedures Act (a statutory violation) rather than simply bad business judgment by FHFA. The panel did not find that HERA, as a statute, was unconstitutional.
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Thanks Tim. This is the best, objective and most informed blog covering this issue.
I am wondering if anyone knows what the timeline for the Sweeney and Lamberth courts would be. I know specifics are hard but are we talking about months or years before we get any kind of ruling in those cases?
Cheers
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I’m following the Sweeney and Lamberth cases fairly closely, and think I have a pretty good idea of where they are. Other readers should correct me if I’m in error, however.
Sweeney has scheduled a single session of oral argument on all of the related cases before her court (including Washington Federal) in mid-November, to decide the issue of whether her Court of Federal Claims has jurisdiction over these matters. I believe she will rule that the CFC DOES have jurisdiction (although I don’t know when that ruling will be made). Assuming that’s the case, discovery then will proceed on plaintiffs’ motion for summary judgment on the claim that the net worth sweep was a regulatory taking, for which they are entitled to damages. No timetable exists that I’m aware of for how long it might take for Sweeney to decide this claim. Then, assuming the Washington Federal case has not been settled or dropped–and that its legal team wishes to continue to proceed with it–that case would begin discovery, and its own lengthy process of wending its way towards a decision.
In the Lamberth remand, all parties agreed this summer on a four-month extension to complete discovery, which should be done in mid-November. What then will follow will be a sequence of expert witness reports, the potential filing of amended complaints, further discovery based on the expert witness reports, and briefing on summary judgment motions. A ruling on the summary judgment motions would likely come in the summer of next year, and assuming that neither the plaintiffs’ nor the defendants’ summary judgment motion is granted, trial is tentatively scheduled to begin on October 19, 2020.
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@franz
Tim has this exactly right, and I would add only one thing that I find curious about Washington Federal. this is the only case that was filed before lapse of statute of limitations that attacks the conservatorship itself. claim is that HERA required board of directors consent for conservatorship (absent other findings) and that consent while given was coerced by Treasury Secretary Paulson. this is a triable claim in the sense that imo no court could grant the government summary judgment on coercion; rather a trial would be needed to find facts. so while this case likely wont get to trial, it isn’t going away anytime soon, and will have to be a part of a negotiated settlement (which I think will be a global negotiation covering the Collins litigation, any exchange of junior preferred for common etc…it is always better to negotiate everything once at the same time). in theory, if the govt put GSEs into conservatorship improperly, the validity of many things (ie warrants) could be called into question. so while I dont think this case ever sees a courtroom, it will be another pesky item on the negotiation agenda. it has holdup value, when viewed uncharitably from the govt’s point of view, but candidly likely not that much value.
rolg
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@rolg
Since I’m not a lawyer, I would like to ask for legal opinion on this question. Fifth Circuit en banc has ruled that FHFA was not authorized to enter into NWS under HERA. Does this mean then Third Amendment of SPSA is illegal? And as stated in section 6.12 of SPSA on non-severability, wouldn’t this also mean that senior preferred and warrants are illegal as well?
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Jim—I’m not a lawyer either, but I can answer your question. The ruling by the Fifth Circuit en banc that the agreement with Treasury to impose the net worth sweep was beyond the powers conveyed to FHFA by HERA did not invalidate the entirety of the Third Amendment (just its net worth sweep provision), and it has no direct implications for the legality of either the senior preferred or the warrants.
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I just want to clarify that when Tim says “it has no direct implications for the legality of either the senior preferred or the warrants.” i would agree that the the holding has no implications on the legality of the senior preferred, but the holding has “indirect” practical implications on the senior preferred insofar as all of the historical sweep payments of dividends stand to be recharacterized as part dividend at 10%/part retirement of preference amount of the senior preferred, leading to a retirement of senior preferred, if all of the NWS payments are to be recharacterized by the district court as relief pursuant to the en banc opinion, and no implications whatsoever, legal or practical, on the warrants.
rolg
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just one more thing on Washington Federal and coercion. some of Ps factual allegations of Paulson coercing the GSE boards of directors come straight from Paulson’s book, written after the event and in which he rather boasted about holding and pointing figurative bazookas and knocking heads. this hubris reminds me of Parrott’s zealous crowing about the NWS in emails that found its way to a prominent place in Judge Willett’s bravura majority Collins APA opinion. that happens when power is exercised without measure and wisdom.
rolg
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Tim, ROLG,
Excellent. Thank you for clarity on this.
Given David Thompson’s post ruling comments about Calabria being on a 15 month shot clock, what is the likelihood of The cases in both Sweeney and Lamberth’s courts being expeditiously settled. It seems that the legal pipeline, especially with ongoing discovery, will tilt strongly toward shareholder relief. Assuming that is the case, what do you believe settlement would look like for the remaining cases that pose the most threat to the government?
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I agree with ROLG that the government will attempt to settle all outstanding litigation simultaneously, but I don’t have any prediction for when that might happen, or what the precise terms of the settlement might be.
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Tim/ROLG-
During the Investors Unite conference call with David Thompson last week, he made a comment (not sure whether he was referring to either Fairholme or Perry remand, or both) that in the DC courts if plaintiffs won on breach of implied covenant of good faith and were awarded damages, those damages were liabilities of the companies, not the government. I’m still trying to understand this. How can the shareholders of the companies be liable for the actions of the government (FHFA), who acted ultra virus, and failed to uphold their fiduciary duty to “conserve and preserve?” Did I hear Thompson right? This throws me for a loop. I understand the difference between direct and derivative claims. Shouldn’t the government be on the hook for the direct claims? They are the primary named party in the lawsuits. If what Thompson says is true, one shareholder will extract legal claims from the rest of the shareholders by successfully suing the government, a third party, for its malfeasance.
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@bw
forget the legal analysis, the big takeaway from David’s point is that there can be no public offering if the issuer GSEs have a contingent liability represented by this litigation…so it needs to be settled in order to recap.
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Tim – Wondering how caps and the 37.5% affordable mandate impacts you’re view on FHFA’s stewardship.
From my seat it doesn’t really appear to be limiting based on issuance data I have seen but your thoughts are always appreciated.
https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Revises-Multifamily-Loan-Purchase-Caps-for-Fannie-Mae-and-Freddie-Mac.aspx
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I’ve not followed Fannie’s multifamily business that closely since I left (mainly because it’s not been subject to nearly as much outside opposition as Fannie’s single-family business), but from what I’ve been able to ascertain the industry is not upset about it, so I would take FHFA’s revised multifamily cap as a neutral to a positive development.
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Tim
interesting leak if true:
@KatyODonnell_
Calabria talked next steps in an all-staff mtg today — raising capital buffer in a limited way and having GSEs operate under a consent agreement at point where they have enough $ to leave conservatorship but not enough to fully comply w/ new capital rules
I think it would be constructive to have GSEs leave conservatorship before meeting (what we can assume to be a rather stringent) capital rule
It is possible that when FHFA/treasury tested the investor waters (assuming they have) the feedback they got was that, yes we would very much be interested in investing into companies with these cash flows, but not in companies controlled by a conservator having HERA conservator powers (the extent of which is still under litigation).
rolg
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Allowing the companies to leave conservatorship before they fully meet their new capital standards would be sensible and welcome, but how sensible and welcome will depend on the details–what is the ultimate capital percentage, at what level prior to that is the release point, and what will FHFA count as capital–which we don’t know yet.
Some numbers here might help, and I’ll use Fannie’s, since that’s the company I know.
For the last few years, Fannie has been earning around $19 billion per year, pre-tax. But what most don’t realize is that since 2012, the company has been booking an average of $3.0 billion a year (pre-tax) in benefits for credit losses, through slowly drawing down the ridiculously high loan loss reserves FHFA forced them to build between 2008 and 2011. In the last 7 1/2 years, Fannie has booked $24 billion in these benefits. But that boost to annual earnings soon will run out. Fannie’s total allowance for credit losses, which was $72.2 billion at the end of 2011, was down to $11.5 billion in June of this year. The company should still be able to pull some of that out, but we’re close to the end. And once that happens, Fannie’s annual pre-tax earnings will drop down to around $16-17 billion per year (and less, if FHFA makes a serious effort to shrink their footprint, and as their total interest payments on CRTs continue to build).
And next year, Fannie probably will have to add about $10 billion to its loss reserve because of the Current Expected Credit Loss (CECL) accounting rule. That will come out of earnings. So as a rough approximation, between now and the end of 2021, Fannie will likely earn a little less than $30 billion after-tax. If you add to that the $6.4 billion in retained earnings they have now (which it looks like they’ll be able to keep), that will bring their capital to around $35 billion at the end of 2021, or about 1 percent of Fannie’s total assets today. I doubt that FHFA would release them for less capital than that, and they probably will insist on a good deal more–at least half the fully effective new regulatory capital percentage. (Winning a reversal of the net worth sweep will add a little more capital to the equation through the application of the overages in sweep payments to cover Federal taxes, but it won’t help that quickly, because of the lower marginal Federal tax rates). So, without a public capital raise, we’re still talking about a fairly lengthy period of time for Fannie to get a “get out of jail free” card through retained earnings alone.
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Tim
after reading the Treasury Plan, I have been trying to understand what Treasury counselor Phillips had been doing the past two years. that Plan could have been written in two days. it had been my understanding that Phillips conducted wide ranging interviews with many parties interested in the GSEs, including within the investment community many of which, given his background, he knows well. I have been trying to get a sense whether there is a “plan not for public consumption” regarding the steps towards recap and release which is the product of his two year inquiry. this tweeted leak, if true, is the first glimmer that I have seen that there is a more substantial plan than that which calabria and mnuchin have been willing to publicize to date. I may be giving the administration too much credit though. what I don’t think calabria and mnuchin are willing to admit is that the Collins en banc APA opinion is a big plus towards raising public capital, reducing the risk factor presented by the stewardship of a conservator claiming to have unfettered power.
rolg
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Tim
so obviously this is speculation, but a smart investment banker like phillips might recommend (and a smart investment banker like mnuchin might agree) that the plan would have the following steps (roughly):
i) initial period of earnings retention, during which fhfa and GSEs would reach an agreement that would amend the SPSA (also presumably settling litigation and eliminating senior preferred) and provide for terms under which the GSEs are to operate post-release from conservatorship; ii) a re-ipo of sufficient funds such that at the closing of the the re-ipo, the conservatorship would end and the agreement would activate (so that new investors would not subject their money to conservatorship whim, but to agreement terms which would be disclosed in the re-ipo); iii) a further period of earnings retention and capital raises raising GSE capital to the level set forth in the final fhfa rule; iv) a plan end state where presumably many transitional items in the agreement would terminate (once the capital rule has been satisfied) and the remaining agreement items would constitute the going-forward “reform” of the GSEs.
rolg
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I have a different take. I’m not sure why most everyone is convinced there will be a “capital raise”. For me, this gradual generic capital build over the next couple of years signals there will not be a capital raise. The situation has competing desires. On one hand, the treasury has the warrants, and why would they want their investment to be diluted by a capital raise. On the other side, you have prospective investors that I’m sure would not want their investment diluted by the warrants.
So, I believe it’s one or the other, but not both. Either the warrants get converted in a couple years slowly, or warrants get cancelled and institutional investors step in and provide capital. I tried, but I can’t wrap my head around the possibility of warrants being converted AND a large capital raise. there is just too much dilution for any takers.
Rather, I see a generic capital build over the next few years that approaches the number that the most recent stress test provided (I think it was 43 Billion).
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For ROLG: The scenario you outline above–in which a consent decree governs key aspects of Fannie and Freddie’s operations until they can meet their new capital targets, which they would have an incentive to do quickly through capital raises–would allow Mnuchin and Calabria to accomplish their reform objectives for the companies in the 15-month period they know they have, and they may well find something like that attractive.
For Daniel: The $43 billion “stress test capital” you cite isn’t anywhere close to the capital figure the companies will have to hit. As I’ve noted before, the Dodd-Frank stress test that produced this loss figure for Fannie and Freddie (which would only have been $18 billion without assuming a reserve for the companies’ deferred tax assets, or DTAs, and which for commercial banks subject to the same test was $114.9 billion without DTA reserves) is simplified and stylized, and not a good approximation for what actually would happen if home prices did fall 25 percent. Even with the DTA reserve, the Dodd-Frank stress loss number is only 78 basis points of the companies’ total assets, and also barely half of the $84.1 billion in core capital the companies had when they were taken over by Treasury in September 2008, for the ( fabricated) reason that they were undercapitalized. If I had to guess, I would say FHFA and Treasury will be shooting for something close to double Fannie and Freddie’s June 30, 2007 capital, which would be around $170 billion, or 3.0 percent of their current assets. Fannie’s piece of that would be around $105 billion. With retained earnings alone–and assuming no asset growth–it’s unlikely the company would reach that figure before 2027. That’s an awfully long way off.
As to the warrants, Treasury will (and has to) make that decision well before any capital raise could take place, so it’s not an “either-or”. I have no insights as to how Treasury is thinking about that, however.
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@Daniel
calabria has been talking about a capital raise to reporters enough for me to believe that there will be a capital raise; my problem has always been that I couldn’t understand how it could be executed if, as I believe it is true, new investors would be reticent to invest money into companies that would remain in conservatorship for some period after the capital raise (because it will require more than one capital raise to meet the capital rule).
this transitional idea where the GSEs go from current state with NWS switched off to retain earnings, to a capital raising state where the companies have been released from conservatorship but operate under an agreement, to a final state where the companies meet the capital rule but continue to operate under some provisions of the agreement (thereby accomplishing “lasting reform” administratively) is brilliant from an execution and logistics point of view.
of course, I may be misreading the leaked tweet.
rolg
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Tim,
The “Current Expected Credit Loss” of $10 billion is that a one time event charge or is that every year?
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The $10 billion figure is my estimate (based on Fannie’s guidance) of the first quarter 2020 addition to the loss reserve Fannie will book as it adopts the Current Estimated Credit Loss (CECL) method for its loss reserving. As the name implies, CECL requires a company to hold in its loss reserve an amount it deems sufficient to cover the lifetime credit losses it anticipates for its current book of business. As I’m sure everyone will recognize, $11 billion in lifetime credit losses–the $1.0 billion in the general (i.e., not specifically identified) loss reserve Fannie has now, plus the estimated $10 billion addition next year–on $2.9 trillion in single-family credit guarantees and $300 million in multifamily guarantees is an extraordinarily low amount: only 34 basis points of combined outstanding single- and multifamily loans. (By way of comparison, Fannie books more in annual guaranty fees than this estimate of its lifetime credit losses.) Going forward, Fannie will make quarterly additions to, or subtractions from, its loss reserves as its estimate of the lifetime expected credit losses on its total book of business changes. These future quarterly entries, however, should be much smaller than the roughly $10 billion I expect the company to book in the first quarter of next year.
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Tim,
Thanks for that info. Can you explain why the statutory capital requirement is at 3% when the expected CECL is only $10 billions? 3% seems rather large which would result in about $100B in reserve.
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Well, the $10 billion is an expected loss number, not a stress loss number, and a capital requirement needs to cover the stress loss with a margin of safety. But a paraphrasing of your basic point–that a 3 percent capital requirement for a company whose 34 basis point expected lifetime credit losses can be covered by less than one year’s worth of guaranty fee income seems far too high–I agree with you on, and it’s a point I’ve made previously. And you can say the same thing about the Dodd-Frank stress losses: in this year’s test Fannie and Freddie’s combined stress losses were $12.8 billion, or 23 basis points of their average loan balance, while the large commercial banks subjected to the same stress environment had credit losses of $296 billion, or 5.7 percent of THEIR average loan balances. When FHFA finally comes out with its required capital for Fannie and Freddie, we will be able to compare the relationship of the companies’ capital requirement to their Dodd-Frank stress losses and CECL expected losses with the same relationship (required capital to Dodd-Frank and CECL losses) for the large commercial banks. When we do this I suspect we will find that Fannie and Freddie are being asked to hold a much larger multiple of these two loss measures than are banks, which I (and I’m sure others) will not be hesitant to point out, and to ask, “why”? At the same time, we also will be able to compare Fannie and Freddie’s capital-to-loss ratios with the FHA, relative it ITS credit losses and delinquencies (it doesn’t do a Dodd-Frank stress test), where I’m fairly certain we’ll find the same thing.
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Quick correction: I’ve learned that Fannie’s estimate for its first quarter 2020 addition to the loss reserve under the CECL accounting standard is likely to be even less than $10 billion. I had interpreted the language in Fannie’s second quarter 2019 10Q to mean that it expected to book around a $4 billion after-tax loss for the first quarter of 2020, due to the additional CECL reserve (making that reserve around $10 billion pre-tax). In fact the $4 billion after-tax number is Fannie’s current estimate of the extra CECL reserve itself. That’s only about $5 billion pre-tax, or half the amount I’d said earlier. Even better!
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I agree with Travis about the weight of the fraud here – don’t see a Moelis style recap being bolstered by what could be the first of many defeats given the 5th circuit’s proper findings with the help of Sweeney discovery materials.
Tim or ROLG do you think there is any way the warrants are invalidated since we now know that the entire c-ship was a stick up and the gov’t had no solid backing for the takeover? I wonder if exercising the warrants will force the hand of major common stock holders to file a takings suit which would then be ripe.
Do the statutes of limitations reset when the takings attempt happens? I would have to assume yes.
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Ditto to fanfred1 and thank you Tim. It’s frustrating to see the main players – treasury. FHFA, congress both sides – seemingly out in left field on this whole fiasco, lacking reality and common sense. And the SBC hearing shows the administration doesn’t seem to get it either. So grateful for the en-banc court to push things back toward sanity, reality, and common sense as well as constitutionality and justice.
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Having re-read this more closely (too rushed for time earlier this morning) I find your comments empowering. I like to comment frequently on GSE articles in NYT, WaPo and WSJ, because no one else seems to be doing so very forcefully. I truly enjoy giving the ideologues there grief in a pleasant and joyful manner. You have given me lots of additional ammo. Thanks.
Jeff Wood
Springdale, AR
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Jeff: You’re welcome, and have at it! The dramatically different treatment of and prescriptions for Fannie/Freddie and the FHA in the Treasury and HUD reports, respectively, would have been an easy, and a great, story for an informed, inquisitive and objective journalist to pursue. If only we had such journalists covering this beat.
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ROLG, if Treasury and FHFA appeal to SCOTUS, will the case close FINALLY before Sept 2020? Or can some lower courts get involved again?
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@Q
one of the interesting things Thompson mentioned on IU conference call was that the Collins APA holding is not a final judgment, just a reversal and remand so that the district court judge can assess relief and then order a final judgment.
any filing for SCOTUS cert now by treasury would be an interlocutory appeal, which SCOTUS is usually disinclined to grant. for instance, there is a big difference between a collins holding which results at the district court in a retirement of the senior preferred and some $25B credit for future taxes, as opposed to no relief granted by the district court (for reasons that I cannot imagine, but until the district court rules, one never knows). SCOTUS typically wants to review not just a legal holding in the abstract but a final judgment that has the relief attached to it. Thompson also mentioned that the solicitor general, knowing this, often doesn’t even file for cert under this circumstance, which could lead to a conversation between Treasury Mnuchin and DOJ Barr.
so the appeal to SCOTUS is uncertain, and the timeline if there is an appeal is even more uncertain.
rolg
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Tim
there was some discussion at SBC re GSE’s increasing amount of mortgages to high DTI borrowers, as well as cash out mortgages and even multi-family lending, and there is the scheduled background the 2021 expiry of the QM “patch”, with uncertainty as to any replacement. My own expectation is that congress will address none of this, so that fhfa will be the party responsible for addressing, or not, this “deterioration” of underwriting standards. while I agree with your commentary regarding the stark differences between HUD and the GSEs regarding credit quality, my fear is that Calabria will restrict GSEs activity under the guise of reducing their “footprint” and may even require higher capital levels in view of this supposed credit deterioration (even though as you note the far greater urgent is to be found at HUD). my suspicion is also that Calabria won’t address most of this until the QM patch replacement, if any, is resolved, leaving this to be at least one year off, but that suspicion is based more on my view of human nature (facing and addressing difficult things take longer than one might think) than anything else.
what I am not clear on is what kind of process must fhfa go through in making any underwriting changes. as opposed to the capital rule which is subject to publication and commentary, I am not aware that in trying to become a “world class regulator” calabria needs to apply a similar publication and commentary process for any underwriting changes. I would be interested to know what you think Calabria’s process will (or must) be in this area.
rolg
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I did note the discussion about higher debt-to-income (DTI) borrowers during the Senate Banking Committee hearing, and also Calabria’s focus on it. When I was in charge of the credit risk analytics at Fannie, there was some correlation between DTI and delinquency and default, but it was relatively weak, and the modestly higher risk of higher DTI loans could easily be covered by slightly more capital or modestly higher guaranty fees. I doubt that’s changed much since I left. And in any event, this sort of thing is a normal part of the credit guaranty business, and in fact the risk-based capital requirement FHFA is now working on is designed to accommodate changes in DTI automatically. They’re certainly not anything the Director of FHFA needs to take regulatory action on.
I understand that Fannie and Freddie don’t have a binding risk-based capital requirement yet, aren’t yet allowed to retain capital, and are still in conservatorship, so the FHFA director has a larger role to play in their governance. But I (and others) sense in Mark Calabria a tendency to want to impose his own, sometimes not-too-well-informed, views on what the companies should or shouldn’t be doing. I believe that as conservator he has very broad powers to direct underwriting or even product changes at the companies, but once they come out of conservatorship he will not. My main concern is that before Fannie or Freddie can get themselves recapitalized he will make ill-advised or ideologically driven changes in their business, to the detriment of the capital-raising effort. The only way to stop that, I’m afraid, is through some form of political pressure, or if Treasury and its investment advisers tell him that he’s being harmful rather than helpful.
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Thanks Tim. I read your blog more closely, and more completely, than any other one out there. And all the comments too! I don’t have the financial or legal background to comment much, but this has been a great education!!
Jeff Wood
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