Some Simple Facts

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.

 

 

63 thoughts on “Some Simple Facts

    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

      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

        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. 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

    Liked by 1 person

      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

  2. 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

  3. 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

      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?

          Liked by 1 person

          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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  4. 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

    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

      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

          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

        1. 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

          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?

            Like

          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

  5. 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

    Liked by 1 person

    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,

      Like

      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.

        Liked by 3 people

        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

          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

  6. 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!

    Like

    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.

      Liked by 3 people

      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

        Liked by 2 people

          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

  7. 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.

    Like

    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.

      Liked by 2 people

      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.”

        Like

        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.

          Liked by 2 people

          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

  8. 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

    Liked by 2 people

    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).

      Liked by 1 person

  9. 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,

    Liked by 1 person

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