Some Simple Facts

~ jtimothyhoward

On October 4, the Federal Housing Finance Agency (FHFA) announced that it would be hiring a financial advisory firm to help it “develop a Roadmap to responsibly end the conservatorships” of Fannie Mae and Freddie Mac. As they carry out their mandate, this firm and those to be retained by Treasury, Fannie and Freddie will benefit greatly from incorporating into their work some simple facts about Fannie and Freddie’s competitive situation and capitalization, set forth below.

The bank competitive issue

There is considerable confusion and misinformation about the roles Fannie, Freddie and commercial banks play in the residential mortgage market, and the competition between them. Much of this has stemmed from proponents of legislative mortgage reform insisting that the most important reform objective is to create a “level playing field” in the market, without ever identifying what the playing field is. In fact, today there is no meaningful area in which Fannie, Freddie and commercial banks compete directly, or even are in the same business. There is, therefore, no common playing field that needs to be, or could be, leveled.

Prior to Fannie and Freddie’s conservatorships in 2008 they did compete with commercial banks as holders of single-family mortgages and mortgage-backed securities (MBS). Banks were the largest mortgage holders. At December 31, 2007, banks held $2.98 trillion in single-family mortgages—$2.01 trillion in whole loans and $973 billion in Fannie, Freddie, Ginnie Mae or private-label MBS—on their balance sheets, giving them a 26.5 percent share of the $11.27 trillion single-family market. On the same date Fannie and Freddie together held $1.45 trillion in single-family mortgages and MBS, for a combined 12.9 percent market share. After the companies were placed in conservatorship, however, Treasury required them to shrink their portfolios, first by 10 percent per year and then by 15 percent per year. As a consequence, as of June 30, 2019 Fannie and Freddie’s balance sheet mortgage holdings totaled only $390 billion (3.6 percent of single-family mortgages outstanding), and going forward their portfolios will be limited to purposes incidental to their credit guaranty business.

With Fannie and Freddie having been directed to exit the one business they did have in common with banks—investing in mortgages for profit—their sole remaining business is guaranteeing the credit on residential mortgages. Banks aren’t in the credit guaranty business at all. Banks originate and service mortgages, which Fannie and Freddie do not do, and have never done. Banks also are deposit-based financial intermediaries, and in that capacity incur substantial liquidity risk (the threat of a “run on the bank”), interest rate risk (many of their assets are funded with short-term deposits and purchased funds), and credit risk on multiple asset types (with historical loss rates far higher than those of single-family mortgages). Fannie and Freddie are not intermediaries, and don’t have those risks. Today, the businesses done by Fannie, Freddie and banks have virtually no overlap.

What, then, is the competitive issue? It’s that deposit-based banks compete with capital markets-based investors to own fixed-rate mortgages. Fannie and Freddie are indirectly involved in this competition, because capital markets investors will not invest in mortgages without a credit guaranty from a reliable, high-quality third party. Since the collapse of the private-label securities market in 2007, Fannie and Freddie have been the only trusted sources of conventional (non-government guaranteed) single-family mortgage guarantees. In a very real sense, these two companies form the gateway through which all international capital markets investors channel funds into the U.S. conventional fixed-rate mortgage market, and the guaranty fees the companies charge are the tolls for using this gateway.

At the end of 2007 Fannie and Freddie charged an average of 21 basis points to guarantee a single-family mortgage. In the second quarter of this year they were charging 56 basis points, 35 basis points more, to provide the same credit guaranty. Ten basis points were added by Congress in 2011 with the Temporary Payroll Tax Cut Continuation Act (TCCA), with the proceeds going to Treasury, and another ten by acting FHFA Director Ed DeMarco in 2013 to “reduce [Fannie and Freddie’s] market share,” and “encourage more private sector participation.” Together, these twenty basis points raised the cost of providing a secondary market credit guaranty without adding to its value, and significantly changed the relative economics of deposit-based versus capital markets-based mortgage investing.

One often reads that banks have been losing market share in mortgages. That’s true for origination and servicing, where over the past decade banks have been supplanted by non-bank lenders such as Quicken Loans and LoanDepot as the main sources of these activities. But this has nothing to do with Fannie and Freddie; it instead is a consequence of the actions of Congress and bank regulators, as well as banks’ own business preferences. And the share change one doesn’t read about is the huge jump over the same period in bank mortgage investment. Banks’ $2.98 trillion—and 26.5 percent market share—in single-family mortgage holdings at December 31, 2007 have soared to $4.01 trillion ($2.26 trillion in whole loans and $1.75 trillion in MBS) of the $10.97 trillion in single-family mortgages outstanding at June 30 of this year, for a 36.6 percent market share. Since just before the crisis, banks have added over a trillion dollars of single-family mortgages to their balance sheets, and increased their share of that market by more than ten percentage points.

It’s not surprising that a jump in bank holdings of single-family mortgages and MBS would follow sharply higher Fannie and Freddie guaranty fees. Banks benefit when guaranty fees are too high relative to a loan’s credit risk, in at least three ways. First, non-bank lenders more often will get a better price for a loan by selling it to a correspondent bank as a whole loan rather than securitizing it with Fannie or Freddie as an MBS. Second, since lenders base their mortgage rates on the cost of selling into the secondary market, higher guaranty fees increase the yields, and the profits, on the unsecuritized loans banks retain in portfolio. Third, artificially high guaranty fees force Fannie and Freddie to overprice their guarantees on lower-risk loans and underprice them on higher-risk loans. Banks can take advantage of this to reduce their credit losses by swapping their higher-risk loans for MBS—which they either can sell or keep in portfolio (and benefit from the lower Basel III capital requirement accorded Fannie and Freddie MBS)—while retaining their lower-risk mortgages as whole loans in portfolio (where they incur no Basel III capital penalty for funding them short).

This is why banks and their supporters have been so insistent that Fannie and Freddie hold “bank-like” capital, in spite of the fact that they are nothing like banks. If the companies’ guaranty fees can be kept high or pushed higher through overcapitalization, the capital markets channel they facilitate will be less efficient, mortgage rates will be higher, and the amount of mortgages banks hold in portfolio, the spreads at which they hold them, and their ability to reduce their mortgage credit losses all will benefit. For banks these may be sensible competitive objectives, but they should have no bearing on how FHFA and its financial advisors assess the amount of capital Fannie and Freddie should be required to hold given the risks of their business. Getting the companies’ capital right is essential to their successful release from conservatorship. And fortunately, it’s not that difficult to do.

Fannie and Freddie capital

In announcing the September 30 letter agreement allowing Fannie and Freddie to retain more capital, FHFA Director Calabria said, “The Enterprises are leveraged nearly 1000-to-one, ensuring they would fail during an economic downturn—exposing taxpayers once again.” This statement implies that it is normal for Fannie and Freddie to lose money during a recession. It is not. Prior to the 2008 financial crisis, neither Fannie nor Freddie’s credit losses ever exceeded their net guaranty fees (guaranty fees less administrative expenses) in their roughly forty years of existence, even during recessions. The highest Fannie’s credit losses ever got was 11 basis points as a percent of total loans in portfolio and mortgage-backed securities outstanding (in 1988), and for the fifteen years I was CFO (1990-2004) its average credit loss rate was less than 4 basis points per year. Fannie and Freddie’s average net guaranty fee today, excluding the TCCA fee paid to Treasury, is 33 basis points. In a normal recession, neither company will come close to losing money; each will remain highly profitable.

The outsized losses experienced between 2008 and 2012 by all mortgage holders, not just Fannie and Freddie, were the result of policy and market failures that have since been remedied. In the late 1990s, the Federal Reserve under Alan Greenspan declined to regulate risky lending practices in the newly-emerging subprime market, favoring market regulation instead. Neither the Fed nor Treasury changed their regulatory stances when many of these practices began spreading to the prime mortgage market in 2003, nor when private-label securities (PLS) became the dominant means of secondary market financing for all single-family mortgages in 2004. In the absence of any prudential regulation, near-unlimited access to mortgages for unqualified borrowers through PLS issuance fueled an unsustainable boom in home sales, construction and prices that continued until the fall of 2007, when the PLS market finally collapsed. With PLS financing suddenly gone, and other lenders pulling back in an attempt to protect themselves, housing sales and starts plummeted, and home prices fell by 25 percent peak-to-trough before they could stabilize.

We learned from our mistakes. Post-crisis, the Fed and Treasury (and even Greenspan) admitted their deregulatory posture during the previous decade was an error. Congress in 2010 passed the Dodd-Frank Act, requiring lenders to apply an “ability to repay” rule to mortgage borrowers and, through its qualified mortgage standard, effectively prohibiting the riskiest mortgage products and loan features that proliferated during the PLS bubble. And investors simply abandoned the PLS market due to its inherent conflicts of interest, and have not come back. These reforms and changes make a recurrence of the mortgage market excesses of 2003-2007 extremely unlikely, and without those excesses anything similar to the subsequent 25 percent collapse in home prices that occurred from 2007 through 2011 is equally improbable.

The requirement that Fannie and Freddie hold sufficient capital to withstand another 25 percent nationwide decline in home prices is thus much more a protection against future policy mistakes than against the inherent riskiness of single-family mortgages in a severe downturn. This is an important point to remember when assessing how much additional conservatism needs to be built into the standard. And as to the amount of capital Fannie or Freddie need to survive a 25 percent home price decline, there is no mystery at all about that. We have data from the previous episode to tell us.

I am most familiar with Fannie’s experience. Fannie’s credit losses exceeded its net guaranty fees for five years, from 2008 through 2012 (in 2013 they did not). During that period the company’s single-family credit losses totaled $76.2 billion. It was able to cover a little over a third of those losses with roughly $27 billion in net guaranty fee income ($15 billion from loans on its books at the end of 2007, which paid off at a 20 percent annual rate, and $12 billion from business added through the end of 2012), leaving $49.2 billion (or just under 2.0 percent of Fannie’s single-family loan balance at December 31, 2007) to be covered with capital, assuming no additional cushion. But these total losses, and capital amount, significantly overstate what would happen in the future. Data published by Fannie show that between 40 and 60 percent of its 2008-2012 credit losses came from two loan types—interest-only (I/O) adjustable rate mortgages and no- or low-documentation (“Alt A”) loans—that now are prohibited by Dodd-Frank. Taking the middle of this range, in a repeat of the crisis without the I/O and Alt A loans Fannie’s five-year single-family credit losses would be $38 billion. Fannie would be able to cover more than all of these losses with guaranty fee income, because its current 34 basis-point net guaranty fee rate would generate $45 billion ($26 billion from the existing book and $19 billion from new business) over the five-year stress period. Counting only income from the existing book (i.e., no going concern income), Fannie would need $12 billion, or about 50 basis points of its initial loan balance, to survive the stress—again with no additional cushion.

We can use these “real world” data to assess the results of two stress tests recently run against Fannie’s business: this year’s Dodd-Frank test (which also has a 25 percent home price decline, but over only a 9-quarter period), applied to the company’s December 31, 2018 book, and a stress test run by FHFA based on the parameters of its 2018 capital proposal, applied to Fannie’s September 30, 2017 book (the two books have similar risk profiles). The Dodd-Frank stress test projected Fannie’s credit losses at $7.2 billion, and its net revenues at $17.4 billion. The FHFA stress test produced “net credit risk” (FHFA’s version of credit losses) for Fannie of $70.5 billion—nearly ten times the Dodd-Frank stress loss amount—and included no projection of net revenues, because FHFA did not count revenues as an offset to credit losses.

These are strikingly different results from measuring what purports to be the same thing—credit losses and revenues stemming from a 25 percent drop in home prices—and neither are close to what actually happened during and after the financial crisis. The Dodd-Frank stress test, which is binding on banks but not on Fannie (or Freddie), produces credit losses for Fannie that are far too low relative to its adjusted 2008-2012 experience, and includes revenues as an offset to them (as a stress test should). In contrast, the stress test based on FHFA’s 2018 capital proposal, which is only for Fannie and Freddie and will be binding on them, produces credit losses for Fannie that are far too high relative to 2008-2012, and by giving no credit to revenues substantially inflates its required capital. Returning to an earlier theme, this is nowhere near a “level playing field” for the stress test that is binding on banks and the one that will be binding on Fannie and Freddie, in an area—measuring the systemic risk to our financial markets—where the playing field should be level. FHFA is only responsible for the mechanics of its own stress test, and here it must ensure that its results properly align with readily available benchmarks from historical experience.

Fannie and the FHA

One additional, indirect, way to assess the reasonableness of the capitalization approach proposed by FHFA for Fannie and Freddie is to impose it upon the only other entity limited to the single-family credit guaranty business, the FHA.

FHFA’s 2018 capital proposal features a “single-family credit risk pricing grid for new originations.” Applying this grid to the average loan-to-value (LTV) ratios, credit scores, and refinance percentages of the business done in 2018 by Fannie (77.0 percent, 743 and 35.0 percent, respectively) and the FHA (91.9 percent, 670 and 23.5 percent) can give us a rough capital requirement for each. The required credit loss capital from these grids for Fannie’s 2018 new business is 2.2 percent, and for the FHA’s it’s 7.8 percent. But we’re not finished. Fannie has private mortgage insurance (PMI) on loans with LTVs over 80 percent, and company data show that over the past 20 years PMI has reduced Fannie’s loss severity on high LTV loans by an average of 42 percent. With relatively few exceptions (refinances of conventional loans into FHA), the FHA has only high LTV loans, and no PMI. Adjusting for this, the 2018 proposed FHFA grids that would require 2.2 percent in credit loss capital for Fannie’s 2018 new business would require more than 12.0 percent if applied to the FHA’s. The FHA’s capital at December 31, 2018 was 2.76 percent.

Since the end of 2007, loans financed by the FHA have grown by 350 percent, while loans financed by Fannie and Freddie have grown by 10 percent. Capital and pricing differences are almost certainly the reasons for this enormous growth disparity.

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By far the most critical element of the “Roadmap to responsibly end the conservatorships” is Fannie and Freddie’s capital standard. If FHFA, Treasury and their financial advisors can agree on a standard that both protects the taxpayer from loss and enables the companies to carry out their credit guaranty function on a scale and at a cost that satisfies homebuyers’ needs, Fannie and Freddie will have successful businesses, and investors willingly will supply the new equity required to return them to private ownership.

The simple facts noted above will help to find the right answer here. Those responsible for determining Fannie and Freddie’s required capital can’t allow themselves to be fooled by claims that it must be “bank-like,” or anywhere close to it; the companies are in no way like banks, so there is no economic reason for their capital requirements to be similar. Also, the principals and their advisors need to be aware that the 25 percent home price decline Fannie and Freddie are being asked to protect against is extremely unlikely in the absence of another major and protracted error in regulatory policy, so the stress test replicating this scenario does not need to be made more severe by further conservatism built into it. The specification of the FHFA stress test must be straightforward and understandable. It should produce credit losses and revenues that closely align with Fannie and Freddie’s 2008-2012 experience, adjusted for changes in their books of business, and clearly identify and explain any cushions or additional elements of conservatism. Finally, required “going concern” capital should reflect revenues from new business expected to be done during the stress period, as well as the existence of a catastrophic risk backstop from Treasury, for which the companies will be paying a commitment fee.

The right answer for Fannie and Freddie’s capital will lead to their smooth and successful exit from conservatorship. And the wrong answer will be obvious, because it will be visibly inconsistent with historical experience, and cause Fannie and Freddie’s credit pricing to be notably misaligned with credit pricing elsewhere in the market. The pathway to the right answer for FHFA, Treasury and their financial advisors is clearly marked; they only have to follow the facts to stay on it.

 

 

238 thoughts on “Some Simple Facts”

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    1. The next version of FHFA’s capital standards for Fannie and Freddie will affect recapitalization much more than yet another statement by Calabria about the benefits of competition in the mortgage market. What gives Fannie’s MBS and Freddie’s PCs value isn’t that they’re issued off the common securitization platform but that they have the credit guaranty of those two companies. The real threat to them is that Calabria might in some way, for ideological reasons, raise the cost or lower the quality of that guaranty to entice new entrants, but I don’t see that happening without legislation, and I don’t see legislation happening at all.

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      1. Tim

        the CSP is a bureaucrat’s pride and joy, which is to say that it amounts to absolutely nothing in real financial terms. PLS are issued now on trust documentation that has been standardized. moving to the CSP is moving to another documentation/issuance standard that accomplishes nothing, inasmuch as those PLS are not guaranteed by any financial party. platforms may be big in software/social media but this platform is a financial nonevent. perhaps this is a tip of the cap to the “level playing field” crowd. More DC nonsense masquerading as financial gravitas.

        rolg

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  4. Tim

    the two Collins cert petitions were distributed for scotus conference held 1/10 (https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/19-422.html) but there was no action taken by scotus (https://www.supremecourt.gov/orders/courtorders/011320zor_4fc5.pdf in which Collins cases are not indicated). so this likely means that scotus will consider the Collins petitions again at next conference 1/17.

    rolg

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    1. I saw the orders that came out this morning, and noted that the Collins case was neither shown as having been granted nor denied. I wasn’t sure (and still am not sure) how to think about that, other than that almost nothing about any of these Fannie and Freddie-related cases has followed the norms.

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      1. Tim

        Usually scotus avoids granting cert if there is good reason, and good reason here would be to allow for a final judgment from the district court first. good reason to grant would be that the Solicitor General really wants the APA claim reviewed now. so there is a tension. that there is a large amount of money at stake is usually not a scotus concern. for example today’s announcement denied review to a terrible (imo) decision by 1st C in the Puerto Rico financial workout that aversely affects $8.5B of PR revenue bonds.

        while there is some speculation as to what would be the most favorable result for GSE shareholders, in my view here is the order of preference: i) deferring review until district court judgment, ii) granting cert on both APA and constitutional claims, and iii) granting cert on only APA claim. even in case of iii), scotus’ review of Judge Willett’s APA opinion is something that Ps should not feel adverse to.

        rolg

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        1. I’d probably flip your ii and i, just because I’m eager to get to the finish line on these cases. But I agree with you that neither plaintiffs nor shareholders should fear SCOTUS review of the Willet opinion.

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          1. Although I would like to see it end with SCOTUS granting cert as you both describe above, is there harm in not granting and letting 5th circuit stand?

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          2. @fisher

            assuming the administrative plan is to position the GSEs to recapitalize during 2020, my own view is that a litigation settlement during 2020 is an important step to achieve that objective. settlement should be an acceptable end game for treasury given its recap objective. I believe the best inducement for the government to settle is the prospect of a massive judgment to be entered against the treasury in federal district court in Houston. while I would appreciate at long last the finality of a scotus decision upholding Judge Willett’s APA opinion and a scotus holding granting retrospective relief for the unconstitutional structure of fhfa, the best course of action for the GSEs is to proceed to an conservatorship exit as soon as practicable. if I am Mnuchin I dont want to see a >$100B judgment against treasury on my watch, even understanding that it is subject to eventual scotus review, and it relates to actions of my predecessor. time to force Mnuchin’s hand, as I doubt Mnuchin wants to be known as having suffered the largest judgment against the US in US history.

            rolg

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          3. This explanation, posted on “SCOTUSblog” yesterday, for Friday’s non-decision on the two cert petitions in the Collins case is the most plausible, and convincing, I’ve heard or read so far: “Although there is no way to be certain, it is possible that the justices are waiting to act on these petitions until they decide Seila Law v. Consumer Financial Protection Bureau, a challenge to the constitutionality of the CFPB’s leadership structure, scheduled for oral argument in early March.” Of course, if true it means more delay, but that’s been the story with all of these court cases since the first one was filed five and a half years ago.

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          4. Tim

            I saw Ms Howe’s statement on Scotusblog. the question she leaves open is whether scotus would refrain from acting on the petitions, leaving the petitions in a twilight zone, or place a hold on the petitions until Seila is decided and a district court final order is obtained with respect to the APA claim (which is usual practice).

            rolg

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    1. This is an American Banker article written by the Director of Research of the American Enterprise Institute’s Housing Center, Tobias Peter, on a subject that is very arcane and that Mr. Peter appears to be either misinterpreting or misstating.

      Peter’s article isn’t really about Fannie and Freddie’s securitized credit risk transfer (CRT) transactions; he just uses them as the “news peg” for his analysis. He says, “To reduce taxpayer risk through increasing the role of private capital in the mortgage market…FHFA required the GSEs to undertake the credit risk transfer (CRT) program in 2013. Ostensibly, to help investors participate in CRTs and appropriately price the risk, the FHFA required the GSEs to release historical loan-level data. These datasets, known as the Loan Performance data, contain origination characteristics and a performance history on millions of loans originated between 1999 and today….However, this data excludes loans with risky product features, such as low or no documentation, loans with an adjustable-mortgage rate, and many affordable housing loans ‘to make the dataset more reflective of current underwriting guidelines,’ according to Fannie.”

      The framing of Peter’s analysis makes it appear as if Fannie and Freddie are deliberately manipulating (Peter uses the word “censoring”) their historical data to make the loans underlying their current CRTs look safer than they are. But here he is mixing apples and oranges, perhaps deliberately (AEI is not known for objective analysis when it comes to Fannie and Freddie.)

      The crucial distinction here is on loan level data for origination years before the financial crisis and after. Pre-crisis, Fannie and Freddie purchased or guaranteed many loans with product or risk features they no longer accept today (largely due to restrictions imposed on originators by the Dodd-Frank legislation of 2010), including no-doc “Alt-A” loans and interest only adjustable rate ARMs. For their risk analysis going forward, the companies (and FHFA) have created a historical database, called Loan Performance, that excludes these loans. This is an entirely sensible thing for them to have done.

      From what I can tell from the article—it’s not written particularly clearly—Peter believes Fannie and Freddie should release the full loan-level data on its pre-crisis loans, and that not doing so somehow disadvantages purchasers of the CRTs the companies are issuing today. I don’t see how. The historical performance of loan types and risk features from 2006 and 2007 (the two years Peter’s analysis focuses on) that aren’t present in loans the companies are acquiring today is of little import or relevance to the risk of CRTs issued against the loans being originated today.

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      1. Tim –

        I just finished reading The Mortgage Wars – WOW! … I really wish here in the States we had a ‘Loser Pays’ system. Anyway:

        Several quarters back – some shareholders asked you to value Fannie’s stock currently … I’ve spent countless hours looking for that post here, but cannot seem to find it? I’d love to take a better look at some of the underlying assumptions etc…. would anyone be able to point me in the right direction here.

        BTW: Buckle up GSE shareholders: FHFA speaking 1/8, and SCOTUS 1/10

        ValueMaven

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        1. I’ve never attempted to value Fannie’s stock on this blog. In the past I have made estimates of Fannie’s “normalized” annual earnings, which are one important element of a stock valuation. My most recent estimate is that over the next few years Fannie should be able to average about $14 billion per year in pre-tax earnings, and $11 billion after tax. (Earnings have been running higher than this since 2012, because Fannie has been able to steadily draw down the extremely high level of loss reserves it built up between 2008 and 2011; with these drawdowns now almost completed, the company soon will switch back to a more normal posture of adding moderate amounts to its loss reserve, and I’ve incorporated this change into my normalized income projection.)

          To get an estimate of Fannie’s future stock price, however, you need two other pieces of information: the average number of the company’s common shares that will be outstanding—to produce an earnings per share (EPS) number—and an estimate of how the market will value those EPS (i.e., a price-earnings ratio). I’ve not made a public estimate of either of those variables. The number of Fannie Mae shares outstanding will depend on the final FHFA capital rule, how Treasury unwinds the senior preferred stock agreement and its liquidation preference (assuming that it does), and what it chooses to do with the warrants it holds for 79.9 percent of Fannie’s common stock, none of which we know now. And the multiple the market accords Fannie’s expected EPS will depend on how it assesses the stability and predictability of those earnings—which in the past has been heavily affected by political risk considerations.

          Until I have a better sense for how Treasury and FHFA intend to complete the process of releasing Fannie (and Freddie) from conservatorship, both the number of likely common shares Fannie will have outstanding and the discount to an average P/E multiple the market will accord those shares will be too uncertain for me to make any public guesses about a target price for Fannie’s common shares.

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          1. @valuemaven and Tim

            Tim nailed the valuation analysis identifying the principal uncertainties (you could probably add whether there will be an exchange offer made to the junior preferred holders and on what terms), but I would add one thing…a time element. GSE common stock values will be depressed initially as compared to their expected value because of the discount that must be accorded the common stock in order to effect one or likely more large common stock offerings. even if the GSEs do multiple offerings, each offering will be extremely large and building the book for these offerings will require the investment bankers to price the common stock at a discount to what their normalized value would be once sufficient capital is raised to satisfy the capital rule (this will not be a hot IPO where supply is constrained so that buyers must compete with each other to fill their orders). so this will be a process over time, and the common stock value at the beginning of the process is likely to be less than at the end of the process, all other things being equal. this needs to be recognized in order to assess the situation realistically.

            rolg

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      2. Tim,

        Ed Demarco opines in a piece out yesterday that “the role of housing finance in the macroeconomy and in the lives of ordinary citizens is too important to leave to one political party.” He argues that reform ought to include more competition, taxpayer protection, and improved solutions for affordable housing and concludes this is best “and perhaps only” accomplished with bipartisan support.

        He thinks there is “broad bipartisan agreement” re: the ‘principles’ that should inform reform efforts.

        Not surprisingly, when asked about FHFA’s proposed capital framework, after commenting favorably on the 2018 proposal’s reliance on “capital charges based upon granular risk characteristics of individual mortgages,” he lauded the plan’s setting aside additional capital to cover potential losses due to risks inherent to the market and GSE’s operations and modeling.

        You’ve commented at length about the problems with the excessive conservatism built in to these kinds of proposals, so I won’t ask for a rehash of that matter.

        One thing I did find interesting, though, is first issue Demarco took (on behalf of the Housing Policy Council, was GSEs’s selective data reporting. While he didn’t use the term “censoring,” the idea was in lockstep with Tobias Peter’s recent piece. 

        For those interested, here are the 4 key issues Demarco offers re: the FHFA capital proposal as it stands:

        1.    GSEs to release historical loan files not currently public—as these reflect riskier loans and more adverse outcomes than those published to date.

        2.    Fix procyclicality (w/ “reasonable” measure of fundamental value).

        3.    FHFA to work w/ “other prudential regulators to achieve some reasonable standard of comparability” re: regulations for credit risk. “Consistent capital standards will enable all lenders to make rational decisions”.

        4.    Treat GSEs as SIFIs *or* (preferably) introduce enough competition to distribute risk across the market.

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        2. I’m not going to do a point-by-point critique of a piece by Ed DeMarco. What I will say is that on the scale I’ve outlined for the resolution of Fannie and Freddie’s conservatorships that runs between the economic and the political–with the former being intended to produce the most efficiency and flexibility for the companies’ business consistent with an agreed-upon standard of taxpayer protection, and the latter being intended to burden them with excessive capital and regulation in the name of “safety and soundness” and thus cripple the capital markets channel to the benefit of primary market banks–DeMarco’s prescriptions have consistently favored the far end of the political spectrum. I don’t expect that to change. Treasury and FHFA will decide where on that spectrum to land, and my hope is that the desire for a successful recapitalization, involving new investor capital, will bring them closer to its economic end. But we will see, beginning with the new FHFA capital proposal.

          On the historical loan file issue, I would reiterate that the loans that both DeMarco and Tobias are talking about involve products and risk types Fannie and Freddie no longer do. Fannie and Freddie may well choose to release this data, but if they do I strongly suspect that opponents and critics of the companies will use it to deliberately conflate the riskiness of their 2006-2007 loans and the ones they are financing today–for a media and public that does not understand the difference–and that this is why it is being requested.

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          1. I bet ACA lawyers closely watching if cert granted for a hint on how SCOTUS likley views Fifth’s, at the time ridiculed, rulings. I thought Fifth taking on ACA was good for NWS whereas previously thought the Fifth would be agnostic at best as was every other court. Now we get to see if SCOTUS level of interest in NWS matches Fifth’s that Judge Sweeney criminally rebuked since. Which if aren’t fighting, or ruling words, then I don’t know what would be for SCOTUS. Judicial momentum at SCOTUS hands would be about when people take notice of GSEs(ACA, too), maybe. Gl,

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    1. I have given Mr. Layton the benefit of the doubt as to his intentions and the objectivity of the commentaries he’s been writing, but this latest effort makes it difficult for me to sustain this posture. Layton uses the conceit of a memorandum from “a fictitious equity capital markets executive at a major investment bank” to detail to his readership the litany of (we soon learn) collectively insurmountable hurdles facing Fannie and Freddie in their “re-IPO,” which ultimately leads this executive to muse that the difficulties of solving all these problems could lead the companies to have to meet their (still unknown) capital requirements entirely through retained earnings, thus making it more likely that his banker colleagues will get a mandate not from Fannie or Freddie for an equity offering, but from Treasury–advising it on how to dispose of its shares in the companies (acquired through exercise of the warrants, and potentially the conversion of its senior preferred stock to common) in a manner least disruptive to the market, and most profitable to Treasury.

      Despite Layton’s (patronizing) claim of wanting to “educate the housing finance and investment communities about the capital-related items (mostly) on Treasury’s plate,” his list of “fourteen items that need to be addressed” contains little if anything that readers of this blog–and anyone else seriously following these issues–don’t already know. Instead, what you encounter is a repackaging, within most of the fourteen points, of the same concerns raised by those who don’t want administrative reform to proceed. “It’s just SO hard to pull off, as much as we’d like it to succeed.”

      So let me say it. It’s not surprising to hear Don Layton talking like a commercial banker, because he IS one. He spent nearly 30 years at Chase, which was one of the founding members of the anti-Fannie and Freddie lobbying group FM Watch in 1999 (before Chase was acquired by JP Morgan in 2000). Layton was brought in as CEO of Freddie only after it was placed in conservatorship, and during his tenure there it was being run by Treasury and FHFA with the goal of “winding down and replacing” it (and Fannie) with a bank-favored alternative. Layton indeed has been quite critical of the pre-conservatorship Freddie. Readers of Layton’s commentaries would do well to bear in mind his background and experience as they evaluate the arguments and judgments he’s making.

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    2. Tim

      having read Layton’s latest, I have some thoughts:

      1. I am not sure why he calls the Aramco IPO a “publicity stunt” and likens any initial GSE re-IPO which would raise limited funds (not sufficient for conservatorship release) to such a stunt (see text to n. 9). Indeed, I believe pursuing a capital raising strategy where there is an initial successful offering which addresses investor concerns (understandable for companies that have been in conservatorship for over a decade), to be followed with additional offerings sufficient to clear the to-be-released fhfa capital rule, is absolutely the right way to go about things. the first step might even be a large private placement.

      2. I find it interesting that former treasury counselor Craig Phillips has conducted an interview where he offers his view on how to achieve the recap (the most prominent advice was cancelling the senior preferred as having been repaid in full), former Freddie ceo Don Layton does likewise with this publication, and the democratic senators have issued their list of a couple dozen question to Calabria and Mnuchin, most of which relate to their plans for a recap. one can question whether not disclosing the administration’s plans for the recap in any detail is a feature or a bug, but interested parties are becoming increasingly vocal in their desire to know more. I will note in passing that when Mnuchin was at Goldman Sachs, the firm was heavily influenced by the thinking of ceo Robert Rubin whose principal mantra was to maintain “optionality”…meaning dont decide questions until necessary since more information may be uncovered after a too early decision is made that makes that decision suboptimal. this may work better within private firms than in connection with this very public recap process.

      3. Layton in #1 refers to a support fee payable to Treasury that relates to all of the liabilities on the GSE balance sheet. this makes no sense. there is a committed congressionally appropriated credit line in place for the GSEs, for which no current commitment fee is paid. Mnuchin is on record stating that such a commitment fee should be payable for this committed line. it is important for the re-IPO that this committed line from Treasury remain in place, at its current committed amount, and that a fair market fee be charged ensuring that it remains in place…nothing more is needed. this balance sheet support fee is the same mistake Pollack has made in his writings.

      4. in #2, Layton absurdly compares the GSE senior preferred to the AIG preferred held by treasury. of course, the AIG preferred did not have a NWS feature that led to >$100B in windfall profits to treasury. one would be forgiven if not congratulated for refraining from proceeding with reading the rest of Layton’s piece at this point, but I continued.

      5. In #4, Layton concludes that the litigation must be settled prior to a successful re-IPO. yes, but he refrains from saying how this settlement would impact the treatment of the senior and junior preferred, as if these items can be considered in isolation (as he does).

      6. in #6, Layton mentions that the GSEs re-IPOs need to be coordinated so they dont compete for same investors. actually, their re-IPOs will compete for the same investors. full stop. it is unclear to me how Treasury could justify imposing restraints on either of the GSEs as to how they raise what their underwriters advise can be raised, when it can be raised.

      7. in #7, Layton proposes to eliminate the negative effect of Treasury’s warrant position overhang with some “clear promise”. this is absurd. if Treasury maintains its warrant position, this position will constitute a huge market overhang, and promise me no promises! I suspect Mnuchin is aware of the futility of eliminating the overhang through promise, and I suspect many large institutional investors will have a conversation with Mnuchin about acquiring some of Treasury’s warrants as an inducement for a pre-re-IPO private placement. but that is a conversation for down the road, with Mnuchin preserving optionality.

      8. in #8, Layton advises that Treasury agree to vote any common stock position it acquires (warrants not having voting rights) in accordance with other common share voting. a recommendation that I agree with.

      9. in #9, Layton intimates that the re-proposed capital rule will likely not impose a higher capital raising hurdle than the prior proposed rule. I would be interested in your view on this.

      10. in subsequent items, Layton correctly points out that much detail about the consent decree phase, any footprint reducing proposals etc need to be addressed (although certain political risks, such as prospective removal of fhfa director without cause, simply need to be assumed). this is all true.

      rolg

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    3. Respectfully, I thought Layton’s comments were sanguine. I feel there is a veritable landmine which will render a quick IPO super difficult (impossible?). The biggest unknown is congress, which might be goaded into action if the exit plan appears to enrich the “hedge fund friends.” That prospect won’t engender confidence for the new investors who risk the possibilty of the rules getting changed after the fact. Even a major court win and a concession from treasury won’t eliminate that overhang. I think the perpetual delays we’ve witnessed from FHFA are related to this. Calabria’s response to the recent list of questions from the Banking comittee will be enlightening. The more I look at this though, the more it looks like a slow recap via retention.

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      1. My comment on the Layton paper was triggered more by what I perceived to be an imbalance in its treatment of his fourteen points: I thought it spent far more time on arguments for why they would be hard to accomplish than on discussions of how they could be. I thus found it less analytical and more colored by an outcome favored (for whatever reason) by the author.

        I personally believe that we don’t yet have enough information to predict how the recapitalization of Fannie and Freddie, and their release from conservatorship, will proceed. The most important missing piece is the FHFA capital standard. Once we have that, we will know (a) how much capital the companies will need to retain or raise, and (b) whether, drawing from how the standard is structured, FHFA and Treasury are taking more of an economics-based or a politics-based approach to the recap. The former would suggest that they will address Layton’s fourteen points with an orientation toward overcoming the obstacles they contain, whereas with the latter we should expect continued indecision and delay in moving the process forward. I don’t know which path Treasury and FHFA will take, but I think we’re getting fairly close to the time when we’ll all know it.

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      2. @John

        “The biggest unknown is congress”. actually imo, congress is known: democratic members of the SBC and HFSC in particular will complain (with extra stridency since it is a potus election year) but will accomplish nothing. SBC chairman Crapo already gave his blessing to Calabria and Mnuchin to proceed administratively, and it seems to me that the mere issuance of the 20 question letter from democratic senators is the best evidence that the SBC democrats could not convince Crapo to schedule a hearing to grill. the administrative plan is the only game in town.

        The most relevant piece of missing information left out of analyses from armchair investment bankers like Layton is the outstanding financial performances of the GSEs, and the huge investment moats they enjoy. Fannie will have more than $13B of net income this year. Mortgage finance is a stable and healthy industry now that the FC liar loan etc mortgages and Countrywide PLS have seen a welcome demise. These are the first things that should be mentioned in any analysis. Financial analysis seems to be forgotten amidst all of the political risk handwringing.

        the political risk posed by the conservatorship is real and the transition to a “consent decree” phase (meaning no more conservator with conservatorship powers) in connection with any capital raise is a smart strategy. while rules can always be changed after the fact, as you say, this is a risk in every regulated industry (and one hopes the GSEs will regain their 1st A rights at some point after release from conservatorship and be able to lobby to protect itself like every other regulated company). but it is very hard to reform a multi-trillion dollar industry dominated by two very effective and profitable companies.

        rolg

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    1. I see the hands of the Mortgage Bankers Association and the American Bankers Association all over this letter. Both groups have made clear that they believe mortgage reform only can be done “properly” by Congress, and both also have perfected the technique of slowing down something they don’t want to proceed at all by posing an endless set of questions that must be answered to their satisfaction first. I agree that almost all of the questions asked by the Democratic members of the Senate Banking Committee are good ones. But good questions have good answers, IF you’re basing your plans for reforming and recapitalizing Fannie and Freddie on facts and solid economics rather than politics. If I were in charge of the companies’ recap, I could do a decent first draft of an answer to the Senators’ questions in a day. And that would be my advice to Calabria and Mnuchin: play this straight, do reform and recap the right way, and the Senators’ questions will answer themselves.

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      1. Tim

        calabria and mnuchin have no one other than themselves to blame for proceeding slowly and without transparency. my advice to them would be twofold: i) simply state to the democratic senators that they are engaged in pending litigation and are not now in a position to address these questions, and ii) settle the litigation and answer these questions through prompt action.

        rolg

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        1. Except that potential new investors in Fannie and Freddie will have many of the same questions the Senators are asking. Calabria and Mnuchin would be well advised to begin working on their answers to them sooner rather than later.

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          1. Tim

            oh, I agree that Calabria and Mnuchin should “answer these questions”! the problem is that no-one in the administration is in charge. the DOJ sought scotus cert of the Collins APA decision on the theory, as explained in cert petition by acting Solicitor General, that this 5th C en banc opinion frustrates the ability of the administration to implement its recapitalization plan. actually, the reverse is true…the Collins APA holding accelerates the ability of the administration to implement the recapitalization…as if a scotus reversal holding that the conservator can do whatever it wants would be a capital-raising friendly result. the longer Calabria and Mnuchin dawdle and let the DOJ/FHFA lawyers run the show, the more likely that they will encounter obstacles to their plan’s execution. frankly, I view these questions as perfectly appropriate, and if they give Calabria and Mnuchin heartburn, fine, let them stew over their responses.

            rolg

            Liked by 2 people

    2. Given similarities between the FHFA and CFPB in structure, what do you think are the implication on the FHFA with the Seila Law case? Oral arguments are March 3, in front of the Supreme Court.

      House Republicans today (link) argue for the Supreme Court to invalidate the CFPB’s statutory powers and send this issue back to Congress to resolve. Would such action void past or limit future actions? If such ruling were to occur, could we imagine a similar outcome in the Collins case if taking up by the court in terms of structure?

      https://republicans-financialservices.house.gov/news/documentsingle.aspx?DocumentID=407548

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    2. Tim

      Having read Judge Sweeney’s methodical opinion, here is the principal takeaway: all Ps may assert the derivative claim that the government improperly expropriated money from the GSEs in connection with the Net Worth Sweep, because FHFA is subject to a conflict of interest, so that even though FHFA has stepped into the shoes of the shareholders under HERA, it cannot assert that claim on behalf of the GSEs.

      This is huge. The Court has already put Ps in the drivers seat with this opinion to prosecute the derivative action, and there is no limit to the amount of the possible damages award based upon whether P stockholders bought stock before or after the NWS. It is the GSE’s claim of expropriation, Ps may assert it because of FHFA’s conflict, and any damages found cannot be limited by shareholder provenance.

      I would add something to address the possible confusion readers may have about the Collins en banc holding that Ps had a direct claim under the APA to assert that the NWS is ultra vires under HERA, and Judge Sweeney’s holding that Ps don’t have a direct claim against the government for a taking under the Tucker Act (which grants the Court of Federal Claims jurisdiction). There is nothing in Judge Sweeney’s Fairholme opinion that cuts against Judge Willett’s Collins opinion. There are different statutes at issue, Tucker for Fairholme and APA for Collins, and the holding of the absence of a direct claim in the former does not affect the holding of a direct claim in the latter.

      rolg

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      1. Tim

        Two more points.

        another important takeaway is the notion that with this opinion from Sweeney, Ps have a backstop in the event soctus either does not take P’s constitutional remedy cert petition, or takes it and denies.

        recall that collins en banc found 12-4 that fhfa was unconstitutionally structured but denied retrospective remedy of invalidating the NWS. basically, the constitution provides for a separation of powers, but scotus would have to imply a remedy for those aggrieved by its violation in an action under the APA or find, as Ps have argued, that the APA itself provides for such relief upon a finding of unconstitutional action. The problem is that scotus might provide only a prospective invalidation of the for cause removal provision, but no backward relief.

        sweeney explicitly stated that Ps have a derivative illegal exaction claim going forward, on the theory that fhfa was unconstitutionally structured at time of NWS and, here is the important point, the Tucker act explicitly provides for a damages remedy against the govt if it violates the constitution. so Ps could lose on the constitutional remedy claim at scotus but still win on an illegal exaction claim before Sweeney.

        also, readers should not confuse Sweeney’s litany of P’s allegations at the introduction to her opinion as findings of fact. these were taken as true by Sweeney in finding Ps made a claim for relief to defeat the motion to dismiss. another basis on which D’s moved to dismiss was tat there was no jurisdiction (FHFA not the government), and here Sweeney did make findings of fact based upon discovery to find that indeed FHFA was the government for purposes of giving her jurisdiction to hear the takings/illegal exaction claims.

        rolg

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        1. As a generalist (albeit one who’s spent considerable time involved with legal processes), plowing through this decision was pretty heavy going, although it was well structured and argued. I was a little concerned when I saw that Sweeney agreed with the Perry Capital conclusion that HERA granted FHFA unusually broad powers that permitted the net worth sweep, but as I kept on reading I realized that Sweeney was being shrewd by not using the ‘ultra vires’ argument as her path to agreeing to hear the case–since so many district courts (except for the en banc Fifth Circuit) had ruled the other way on that–but instead taking a different and safer route (the Tucker Act and plaintiffs’ right to bring derivative actions because of FHFA’s inherent conflict interest) to get to the same place. Good for her–an “exceedingly fine” grind of the wheels of justice.

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          1. Tim

            “I was a little concerned when I saw that Sweeney agreed with the Perry Capital conclusion that HERA granted FHFA unusually broad powers that permitted the net worth sweep,”

            remember two things: i) under the tucker act, govt may have legal capacity to act (eg power to condemn your house for a “public renewal” project) but can be held to pay damages if it doesnt provide just compensation under 5th A. and ii) Sweeney is not the final arbiter of this legal point; she will take direction from scotus if it takes APA cert petition (or the Federal Claims appellate court should Ps wish to appeal this point). while I am not a tucker act maven, it is not clear to me whether govt owes more in the case of a taking without compensation depending upon whether or not it had statutory authority to undertake the act.

            rolg

            Liked by 1 person

          2. My reason for bringing up the “HERA permits the sweep” point was to offer a theory for why a smart and fully informed judge like Sweeney might agree with such an evidently flawed interpretation of HERA (to accept the Lamberth APA interpretation, you have to believe that the permission given to FHFA to act in its own interest–rather than those of the companies– in a section labeled “incidental powers” can be read to apply to the statute as a whole, thus rendering the specific directives in that statute meaningless). My thought was that she didn’t really believe that, but rather than take the opposing view and conclude that plaintiffs could bring a derivative suit for illegal exaction because FHFA’s approval of the sweep was ultra vires, she took the less controversial route of ruling that plaintiffs could sue derivatively for regulatory takings because “FHFA-C” was the government. I doubt that it makes a much of a difference legally–I would think the remedies for illegal exaction and takings are substantially the same–but it makes me feel better to think that Sweeney doesn’t actually believe that “FHFA can do whatever it wants” under HERA, even though (as you point out) there would be no legal ramifications if she did.

            Liked by 2 people

          4. @B

            carney is making the AIG no damages argument. the court of federal claims in Starr v US found that there was an illegal exaction by treasury but, on the facts relating to AIG at the time, there were no damages because AIG was a financial zombie. of course, having won that case on those facts, treasury has tried to litigate the GSE cases in a similar manner…that the GSEs were in a death spiral etc. the second rule of litigation is do what worked last time. if Ps cant make showing that GSEs were financially solvent and about to enter into their “golden age of profitability”, to quote Fannie’s cfo at the time, then maybe Judge Sweeney will rule as Judge Wheeler did on GSEs facts. at some point, facts will be determinative, and Ps have been waiting for over 5 years to be able to prove their fact allegations at trial.

            rolg

            Liked by 3 people

          5. In his Breitbart article, Carney also argues that Sweeney’s ruling that her Court of Federal Claims has subject-matter jurisdiction because when FHFA agreed to the net worth sweep it was acting not as receiver but as conservator–and in this capacity was the United States–is legally flawed, and vulnerable to reversal upon appeal. Carney contends that the decision Sweeney cites as precedent for her ruling, Sisti vs. Fed. Hous. Fin. Agency in the U.S. District Court for the District of Rhode Island, relies “on an argument made in a student-written law review article,” making it unlikely to stand up in a case as prominent and consequential as Fairholme vs. the United States. I don’t have a good basis for evaluating Carney’s legal assessment.

            Liked by 1 person

          6. Tim

            there is an interesting dilemma posed to fhfa/treasury by the fairholme and washighton federal cases regarding the “contractual” terms under which the GSEs were placed into conservatorship by fhfa/treasury.

            wash fed is arguing that treasury coerced the GSEs into conservatorship…that the GSEs’ boards agreement to go into conservatorship was invalid because of treasury’s undue influence, so the conservatorship itself is invalid (the conditions for an involuntary conservatorship were not met, and indeed treasury’s focus on getting the boards to assent is the best evidence of this).

            fairholme is arguing that in connection with the GSEs agreeing to the conservatorship, there was an implied contract between fhfa and GSEs that the conservatorship would be conducted in a manner that would conserve and preserve…which were what fhfa’s own regulations provided, and that the NWS breached this contract. Judge Sweeney has allowed fairholme’s breach of implied contract to go forward to trial on a derivative basis and hasn’t ruled yet on wash fed’s claim.

            one might think that even if wash fed loses on its coercion allegation (assuming Judge Sweeney lets it go to trial) on the facts, this factual determination would nonetheless reinforce fairholme’s allegation that there was a contractual basis for the manner in which the conservatorship was to proceed so that, even if the NWS is authorized by HERA, still the NWS violated this contractual undertaking by fhfa.

            rolg

            Liked by 3 people

          7. I agree. It’s also interesting how these cases have changed character as more facts about them have become known. In the very early stages of the Fairholme case, I had several discussions with counsel at Cooper & Kirk about placing more emphasis on the circumstances and methods of Treasury’s placement of the companies into conservatorship. They were understandably reluctant to do that, given the wide latitude courts give to actions by the government in times of crisis. But with the documents produced and made public during discovery authorized by Sweeney, things have changed. I will be be very interested to read Sweeney’s decision on Washington Federal.

            Liked by 4 people

          9. Thanks. I was unaware that the judge in Sisti had denied defendants’ request for an interlocutory appeal, and Carney omitted that fact in his article. He has not been a reliable reporter about Fannie and Freddie since he began covering them.

            Liked by 4 people

          10. Tim

            I would only add that fhfa is in no hurry to litigate Sisti to final order so that it would then be able to take an appeal to the First Circuit. the denial of the fhfa motion for interlocutory appeal was 10/15/18, and fact discovery for trial was supposed to be ended 2/1/19. the trial schedule has been twice delayed so that fact discovery is now scheduled to end 4/30/20. this is a case that fhfa wants to settle, not a case that fhfa wants to try and appeal. yet perhaps carney knows better…

            rolg

            Liked by 1 person

          12. @mark

            the consequences for a finding that the instantiation of the conservatorship was improper could be exceedingly small…or exceedingly large.

            remember wash fed Ps are asking for damages, not invalidation of warrants etc. also Judge Sweeney is on record in her oral argument as believing that from where she comes from, only “then and now” shareholders can claim damages, though she may certify the question whether the claim follows the shares when transferred to the federal appeals court.

            this is not a de minimus claim brought by wash fed, and I believe that all current shareholders do have standing to claim damages, leading to Ps claim for $41B in damages, but this requires that Sweeney hold that Ps have direct claims for treasury’s improperly putting GSEs into conservatorship, and those claims survive transfer from original shareholders. we await her opinion.

            rolg

            Liked by 1 person

  9. Tim

    WSJ out with article noting that GSEs’ percentage of high DTI/low downpayment loans (essentially non QM) has trended down over last year: https://www.wsj.com/articles/fannie-mae-and-freddie-mac-curb-some-loans-as-regulator-reins-in-risk-11575973801?mod=hp_lead_pos7. calabria is quoted as saying this is connected to preparation for exiting conservatorship (lowering GSE overall risk profile).

    none of this focus on riskier non QM loans takes into account the GSEs’ duty to serve requirement which, as best I can tell, is set forth in pps.15-17 of https://www.fhfa.gov/SupervisionRegulation/Rules/RuleDocuments/2018-2020%20Enteprise%20Housing%20Goals%20Final%20Rule.pdf

    my question is, what is fhfa’s policy with respect to riskier non QM loans that are beyond the loans needed to be bought in order for the GSEs to meet their duty to serve mandates? shouldn’t this fhfa regulatory policy be clear? isn’t this the first question that institutional investors will ask on a re-IPO roadshow?

    rolg

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    1. I draw a distinction between FHFA’s roles as conservator and its roles as regulator. As a conservator, it can set limits on concentrations of credit risk as it sees fit. Calabria has made a number of public comments indicating concern about the increased percentage of loans Fannie and Freddie have been financing that have debt-to-income (DTI) ratios above 43 percent. DTI ratios, by themselves, were never a significant predictor of credit performance when I was at the company, and I was surprised that Calabria was making so much of them (I suspected it was at least partly political, because of Fannie and Freddie’s exemption from the “qualified mortgage” 43 percent DTI ceiling). Fannie had never thought DTI ratios to be an important enough risk indicator to include in the Key Credit Risk Characteristics tables it publishes in all its 10Ks and 10Qs until…last quarter. Then, for the first time–undoubtedly because of the attention Calabria brought to them– it began disclosing the distribution of its book by DTI at origination. At September 30, 2019, 77 percent of Fannie’s total single-family loans had original DTIs of 43 percent or less; 9 percent had DTIs between 43.01 and 45 percent, and 15 percent of its book had DTIs over 45 percent. But in recent quarters as much as 25 percent of Fannie’s new business had original DTIs above 45 percent, and THAT’s the business Fannie has said it would cut back on, I presume at Calabria’s request. I don’t, however, think it will make a significant difference in the company’s overall risk profile.

      High loan-to-value ratio loans are another matter; they do significantly increase the risk profile. At December 30, 2018, only 4 percent of Fannie’s book had original LTVs between 95 and 100 percent. So far this year, 8 percent of Fannie’s new acquisitions have had LTVs in that range. Most of this increase could have been expected given where we are in the housing cycle, but it’s still a negative risk factor. If Calabria wants the companies to try to cut back on these loans, I don’t think they’ll find that directive objectionable.

      That’s FHFA as conservator, with Calabria wanting to be able to say that he’s “getting Fannie and Freddie ready to be released from conservatorship.” In that role, I’m not too worried about the credit micromanagement (although I think the DTI component is overstated as a risk); it doesn’t harm, and may actually help, the companies. Once they’re out of conservatorship, though, it will be up to them to determine the risk profile of their business, including how they manage it to meet their own and FHFA’s affordable housing and duty to serve goals. FHFA’s primary influence over this mix will be their risk-based capital standards, which automatically will require Fannie and Freddie to hold more capital the riskier that mix becomes. If either Fannie or Freddie has a different answer for this question when it is asked on an equity raising roadshow, I would be surprised (and concerned).

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      1. Tim

        I appreciate the conservator transitioning to regulator fhfa concept, and agree that the GSE business model should become more stable and coherent as capital is built and conservator responsibility wanes from conservatorship to consent decree to full release. but there is an inherent skepticism that I imagine institutional investors will have on the re-IPO, trying to understand how the next few years of post conservatorship operation can be gleaned after a decade of conservatorship supervision. this is something you have lived with, as new common stock investors care more about profit maximization than addressing public policy concerns. I suppose the good news is that if the GSEs could prosper under conservatorship and the Damocles sword of wrong-minded reform proposals, then the auspices for non conservatorship operation are promising. I just think that fhfa and the GSEs should try to coalesce around a clearly articulated business model going forward after conservatorship release that inspires investor confidence. if the capital rule becomes the self-executing proxy for understanding how the post conservatorship business model will function, then that should be welcomed by investors as a rational rule independent of bureaucratic tinkering.

        rolg

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        1. The FHFA capital rule will tell us–and potential new investors in Fannie and Freddie–a lot about how Calabria intends to influence the operations of the companies post-conservatorship. As I indicated in the current post, there is an economics-based approach to the capital standard and a political-based approach, and it will be obvious which FHFA has favored when it releases its new proposal. If FHFA strays too far from the economics-based approach, I would expect large institutional investors (many of whom I know) to register their strong objections with Treasury as well as FHFA. Nothing is going to “slip by” in the recapitalization of the companies: it will be done openly and in front of an informed and financially sophisticated audience. If Treasury and FHFA want the recap to be successful, they will have to set the companies up to succeed. It really is that simple.

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    1. I’m not a lawyer, but I don’t believe Sweeney’s denial of direct claims in the net worth sweep cases has any implication for how she might rule on the motion to dismiss Washington Federal, which is a direct claim, but for takings or illegal exaction.

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      1. it is correct to say that the claims of taking and illegal exaction in wash fed are direct claims only, but until we read her opinion in fairholme (or she dockets her opinion in wash fed), we wont know her reasoning nor whether there is read over from her consideration of the NWS to the actual imposition of conservatorship on the GSEs. takings jurisprudence is somewhat clunky, and especially so when the taking is alleged with respect to an intangible property right…words on paper as David Thompson put it. so we have to hold tight on that.

        rolg

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    2. @srg4

      back to your question, now that we can read Judge Sweeney’s opinion in Fairholme, whether denial of direct claims by Judge Sweeney dooms the direct claims challenging the conservatorship in Washington Federal. Washington Federal addressed some of the distinction between the respective Fairholme and Washington Federal claims in its reply brief to govt’s motion to dismiss: https://www.dropbox.com/s/f2m29qe5a9v3nol/wash%20fed%20reply%20brief%20to%20govt%20motion%20to%20dismiss.pdf?dl=0

      put briefly, Washington Federal distinguishes between the NWS, and the injury it caused the GSEs which give rise to shareholders’ derivative (but not direct) claims in Fairholme, to the wrongful commencement of the conservatorship itself, which caused direct injury to the shareholders in Washington Federal. so imo there is no direct read over from Fairholme to Washington Federal insofar as Washington Federal is focusing on the instantiation of the conservatorship rather than the NWS, but it is still not clear to me how Judge Sweeney will rule. She may be struggling with it herself.

      rolg

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  11. Tim

    assume for a moment that in connection with any settlement, treasury promises to make a payment to the GSEs in the future (say, for example, a credit to be applied in the future against future taxes payable). I take it on the date of settlement this would be recorded as an asset receivable from treasury on the GSEs’ B/S. would it also constitute regulatory capital at that time?

    rolg

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    1. I am not an accountant but I did have Fannie Mae’s controllers department reporting to me for 15 years, and I’m fairly certain that were the company to be given a $13 billion credit against future federal income taxes payable as the result of a mandated unwinding of net worth sweep payments in excess of a ten precent dividend on outstanding senior preferred stock, this amount would not be reflected in capital immediately; it would only be added to retained earnings (and thus capital) as the pre-tax net income sheltered by these credits was earned. I cannot, however, tell you what specific accounting entries would be made to produce this result.

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      1. Tim

        makes sense that the retained earnings realization over time is what credits capital. I guess at the outset, the receivable debit is double accounting balanced by a credit to some timing reserve. just trying to understand whether capital can be conjured like nitrogen from the air from a promise to pay from treasury.

        rolg

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    1. @bird

      if I were calabria or mnuchin, I wouldn’t begin any settlement negotiations with Ps unless I was advised by both a financial advisor and a deal lawyer (meaning, not general counsel of fhfa or treasury, fine lawyers as I am sure they are, but law firms that specialize in complex settlements having a litigation and financial restructuring component). until we see these advisors hired, I think the process proceeds at its slow pace, with the litigation unfolding, in my belief, to the govt’s growing disadvantage.

      rolg

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  13. Tim / ROLG,
    Sweeney granted defendants claims for dismissal of direct claims but dismissed defendants claims for derivative claims. Do you think the dismissal of direct claims for shareholders will affect how plaintiffs move forward since they will not receive any direct damages? What are your thoughts on the ruling going forward?

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    2. @jerry

      to try to get a sense of what the lay of the land is, and understanding that this is provisional until Judge Sweeney publishes her opinion, perhaps forget for a moment about what claims are “direct” and “derivative” and who is to receive what damages, and assess what treasury’s position is at this moment.

      if you are the govt you are facing claims that are going to go to trial, whether they are direct or derivative. in collins, the claim is a “direct” claim filed by a shareholder because APA Section 706 authorizes such a claim, but the assertion of the claim, even though direct, would lead to a payment from treasury to the GSEs if successful. the govt will also apparently be facing claims in fairholme (status of Washington Federal is still uncertain since its docket hasn’t been updated), which have been styled “derivative”, which will also see funds flow from treasury to GSEs if successful. and there is fairholme before Lamberth, which is a “direct” claim for damages that would see money flowing from treasury to shareholders.

      so while I would need to read Judge Sweeney’s opinion, it seems that the govt will be entering 2020 subject to three separate lines of attack (and possibly four, if Washington Federal survives dismissal), subject of course to what SCOTUS might do to the collins claim (either eliminating the APA statutory claim under the govt’s petition or reviving the constitutional claim for a remedy under the Ps petition), and subject to any govt appeal in the federal court of claims system by the govt of Sweeney’s still unpublished opinion.

      rolg

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      1. ROLG,
        Thanks for your perspective on the Sweeney ruling. I would assume that both parties will probably appeal which will drag this out a bit longer. I guess this is what Judge Sweeney meant when she stated in oral arguments that both parties will not be pleased with her opinion.

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        1. @jerry

          Sweeney has scheduled a conference for early January so she looks like she is thinking trial is on for the derivative claim, which I dont think can be appealed by govt since it is not a final order (just not sure of fed ct of claims procedure).

          rolg

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  14. Tim,
    The market seems to be reacting favorably to the news that Anthony N. Renzi is appointed as CEO of Common Securitization Solutions. He seems to have a solid BIO. Do you have any views on his appointment?
    Thank you for your blog and continued great insights.

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    1. No, I don’t know anything about Renzi. But I did note in one of the stories about his appointment that Fannie’s president Dave Benson had very complimentary things to say about Renzi, and I trust Dave’s judgment.

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  15. Tim

    I thought this was a sensible analysis of the Judge Sweeney oral argument in respect of the Washington Federal case: https://gselinks.com/wp-content/uploads/2019/12/More-shoes-to-drop-3.pdf

    there is much recrimination among a segment of shareholders concerning the manner in which treasury put the GSEs into conservatorship and the 79.9% commons stock position it took for making the senior preferred purchases. I have discounted the viability of this cause of action for several reasons but, mea culpa, if as it would appear from the transcript, that Judge Sweeney will allow the Wash Fed cause of action to go to trial, this contingent liability (on treasury’s books, not the GSEs books) will become a serious negotiation item for treasury to settle to close the chapter on the GSEs conservatorship. and given that it was Mnuchin’s predecessor who acted in the manner mostly redacted in the Wash Fed amended complaint, it might be easier for Mnuchin to settle than if he was the secretary at the time.

    rolg

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    1. I also was struck by the statements Sweeney made about the Washington Federal case. I’ve always felt Washington Fed was right on the facts, but because many observers (including yourself, as you point out) felt its counsel didn’t have the financial resources to take the case all the way to trial, I had discounted its significance in the settlement process. I think we all have to rethink that now.

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      1. Tim

        so interestingly enough, wash fed was able to benefit from the discovery that fairholme performed. wash fed is represented by class action lawyers who dont get paid by the hour, while fairholme’s lawyers do. discovery is an intensive and costly process that class action lawyers only engage in when there is a high probability of a big payoff lying at the end of the rainbow, and I didn’t see it in this case. low and behold, fairholme’s lawyers do all this good work (paid for I presume by fairholme) and come up with discovery very helpful not only for their own but also the wash fed cause of action…that and Hank Paulson’s vanity book which is a gift from above, a self-indictment par excellence. there is a lot to bemoan about the GS#E saga but this turn of events is beyond hopeful expectation.

        rolg

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  16. Tim,

    Could the GSEs unlock the DTAs and count them as core capital as an efficient means of getting out of conservatorship quicker?

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    1. Fannie and Freddie’s deferred tax assets (DTAs) are not ‘locked;” they are on the companies’ balance sheets at their full asset values. Were those values to ever be subject to any doubt (as FHFA asserted they were, most would allege incorrectly and probably improperly, shortly after the conservatorships), a reserve would be created against some of all of them, and these DTA reserves would reduce the companies’ capital dollar-for-dollar, as they did between 2008 and 2012. But there is no way the DTAs could be used to increase capital.

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      1. Tim,

        With the management of the companies in charge of the capital raising plan subject Mr. Calabria’s approval, in your experience, how much weight and input during a capital raise process do executive committee’s take from the existing largest shareholders?

        Because, while this report (link below) from Bill Ackman (largest shareholder of the companies) maybe a little dated due to changes in the tax code and overall health of the companies/economy, it may provide great insight to the line of thinking of the firms going forward in the process.

        Click to access ebc3f688-d51b-11e3-adec-00144feabdc0.pdf

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        1. The companies (or their investment bankers) definitely will solicit the views of large institutional investors, both existing and potential, prior to doing any equity offerings, As you note, however, the Ackman piece is dated (it’s from the spring of 2014), and much has changed since then. I wouldn’t use it as a roadmap for what may actually happen.

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  17. Is there a problem with receiving comments? Bryndon Fisher said on the Google Board that he is trying to post a comment here but has been unsuccessful. He doesn’t know how to contact you.

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    1. Jeff: The majority of comments show up on the blog directly, but some require me to approve them (I’m notified when that happens). I don’t know what causes a comment to go into the “needs approval” bucket; usually it will be a comment from a new poster, but some new posters’ comments get posted directly, while there have been instances when a comment from a frequent poster has gone into the “needs approval” box. Bryndon’s comment, though, hasn’t shown up in either category, and I don’t know why. I wish I could offer suggestions, but the access I have to the blog (obviously) is different from what readers and potential commenters experience.

      [December 4 postscript: I dug into this further, and for some reason each time Bryndon tried to post his comment it went directly into spam. I never check the spam file (if you could see some of what ends up there you’d know why) and I don’t get notifications of when I get spammed (thankfully). The mystery is why Brandon’s comment ended up there; it bore no resemblance to anything else in that file.]

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        1. In the linked comment, Mr. Fisher reacts to comments made recently (and linked below) by former Treasury official Craig Phillips, concerning how he believes Treasury ought to go about the process of recapitalizing Fannie and Freddie. Mr. Fisher disagrees with much of what Phillips said.

          I have consistently stayed out of the discussion about how Treasury should go about the recap, for two reasons: it’s not my area of expertise, and I know my opinion won’t make any difference. The principals at Treasury are getting huge amounts of input (and opinion) from the interested parties, ranging from litigants in the lawsuits to the large investors who will make or break the recap to the major players in the mortgage market (including the banks), and ultimately it will do what it believes best achieves the objectives it has for the exercise–and I don’t know what those objectives are. So in this blog I’m going to stick to what I know and where I may be able to have some influence: the right way to structure, capitalize and regulate the reformed companies so that they can be successful for all their stakeholders–investors, homebuyers and taxpayers–once they’re (finally) released from conservatorship and allowed to operate as independent entities.

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    2. @Jeff

      I for one would encourage mr. fisher to try posting here again, and perhaps mr. fisher could explain why he had his counsel submit an amicus brief re the APA cert petition that counters the collins reply brief with respect to whether Ps claim is direct or derivative. see https://www.supremecourt.gov/DocketPDF/19/19-563/123957/20191127164821127_Amicus%20Brief%202019%2011%2026%20final.pdf

      I thought this amicus brief was decidedly unhelpful insofar as Cooper & Kirk has persuasively argued that the Administrative Procedure Act Section 706 entitled Ps to a direct claim, while the Fisher amicus brief seems to only support the business practice of mr. fisher’s class action counsel.

      rolg

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      2. rol
        No, I’m sorry, that was not actually Bryndon, but someone else who responded. To avoid confusion you may want to follow the link that I posted to reach Bryndon Fisher yourself.

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      3. I saw that amicus and was curious what your thoughts were on it ROLG. I was disheartened by it, but at the same time, the argument appears to be “yes it’s derivative, but the NWS was done with a manifest conflict of interest, so plaintiffs had standing nonetheless.” I don’t know if he expects that to give SCOTUS another option to rule that it’s derivative, but still right to find for plaintiffs due to conflict of interest? So they avoid having to rule broadly on derivative claims and create some new standard precedent for conflict of interest?

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        1. @fisherman

          I really dont think that amicus will go anywhere as it relates to a question that was not a “question presented” by the DOJ in its petition. if the DOJ petition is granted I dont expect it to be enlarged to consider questions not covered by the petition. I just didn’t understand why that amicus was filed, since on the direct v. derivative question, Ps won at collins en banc (direct) and the DOJ did not directly challenge this issue. total amateur hour imo.

          rolg

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    3. Weirdly my previous comment has been removed. But does this line of reasoning from Mr. Laufgraben of the Department of Justice in the Sweeney oral arguments mean that once the warrants are executed, they can be subject to a dual nature claim under Delaware Supreme Court law? If so, could not shareholders seek a permanent injunction to force the Treasury to refrain from acting on the warrants?

      Mr. Laufgraben, “So, first, they argue that they have a dual nature claim. Now, under Delaware Supreme Court law, a dual nature claim only exists in two circumstances or — sorry, in one circumstance with two requirements. The corporation has to issue excessive shares of its stock in exchange for the assets of a controlling shareholder that have lesser value, and the issuance of those excessive shares dilutes the voting power of the minority shareholders. So it’s a very specific, narrow scenario, and Plaintiffs lose on both points. So putting aside that Treasury is not a controlling shareholder, the Third Amendment involved no issuance of new shares, and minority shareholder voting power was the same as it was before and after the Third Amendment. So the dual nature theory has no application here.” Page 45 (177 to 180)

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      1. Nick: Your comment was not removed “weirdly;” it was removed deliberately. You’re a relatively new commenter on the blog, so you may not know that I have a longstanding policy of not accepting questions about Treasury’s warrants for Fannie and Freddie’s common stock. I’m no fan of the warrants, but I don’t know what Treasury will do with them and have no interest in speculating about it. There are other sites where people can (and do) discuss their theories of and predictions about the warrants at length, and I don’t want this site to become one of those. Despite my stated policy I still get questions like, “What do you think about my idea of why the warrants won’t be exercised, are illegal, will be met with lawsuits if they are exercised, are immoral, cause cancer in laboratory mice, etc., etc,” and I delete them. Your warrant question stayed up for a while–mainly because I’ve been away from the blog a lot the last couple of days–and since no one had responded to it and I wasn’t intending to, I removed it today.

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        1. Tim,

          Understood, thank you for informing me. I did not know about the policy. I will refrain any from further comments on the warrants.

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        2. Tim

          I just read your post about discussing warrants so I wont. My question is simple, I’m sure you read Gasparino talking Ipo again. How can you IPO these 2 companies if A there are so many court cases moving and B they trade on the OTC?

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          1. The “news” in the Gasparino piece was that he had heard that the Federal Housing Finance Agency had narrowed its list of possible financial advisors to a small number of firms, including, according to Gasparino “Perella Weinberg Partners and possibly PJT Partners.” The rest of the piece was a rehash (sometimes inaccurate, such as his description of Moelis & Company as representing “shareholders who are suing the government”–Moelis was retained by and does work for non-litigating shareholders) of rumors and speculation about the recapitalization process and the possible size of a public offering.

            In response to your specific question, the companies, and not FHFA, will decide how much new equity to raise and when to raise it. Fannie and Freddie each will retain their own investment banks and underwriters to advise them on this, and almost certainly will not do any public offering until the net worth sweep and Treasury’s liquidation preference have been eliminated, whether through some final legal ruling or a settlement of the lawsuits. Finally, the amount of capital each company will raise remains unknown. It will depend primarily on two factors: the final capital requirement set by FHFA–which hasn’t been determined yet–and the mix of retained earnings and new equity issuances each company elects to use in reaching its target capitalization.

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          2. Tim,

            You said “the companies, and not FHFA, will decide how much new equity to raise and when to raise it.” However, according to HERA, it is FHFA that has the authority to “Require the regulated entity to acquire new capital in a form and amount determined by the Director.” while the company is classified as significantly undercapitalized.
            https://www.law.cornell.edu/uscode/text/12/4616

            That classification applies while the companies have less than the minimum capital amount that Calabria will determine in his capital rule; it will override the statutory minimum as I believe you have pointed out before. Presumably, the purpose of the equity raise will be to get the companies up to, or past, this minimum capital standard so that FHFA’s supervisory authorities will be lessened. Reading that list of authorities, I don’t see how investors would be willing to invest while FHFA retains that level of control.

            It then appears that Calabria, not the companies, will be making all the important decisions when it comes to the capital raise. That is, unless you see some way for the companies to meet Calabria’s minimum standard without third-party capital?

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          3. Midas– I was making a simpler and more general point: by the time both Fannie and Freddie fully meet their new capital requirements–risk-based as well as minimum–it will be the companies, and not FHFA, that will have determined the mix of retained earnings and new equity that accomplish this. Calabria has said many times and in different ways that it will not be up to FHFA, but the companies, as to when they exit conservatorship. He has since qualified this by adding that he may allow the companies to exit conservatorship relatively early in the capital building process, under a consent decree that will be binding until they are fully capitalized. You are postulating another scenario: that Calabria may not release Fannie and Freddie from conservatorship until they meet their (new and unknown) minimum capital requirement, and that making the minimum the release threshold will give the companies a strong incentive to do a capital raise to get there. That may be, but Calabria hasn’t said anything about that yet, so it’s pure speculation.

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          4. Tim,

            I didn’t mean to imply that Calabria’s minimum standard will be the threshold for release. Instead, my read of HERA is that Calabria’s statutory supervisory authority over the GSEs while they are classified as significantly undercapitalized gives him (not the companies) the authority to choose the form and amount of any capital raise until they meet that minimum standard, even if they are out of conservatorship. Those supervisory authorities are all already in place in conservatorship anyway.

            In other words, FHFA calls all the capital raise shots until the companies hit Calabria’s minimum, even if they are released. I don’t see any other way to interpret the part of HERA I linked to. This conflicts with your point, so I would like to know if I am misreading or misunderstanding HERA in some way.

            I always took Calabria’s comments about leaving the capital raise up to the companies to mean that FHFA doesn’t have the power to issue any shares, not that he will allow them to make the decisions. He has to approve any capital restoration plan anyway, which means he might as well write them because it would be a waste of time for the companies to write and submit plans that he won’t approve of.

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          5. Midas: You have a right to your opinion, but I don’t share it. The fact that under HERA the FHFA Director has the authority to “Require the regulated entity to acquire new capital in a form and amount determined by the Director” doesn’t mean that’s what he’ll do. I’ve lost track of the number of times I’ve read Calabria saying he can’t tell us when Fannie and Freddie will exit conservatorship (or fully meet their capital requirements)– it could be late 2021, 2022, 2023, or after his term is up in 2024–it all depends on the companies. I’m taking him at his word.

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    1. Tim and rolg,

      Excellent commentary.

      What do you think the chances are for a move to summary judgment in the Sweeney cases given her now “complete tapestry” of the events that have occurred? Additionally, Judge Sweeney’s tone of regret over the time this has consumed.

      It appears both shareholders and the administration are aligned on this issue of wanting to come to a final ruling as quickly as possible. And given the myriad of legal and desired administrative activities that will likely be occurring next year related to the GSEs, a motion for summary judgment sounds logical given the cases likely move forward. What do you think the timeline would be as well?

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      1. @nick

        the best way to answer is to first read Judge Sweeney’s opinion when it comes out. while the oral argument transcript is highly informative, it is just a footprint in the sand…the written opinion is the real thing. I have found Cooper & Kirk to be smartly strategic regarding tactics, so while pedal to the summary judgment metal sounds to me like a wise course of action, there may be an advantage to actually having a trial at which all of the dirty laundry is aired.

        rolg

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        1. rolg,

          Very true, it seems to me in this battle of attrition between shareholders and the government the longer this goes on the better it gets for shareholders as more of the dirty laundry comes out. Hopefully, Christmas comes early in terms of her opinion.

          “Patience is the key to success not speed. Time is a cunning speculator’s best friend if he uses it right.” – Jesse Livermore

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  19. Tim

    it occurs to me that Judge Sweeney’s decision/opinion (and I assume based upon the oral argument transcript that she will deny the govt’s motions to dismiss re both entry of conservatorship/washington federal and NWS/fairholme) will assume greater significance going forward than one might think at first blush.

    first, even assuming that scotus grants cert on one or both of the collins petitions, and even if the govt believes that it will prevail at scotus (which is hardly a foregone conclusion) by the end of summer 2020, the govt will still know that it will face three trials (fairholme NWS and Washington Federal entry of conservatorship before Sweeney, and breach of fair dealing etc re NWS in front of Lamberth), so that if the govt wants to stick to its process of recapping and consent decree/release of the GSEs, it will still have to settle litigation before it raises any new capital. so even winning before scotus will not be a knock out blow this summer 2020, and after having been advised by Judge Sweeney that she likens the NWS to a “mob” financial arrangement, and with Ps able to put treasury secretary Paulson on the stand and ask him what he meant when he said to POTUS that “the first thing the [GSE boards of directors] will hear is their heads hitting the ground”, reiterating the mob theme, these are not trials that the govt should relish.

    but more importantly, this opinion by Judge Sweeney (and she has stated that she has a good working draft already completed) will be the first occasion for a judge to have actually considered and opined with respect to testimony and evidence. until this decision, the govt has consistently (and improperly, and knowing full well that it was improper) characterized events relating to GSEs in the light most favorable to the govt and, since all cases to date have been motions to dismiss, this is exactly backwards, as on a motion to dismiss the court is constrained to accept Ps allegations as true. you saw this in every govt brief and argument in all district and appeals court hearings and surprisingly the govt has gotten away with it until very recently. in the collins 5th circuit en banc hearing, you saw judge jones finally blast the govt attorney on the oral argument taping, cutting him off by saying on a motion to dismiss it is the Ps allegations, not the govt’s allegations of fact, which are accepted as true. you see it again in Cooper & Kirk’s APA cert petition reply (https://www.supremecourt.gov/DocketPDF/19/19-563/123839/20191127103429028_USSC%2019-563%20Brief%20for%20Respondents.pdf) where at pps 10-14, Cooper & Kirk is obliged to once again point out how the govt has improperly asserted as true facts that are contrary to Ps allegations that scotus must accept as true for purposes of reviewing the 5th circuit’s en banc decision.

    finally, with judge Sweeney’s decision in fairholme, which should be released about the time of any scotus argument in collins should scotus grant cert., Ps will be able to point to an actual judicial decision that is premised on actual discovery relating to the GSEs, a judicial decision based upon actual testimony and discovery. Judge Sweeney’s opinion should provide Ps the opportunity to finally put a lie to the govt’s presentation of the facts relating to the GSE conservatorship and NWS. it is one thing for counsel to admonish govt’s lawyers before a judicial hearing with the first rule of civil procedure that all law students learn, that on a motion to dismiss one accepts Ps complaint allegations as true, but it will be quite another thing for Ps to point to an actual GSE judicial decision based upon the merits after factual discovery…and I don’t expect that decision to be salutary for the govt after reading Judge Sweeney’s transcript.

    rolg

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    1. I agree with you. Sweeney’s unambiguous comments on what I’ve called “the takeover and the terms” of Fannie and Freddie’s placement into conservatorship by the government make clear that she “gets it,” as indeed any objective person (or judge) familiar with the pattern of Treasury’s actions with respect to the companies leading up to, during and after the conservatorships is likely to as well. The facts are hiding in plain sight. I documented the most significant ones in the amicus curiae brief I did for the Jacobs-Hindes in Delaware, and Cooper & Kirk and other plaintiffs’ counsel have been increasingly specific, and pointed, about these facts in their recent filings. Nothing in the fact pattern is consistent with a rescue, and everything is consistent with a pre-planned nationalization for policy purposes. Even if SCOTUS does not grant cert on the APA claims, or finds for the defense (which I don’t believe it will), the government now has to know it will lose in a trial for takings, illegal exaction or breach of contract, because its fictions of what it did and why won’t hold up under challenge.

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    2. If the Washington Fed case continues and they have a real chance of winning, then one has to ask the question – how is the gov’t to ever settle and make a deal that works both for the WashFed people and the the Pref shareholders??…..I guess the real question is, what is the magic number that would make Washington Fed people happy…If you think about it, common shareholders lost tons of value when forced into conservatorship…so a small bump in stock after recap wouldn’t do it for them…any thoughts?

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      1. @bigE

        Washington federal’s amended complaint can be read here: https://www.dropbox.com/s/kurcg5l6noslcl2/wash%20fed%20amended%20complaint.pdf?dl=0

        it is a purported class action on behalf of all GSE shareholders as of 9/5/2008 seeking $41B or such other amount as is determined at trial. the implications of this case going forward to trial are numerous and I suspect not something the DOJ has discussed in depth with Treasury about…but that might change soon.

        rolg

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  20. After reading the Sweeney comments out of the Court of Federal Claims so nicely provided to everyone via Mr. Metzner @ ACG – I think the Washington Federal Plaintiffs have a pretty decent chance of finding the financial sponsorship to keep perusing a full reversal of the conservitorship.

    Click to access Fairholme-Condensed-Transcript.pdf

    ROLG or Tim – please feel free to throw cold water on my read. Happy Thanksgiving.

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    1. That’s not what intellectual feast means. Such can be draining but the important pertains to much to think upon. Justice Bork even employed the phrase in the context of coming on SCOTUS. I think many can feast intellectually yet without becoming drained. Some even get energized!

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    2. This is a lengthy transcript which I’m going to have to read in sections over the next few days. I’ve now finished the morning session (through page 157 of 392), and haven’t yet encountered anything I would say is favorable for the Washington Federal case; to the contrary, a question has been raised whether the primary Washington Fed claim sounds in tort rather than being a taking. If it’s tortious, Sweeney’s Court of Federal Claims wouldn’t have jurisdiction, and it would be dismissed. Perhaps there will be more about Washington Fed in the afternoon session. In the net worth sweep cases, David Thompson for the institutional plaintiffs and Hamish Hume for the class plaintiffs so far have made solid arguments, with which Sweeney has been either sympathetic or in agreement.

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    3. “I think the Washington Federal Plaintiffs have a pretty decent chance of [winning] . . .full reversal of the conservatorship[s].” Agreed. In fact, here’s a quote from the final arguments of the hearing:

      “Washington Federal agrees that the critical time to assess the Government’s conduct was in August of 2008 when the directors of the enterprises were confronted with, as the Court put it, ‘a Hobson’s choice’ — agree or you’re out. And the Court had used the terms ‘undue influence’, ‘death threat,’ or ‘death grip.’ And our complaint alleges in great detail allegations showing coercion, and I’m not going to repeat those because they’re under seal, but they are detailed and I think quite compelling.” (Pgs 378-379)

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      1. I’ve now finished reading the entire 392-page transcript of the Oral Argument in the Defendant’s Motion to Dismiss the various lawsuits in Judge Sweeney’s Court of Federal Claims, and agree that the Washington Federal case—the only one which challenges the 2008 conservatorships—is likely to survive the motion to dismiss. The government made two arguments for dismissal—that the Washington Fed suit needed to be filed within the 30-day window applicable to the companies were they to have challenged the conservatorships, rather than the general six-year statute of limitations that applies to the other suits, and that the Washington Fed plaintiffs had failed to state a valid takings claim. My reading of the transcript is that Sweeney will side with the plaintiffs on both issues, allowing the Washington Fed suit to continue.

        Most if not all of the suits against the August 17, 2012 net worth sweep are likely to survive as well. Sweeney all but conceded as much when, just prior to breaking for an afternoon recess, she said, ““I want the parties to have their day — well, we’ll have many days in court, but I mean, for this initial oral argument…”.

        I also was struck by Sweeney’s clear and direct statements about how she sees the merits of both the 2008 conservatorship challenge and the 2012 net worth sweep. On the former she said, “I’m very concerned that Treasury approaches the board of directors of the enterprises and says, you either agree to the conservatorship or you’re out. That’s – that sounds like undue influence, if not a death grip,” and “The enterprises were never able to repay the debt to the United States taxpayer… and so the– Freddie — the enterprises were never able to right their financial ships of state and then make their profits while not borrowing anything from the U.S. taxpayer and then pay what dividend they can to their shareholders. And that doesn’t seem cricket. That doesn’t seem cricket to the way our government operates.” She was even more unambiguous in her description of the net worth sweep: “I hate to say it, I’m not — this is going to sound so flip, and I don’t mean for it to, but this is like the mob. And it’s not, of course, but, I mean, you have all the money is being turned over to the Treasury.”

        The substance and tone of Sweeney’s comments throughout the hearing were strikingly different from we’ve noted in the recordings or transcripts from other cases concerning Fannie and Freddie, and of course there’s a reason for it. All of the proceedings so far have dealt solely with issues of law, and the government has consistently given a false rendition of the facts leading up to and surrounding the companies’ initial placement into conservatorship as well as the subsequent net worth sweep. Judge Sweeney permitted discovery in her case, and she therefore has become intimately familiar with the facts, which to put it mildly do not favor the government. Sweeney’s view of the merits of the case thus is not just a harbinger for how she might rule if the cases in her court ever make it to trial, it’s a foreshadowing of how the judges in other cases likely will react once they focus on the actual facts of the issues they’re being asked to adjudicate.

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        2. Thanks for your Insights, and I hope you enjoyed your Thanksgiving, Tim. It’s reassuring to know that Judge Sweeney understands the root cause of the government’s actions. I wonder how much longer it is before the government realizes it’s gone too far, as more and more legs get knocked out from underneath its shaky legal defense.

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  21. ROLG,
    I would have thought we would have seen a next steps scheduling request from Collins Plaintiffs to judge Atlas by now. Do you have any idea why we wouldn’t have seen a meeting request by now?

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    1. @jerry

      agreed, and I dont know why. Cooper & Kirk have been working on the fairholme motion to dismiss in the fed ct of claims and the APA scotus cert petition response due in a week. it just may be their sense that if they put papers in front of judge atlas now, she would just wait for the scotus determination on the cert petition in any event, so this can wait.

      rolg

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      1. Rolg,

        Apparently during the recent 11/19 hearing before Sweeney she stated she would likely certify several questions to the Federal Court of Appeals. What exactly does that mean, entail and how may that impact the timeline?

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  22. Tim

    WSJ with a “scoop” of a summer meeting between administration and large agency mbs buyers clamoring for a direct government mbs guaranty, here is link: https://www.wsj.com/articles/firms-warn-of-risks-in-plan-to-take-fannie-mae-freddie-mac-private-11574591423?mod=hp_lead_pos4

    I am not surprised this meeting was held in the summer and these mbs buyers want a direct government guaranty. it is now fall entering winter and the administrative process is proceeding albeit slowly, and congress seems otherwise occupied.

    this market has existed over 50 years without a govt guaranty on far less capital (and yes, with a wink/nod implicit guarantee), and it will be proceeding with far more capital and a direct paid for back stop line (which of course is far more than there has been in terms of credit in that 50 year period). WSJ article references a securities firm saying the congressionally-appropriated backstop line (now to be paid for) can be revoked by a future administration and for this reason prefers a direct guaranty, but of course a direct guaranty passed by congress can be revoked by a future congress. all this will likely affect pricing, with agency mbs being more expensive than treasuries, but the GSE transition out of conservatorship with more capital will be a credit-positive event compared to the status quo.

    to my mind, when I see a leak to a reporter of a meeting held some 6 months ago, I see desperation.

    rolg

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    1. It made complete sense for BlackRock, PIMCO, Fidelity, B of A, Nomura Securities and others to attend a meeting set up by SIFMA and hosted by Larry Kudlow’s National Economic Council during the summer, when everyone was trying to influence what would go into Treasury’s announced and impending report on housing finance reform. And it also made sense that the investment firms would advocate for an explicit government guaranty on the securities of the next iteration of Fannie and Freddie. Now we have an article in the Wall Street Journal reporting on the meeting. Why? Almost certainly, it’s because someone (whoever gave the story to Andrew Ackerman, the WSJ reporter who filed it) doesn’t like what they’ve been reading and hearing recently about the elements and timing of the process of releasing Fannie and Freddie from conservatorship. For me, the critical question is, “who’s not happy, and how much political pressure do they intend to exert on Treasury, or elsewhere in the administration, to make the extent of their displeasure known?” If it’s just Ken Bentsen and SIFMA, getting this article in the WSJ to show their members that they’re “on the case” and doing the best they can, it’s not a big deal. If it’s the large investment firms, it could be an issue.

      Calabria is quoted in the article saying, “‘Indefinite limbo’ isn’t an option for Fannie and Freddie,” but if the large investment firms are serious about opposing releasing the companies from conservatorship without such a guaranty–and they can get Treasury to support them–then indefinite limbo is exactly what the outcome will be, since there is very little chance an explicit guaranty on Fannie and Freddie’s securities will be able to pass the Senate anytime in the indefinite future. My personal view is that the investment firms won’t push it that far, but it’s definitely worth monitoring.

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      1. Tim

        general strikes dont work on Wall Street, especially in trillion dollar markets. investment firms are in the business of doing business, and if they need a little more spread to treasuries on the GSE mbs, they will require it and they will get it. they will not go to the ramparts to make a policy point when there is business to be done. within each firm, there are multiple fixed income desks, and the GSE mbs desks will continue to be active even without a federal guaranty. these desks are already buying GSE mbs in conservatorship and will buy GSE mbs with improved credit after conservatorship.

        rolg

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  23. Tim

    I have a capital question. i just watched ACG Analytics’ most recent video: https://www.youtube.com/watch?v=jwEweCIyo24&feature=youtu.be. at around 14:40, Gabriella Heffesse says that an exchange of junior pref for common increases capital (which would enable the conservator to move the GSEs into a consent phase). Is this right? she says this would help GSEs meet statutory capital level. it seems to me this would not affect capital. what am I missing?

    rolg

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    1. You are more correct than Ms. Heffesse. A par exchange of junior preferred stock for common stock would leave capital unchanged. A preferred-for-common exchange at a discount would increase capital by the dollar amount of the discount, while a preferred-for-common exchange at a premium similarly would reduce capital.

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      1. Tim

        thanks. gabby may have just got some wires crossed because, and correct me if i am wrong, but by the time just before the 2020 election, with earnings retention, the GSEs should hit or be close to their statutory levels (eg the $25B letter agreement cap for Fannie would approximate this statutory level), so I think they could enter into a consent decree phase then, and make it impervious to attack by a new potus/fhfa director if necessary by doing a settlement which could provide for junior into common exchange, but the exchange wouldn’t be affecting capital but rather the other way around, that by retaining earnings and getting to the statutory level, the consent decree/settlement/exchange would then be possible by hitting statutory capital. if this is right, it seems to me that this may be the reasoning underlying the letter agreement.

        rolg

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        1. A number of people (perhaps including Gabby) seem to be assuming that Fannie and Freddie will be released from conservatorship under a consent decree shortly after they’ve retained enough capital to meet their current statutory minimum requirement of 45 basis points for off-balance sheet obligations and 2.50 percent for on-balance sheet assets (with all MBS counting as “off-balance sheet,” even though the financial statements show them as assets). For Fannie that would about $21 billion, or roughly double what it has now ($10.34 billion). But I wonder about this, for three reasons. First, Calabria has never said that’s the threshold. Second, I seriously doubt that the companies will be released from conservatorship before they have their new capital requirements, and those will render the old statutory minimums obsolete. Third, in HERA the capital threshold for putting Fannie and Freddie into conservatorship is falling short of their critical capital levels, not minimums, so by inference that also should be the threshold at which they could exit conservatorship. Currently these critical capital percentages are only 25 basis point for off-balance sheet MBS and 1.25 percent for on balance sheets assets. For Fannie that’s only $11.6 billion, which it almost has today, and is too low to be a credible release threshold. The reality is that we don’t know what capital number (or percentage) Calabria has in mind for releasing Fannie and Freddie under a consent decree, because he hasn’t said.

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      2. Tim,

        On another site I raised the same question as ROLG. The only way I could make sense of GH’s remark was if reducing dividend obligations can be accounted as a capital increase or at least a path to raising capital faster. That didn’t seem correct to me but neither did her remark.

        Can you elaborate on how exchanging junior preferreds at a discount would immediately increase capital whereas exchanging preferreds at a premium would immediately reduce capital? Is par already baked in and any deviation in either direction would affect capital?

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        1. The reduction of dividend obligations is something that would benefit retained earnings over time, but only after the dividends have been turned back on (Fannie and Freddie’s junior preferred stock is non-cumulative), which wouldn’t happen until the companies are in full capital compliance.

          The effects on capital of conversions of junior preferred at a discount or a premium that I mentioned are my understanding of how the accounting would work. I’ll give you an example using conversions at a discount. Fannie now shows $19.13 billion in junior preferred stock in its capital account. Let’s say (not a prediction, just for illustration) that all these shares convert at 90 percent of par. Fannie would pay (or credit) $17.22 billion to move $19.13 billion from the junior preferred category of its capital stock to the common category. The difference, or discount, of $1.91 billion would be reflected as a reduction in the company’s accumulated deficit, raising total capital by that amount. The reverse would happen for conversions at a premium.

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          2. I don’t understand the rationale for a conversion of the JPS; per their prospectus, they are not convertible, so you would have to vote to amend them, and they are already apart of core capital.

            Can’t see JPS holders voting to convert at a discount so that the companies can raise capital from it when they are currently seeking a value of par plus a remedy for unpaid dividends. The $2B in dividends can’t be paid till reaching regulatory capital levels so they won’t get in the way of fully retaining earnings till meeting the requirements.

            The capital restoration plan is up to the management of the companies, with Calabria approval. I would assume that when shareholders have reinstated their rights, it would be across the capital structure, not just the JPS at first for a conversion, and then to the common shareholder. I don’t know why management would do something that hurts the only part of the capital structure with voting rights, not focus all efforts on raising capital by working on conversion, and then right after trying to raise capital via a public offering. I guess you can say it will end lawsuits, but it seems that ending the NWS and amending the PSPA likely ends most.

            Liked by 1 person

          3. An offer to convert the junior preferred of Fannie or Freddie would be just that, an offer; it would not be mandatory. The terms of the conversion would be determined by the issuer, presumably in consultation with the large institutional holders of the preferred.

            As to why junior preferred holders might convert to common stock, today, because of the net worth sweep, they own the equivalent of a perpetual zero-coupon bond. There is some value between the current market price of the preferred and par where current holders might be tempted to convert to common stock as a way of liquidating their non-dividend paying investments.

            Obviously, future developments in the legal cases will affect what a fair conversion offer might be. But again, it won’t be mandatory. Junior preferred holders will have the option to keep their shares and wait for the dividends to be turned back on, whenever that may be. Note, though, that at least some of the junior preferred is redeemable at par at the option of the issuer (I know the junior preferred Fannie issued while I was CFO is), so a holder would need to consider redemption risk as part of their calculus.

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          4. Tim

            as to the terms of the exchange offer of common for junior preferred that I expect to be offered by each GSE, I also expect the terms of the offer to have an exit consent attached to it such that, if 2/3rds of each class of junior preferred elects to accept the exchange offer, then as part of that acceptance, those holders will vote to amend the terms of any preferred shares that remain outstanding, and there is no prohibition in the respective certificates of designation limiting the manner in which the shares may be amended. so for example their dividend rates could be reduced to zero. I fully expect the GSEs to use this coercive exit consent process to force all holders to “go along” in connection with any offer that obtains the requisite 2/3rds vote. this permits the GSEs to “clean up” the balance sheet. the protection small holders have is that the big holders will extract a beneficial exchange rate as a condition for accepting the offer.

            rolg

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          5. I hadn’t been aware that this sort of “coercive exit consent” was being contemplated for a potential offer to convert Fannie or Freddie junior preferred into common. I see that it’s permitted by the prospectus (which states that “the terms of the Preferred Stock may be amended, altered, supplemented or repealed…with the consent of the Holders of at least two-thirds of the outstanding shares of Preferred Stock”), but that’s not something that was discussed as a possibility–or a risk to a potential purchaser of junior preferred–during my CFO days. But then times, and circumstances, have changed since then.

            Liked by 1 person

          6. Another rationale for accepting conversion at some fraction of par could be timing. If it’s clear I wouldn’t realize full RV for an additional year (if not longer due to pending suits) then accepting some discounted offer twelve months prior could be optimal. Depends on the offer, the perceived options and one’s attitude toward risk.

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          7. Tim

            well. I dont know what is being contemplated, but if GSEs want to “clean up” balance sheet, this is the strategy that their advisors will recommend.

            rolg

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          8. I couldn’t make sense out of the junior preferred rights offering adding to capital reasoning either.

            Noncumulative preferred stock is eligible as Tier 1 capital and GSE risked-based capital. All GSE junior preferred is noncumulative, so a rights offering would presumably only change qualifying junior preferred to another qualified equity component and capital would remain unchanged.

            Senior preferred stock issued under TARP was eligible as Tier 1 capital and GSE senior preferred stock is treated as risk based capital.

            However, the GSE’s can’t control redemption of their senior preferred and it’s cumulative (through additions to the liquidation preference), which is a feature which would otherwise disqualify preferred stock as Tier 1 capital.

            Under the letter agreements, the FHFA’s assertion that the GSE’s are increasing capital through deferral of cash payments isn’t convincing since it does add to the liquidation preference. And Treasury’s liquidation preference is, for all intents, callable.

            Senior preferred stock is the largest capital component (normally a 25% restriction as Tier 1 capital) only because the FHFA declares it to be, but not in any practical sense in my opinion.

            Liked by 1 person

  24. Tim,
    In the July 2018 Minnesota District Court opinion in Bhatti, on page 6 the judge wrote “In return, Treasury received a million shares of senior preferred stock in the Companies and warrants entitling it to purchase up to 79.9 percent of the Companies’ common stock at a nominal price. By operation of law, Treasury’s right to purchase common stock in the Companies expired on December 31, 2009.”

    This was just written in there for analysis and not from a specific challenge standpoint but I would think this is very important

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    1. Treasury’s exercise of warrants to acquire Fannie or Freddie common stock would not be deemed a purchase of shares, and thus not be in violation of HERA. To verify that this is the case you need look no further than Fannie’s published financial statements, where it reports its basic common shares outstanding as 5.762 billion–that is, its current outstanding shares of 1.158 billion plus the 4.604 shares that will be issued when Treasury converts the warrants (as Fannie is required by GAAP to assume it will). Were there to be any question about the legality of the warrant exercise, Fannie would be showing its basic common shares outstanding as 1.158 billion, not 5.762 billion.

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  25. Tim

    fhfa to repropose capital rule: https://twitter.com/Alec_Mazo/status/1196877555850039296?s=20

    as I recall, once reproposed, there is a 60 day period for public to comment (last rule comment period was extended for another 60 days). I find this to be benign, in the sense that i) fhfa’s financial advisor will presumably have input into the new proposed rule (which should tend to make it more achievable from a capital markets point of view), and ii) Calabria’s context, that the conservator’s view as to release from conservatorship has changed from Watt to Calabria, seems to incline one to believe that FHFA will take more seriously the entire project, and iron out some of the head scratching aspects of the original rule. Adoption date still seen as sometime in 2020.

    of course, everyone’s patience is already overextended, so grumpiness will ensue.

    rolg

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    1. ROLG what is the likelihood of a Collins settlement without the Capital rule finalized, they seem intertwined ? To me the extra time needed for captial re-proposal pushes a possible Collins settlement to 2h 2020, as opposed to when ppl were rumoring EOY or Q1 2020.

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      1. @Elliot

        I would be interested in Tim’s view, but my experience is that difficult negotiations involving multiple parties and issues take a long time, and the involvement of govtal actors should only extend it further. I see no reason why any settlement will occur before the capital rule is finalized.

        rolg

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        1. The decision by Calabria to re-propose the capital rule does not surprise me. As I discussed in my December 2018 post, “The Interested Parties Respond,” there were many serious criticisms made of the June 2018 capital proposal (including by me), and they did not have easy fixes.

          We now move to the question, “How long will it take for FHFA to do the re-proposal?” I would hope to get some guidance from Calabria on that, but would think the earliest would be the spring of 2020. And with a 60-day comment period and then final rule making, we’re likely well into the second half of next year before there is any realistic chance of having a final capital rule in place.

          I don’t know why there couldn’t be a settlement between plaintiffs and the government on the net worth sweep and liquidation preference issues in the absence of a final capital rule. The two are related, but the first two are not dependent upon the last. In any case the companies will need to have built a significant capital base through retained earnings before they can do a public offering, and this will take time. Provided that FHFA does produce a final capital rule by the end of next year, we should still be on track for the sort of “staged release” from conservatorship that Treasury and FHFA have been describing over the past several months: final capital rule, settlement with plaintiffs canceling the net worth sweep and liquidation preference (with these now possibly being reversed in the sequence), negotiation with the companies of a consent decree governing them until they can attain the status of “meets capital requirements” and be freed from transitional regulatory restraints, release from conservatorship, then finally public offerings of equity.

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          1. Tim/Elliot

            I take it that Elliot’s question relates at least in part to 2020 POTUS election timing…if the promulgation of the final capital rule occurs well into the second half of 2020, then is it possible for the entire recap process, with the conservatorship going into a consent decree/capital raising phase, to be stopped by a new POTUS, after appointing a new FHFA director. Tim is absolutely correct that a litigation settlement that eliminates the senior preferred could be negotiated prior to the adoption of the final capital rule, and I believe that once this settlement is reached, there would be massive financial exposure to the govt in the event a successor FHFA director tried to reverse any such settlement. the practical reality of this administration’s actions to date, however, is that what has been thought to be able to be done relatively quickly actually gets done quite slowly. In terms of the effect of delay upon the settling parties, usually the party that has the “most to lose” from a settlement delay must consider “giving up” more to get the settlement done sooner rather than later…and that party in this case would be GSE shareholders.

            rolg

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          2. There may be information content in the vagueness with which Calabria has been addressing the substance and timing of the revised capital rule for Fannie and Freddie, which is fully under his direction and control. My current theory–admittedly speculative–is that Mnuchin, Calabria and perhaps others in the administration have become concerned about the sequencing of the adoption of a final capital rule and the settlement of plaintiffs’ lawsuits that is a required prerequisite for Fannie and Freddie’s release from conservatorship. I have long felt that Treasury would greatly prefer to have the political cover of a high-profile loss in one of the lawsuits before it agrees to give up the net worth sweep and relinquish its liquidation preference in the companies, to avoid the charge of a massive give-away of taxpayer money to reward Mnuchin’s hedge fund friends. If FHFA adopts a final capital rule before Treasury has this cover, it (Treasury) has no plausible argument for delaying the next step in what it says is the path to getting Fannie and Freddie out of conservatorship–ending the net worth sweep. So, why not delay the promulgation and adoption of a final capital rule for as long as you can, to see what sort of cover might emerge–including a denial of cert by SCOTUS in the Collins case–before you run out of time to get everything completed before the election?

            FHFA has had all of the public comments on its June 2018 capital proposal for over a year (the deadline for submitting them was November 16, 2018), so it knows what the criticisms of it are, and that they can’t be fixed by “tweaks.” My analysis of the rule was that it was engineered to produce a “bank-like” 3.24 percent combined capital percentage for the companies (with FHFA going so far as to base its calculation on outdated financial statements from September 30, 2017 because that produced a higher deferred tax asset capital reserve), but that this then produced a large number of unintended and adverse consequences on a going-forward basis that made the standard as proposed unworkable. I’ve noted in several comments and posts, including the current one, that getting the risk-based capital standard right is not hard. It’s possible that FHFA has decided to do a straightforward and transparent specification of the standard, and if that’s the case it shouldn’t take long to write that up (the FHFA analysts by now would have done most of the work required to produce this). My admittedly speculative interpretation of recent events would have FHFA working up its capital standard in a manner and at a pace that allows Treasury to determine the most favorable time to begin the sequence of capital standard announcement, lawsuit settlement, consent decree negotiation and release from conservatorship–but in no case later than consistent with having the entire process completed before the 2020 election.

            Liked by 5 people

    2. At the same time, how ironic again, Sweeney oral arguments….any thoughts? From what I heard from third parties it was all good except she made the argument that only shareholders at the time of the taking should receive damages. Dialogue highlighted below

      “Lots of discussion on standing for those who purchased after NWS. Sweeney sticking to her world view. Plaintiff arguing that unlike physical property, claims must travel with stock, as does Lamberth’s contract claims, or chaos would result in markets. “What stock did I just buy – one with full rights, or did I leave my right to claims with the prior owner”. At end, Sweeney said she MAY rule such that she “may certify to the federal circuit “ so that she would not be guessing (asking for an opinion?) In Winstar, she said, all circuits ruled against but on final appeal ruled for (?). Nevertheless, I will give you a lot to chew on (speaking to plaintiff) in my ruling.

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    3. A little change of subject and you all may have covered this in the past, but how do you view the Starr International Co. v. United States: The AIG Bailout Ruling (Hank Greenberg’s case from a few years ago) with the Treasury’s ability to execute the warrants to purchase 80% of the companies? In the Greenberg case, the Judge ruled in favor of the plaintiff shareholders that it was illegal for the government to take 80% equity ownership in AIG. Do you believe this limits Treasury’s ability to execute the outstanding warrants in the GSEs also given an increasingly hostile view towards the government’s position by the judicial branch, ie Judge Sweeney & 5th Circuit ruling.

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      1. I’m familiar with the Starr International case, and noted the judge’s ruling on the AIG warrants at the time it was made. In the past when I’ve brought this up with people close to or likely to be engaged in any settlement negotiations, I was told that cancellation of the warrants was unlikely to be a condition for settlement of the lawsuits. One reason is that the only suit challenging the warrants is Washington Federal, and the firm that brought that suit does not have the financial resources to carry it through a possible trial stage, which reduces the leverage for including warrant cancellation in the settlement. A second reason is that the parties on the shareholders’ side believe there needs to be some benefit for the government in any settlement, which exercise of the warrants and sale of the common stock would provide.

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        1. Tim/nick

          agreed, and I would go further to note that the warrants may provide an actual benefit rather than just a stumbling block to the recap process. one of the things I expect financial advisors to the GSEs will explore is the possibility of a large common stock private placement to a private equity/financial institution as a prelude to a public offering. the GSEs will have built capital through retained earnings by this point, and an additional infusion of private placement capital before a public offering commences would go a very long way to improve the prospects for a successful large follow on public offering.

          now the trouble with these heavy hitters (think Berkshire Hathaway or Blackstone) is that they like to buy right, meaning they will want very attractive terms. this is where the warrants come in, as they provide precisely the financial upside that any private placement buyer would want, and the treasury should be inclined to offer them up in connection with a private placement on attractive terms (a combined primary offering of common stock and a secondary offering of warrants)….remembering that the govt at this stage in the process may value a successful recap as much or more than the monetary return on its warrants.

          rolg

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          1. Thank you, Tim/rolg.

            That interesting, you would think given the likely value to existing holders into the tens of billions of dollars someone would come in with the financial resources and carry it forward. I wonder how the Treasury lawyers given the Starr International ruling/similarity of bailout terms can give the go-ahead and execute them given the case outcome that holding equity and acquiring voting control of a corporation was outside the Government’s express statutory authority. But then again, Treasury has yet to execute them.

            The upcoming Judge Sweeney’s ruling should be fascinating. She seemed deeply concerned with the Treasury from the outset of conservatorship with describing their actions as a “death grip” and sounds like “undue influence”. While I don’t think its a very likely outcome she seems like she considering labeling the whole notion of conservatorship illegal.

            I don’t see how the warrants help in the recap process. They don’t raise any capital for the companies as they are priced so low, and once executed, you will have a large block seller in the Treasury for years to come putting downward pressure on the share price.

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        2. Is it possible that they believe that so they expedite their payout and not because they think the common plaintiffs don’t have a case?

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          1. nick

            to be clear, AIG and GSEs are not analogous insofar as the GSEs were put into conservatorship. Washington Federal is challenging the coercion that then treasury secretary exercised on GSE boards to accept the conservatorship, but not the issuance of the warrants, as HERA gave the conservator power to issue the warrants. AIG wasn’t in conservatorship though the court found an illegal exaction. the only illegal exaction claimed in Fairholme cases relate to the NWS. so apples and oranges. as for the warrants facilitating the capital raise, they are a sweetener that may induce a private placement before a public offering IF treasury wants to sell them on advantageous terms to the private placement buyer.

            rolg

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          2. rolg,

            Thank you for the clarification.

            But does HERA freely authorize the Treasury to purchase the warrants? There is a section in the law that states:

            EMERGENCY DETERMINATION REQUIRED.—In connection with any use of this authority, the Secretary must determine that such actions are necessary to—
            ‘‘(i) provide stability to the financial markets;
            ‘‘(ii) prevent disruptions in the availability of mortgage finance; and
            ‘‘(iii) protect the taxpayer.

            The current environment really doesn’t currently support one of the three.

            i – financial markets seems stable and are at/near all-time highs
            ii – availability of mortgage finance seems stable and growing
            iii – paid back in full, increasing amounts of equity capital and profitable run companies

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          3. The warrants would not be purchased, they would be exercised (at a minuscule strike price of one one-thousandth of a cent per share). To monetize them, Treasury would then sell the shares at the prevailing market price.

            Having almost 80 percent of the common shares of Fannie and Freddie in “weak” hands–that is, owned by an entity that intends to sell them at some point–would be a complicating factor in the companies’ public offerings of common stock. ROLG’s point, I think, is that if Treasury could successfully sell some of all of those shares privately to one or more large investors committed to treating them as a core holding–whether at the prevailing market price or a discount to that price–this would remove much of the future price uncertainty that might prevent other investors from bidding aggressively for new equity offered by the companies in subsequent public offerings.

            Liked by 2 people

          4. I’m not a lawyer, just a reader but wouldn’t the exercise of the warrants be the defacto Purchase of a security issued by the Corporation?

            The PSPA defines “Warrant” as the purchase of common stock of Seller representing 79.9% of the common stock of Seller on a fully-diluted basis.

            In HERA for the Secretary of Treasury to use its authority to purchase any obligations and other securities issued by the Corporation it must determine that such actions are necessary to meet the Emergency Determination Requirement?

            Completely agree with the “weak” hand argument complicating an upcoming public offering.

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          5. Nick,

            HERA allows Treasury to exercise the warrants even after 2009. It isn’t a purchase. That also means that emergency determination is not required.
            https://www.law.cornell.edu/uscode/text/12/1719

            “(2) Rights; sale of obligations and securities
            (A) Exercise of rights

            The Secretary of the Treasury may, at any time, exercise any rights received in connection with such purchases.”

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          6. Midas79,

            Does not emergency determination have to come in before exercise of rights? Or is it that when the companies issued the warrants, they met the emergency determination requirements and that those rights carry forward till expiration and or exercise no matter the current state of the companies?

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          7. Nick,

            The second one is correct. Treasury purchased both the seniors and warrants in 2008 as part of the PSPA agreements, well before the December 31, 2009 deadline for purchases set forth in HERA. The emergency determination was made in 2008 and does not need to be made again.

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          8. as an aside, the 2009 cut off date for treasury acquiring securities was an argument made in connection with the NWS amendment, since the changes to the senior preferred were so significant that, under applicable federal securities law, the NWS senior preferred would be deemed a different security than the predecessor 10% dividend senior preferred. and so, if different for purposes of federal securities law, why not different for purposes of HERA? I always thought this was a good argument but both Lamberth and Millet/Ginsburg dismissed it, in my view by working backwards from the decision they wanted to reach to the analysis that was necessary to get there.

            rolg

            Liked by 1 person

          9. The argument plaintiffs’ counsel made in Lamberth and other cases was that changing the ten percent dividend to a net worth sweep in the Third Amendment constituted the creation (or “purchase”) of a new security, which the PSPA prohibited Treasury from doing after 2009. I also thought that was the correct legal interpretation, but no justices so far have agreed with it. I would point out, though, that the exercise by Treasury of warrants granted in 2008 would not qualify as a purchase of a new security, and none of the plaintiffs in any of the existing cases have asserted that it would be.

            Like

    1. My initial reaction upon learning that Treasury had petitioned for cert on the APA claim was that plaintiffs’ counsel ought to support it (as it now has), but I also like them having used Treasury’s own language to argue that SCOTUS must at the same time grant cert on plaintiffs’ petition on the constitutional issue, stating that, “…if the ‘cloud of uncertainty’ created by ongoing litigation over the Net Worth Sweep justifies immediate review of the Fifth Circuit’s statutory ruling despite its interlocutory posture, then immediate review of the Fifth Circuit’s remedial ruling is likewise needed,” and noting, “Indeed, the remedial questions presented in Plaintiffs’ petition are plainly more cert-worthy than the statutory issues Defendants ask this Court to decide.” Well done.

      Liked by 2 people

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      1. Tim

        so this P reply relates to P’s own const. clam cert petition (docket #19-422); P’s reply to treasury’s APA claim cert petition (19-563) is due at end of month. easy for everyone to do a docket search with these numbers at https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/19-422.html and https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/19-563.html. but I sense that P’s APA claim reply will rhyme with its const claim reply, which is to say that scotus shouldn’t grant treasury’s APA claim petition unless it also grants P’s const. claim petition.

        rolg

        Liked by 1 person

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          1. If my poor memory serves, I believe the Honorable Judge Margaret Sweeney was visibly frustrated at UST’s heavy handed delays re discovery during recent sessions, all to say, let’s hope history repeats itself tomorrow and she lambastes UST given the Fifth’s ruling. A little judicial continuity would be nice. Very curious to see how first court since last court reacts to all this cr, er, stuff. Gl,

            Liked by 1 person

  27. Tim

    Calabria confirmation of consent decree intermediate phase in pathway out of conservatorship:

    [twitter]. https://twitter.com/CSBSNews/status/1194629486370623488?s=20

    “@CSBSNews
    “There will be a level of capital where we think it sufficient to let them out of conservatorship but are not adequately capitalized. During that they will operate under a consent decree.” –
    @FHFA
    @MarkCalabria”

    I find this to be an important confirmation because it shows me that fhfa has given the capital raising effort some serious thought, even in advance of hiring a financial advisor…and I infer that if fhfa has done so, then treasury has also done so.

    a current first phase of earnings retention/capital buildup makes sense because you want the first capital raise to be on top of some foundational capital base. new investors dont want to be the only chickens in the coop. Investors also dont want to invest new money into a conservatorship where treasury maintains to this day that HERA permits the conservator to do anything it wants, free from judicial scrutiny (and no new investor would take solace that this is a position that the current fhfa director disagrees with). so the first capital raise will close coincident with a release from conservatorship into a consent decree whose terms will be spelled out in the prospectus…no surprises like a NWS in the middle of the night. then presumably a release from consent decree when the new capital rule is satisfied.

    this pathway makes sense to me.

    rolg

    Liked by 2 people

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      1. @bird

        while the market will decide these questions re timing, I would also point out that calabria/mnuchin are not without an ability to “bake in” the process in event a D POTUS is inaugurated on 1/21. IF there is no re-IPO before 1/21 and IF a D POTUS is elected that will want to reverse any conservatorship release process, and IF calabria/mnuchin wanted to bake the process so there could be no easy way for their successors to reverse it, then they could do the litigation settlement and SPSA amendment before the D inauguration. this would create a shareholder valuation that would be too much to be ignored by any D POTUS who wanted to renationalize the GSEs.

        rolg

        Liked by 1 person

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    2. I think your line — Investors also dont want to invest new money into a conservatorship where treasury maintains to this day that HERA permits the conservator to do anything it wants, free from judicial scrutiny — hits the whole issue on the head. The current stock prices would be higher if investors trusted the government.

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    1. This is an article from the Wall Street Journal that contains one fact–that JP Morgan issued a $750 million credit risk transfer (CRT) security against a pool of jumbo mortgages last month–and abundant conjecture. I would pay no attention to the conjecture.

      It’s not clear to me, though, why JP Morgan would have issued this CRT, since it is no more likely to be economic than the CRTs Fannie and Freddie have been issuing (for the same reason: investors price these securities so that amount of interest payments they will receive is comfortably above the amount of credit losses they expect to absorb). The author speculates that JP Morgan might get favorable capital treatment, but FHFA said in its June 2018 capital proposal for Fannie and Freddie that under Basel III banks do NOT get capital credit for CRTs. I’m not familiar enough with Basel III to know how it treats credit risk transfers, but I am more inclined to think the FHFA staff has this correct, and that the WSJ author does not.

      As to your specific question, I don’t believe banks will ever be issuing enough CRT securities for them to have any effect on banks’ financial performance during a housing market downturn.

      Liked by 1 person

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      1. Tim

        there is that much ado from wsj/banking community about a single bank issued CRT, and there is a similar reaction to a proposed SEC relaxation of the disclosures for PLS issuances (which Calabria is encouraging). sure beats the beating drum from banks about the need to wind the GSEs down.

        rolg

        Liked by 1 person

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        1. Agreed. And the private-label securities market has many more impediments to its potential rebound than the SEC’s disclosure requirements. Moreover, there is a reason these extensive disclosures were mandated post-crisis. Unlike an entity-based credit guarantor–whose interests invariably are aligned with the investors in the MBS it issues–the interests of a PLS issuer and its investors can be adverse.

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          1. Tim – there is an article about JPM’s CRT deal that quotes Mark Fontanilla saying that “banks may find a private CRT attractive for capital relief, better return on capital and improved capital velocity”.

            Which implies he thinks it may be structured to lower their capital reserve requirements.

            It also says JPM needs Office of the Comptroller of the Currency blessing to get the deal done.

            Like

  29. The Dir is haplessly trying to paint a complete picture with the only paint he is permitted to use, woefully incomplete thought it may be. Remarkable that aside from negative connotations not a single person he speaks to believes a single word he says. Which actually fits right into the bigger picture. Gl,

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  30. Just read some headlines regarding a speech Calabria is giving today…..the HEADLINES (that’s all I’ve seen so far, not a full story) say that Calabria said:

    5) *FHFA HAS ABOUT A YEAR TO WORK OUT CHANGES TO SWEEP: CALABRIA

    6) *FHFA DISCUSSING INTERNALLY WHAT IT WANTS IN TALKS: CALABRIA

    7) *FHFA NEGOTIATING END OF PROFIT SWEEP WITH TREASURY: CALABRIA

    8) *FHFA IN EARLY STAGES OF NEGOTIATING END OF GSE SWEEP: CALABRIA

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      1. I listened to this, and didn’t find anything new in it, other than the latest on the capital rule being that Calabria will announce whether some or all of it will be re-proposed “in the next couple of weeks.” (And for those who may have missed it, at a speech Calabria made on Monday at a conference put on by the Structured Finance Association he said he would “soon be announcing whether the capital rule will be re-proposed and under what terms.” If FHFA weren’t intending to re-prepose at least part of the rule, there would have been no reason for Calabria to have mentioned terms.)

        Liked by 3 people

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  31. It’s just not tenable for FHFA and Treasury to defend these lawsuits with multiple public comments acknowledging it’s a statutory requirement to recapitalize the firms. How to resolve this bizarro logjam?

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    1. @bird

      the treasury APA cert petition focuses on two purported errors in Collins en banc APA majority opinion: that the Ps claim is derivative and not direct, and that the anti-injunction clause in HERA bars the suit.

      as to the latter, Ps can bring suit (there is no anti-injunction bar) if the NWS is beyond the scope of the conservator’s powers. FHFA’s recent strategic plan is replete with assertions that the conservator has a statutory duty/mandate to conserve and preserve, and Calabria’s most recent public statements make clear that he believes he has a statutory mandate as conservator to bring the GSEs out of conservatorship with adequate capital. the NWS is inimical to this duty.

      the entire anti-injunction argument made by the treasury in its cert petition is absolutely undercut by fhfa…which arguably is the primary interpreter of its own organic statute. I expect collins P will oppose granting cert in part by making this argument that the left hand doesn’t know what the right hand is doing. as well, SCOTUS rarely grants cert on interlocutory appeals from non-final orders such as the Collins APA order.

      so for treasury this may be a long run for a short slide.

      rolg

      Liked by 2 people

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  32. Tim – are you at all concerned that 28% of the GSE’s YTD volume (~$102B of UPB) exceeds the QM DTI of 43% and has been ‘patched’? That % seems high to me but don’t have context from prior years.

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    1. I’m not concerned that 28 precent of Fannie and Freddie’s 2019 year-to-date credit guarantees are on loans with debt-to-income (DTI) ratios above 43 percent (if indeed that’s the correct percentage; I haven’t checked it), for two reasons. First, DTI historically has not been that strong a predictor of loan performance, particularly when there are other positive factors, such as a high credit score, on the loan. Second–and related to the first point– Fannie has a very sophisticated system for underwriting loans, its Desktop Underwriter (or DU) application, and I have confidence that DU is properly grading and pricing the loans it’s seeing, taking into account all relevant data on the property, borrower and loan product, including the DTI. I assume Freddie’s underwriting system is doing the same. For a risk feature like a higher DTI, you don’t make that a disqualifier–and not guarantee the loan at all–you charge a somewhat higher fee for it, with the idea of making up in guaranty fee any additional credit losses that might be incurred because of that feature. I’m sure that’s what Fannie and Freddie are doing with their higher DTI loans, and I’m perfectly fine with that.

      Liked by 2 people

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      1. Tim

        as a follow up, if fhfa were to decide to prevent the GSEs from making non-QM loans once the CFPB reconsiders the QM rule…ie “reduce their footprint”…will this adversely impact the GSEs’ results and operations. or assuming there is to be no gap between the GSEs and FHA (a recent calabria quote), do you expect the GSEs to continue to be able to guarantee mbs containing a substantial quantity of mortgages from low-income borrowers (which of course is part of their mission) in connection with any QM “fix”.

        rolg

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        1. It’s hard to answer those questions in the abstract. At a general level, though, I suspect that Calabria will be very cautious on initiatives taken to reduce the companies’ footprints. As conservator he has more discretion on that front than he will have as a regulator, but even with his conservator hat on he will need a good reason for restricting Fannie and Freddie’s business. Is it because he thinks a certain product type or characteristic is too risky? Unless it’s a truly toxic product–and Dodd-Frank bans most of those–he’s got a tool for dealing with that in the risk-based capital standard: have them hold more capital for it (if it can be justified by historical performance). If the footprint reduction is just because he thinks that as a matter of policy Fannie and Freddie should be guaranteeing fewer loans, then he has to defend any such action to the customer types who will be hurt by it, or address how those customers’ needs can be met elsewhere, and why that’s a better approach. As I discussed in the current post, I believe Calabria’s predecessors already have made Fannie and Freddie operate at a disadvantage to the FHA, with the result that the FHA’s business has grown extraordinarily rapidly and the companies’ has hardly grown at all. Does Calabria really want to exacerbate that?

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          1. Dir Calabria said numerous times that UST is heading GSE negotiations making the chances the Dir alone breaks anything relevant to RnR next to zero. Would be nice to hear from TSY Mnuchin soon. Gl,

            Liked by 1 person

      2. One major factor not accounted for in those loans with greater than 43% DTI is a borrowers additional income that has not been included. For example, Think of a borrower who earns both salary as well as commission. His salary is high enough where his DTI is 45% and gets DU to approve it. An underwriter may not request additional documents from the borrower in order to include the commission income since it is not needed to qualify. FHFA has it wrong if they think Fannie and Freddie are taking the higher risk loans since they do not adhere to the 43% rule. If they were to restrict the GSE’s from lending on DTI above 43%, a majority of those same borrowers would still qualify for loans, they would just be asked to provide more documentation for the additional income being included.

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  33. Tim

    as if the Collins en banc APA opinion by Judge Willett wasn’t strong enough, see this from FHFA Director Calabria from the new FHFA strategic plan (p. 8) regarding the mandatory nature of the conservator’s authority:

    “”The Enterprises, by themselves, cannot be blamed for these results. Fannie Mae and Freddie Mac have been operating under government control throughout the conservatorships. As such, their performance is determined, at least in part, by the government policies under which the conservatorships have been managed. For instance, the so-called net worth sweep required the Enterprises to pay out any excess capital beyond a modest cushion as a dividend to the senior preferred shares. Fulfilling HERA’s statutory duty to maintain “adequate capital” at the Enterprises necessitates a different policy path that enables the Enterprises to build and earn a reasonable return on capital. Generating that return by charging adequate guarantee fees aligns with statutory mandates.

    Taken together, (1) FHFA’s statutory mandates, (2) the adverse impacts of continued government control of a very large segment of the U.S. housing finance system, and (3) the enormous financial risks taxpayers continue to face from backing Enterprises with very limited capital cushions, compel a fundamental shift in the implementation of the conservatorships. FHFA will act on its statutory mandate to put the Enterprises back into operation in a safe, sound, and solvent condition.”

    “statutory duty/mandate”

    collins plaintiffs may now wish to call FHFA director Calabria as its first witness in federal district court as the mandate to the district court issues 10/29 for the district court to implement the en banc appellate APA opinion.

    rolg

    Liked by 3 people

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    1. I just got around to reading the FHFA 2019 Strategic Plan this morning, and saw this language. I agree with you about calling Calabria as a witness in the district court for Collins, although I might be inclined to do it after a couple of other witnesses convincingly establish that the “death spiral” rationale given at the time by Treasury and FHFA was a conscious fabrication, and that both parties to the agreement knew then that its real purpose was to confiscate all of Fannie and Freddie’s capital to make it impossible for them to do what Calabria now insists they must–use their financial strength to recapitalize themselves and exit conservatorship.

      Liked by 4 people

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      1. Tim

        so now we have Calabria i) not only footnoted in the Willett opinion as acknowledging that the conservator has a statutory duty to make the GSEs safe and sound (since he was a private citizen at the time, this is more informational than authoritative), but ii) also making clear now as fhfa director that this is current fhfa policy in an official fhfa strategic plan. this is not some off the cuff statement. fhfa officially agrees with the Willett opinion.

        perhaps I am crediting this statement in the fhfa strategic plan with too much importance, but I no longer see how fhfa can even hope to win on the APA claim even if SCOTUS were to grant cert (and given this statement in the fhfa strategic plan, it is hard to see how fhfa would justify petitioning SCOTUS for cert). such a win could only occur if SCOTUS were to agree that it is permissible for fhfa to interpret HERA inconsistently in 2012, so as to permit the NWS in 2012, but not now. and this argument doesn’t pass the red face test.

        if I were advising collins Ps in any negotiation of a settlement, I would hold out for a total elimination of the senior preferred stock plus a return of the approximate $20B sweep overage to treasury (which could be paid back into the GSEs over time, as a tax credit against future income taxes). if you have a winning hand, you need to play it like a winner.

        rolg

        Liked by 6 people

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          1. Tim

            treasury petitions SCOTUS for cert on APA claim:https://www.supremecourt.gov/DocketPDF/19/19-563/120380/20191025201313249_Mnuchin%20FINAL.pdf

            focuses on the anti-injunction clause and P standing (succession clause), more so than the question as to whether fhfa had a duty to conserve (which fhfa has all but conceded in its strategic plan).

            Interesting question posed for Ps: whether to argue that petition should be denied as premature since no final judgment, or if confident that willett opinion is correct, call treasury and raise by asking for cert grant.

            rolg

            Liked by 2 people

          2. I’m a little surprised that Treasury would petition for cert here, but given that it did if I were plaintiffs’ counsel I would request that cert be granted. The APA case is going to get to the Supreme Court at some point; why not sooner rather than later, and with the tailwind of the Willett opinion?

            Liked by 2 people

          3. Tim

            treasury makes a big deal in its cert petition about Collins creating uncertainty for the administrative plan to get GSEs out of conservatorship, but exactly what Collins does to the plan isn’t clear until the district court proceeds with the mandate from the 5th C to consider a remedy, which is precisely why interlocutory orders usually dont give rise to SCOTUS cert grants. so this is a weak cert petition by treasury insofar as it doesn’t really explain why the Willett opinion creates the uncertainty that would cause SCOTUS to grant cert for an order that isn’t final and doesn’t specify relief.

            notwithstanding this, Collins Ps might just be confident enough that Willett will be affirmed by the SCOTUS “conservative” majority to call and raise, and a SCOTUS grant “should” only increase the pressure on all parties to enter into settlement negotiations. but this is all unchartered territory.

            rolg

            Liked by 2 people

          4. Tim

            still trying to understand treasury’s motivation to petition for cert…unless treasury is just following DOJ’s advice, and DOJ hates to lose cases. only reason that makes any sense is for treasury to preserve some sort of negotiating leverage (avoid an adverse district court remedy order, and another recitation of facts treasury would prefer not to have dredged up). but since the relief that Ps are seeking is precisely within the parameters of the kind of action treasury has to undertake in any event in order to implement its plan, one wonders whether this is more a show of weakness than strength on treasury’s part.

            rolg

            Liked by 3 people

          5. Tim

            If the objective of the treasury cert SCOTUS APA filing was to halt the Collins proceedings in accordance with the Willett opinion at federal district court then that seems to have failed, as the mandate has already issued and has been docketed at the federal district court

            5th C. rule regarding stay of mandates:

            41.2 Recall of Mandate. Once issued a mandate will not be recalled except to prevent injustice.

            rolg

            Liked by 3 people

          6. That had been my main (and really only) theory for why the government filed for cert on the APA issue in Collins–to try to delay the hearing of the case on the facts in front of Judge Atlas. Now I’m pretty much left thinking it’s “let’s throw everything at the wall and see if anything sticks.” Unfortunately, this suggests Treasury may be reluctant to make plaintiffs an attractive settlement proposal until some further legal action adverse to defendants (beyond the en banc rulings in Collins) gives it the political cover of being able to say “we really had no choice but to do this.” Perhaps denial of cert by SCOTUS on the APA issue would be cover enough for that. If not, this could drag on for a while. The Willett opinion in Collins has greatly strengthened plaintiffs’ hand, and they have little incentive to make Treasury’s job easier by settling for much less than they could get by letting the legal processes run their course.

            Liked by 4 people

        2. Tim

          I have found counsel for Collins to be excellent attorneys in all domains, technical, strategic etc.

          my best guess is that Collins counsel will determine that it is in the best interests of Ps to proceed with the district court proceedings to reach a final order and remedy. in order to proceed in this way, I also expect them to argue to SCOTUS that it should hold off in considering the treasury APA cert petition until a final district court order is issued, at which point treasury would have the opportunity to supplement its petition. treasury makes conclusionary statements in its petition about the effect of the Willett opinion on the administrations plans for the GSEs, but there is no reason to jump to conclusions when a district court is proceeding to fashion a remedy that would make the import of the Willett opinion and its effect on the administration’s plans definitive, at which point SCOTUS would be in a better position to assess the petition.

          I expect SCOTUS to do this…but again this is unchartered waters.

          rolg

          Liked by 2 people

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          1. ROLG, is there an estimated time frame for the district court to fashion a remedy (2 months?, 2 years?). How does that work? Are they already working on it, and then they’ll announce their decision when they’ve made it? Do they schedule a court date?

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          2. @Daniel

            keep an eye out on the Collins district court docket. I am guessing that Collins Ps will ask for a scheduling conference. if so, judge atlas can decide how she wants to proceed after that conference.

            rolg

            Liked by 1 person

          3. Tim

            if SCOTUS practice remains consistent (which is to usually not grant cert re petitions regarding interlocutory orders, as SCOTUS reviews orders not opinions), its is unlikely that it grants treasury’s APA cert petition at this time…perhaps it will be inclined to do so after district court has rendered a final judgment.

            if treasury wanted to stop the district court from receiving its mandate to proceed on to the APA remedy, it would have filed its APA cert petition before there 5th C issued its mandate…and there was clear warning that the mandate would issue 10/29 since that date was referenced on the docket when the en banc decision was released.

            but treasury didn’t do so. I will leave it to others to speculate as to why

            rolg

            Liked by 2 people

          4. My speculation would be that Treasury IS looking for some legal cover to negotiate an end to the sweep. By waiting to file cert until after the Fifth Circuit District Court had issued its mandate, Judge Atlas’ process can move forward unimpeded. And filing cert will lead to one of three outcomes: cert is denied (most likely), SCOTUS takes the case and finds for plaintiffs on the APA issue (second most likely) and SCOTUS takes the case and finds for defendants (least likely). The last outcome would enable Treasury to drive a much harder bargain with existing shareholders, the middle outcome would give Treasury the excuse of giving plaintiffs the remedy they sought (unwinding the sweep, which would pay down the liquidation preference and result in more than $12.5 billion in future tax or other credits to each company), and the first could enable Treasury to say publicly, “We tried to get a definite judicial ruling from SCOTUS but it declined to review the case, so we are proceeding to settle it with plaintiffs in order to move forward with removing Fannie and Freddie from conservatorship.”

            Liked by 2 people

          5. this will be my final speculation on the matter (which intrigues me):

            it may well be that the (acting) Solicitor General didn’t think the chances of SCOTUS granting cert were that good (and there would be good reason for SG to think so since there is no final APA claim order), so that the deal the SG may have made with DOJ was to file the cert petition after issuance of mandate to district court….SG needs to keep its credibility/relationship with SCOTUS on the up and up, and SG knows that SCOTUS doesnt want interlocutory appeals slowing down district court work, so that here the collins P should be able to proceed in the district court while SCOTUS considers the petition

            rolg

            Liked by 1 person

          6. Tim

            just to put a ribbon on this speculation re treasury cert petition in collins, here is the notice that the SCOTUS clerk sent to the 5th C: https://www.dropbox.com/s/o8z0eiygb2sekhd/treasury%20cert%20pet%20in%20collins.pdf?dl=0

            as you can see the petition was filed 10/25 with SCOTUS clerk but docketed on 10/29. so treasury could have tried to have filed cert before the Collins mandate issued. but it failed if that was its objective.

            rolg

            Liked by 2 people

          7. I don’t have much familiarity with the process for filing a writ of certiorari with the Supreme Court, but I did notice the odd dating of Treasury’s filing in Collins: it just said “October 2019.” The two filings for cert in Perry Capital (one by Boies Schiller and the other by Cooper & Kirk) and the Cooper & Kirk filing in Collins all had specific dates (October 16, 2017 for the first two and September 25, 2019 for the last one). If Treasury really wanted to beat the deadline for the petition in Collins it filed on October 25, you’d think it would put the date on it.

            Liked by 2 people

          8. 1. first, recognize that fhfa did not join in treasury’s APA claim cert petition. given the statutory duty/mandate language in the recent FHFA strategic plan, it “may” be that fhfa no longer wants to be identified with the argument that anything goes in conservatorship (it also may mean fhfa thought that if treasury was filing, then fhfa concluded it simply didn’t have to file or join in treasury’s filing). this fhfa language also nicely cuts against treasury’s petition…not that the fhfa and treasury have to always agree, but fhfa should be considered the primary interpreter of its own organic statute. since treasury’s petition cites the anti-injunction clause, and the anti-injunction clause does not apply if the NWS is ultra vires, collins Ps have a ready argument from the fhfa’s own strategic plan to counter this part of treasury’s petition.

            2. second, it seems to me that given how good the DOJ/Solicitor General attorneys are, if they wanted to petition in a way that would stay the Collins APA mandate, they would have done that. I just find it interesting that they didn’t.

            3. all this may mean nothing.

            rolg

            Liked by 2 people

  34. Tim

    see new FHFA strategic plan: https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2019-Strategic-Plan.pdf

    this part is new, and I am sure you can contribute much to fhfa’s analysis in this regard:

    “Given the growth and total size of the CRT program, Section 2 calls for a comprehensive review of the program, including costs and benefits, to better inform future direction. This program is now more than six years old, providing credit enhancement on approximately $3 trillion of Enterprise guaranteed mortgage loans. It is therefore appropriate to look back and assess the program, develop lessons learned, and strengthen it for the future.” p. 14

    rolg

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    1. I’m positive he already did. My fave part was saying that GSEs will need to prove their financial viability to private investors going forward. Myopic ones, anyways. We’ll take our chances. Would be nice if he stopped speaking in the abstract one day. Gl,

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      1. I didn’t see anything new in the MBA speech, which I think is a good thing. It’s also good that FHFA seems to be looking more objectively at the CRT program. I hope both Fannie and Freddie contribute their views and analysis. Once out of conservatorship it will be their responsibility as to whether and how to use CRTs. As I’ve noted previously, however, one of my biggest worries about the capital rule is that FHFA will add cushions and elements of conservatism that push the headline capital percentage well above where it should be based on loan risk, but then give Fannie and Freddie an incentive to “buy down” this percentage by issuing non-economic CRT securities. This will work (sort of) in good times, but not during times of stress, when the CRT market will dry up and each company’s required capital on new business–both purchase money and refi–will suddenly jump up to the headline percentage; the companies won’t have that amount of equity on hand and won’t be able to obtain it in the market, so will have to drastically curtail their business, greatly worsening the downturn. Recognizing this trap and not falling into it rests squarely with FHFA, as the companies’ regulator and promulgator of the capital rule.

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        1. Tim

          Calabria has talked, loosely if I might say so, about leveling the playing field between GSEs and other mortgage participants, but in reading his MBA speech, he seems to focus on the QM patch, and on the notion that it isn’t proper for the GSEs to be able to continue to make non-QM compliant loans while others need to observe the rule. (“The Strategic Plan and Scorecard direct them to support the development of a QM standard that applies equally to all players originating responsible loans, with no special advantages for anyone.”). putting aside the merits of the QM rule (which I find somewhat perverse), it seems to me that a level QM playing field (however this evolves under a new CFPB rule) is not objectionable in principle. so that if playing field leveling amounts primarily to this, perhaps much ado about nothing. agree?

          rolg

          Liked by 1 person

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          1. Yes; if Calabria’s main “level playing field” issue is the QM patch, that shouldn’t be difficult to resolve. If it were me I would raise the debt-to-income ratio cutoff modestly–from 43 percent to, say, 45 percent–and have the same QM rule for everyone. If the affordable housing advocates aren’t happy with that, they, and not Fannie or Freddie, should be the ones to propose something different.

            Liked by 1 person

  35. I see Alex Pollock has a new piece out titled …Eliminating Fannie & Freddie’s Competitive Advantages by Administrative Action:
    https://www.realclearmarkets.com/articles/2019/10/25/eliminating_fannie__freddies_competitive_advantages_by_administrative_action_103956.html  

    I was wondering if you’ve had a chance to read it and if so what your thoughts might be on it. 

    P.S. Thanks for taking the time to make a murky subject somewhat more understandable!

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    1. This is why I did my latest blog post: to get some actual facts on the record to counter the false premises on which pieces like this are based.

      Pollock’s three recommended administrative actions are:

      Action 1: “Capital requirements equal to those of private institutions for the same risks.” There are no private institutions that are limited to doing credit guarantees on residential mortgages, so there is no valid reference point. The FHA is the only entity that is comparable to Fannie and Freddie, and it’s government-owned. Its statutory capital requirement is 2.0 percent, which is way too low for the FHA, but maybe not for Fannie and Freddie.

      Action 2: “Pay the same fee to the government for its credit support that other Too Big To Fail financial institutions have to pay.” Here Pollock is talking about FDIC insurance. I have two responses to this: (a) FDIC insurance is not a payment for TBTF—it’s a payment for the federal government insurance program that allows banks to pay a one basis point interest rate on demand deposits and still have consumers put money into them, without knowing (or caring) what’s being done with it, and (b) if it WERE a TBTF fee (which it isn’t), each financial institution’s fee should be proportional to the risk of the entities being backstopped, and banks have far greater risks (and historical losses) than Fannie and Freddie.

      Action 3: “Set Fannie and Freddie’s g-fees at the level that includes the cost of capital required for other private institutions to take the same risk.” We don’t know what that capital amount is, because there are no private companies in the residential mortgage credit guaranty business. If Pollock means banks, there is zero overlap between Fannie and Freddie’s business and that of banks, so there is no reason why their capital costs should be anywhere close to equal.

      Without facts, Pollock’s three actions may seem reasonable; with facts, they’re not.

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      1. Tim

        the real import of pollock’s article, to which he wont admit, is that there probably should be a TBTF fee, paid by large financial institutions solely for the right to be large financial institutions. but there isn’t for banks, so there shouldn’t be for GSEs. I imagine that pollock should advise the warren campaign.

        rolg

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          1. Tim

            as you have pointed out, there cant be a “run on the bank” since GSEs dont take deposits, so the FDIC insurance analogy is misguided.

            rolg

            Liked by 1 person

  37. Tim – what do you think about Calabria saying he’s willing to wipe out current shareholders? This doesn’t sound like a person that knows how capital markets work outside of theory.

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    1. It sounds like this remark by Calabria was driven by leading (and uninformed) questions from Representative Bill Foster (D-Il), who according to Bloomberg “would like to see shareholders of Fannie and Freddie wiped out,” so I wouldn’t make too much of it, and certainly not interpret it as an indication of Calabria’s policy preference.

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      1. How about Mnuchin then?

        “Rep. Alexandria Ocasio-Cortez, a Democrat from New York, raised the subject, noting that Fannie and Freddie’s share prices increased substantially following Treasury Secretary Steven Mnuchin’s Senate confirmation hearing in which he said releasing Fannie and Freddie to the private sector was a priority.
        “I think it was clear the market didn’t understand my comments and what they implied,” Mnuchin, who was also in attendance at Tuesday’s hearing, said in response to Ocasio-Cortez.”

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        1. I find it odd to be defending a Secretary of the Treasury, after experiencing almost forty years of having Treasury as an institution be consistently and sometimes relentlessly anti-Fannie and Freddie. But put yourself in Mnuchin’s shoes. I wasn’t at the hearing and haven’t seen either a video or a transcript, but I understand that one of the themes being spun there was the “releasing Fannie and Freddie is a giveaway to the hedge funds” notion that critics and opponents of the companies have seized upon as their last hope of stopping what Treasury and FHFA have announced they want to do. Mnuchin has been characterized by these critics and opponents as “in bed with the hedge funds.” If you were him, wouldn’t you want to try to put some distance between your November 2016 statements and the market’s reaction to them? I would, and I think one almost has to.

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          1. Tim,

            Yes. I concur.

            I watched a clip from today in which Mnuchin was stellar. He didn’t fall for a trap that Calabria wasn’t able to maneuver quite so well.

            The Mnuchin quote provided above, which I haven’t seen on tape, like so many of his words can (I trust) be filled in to make better sense. In this case, I don’t think it’s a stretch to interpret him as: “I think it was clear the market didn’t understand my comments, (which strictly pertained to releasing the GSEs and no more) and what they implied (which at face value had nothing to do with a secondary offering, warrants, competition or any other pps consideration.)” Here’s to hoping!

            As for Mr. Calabria, he really should stay on script. He got outfoxed by an Illinois representative and in the end looked like a willing accomplice, one who’d work with the rep against free market and in wiping out shareholders. Calabria looked flabbergasted, as if to say, how did I get roped into that one!

            Liked by 1 person

          2. Tim,

            I watched much of this hearing. I would say first, this HFSC hearing was political theater. very little substance. second, to the extent that mnuchin and Calabria said that decisions have not yet been made about release from conservatorship vs receivership, or that if circumstances warrant the GSEs will be put into receivership, these were responses to chest-puffing inquires from 5 minute camera time questioning. and they were correct responses. and they were well-played. and they are much ado about nothing.

            rolg

            Liked by 3 people

  42. Tim

    I don’t understand what is the possible justification for FHFA to ignore revenues in connection with their proposed capital rule. this seems to assume that the entire mortgaged homeowner population stops paying their mortgages. am I missing something?

    rolg

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    1. Here is what FHFA said in its June 2018 capital proposal about its decision not to include revenues as offsets to credit losses in its stress test: “FHFA believes there is greater benefit to having a risk-based capital requirement that ensures sufficient capital without considering new revenue. Inclusion of revenues could result in very low or zero risk- based capital requirements for specific portfolio segments. FHFA also considered additional reasons for excluding revenues such as that Basel capital requirements exclude revenue, and that revenue serves to build capital during stress events so that the Enterprises can continue as going concerns.”

      I found that explanation to be nonsensical, as did most of the other people who commented substantively on the FHFA proposal. Not counting revenues in the stress test obviously is much more conservative (“greater benefit”) than counting them; so too would be doubling the dollar amount of stress credit losses. And citing the fact that Basel doesn’t count revenues as capital ignores the obvious fact that the Basel III requirements aren’t based on a stress test.

      FHFA didn’t count revenues because it wanted the result of its exercise to be a higher number—i.e., more “bank-like.” But as you do that you separate capital from risk, and make the business less economic. This is a point I hope the financial advisors not only will grasp but also counsel FHFA to change. The more unnecessary capital the companies are burdened with, the less valuable they will be to potential new investors as businesses. And as I tried to explain in this post, the amount of overcapitalization will be obvious, either because the FHFA stress losses won’t be consistent with past experience or because there will be numerous added cushions and elements of conservatism (like not counting revenues).

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  44. One can only hope you’re being trolled. At @NCSHAhome Director Calabria says, “To achieve their statutory missions, Fannie and Freddie must remain financially viable. This means their capital levels must match their risk profiles.”Gl,

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