How We Got to Where We Are

It is difficult to evaluate the wide range of opinion about how best to end Fannie Mae and Freddie Mac’s conservatorships, or the alternatives Treasury and FHFA now have for doing so, without an understanding of the political battles that have engulfed the companies over the past two decades, which I call “the mortgage wars.”

Following two thrift crises in the late 1970s and late 1980s, Fannie and Freddie’s access to the international debt and mortgage-backed securities markets enabled the U.S. mortgage finance system to undergo a smooth transformation from having been heavily deposit-based in the mid 1970s (when nearly three-quarters of all single-family mortgages were held by thrifts or banks) to being much more evenly balanced between deposit-based and capital markets-based sources of funding in the late 1990s, with Fannie and Freddie either owning or guaranteeing two of every five residential mortgages in the country.

The increased competition with deposit-based mortgage lenders by capital markets investors, facilitated by Fannie and Freddie, benefited homebuyers by adding greater standardization and increased liquidity to the 30-year fixed-rate mortgage. But it also reduced deposit-based mortgage lender profitability, because capital markets investors could price 30-year mortgages more efficiently than depositories, who had to compensate for the risk of funding them with short-term deposits and purchased funds. This better pricing lowered mortgage rates in general, led to a relative shift in volumes away from depositories, and reduced the net interest margin on the mortgages depositories did hold. In addition, Fannie and Freddie’s influence over secondary market underwriting limited the ability of primary market lenders to customize or “brand” their mortgages, because they wanted  them to remain eligible for sale as Fannie or Freddie mortgage-backed securities.

Large commercial banks and bank-owned lenders chafed at the constraints imposed on the pricing, underwriting and profitability of their mortgage operations by the secondary market activities of Fannie and Freddie. In reaction, in June of 1999 three large banks, two mortgage insurers and one subprime lender formed a lobbying group called FM Watch, whose goal was to attempt to undermine the strong bipartisan support the companies had in Congress, and ultimately obtain legislation favorable to themselves. From its inception, the message of FM Watch to Congress, and the public, was that Fannie and Freddie’s unique federal charter needed to be amended or repealed because the companies were using it to take enormous financial risks at taxpayer expense (pre-crisis, this was always said about interest rate risk, and never credit risk), and to channel its benefits to shareholders and management rather than homebuyers. These claims were demonstrably false, and while I was at Fannie we easily could counter them in Congress with verifiable fact. Yet over time the constant barrage of FM Watch-based misinformation had a profound negative effect on Fannie and Freddie’s public image, and this paved the way for what Treasury was able to do to the companies during the financial crisis and afterwards.

Treasury had been advocating publicly for changes to the companies’ charters since 2000, without success. But in the summer of 2008 Secretary Henry Paulson saw an opening to achieve all of Treasury’s historical objectives for Fannie and Freddie, and then some. A series of negative articles about them (citing rumors from an unknown source) had caused severe weakness in their stock prices, and in response to one such episode Paulson made a public pledge on July 11 to support Fannie and Freddie “in their current form.” Paulson could not provide this support without the reform legislation Treasury was sponsoring—the Housing and Economic Recovery Act (HERA)—and as he writes in his book, On the Brink, “Fannie and Freddie needed to be brought on board, quickly. Without their support, legislation would go nowhere. On Saturday I called Dan Mudd and Dick Syron to get their cooperation.” Taking Paulson at his word that HERA would be helpful to their firms, both CEOs agreed not to oppose it, and the legislation passed easily.

Mudd and Syron had little reason to suspect that what Paulson really wanted was not to help the companies out but to take them over. At the time Fannie and Freddie were fully in compliance with their statutory capital requirements, and were the only healthy sources of residential mortgage financing in the market. The private-label securities market had imploded, and banks were suffering from mortgage delinquency rates three times those of Fannie and Freddie. Under the circumstances, Mudd and Syron can be excused for not having paid more attention to a clause in HERA not found in any other regulatory statute: “The members of the board of directors of a regulated entity shall not be liable to the shareholders or creditors of the regulated entity for acquiescing in or consenting in good faith to the appointment of the Agency [FHFA] as conservator or receiver for the regulated agency.” Paulson knew he would be able use this clause, together with what he termed “the awesome power of the government,” to force the boards of directors of Fannie and Freddie to accept conservatorship notwithstanding that neither company met any of the criteria for conservatorship listed in the HERA legislation they just had been tricked into supporting.

From the moment the companies came under government control, the official narrative about them differed markedly from economic and financial reality, and closely tracked the mantra created by FM Watch almost a decade earlier of “flawed charter, excessive risk to taxpayers, and questionable benefits to homebuyers.” In conservatorship Fannie and Freddie no longer were free to counter this narrative, and the media did not question it, in spite of the many contradictions between what Treasury and FHFA said was happening with the companies and what was readily observable about them. One early example was Treasury’s claim that Fannie and Freddie urgently were in need of financial help, and then having its first requirement of them be that they shrink their mortgage portfolios by ten percent per year, even though the net interest income from those portfolios was helping to absorb the losses from their credit guaranty businesses. That didn’t matter to Treasury: shrinking or eliminating Fannie and Freddie’s portfolios had long been on its “hit list,” and it now had the power to require that.

The companies’ critics also got away with completely switching the focus of their claims of excessive risk-taking. Prior to the crisis they uniformly asserted that the threat posed by Fannie and Freddie to taxpayers came from the interest rate risk in their portfolios (which were tightly duration matched, rebalanced continually, and performed superbly during the downturn), and that they weren’t taking enough credit risk with their affordable housing initiatives (and instead were “gaming the system” and making only safe, profitable loans) because their credit losses were so low. But post-conservatorship these same critics instantly, and shamelessly, began saying the opposite: that Fannie and Freddie’s “flawed business model” had caused them to take so much credit risk as to trigger the mortgage crisis. Of course, both before and after the crisis contemporaneous data on mortgage credit performance were freely available to anyone who cared to look at them, and they consistently showed Fannie and Freddie’s delinquency and default rates to be about one-third those of banks and one-tenth those of subprime lenders and the loans in private-label securities. But that didn’t matter either; the media ignored the facts and printed the fiction, while Fannie and Freddie remained within their enforced cones of silence.

I won’t retell in detail the story of how Treasury and FHFA engineered massive amounts of discretionary book losses for Fannie and Freddie between the third quarter of 2008 and the fourth quarter of 2011 to force them to take $187 billion in senior preferred stock from Treasury, at a 10 percent annual dividend, that they didn’t need and Treasury wouldn’t let them repay, nor of how Treasury and FHFA agreed to the net worth sweep in August of 2012 when they realized that a huge amount of these book losses were about to reverse and become income and then capital, which they desperately did not want the companies to be able to retain. The net worth sweep, however, proved to be “a bridge too far,” and it resulted in a flurry of related lawsuits against the two agencies. Suits filed in the U.S. Court of Federal Claims were granted fact discovery, and documents produced from it left no doubt that Treasury and FHFA had entered into the sweep not for the reason they gave at the time (to prevent a “death spiral” of borrowing to pay senior preferred stock dividends) but to prevent the companies from rebuilding their capital.

Paulson and others at Treasury never expected things to get to that point. The prevailing view among members of the Financial Establishment when Fannie and Freddie were taken over was that Congress would replace them relatively quickly with a secondary market mechanism more to their liking. Consistent with this expectation, Treasury and FHFA had openly managed the companies not to prepare them for release from conservatorship but to ultimately wind them down, with FHFA requiring that they collaborate in building a common securitization platform that could be used by their eventual successors, and mandating them to “de-risk” themselves by issuing non-economic credit risk-transfer securities. Yet even with no opposition from Fannie, Freddie or their past supporters, opponents of the companies never were able to come up with a viable replacement for them. The reason should have been obvious long ago: contrary to the now two-decades old label from FM Watch of Fannie and Freddie as a flawed business model, the two companies did and do work effectively and efficiently, while the ideas devised by the Financial Establishment for replacing them with something different did and do not.

When Treasury Secretary-designate Steven Mnuchin said in November of 2016, “we gotta get [Fannie and Freddie] out of government control….and in our administration it’s right up there in the list of the top ten things we’re going to get done, and we’ll get it done reasonably fast,” he undoubtedly believed that the path for releasing the companies would run through Congress. Today, he and FHFA director Mark Calabria both understand that the only way to make good on Mnuchin’s pledge is through administrative reform. But neither, I believe, has fully come to grips with the crucial fact that in switching between these two tracks, the fictions about Fannie and Freddie that were essential elements of the attempt to replace the companies in a legislative process become impediments when the goal is to successfully recapitalize and release them in an administrative process.

If the best economic result were the overriding objective, getting Fannie and Freddie out of conservatorship would be no more difficult than it was to get them in: Treasury would settle the lawsuits by unwinding the net worth sweep and canceling its liquidation preference; FHFA would specify a true risk-based capital standard without excessive conservatism—making the companies attractive to new equity investors—and based on their updated capital requirements Fannie and Freddie each would prepare capital restoration plans for FHFA’s approval. In these plans they would use retained earnings to reach the critical capital requirement in the new standard, at which point they would be released from conservatorship under a consent decree and be free to raise new equity in whatever amount and at whatever pace they chose. Then, once they fully met both their minimum and risk-based capital requirements, they would be released from their consent decrees to return to their former status of independently managed shareholder-owned entities, under FHFA’s supervision and regulation.

But that’s not how the process will work, because of two carryovers from the failed legislative efforts of the past. The first is that the Financial Establishment and its supporters remain committed to their twenty-plus year goal of hamstringing Fannie and Freddie’s competitive position, and are hoping to accomplish this in administrative reform by convincing FHFA to subject the companies to excessive and unnecessary required capital and burdensome regulation by using the arguments of promoting safety and soundness and a “level playing field” for new competitors. The second is that Treasury as of yet has shown no signs of moving away from the false claims it’s been making about Fannie and Freddie since before the conservatorships, which it must do if it wishes them to be able to raise new capital. Investors will not put tens of billions of dollars into companies Treasury describes as having a “flawed business model.”

It seems that FHFA will be the first of the two agencies to reveal where it has come out in the choice between fiction- and fact-based alternatives, if as most observers expect it issues its revised Fannie and Freddie capital proposal for comment sometime this quarter. If FHFA removes some or most of the cushions and conservatism it built into its June 2018 proposal—which were designed to produce an artificially high but “bank-like” risk-based capital number of 3.5 percent—it would be a strong positive signal that it and Treasury are willing to go at least some distance towards allowing Fannie and Freddie to function efficiently as private entities. The consequence should be a relatively rapid recapitalization, fueled by significant access to private capital. A revised FHFA capital proposal with few changes to the 2018 version would send the opposite signal, foreshadowing a much slower recapitalization, accomplished largely if not exclusively through retained earnings, before the companies could free themselves of FHFA-imposed operating restrictions.

For its part, Treasury seems inclined to wait until the revised FHFA capital proposal is out and the timing of a potential Fannie or Freddie capital raise is more clear before giving any indication of its thinking about ending the net worth sweep and canceling its liquidation preference (which are essential steps before Fannie or Freddie could raise new capital). The key unknown is the critical capital requirement, which will be half the new statutory minimum. In my view it is likely that for minimum capital FHFA will select “Alternative 2” from its June 2018 proposal: 1.5 percent of trust assets (mortgage credit guarantees) and 4.0 percent of non-trust assets. Applied to the companies’ current balance sheets, these percentages would produce required minimum capital of around $60 billion for Fannie and around $40 billion for Freddie, and required critical capital—which could trigger release from conservatorship under a consent decree—of about $30 billion and $20 billion, respectively. Both companies are very likely to use retained earnings to meet their critical capital targets, which would push any potential capital raise by Fannie well into 2021 and by Freddie probably into 2022.

Based on this timeline, Treasury should have plenty of discretion to pick what it thinks is the best approach to and timing for a settlement of the lawsuits. I have long believed that Treasury will want some political cover for any settlement it negotiates, to avoid the charge (leveled loudly and often by Fannie and Freddie’s opponents) that it is “giving away the taxpayers’ money to hedge funds.” Treasury is closely monitoring the three suits that are moving towards trial on the facts—Collins under Judge Atlas, Perry Capital under Judge Lamberth, and Fairholme under Judge Sweeney—and I’m sure it realizes, because of the documents produced in discovery in Sweeney’s court, that it won’t prevail in any of them. My analysis is that Treasury will initiate serious settlement talks with plaintiffs when the first of those three suits (now most likely Collins) is getting close to the trial date, with the goal of of reaching settlement before that trial occurs in order to avoid a public airing of facts unfavorable to the government, as well a high-dollar settlement award to plaintiffs.

It is regrettable, though, that the sequencing isn’t reversed, with Treasury first settling the lawsuits and FHFA issuing its capital proposal subsequently. In that order, I believe there would be a much better chance for the investment community to convince Treasury that it has to structure Fannie and Freddie to succeed in order for their recapitalization to be a success as well, and for Treasury to be able to maximize the value of the warrants it holds for 79.9 percent of the companies’ common shares. Treasury then could convey this reality-based message to FHFA as it re-engineers its capital rule. But the sequencing die has been cast, and we now are left to wait to see whether the proposed future versions of Fannie and Freddie that emerge from Treasury and FHFA’s administrative reform process are based on historical fact or fiction. It will not be difficult to tell which it is.

142 thoughts on “How We Got to Where We Are

  1. Hi Tim,

    Thanks so much for all the information you put out on Fannie. I find it incredibly helpful in truly understanding its underlying business function and how it relates to credit availability in the broader mortgage market. My question is, Director Calabria came out today and said Fannie may need capital if this crisis lasts more than 12 weeks. Why would they need capital if they issued CRTs on half their book? Isn’t this a credit event? Shouldn’t the CRT holders be in the first loss position? I’m trying to understand where that capital they’ve built up over the last year would be going. As of 12/31 Fannie had $14B in capital.

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    1. I wish Director Calabria would not keep making vague statements like, “Fannie may need capital if the crisis lasts more than 12 weeks.” Yes, and it may not; it depends of what specific set of circumstances the company, the economy and the financial markets in general are facing after that period.

      Fannie is vulnerable to two main types of losses from the coronavirus pandemic: higher interest costs if it has borrow to make advances to its MBS holders of forborne monthly mortgage payments (which it currently does not have to–mortgage servicers have that responsibility–and it has not been required to do so, although this could change), and higher credit losses if unemployment stays high for a protracted period of time, and home prices weaken or fall as a consequence.

      With interest rates currently so low, the impact on Fannie of having to borrow to advance monthly mortgage payments would not be very large, and certainly not threaten its capital. Based on the percentage of Fannie’s 17 million single-family loans that request forbearance, and how long that forbearance period is, these costs obviously could mount (and mount faster if the spreads on Fannie’s debt relative to Treasuries widen due to credit concerns), but they still would rise relatively slowly, and be predictable.

      Depending on the length and severity of an economic downturn, credit losses for Fannie would be the bigger worry. But here, Fannie’s CRT issues WOULD offer significant protection. In addition, for the last three years the company has been averaging nearly $19 billion in pre-tax net income, which would absorb credit losses before Fannie had to tap any of its $14.6 billion in capital. There is some credit loss scenario that would eat through all of Fannie’s capital, but you can’t just say, “if the crisis lasts more than 12 weeks we’ll be there.” To make a responsible prediction about Fannie’s financial resiliency, one would need to take Fannie’s current book of business by origination year, CRT issuance against that book, and projected pre-tax net income, then ask, “what cumulative volume of credit losses would be required for Fannie to exhaust its $15 billion of capital, and how long would it take for that to happen?” My sense is the answer would be a favorable surprise to most people. But until someone actually does this level of analysis–and discloses their assumptions so that others can evaluate them–I would be leery of any general statements about how the crisis might affect Fannie or Freddie.

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      1. Tim, given your unmatched expertise in MBS and Fannie operations, what steps would you take to execute the forbearance program with minimal damage to the housing industry & the economy if you were in Mnuchin’s shoes?

        Some specific q’s:
        1. How would you treat the mortgage servicers?
        2. What would you instruct the big and small banks to do?
        3. What actions, if any, would you take re mortgage REITS?
        4. What should the GSE’s do?

        Thank you for your time.

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        1. While experience and expertise in the MBS and secondary mortgage markets is certainly important, this is going to come down to a public policy call.

          It’s helpful to start by clearly defining the problem: the coronavirus had led to a completely unexpected loss of income for millions (and maybe tens of millions) of people for an indefinite period of time, and this in turn has put in jeopardy their ability to continue to make their mortgage or rental payments. Those most directly affected by this are first, the borrowers themselves; second, any institution that either has lent to these borrowers or guaranteed the timely payment of principal and interest on their mortgage loans, and third, landlords whose tenants now are unable to continue to pay their rent.

          You’ll note that servicers are not among those directly affected. Their problem is that because of the terms of their servicing agreements, they are obligated to advance the monthly payments on any loan that’s been sold to either Fannie, Freddie, or Ginnie Mae, with the understanding that they will be reimbursed by the respective guarantors once the loan either returns to its paying status, is bought out of the MBS pool, or is foreclosed upon. But this advancing arrangement did not contemplate an open-ended program of government-mandated borrower forbearance.

          If I were Mnuchin, I would look for a way to help the servicers out. I understand that there is a flaw in their business model, but this is something that should be addressed post-crisis, and not used as an excuse to force all but the most resilient into failure, with a (potentially chaotic) transfer of their servicing rights to stronger lenders. In putting a servicer support package together, I would bring in the final holders or guarantors–the depository institutions, Fannie, Freddie and Ginnie principally–to work on a long-term approach to spreading the economic hardship caused by the pandemic to those best able to bear it. I would have the servicers be required to make advances of monthly payments up to a certain point (which without data I won’t be able to define here) after which it would become the responsibility of the lenders and credit guarantors to make those advances. In exchange for this support–and “burden-shifting” to the lenders and guarantors– I would require the servicers to agree to allow the lenders and guarantors to determine how best to reduce their accumulations of forborne mortgage payments, so that the ultimate costs of the forgone payments are dependent upon the judgments and choices they make. To aid the lenders and guarantors in doing this, Congress probably will need to give more structure to the forbearance program that it has now–for example by requiring those who wish to extend their forbearance indefinitely to produce written documentation for why they are requesting this.

          I don’t have great ideas on how to handle renters who fall behind on their rents. For landlords who have loans from banks or credit guarantors, some burden-sharing arrangement comparable to what is decided upon for single-family homeowners would be worth looking at. For renters whose landlords own their properties free and clear, some form of hardship-based direct subsidy should be considered.

          I am less familiar with the circumstances of or the arguments being made on behalf of mortgage REITs, but from what I do know about them my view would be a version of what Hyman Roth said in Godfather II: “This is the business we’ve chosen.” If there were systemic risks posed by the failure of one or more of the REITs I would look for ways to mitigate those, but I would be disinclined to bail out any of the firms individually.

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          1. Tim

            based upon my reading and anecdotes I have heard, this forbearance schema is being processed through the servicers, who generally do not have online capability yet to process the logistics of this new program, and hence they are fielding telephone inquiries, which means mortgagors seeking answers if not forbearance are waiting for multiple hours on telephone hold to understand their options or to defer payments. and about their options…the CARES act is silent as to when forborne amounts are due and payable, and I am not aware that fhfa has taken a firm position, so that servicers, who as you point out are in something of a first loss position and therefore are chary to be charitable, are apparently free to require that forborne amounts are due at the end of the forbearance period, as opposed to maturity of the loan.

            this is not good execution of public policy, though I understand we are in the early innings. from the GSEs’ point of view, keeping a safe social distance from this messy rollout seems the best of all courses of action.

            rolg

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          2. @ROLG It would be a mistake to say the servicers are in a ‘first loss position’. What the servicers are liable for are advances of P&I to the trust that holds the mortgages on behalf of the bondholders so the cash flow to the bondholders remains uninterrupted in a time of stress for a borrower in normal times. Those advances are actually super senior to the waterfall in any given trust, which means they get paid back first, which actually causes interest shortfalls to the subordinate classes in any given deal. The issue is that some servicers, as Tim points out, never contemplated having to do be liable for this en mass, country wide (ha ha), at the same time.

            So some, other than the banks, aren’t adequately capitalized to meet this sudden contingent liability.

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          3. @anon

            yes, agreed, servicers are first in temporary time, which apparently gives them a liquidity issue nonetheless, which I was thinking would possibly incline them to hardball, or slow go, the whole forbearance process since they are all on a liquidity edge, and the process will only sharpen that edge pending any federal relief. I am not saying I know this will result, i am just saying I have been in situations where incentives have a predictable effect.

            rolg

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      2. From a public policy perspective, do you have any belief or thoughts about the loan packages offered to larger companies assisting through the current Coronovirus period of financial distress? I write this question because just as the 2008 TARP bailout offered a way for companies to receive funds and also receive an exit path to paying back these funds, a new wave of business loans to companies in 2020, will once again be given and now provide paths to pay back these loans. This new loan package (with exit path) underscores the ridiculous nature of the ‘no way out’ forced ‘net worth sweep’ for the GSE’s. Hopefully, new members and old members of Congress (or maybe also the public) will see that a ‘perpetual’ tether is not appropriate for the GSE’s.

        Liked by 1 person

        1. I support the lending programs to companies of all sizes that are intended to help them “get to the other side” of the coronavirus pandemic. I believe these loans should be repaid whenever possible, and that the government has the right to impose conditions on the operations of the companies who receive them (including but not limited to no share repurchases) until they are. And while the terms of the assistance should not be punitive, I believe the government should be allowed to take ownership stakes in companies who do not make reasonable efforts to repay their indebtedness once the crisis has passed.

          As some of us believed at the time, and discovery in the court cases has now made clear, the Treasury Department’s treatment of Fannie and Freddie leading up to, during and after the 2008 financial crisis was deliberately prejudicial, and intended to allow the government to take full control of the companies until it could restructure or replace them in a manner that conformed with its policy, ideological and competitive objectives. I hope that nothing similar happens to any other companies or industries during this crisis, and I agree that the current environment highlights the unfairness of the treatment Fannie and Freddie were subjected to over a decade ago, and reinforces the wisdom and equity of returning them to shareholder-owned status as soon as practicable.

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    1. The “take up” rate apparently is the percentage of Fannie and Freddie’s borrowers who take up the offer of forbearance of their monthly mortgage payment as a result of the coronavirus pandemic. The numbers Calabria is now estimating–although he notes these estimates could change–of 300,000 loans this month rising to 2.0 million loans in May, would be a little over 1 percent and about 7 percent, respectively, of the companies’ total mortgages. These may seem like high numbers, but forbearance is not forgiveness, or delinquency. During the financial crisis, the serious delinquency rate on Fannie’s single-family loans hit a peak of 5.59 percent (in February 2010). At the end of last year it was back down to 66 basis points, and it was only 35 basis points on loans originated after 2008 (which are 94 percent of Fannie’s current book of business).

      It’s fortunate that we entered the pandemic with a healthy housing market–with low delinquencies, and no evident excesses in underwriting or overheating in any major regions. Assuming the forbearance period does not extend much beyond 3 or 4 months, the economic effects on Fannie and Freddie of the forbearance program shouldn’t be too severe. The risk, though, is that the longer people have to stay away from work the more severely the economic pause will feed on itself, and worsen. In this case not only would the percentage of loans in forbearance rise, but increasing percentages of those loans would become delinquent, and ultimately default.

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      1. I would think that FHFA has an incentive to refinance or otherwise modify these loans in forbearance when large lump sum payments come due, and naturally the homeowners will as well. Is it possible to stave off a wave of delinquencies this way?

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        1. Your question tiptoes into an area that isn’t getting much attention currently, which is: with Fannie and Freddie allegedly on the path to being released from conservatorship under a consent decree, who will be making the critical decisions on their behalf in the interim, and on what basis will those decisions be made?

          When I was at Fannie, we became the industry leaders in loss mitigation. When there two parties to consider—the borrower and the credit guarantor—loss mitigation decisions are a balancing act: you’re trying to find the “sweet spot” that produces the maximum reduction in credit losses at a minimum of foregone revenues to yourself, as guarantor. Were you to take away the cost constraint—and say the only goal is to reduce foreclosures—you would modify every loan that goes delinquent by cutting its interest rate to zero.

          When you say “FHFA has an incentive to refinance or otherwise modify these loans in forbearance when large lump sum payments come due,” well, yes, if its only objective is to reduce foreclosures. Director Calabria seems to be on television every other day saying what “he” will be doing to get the companies through the crisis. Fannie has a very capable and experienced management team (I assume Freddie does as well, but I don’t know them), and they will have a point of view as to how to best manage their growing inventory of loans in forbearance. I know Fannie management has an open and ongoing dialogue with Calabria, and that they won’t be shy in giving him their point of view on this issue. What I don’t know is whether Calabria will listen, or whether he intends to use Fannie and Freddie as instruments of the government, at shareholders’ expense. What Fannie and Freddie do with their inventory of loans in forbearance will tell us a lot about how seriously Calabria takes his task of preparing them for a successful exit from conservatorship.

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          1. Do you intend to continue your blog after the GSEs release (assuming they are one day released) going forward?

            Your version of FM Watch is more informative than the latter!

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          2. That’s not a decision I expect to have to make any time soon, unfortunately.

            I began the blog because I thought the mortgage reform dialogue would benefit from having a reliable source of accurate and objective information about Fannie and Freddie, given the large amount of misinformation about them that was being deliberately disseminated for ideological, competitive or political purposes. As the person who I believe has spent the longest continuous period of time (23 years) in a senior management and policymaking capacity in the business and financial areas at either company pre-conservatorship, I felt obligated to do what I could to help the reform process reach an end point that was guided by fact and experience, rather than fiction and aspiration. As I noted in a previous post, much of the information I wanted to get “into the water system” I’ve already put out, so the frequency of my posts has dropped off accordingly. But I have no plans to stop the blog before the fates of Fannie and Freddie have been irrevocably decided. After that, we’ll see.

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          3. Tim

            I for one would be pleased to participate in a retirement party for this blog, at the appropriate moment. alcohol will be served.

            rolg

            Liked by 1 person

          4. Tim –

            Is it possible for Fannie Mae to issue corporate bonds to alleviate any potential cashflow issues due to forbearance? Can they do that and purchase some of these MBS or mortgages such that they would be paying back to themselves?

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          5. Fannie can, and does, issue “corporate bonds,” although they’re more commonly referred to as agency debt. As of December 31, 2019, Fannie had $182.2 billion in agency debt outstanding–$155.5 billion in notes and bonds with an original maturity in excess of one year, and $26.7 billion in short-term debt with a maturity of less than a year. And if you were to go back to June 30, 2008, just before the company was put into conservatorship, it had $800 billion in agency debt outstanding, most of which was issued to finance its on-balance sheet mortgage portfolio. But after the conservatorship Fannie and Freddie were directed by Treasury to shrink their portfolios, and both have done so. At December 31, 2019, Fannie’s mortgage portfolio was only $156.3 billion, compared with $758.1 billion at June 30, 2008.

            Could Fannie issue more agency debt and buy mortgages? Yes, but it would need to be permitted to do so by Treasury. And as I’ve noted before, Treasury so far has shown no signs of being willing to do that.

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          6. Tim

            I tried to do some back of the envelope “take up” analysis for Fannie. I feel like I am omitting something, but I cant figure out what it is. perhaps you can critique.

            approximately $3T of single family guaranteed book of business (ignoring multi-family for this analysis). assume 5% take up rate=$150B of mortgages in forbearance. assume 5% annual interest rate (and disregard principal portion of payments)=$7.5B forbearance deferral amount per year. Compared to Fannie capital at +-$15B.

            obviously the key assumption is the take up %, but at this level of take up, the stress seems manageable(?)

            rolg

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          7. The impact of mortgage forbearance on Fannie will depend on the percentage of Fannie’s 17 million loans that go into forbearance, who bears the cost of that forbearance, and for how long. In your example you have 5% of Fannie’s loans going into forbearance. But if servicers are the ones advancing the monthly payments on those loans Fannie won’t bear any cost, unless some of the loans go into default (in which case Fannie will reimburse servicers for the advanced payments).

            The problem with estimating the impact of forbearance on Fannie and Freddie is that we don’t yet know how the program will work in practice. Forborne mortgage payments are effectively loans to borrowers. The cost of those loans will depend on who has to finance them, and how long the loans are outstanding. Non-bank servicers do not have the financial capacity to advance forborne payments for very long. (This point has been made repeatedly by the MBA, although so far without evident response from the administration.) But if not servicers, who? Will Treasury be the lender, through some special program it runs? Or will Fannie and Freddie be asked to take on that role, issuing debt in an amount equal to the aggregate monthly payments advanced to the investors in its guaranteed MBS? Until we know how the forborne payments will be financed, we won’t be able to estimate the impact on Fannie or Freddie of even a relatively short forbearance program.

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          8. The Calabria media tour is indeed repetitive. But I did find the conclusion to today’s FT article at least somewhat encouraging. There, Calabria states that F&F won’t be funding the servicers. Of course, others may have a different opinion. And, Calabria’s view could change (or be changed). But, that’s not a bad quote to see from the Head of the FHFA. The last 2 paragraphs of that FT article stated:

            ‘ Mr Calabria said that while various solutions were under discussion, additional funds for the servicers would not be coming from Fannie and Freddie, which were placed in a government “conservatorship” during the financial crisis of 2008.

            “I’m not the Fed,” he said. “Fannie and Freddie are still in conservatorship and levered 240 to 1. We need all the capital we can muster for ourselves.” ‘

            The whole FT Article is here: https://www.google.com/amp/s/amp.ft.com/content/575e818e-c35a-462b-8daa-ab784163f604

            Note: This may be paywalled. The article is dated today, with this title and sub-title. “Fannie and Freddie could require bailout if lockdown lasts. Regulator says US mortgage guarantors have sufficient resources for about 12 weeks”

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  2. Tim – IMFpubs are out today with news that the FHFA is directing both GSEs to suspend their CRT programs. Will this adversely impact the need for private capital for their exits from conservitorship?

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    1. From IMF:

      “FHFA Directs Fannie and Freddie to Wind Down ‘Up Front’ CRT Arrangements
      March 31, 2020Dennis Hollier
      dhollier@imfpubs.com

      At least one mortgage real estate investment trust is already feeling the effects of Fannie Mae’s and Freddie Mac’s moves to unwind obscure credit-risk transfer programs by the end of the year.

      The policy change came at the direction of the Federal Housing Finance Agency.

      PennyMac Mortgage Investment Trust is one of just a handful of companies invested in what Fannie calls front-end CRT. These deals, also known as lender risk-sharing arrangements, make up the company’s largest and most profitable asset class. The loss of the CRT program could be costly.

      In a recent industry update, analysts at Keefe, Bruyette & Woods attributed the 8.8% drop in PennyMac’s book value at least in part to the policy change – the reason for which is unclear. For full details, see the new edition of Inside The GSEs, now available online.”

      Liked by 1 person

      1. There is nothing currently on the FHFA website about a suspension of Fannie and Freddie’s credit risk transfer (CRT) programs, but whether FHFA directs the companies to suspend CRT issuance or not, that market is closed for the foreseeable future.

        The shutdown of the CRT market could have an effect on the speed with which Fannie and Freddie reach their new capitalization targets, but it will depend on how CRTs are treated in the revised capital rule. The initial (June 2018) capital rule set Fannie and Freddie’s “headline” capital requirements at over 3.0 percent of assets, but allowed the companies to reduce that capital percentage significantly by issuing CRTs. I suspect FHFA is now rethinking this aspect of the rule, in light of the now-obvious reality that the market for these CRT securities disappears during a crisis.

        I’ve always thought that FHFA had been “too clever by half” in its June 2018 standard, when it used excessive conservatism and cushions to push Fannie and Freddie’s required capital percentage up near the “bank-like” level the banks and Fannie and Freddie’s other critics or opponents wanted, but then allowed the companies to reduce that percentage to a more reasonable and manageable level by issuing CRTs. The clear problem with this construct was that while it would work well in good times—when investors happily would buy CRTs on quality books of business—it wouldn’t work at all in times of stress, when the CRT market would dry up and Fannie and Freddie’s marginal capital requirement would jump back to its headline level at the worst possible time (when new equity was not available), forcing the companies to drastically cut back on new credit guarantees when they most were needed to stabilize the market.

        I’m hoping that FHFA has figured this out, and that this is the real reason it’s given itself another two months to work on the revised capital rule, as opposed to the unconvincing rationale given at the time—that people needed longer to comment on the rule because of the coronavirus. Unrealistic treatment of CRTs in the revised capital rule WOULD be a problem for the companies’ recapitalization, so it’s critical for FHFA to get this right.

        Liked by 3 people

  3. (Bloomberg) — Mortgage bankers are sounding alarms that the Federal Reserve’s emergency purchases of bonds tied to home loans are unintentionally putting their industry at risk by triggering a flood of margin calls on hedges lenders have entered into to protect themselves from losses.

    In a Sunday letter, the Mortgage Bankers Association urged the U.S. Securities and Exchange Commission and the nation’s main brokerage regulator to address the problem by telling securities firms not to escalate margin calls to “destabilizing levels.” The MBA, whose members underpin the housing market, asked the watchdogs to issue guidance directing brokers to work constructively with lenders.

    The rally in prices for mortgage-backed securities that’s been fueled by the Fed’s large-scale buying is “leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders,” the trade group wrote in its letter to SEC Chairman Jay Clayton and Financial Industry Regulatory Authority President Robert Cook.

    ===========

    Do MBA members bet against stable or increasing MBS price ?

    Liked by 1 person

    1. Mortgage bankers are subject to pipeline risk, which is the risk of changes in interest rates between the time they “lock” an interest rate quote for a potential borrower and the time they deliver that loan to a buyer. Most mortgage bankers do partial hedges of this risk, but when volatility spikes–as it’s done recently–the hedges don’t provide that much protection.

      Many mortgage banking firms appeared to have been badly “whipsawed” in the past couple of weeks. When the Federal Reserve cut the fed funds rate to zero, they expected mortgage rates to fall as well, so they left much of their origination pipelines uncovered. When mortgage rates rose instead, lenders had to sell their unhedged loans–now with below-market rates–at lower prices. And based on comments over the weekend from the Mortgage Bankers Association (MBA) about margin calls to members, it seems that after mortgage rates shot higher originators did begin to hedge their current production by selling the loans forward (that is, committing to deliver a high percentage of their new originations at a fixed price in the future, when the originators expected them to close) only to see mortgage rates suddenly drop when the Fed (ironically, in response to urgent requests by the MBA) bought billions of dollars of MBS in the market. With mortgage rates dropping, many borrowers chose not to close on their now above-market-rate loans, leaving the originators to bear the cost of either buying back (or “pairing off”) their forward sales, or selling their new lower-rate loans at a discount, to produce the higher yield they had committed to deliver.

      While these losses to originators are unfortunate, they’re a cost of doing business. But they’re coming at a very bad time, when seller-servicers are about to be asked to make a large number of advances of monthly mortgage payments on loans granted forebearance by the coronavirus legislation. The latter SHOULD be the focus of some type of special assistance from the government, and I believe they will be. The pipeline losses, though, will need to be absorbed by the originators.

      Liked by 1 person

  4. Tim

    a couple of tidbits from the covid-19 stimulus bill. CECL accounting (scheduled for this 1Q) has been suspended. and anyone adversely affected directly or indirectly by the crisis can request forbearance of payments on GSE securitized mortgages, for as long as the emergency is in effect (per POTUS EO) but not later than end of this year. the forbearance defers payments due without penalty interest or other penalty.

    CECL would have had the effect of piling on a bad situation so that its absence wont be missed. I would be interested in your view as to the stress this forbearance will put on the GSEs, especially in light of Calabria’ interview that the GSEs wont begin to feel stress until after two months of crisis conditions, and whether there is anything in the accounting lore which might treat the terms of the forbearance (pursuant to federal statute) as permitting GSEs to avoid creating loss reserves (as payments are deferred, and payment deferral is pursuant to governmental authorization rather than purely payor decision).

    rolg

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    1. I saw that the Covid-19 bill had a provision suspending the implementation of CECL accounting. I’m glad they did that (although I wish they’d rethought, and abandoned, the entire “life of loan” reserving principle–whenever it’s implemented, it’s going to be pro-cyclical).

      What will be important for Fannie and Freddie’s economics is how the Covid-19 crisis ultimately affects their delinquencies and defaults. The forebearance by itself may have some impact on the companies’ loss provisioning decisions–if they choose to err on the conservative side in their assessment of future credit losses, even without CECL–but the real impact will come if unemployment spikes and stays high, or if home prices begin falling. And I also should emphasize that the CRT securities the companies have issued over the last several years–which I critiziced as being non-economic at the time (and they would have been absent the pandemic)–will turn out to be of significant benefit if the companies’ credit losses do indeed shoot up. But it’s too early to say whether that will be the case.

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        1. The Federal Reserve, FDIC and Comptroller of the Currency issued a joint press release today that among other things said, “Banking organizations that are required under U.S. accounting standards to adopt CECL this year can mitigate the estimated cumulative regulatory capital effects for up to two years.” I’m assuming that FHFA will grant similar flexibility to Fannie and Freddie, although to my knowledge it has not yet done so.

          Like

    2. From web: State financial regulators are calling on the Fed to establish a lending facility for mortgage servicers, warning that the coming wave of missed mortgage payments could wipe out servicers without adequate capital.

      I remember you said, GSES would pay, then CRT holders. Why servicers?

      Like

      1. The problem for servicers is that even though they ultimately get reimbursed for the monthly payments they are required to advance for 3 to 4 months (and perhaps more, under the government’s forebearance plan) on Fannie or Freddie-guaranteed MBS, many likely will have neither the capital nor the liquidity to be able to make these advances in the volumes that may be required. This is why state regulators are calling for some type of federal lending program for servicers.

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  5. Tim – hoping you made it back stateside without issue.

    If you care to comment on the recent FED actions as it relates to the GSEs and the calls to allow them to buy MBS paper it would be helpful to get your take on the government’s response.

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    1. I’m not sure where to begin on this one.

      Prior to the 2008 financial crisis, Fannie Mae’s portfolio investment business had been the “bete noire” of the Financial Establishment for longer than the 17 years I was responsible for it (from 1988 to 2004). Fannie had indeed almost failed in the early 1980s because of a mismatch between its mortgage and debt durations, but in the late 1980s the company began using callable debt and derivatives to “rebalance” those durations much more frequently and cost-effectively. From the early 1990s, Fannie’s portfolio was not the “snarkily managed hedge fund” the Wall Street Journal labeled it, but instead a consistent buyer of 30-year fixed-rate mortgages that helped keep interest rates on mortgages low, while at the same time being a significant source of profitability for Fannie. This, however, did not stop Treasury from requiring Fannie (and Freddie, which had been a late entry into the portfolio business) to shrink its portfolio by ten percent—later increased to 15 percent—per year after it was put into conservatorship.

      Well, now portfolio investments in mortgages and MBS ARE risky. The recent sharp widening in mortgage-to-Treasury spreads reflects not just the typical “flight to safety” one sees during times of market stress but also the fact that with short-term interest rates at zero 30-year fixed-rate mortgages originated today could become extremely long-duration assets. A debt-based mortgage investor in new long-term mortgages therefore must have a very large rebalancing budget to cover the risk of having the durations of these loans extend to an unprecedented degree. It doesn’t surprise me that the Financial Establishment would like to have Fannie and Freddie be permitted to add to their portfolios again—the mortgage market is badly in need of support—but its willingness to ignore the interest-rate risk these investments would pose to the companies, which seemed to be of such great concern when those risks were considerably less, can’t be allowed to go without comment.

      Yet, “be careful what you wish for.” The current vision of Fannie and Freddie as recapitalized and released companies limits their portfolios to purposes incidental to the credit guaranty business, such as aggregating purchases from smaller lenders prior to packaging for sale as MBS, or holding non-performing loans bought out of existing MBS pools. Were Fannie and Freddie to be allowed to rebuild their investment portfolios, Treasury and FHFA almost certainly would have to agree to extend whatever government support they intend to provide for their MBS credit guarantees (most likely continued access to draws of senior preferred stock, for a fee, in the event of financial difficulty) to the debt that funds their newly expanded portfolio business. Buying government-backstopped MBS using debt without such a backstop is not a viable business proposition. (Remember, banks can fund their fixed-rate MBS with FDIC-insured consumer deposits, and incur no capital penalty for the interest-rate risk they take in doing so). The question thus becomes: does the Financial Establishment want Fannie and Freddie’s support as mortgage purchasers over the next few months to a year badly enough to extend to their debt the same type of government support it’s willing to give to their mortgage guarantees in the companies’ post-conservatorship future? Somehow, I doubt it.

      Liked by 1 person

      1. Mr Howard

        In a nutshell, would the investment portfolio at 2007 (that was forced to liquidate) but allowed to rebalance and continue, provide enough income to mitigate interest rate risk going forward (since we are now at the wrong end of the interest rate cycle) by your estimate?

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        1. The correct reference point for this hypothetical question isn’t the end of 2007 but the fall of 1998, when there was a similar widening in spreads between mortgages and Treasury and agency debt in the wake of the Russian debt crisis and the subsequent liquidity crisis and failure of Long-Term Capital Management. Plummeting interest rates triggered an avalanche of mortgage liquidations and refinances, which overwhelmed the capacity (or willingness) of capital markets investors to absorb. In these circumstances, Fannie and Freddie’s portfolios served as automatic stabilizers. The companies were willing to issue virtually unlimited amounts of the fixed-term or callable agency debt that investors wanted to buy, then use the proceeds to buy the mortgages and MBS these same investors were shunning. I was running Fannie’s portfolio business at the time, and we built into our pricing an additional spread (which I labeled in my earlier comment a “rebalancing budget”) that we believed compensated us for the increased option risk we were incurring in making these purchases. So, yes, mortgage spreads did widen, but only to the point where there was enough compensation for Fannie and Freddie to play their market-stabilizing role.

          What made this work back in 1998, though, was that Fannie’s debt and MBS both were assessed by the market as having the same high credit quality (known at the time as the “implicit government guaranty.”) Things are very different today. Treasury’s first act upon putting Fannie and Freddie into conservatorship was to require them to wind down their investment portfolios. At December 31, 2007 Fannie and Freddie’s mortgage portfolios accounted for 28.9 percent of their combined books of business; at the end of last year that percentage was only 6.4 percent, and both companies were operating under the assumption that they will not have profit-making portfolio investment businesses in the future.

          I believe that post-conservatorship Fannie and Freddie can hold debt-funded mortgages incidental to their credit guaranty businesses on the order of around 5 percent of their total credit guarantees without that debt having any form of government support. But if Treasury and FHFA want the companies to go back to playing a version of the role they played in the fall of 1998, they will have to commit to giving Fannie and Freddie debt the same form of support they intend to make available to their MBS going forward. Requiring them to buy and fund government-supported MBS with debt that does not have that support would be a recipe for future disaster.

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      2. Tim

        there has been reporting that the expected wave of missed payments on mortgages will first directly impact mortgage servicers, who will be on the hook for advancing sums upon missed mortgage payments. could you please explain the “life cycle” of a missed mortgage payment…do the servicers on the mortgages that are securitized in GSE guaranteed mbs pools have the first obligation to make good on missed mortgage payments? if so, for how long and how much generally? when does the obligation of the GSEs to make good on their guaranty kick in? I am not looking for a securitization 101 course, but I suspect I dont clearly understand the process in which funds are supplied to the GSE securitized pools are advanced upon mortgagor missed payments. Thanks!

        rolg

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        1. I read that reporting, and it was not correct as it relates to mortgages sold to Fannie or Freddie. Servicers are obligated to remit all payments on these loans to the companies, but they are not required to (and do not) advance missed payments. That’s Fannie and Freddie’s role as credit guarantors, to make “timely payments of interest and principal” on any mortgage they’ve guaranteed. If the borrower does not make a payment to the servicer, it’s Fannie or Freddie’s obligation, not the servicer’s, to advance that payment to the investor in the MBS. Fannie and Freddie will continue to advance those payments until one of two things happens: the borrower begins paying again, or the companies foreclose on the property (or buy the loan out of the MBS pool) and repay the principal amount due on the loan to the investor, in full and at the companies’ expense. Fannie or Freddie then will sell the home that collateralized the mortgage, and recoup whatever proceeds they can, including reimbursement from private mortgage insurers if the loan had such insurance.

          [8:40 pm update] A former Fannie Mae colleague wrote to remind me that under most of Fannie’s servicing arrangements servicers ARE required to advance the first 3 or 4 months’ missed payments, although they then are reimbursed for those advances so that Fannie ultimately bears the cost. Still, and in contrast to what I said above, when there is a surge in delinquencies servicers can face initial cost or liquidity burdens, while the impact on Fannie (or Freddie) is deferred until such time as they reimburse the servicers for their outlays.

          Liked by 2 people

          1. Tim

            Thanks, that does clear things up. just one more question re GSE mbs pools. is there any credit support apart from the GSE guaranty within the pool (eg overcollateralizaton) or any other reason why there could be a time lag between missed mortgagor payments and GSE guarantor payments? put another way, assuming mortgagors start missing payments this month, would one expect GSE guaranty payments on mbs to be made in April?

            rolg

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          2. No; if borrowers start missing payments in April, Fannie and Freddie will start advancing those payments shortly afterwards (in accordance with the remittance delays built into the stucture of their MBS). The initial impact of these advances on the companies’ cash net income will be very modest, however, because interest rates are so low (they will borrow the funds they advance to MBS investors). A quicker and far larger financial impact will come from Fannie and Freddie’s provision for credit losses, with the now-applicable “current expected credit loss” or CECL accounting standard requiring the companies’ loss reserves to reflect their current expectations for the lifetime credit losses on their loans. Today these are almost certainly higher than they were a month ago, and they are likely to rise still further in the coming months.

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  6. Tim-

    Is it possible to comment at this early point on how this economic disruption might impact Fannie and Freddie’s operating results and financial position?

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    1. It is far too early to speculate about how the coronavirus and its ramifications will affect Fannie and Freddie’s operating results, because the crisis is still in its early stages and we don’t yet know what its ultimate economic effects will be. So far the main effect has been a sharp decline in interest rates, which is (a) a negative for the companies’ (now relatively small) portfolio businesses, because it will increase their costs of rebalancing their asset and debt durations, (b) a positive for business volumes, because of increased levels of refinancing (historically Fannie and Freddie have gained market share during refinancing booms), and (c) probably a positive for their average guaranty fee rates, as more older lower-fee business gets refinanced at the current higher fee rates. The impact to date on credit losses is probably also a net positive, but that will change if the economy slows or goes into recession and unemployment rises. But my main point is that we simply don’t know how the coronavirus will affect the companies’ future profitability, and we won’t have a good idea about that for a while.

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        1. First of all, less than a week after I wrote the comment above, it’s already become clear that the coronavirus is likely to have significant negative effects on Fannie and Freddie’s credit performance, because of the expected sharp declines in income and rises in unemployment caused by the virtual cessation of activity in about one-quarter of the American economy. How severe these losses are will depend on how long economic activity remains depressed, which is not knowable at this time.

          The likely prospective environment WILL, in my view, provide a good test for credit risk transfer (CRT) securities. The first test starts now: will Fannie and Freddie be able to sell CRTs against new production? My analysis would be “no;” the uncertainty about the performance or new mortgage loans has spiked, and I believe that will scare off investors. But we will see. It’s also not clear what the real lesson will be about the CRTs issued in the last few years. My criticism of these securities was that their cost was way too high given the remoteness of the credit risk on these very high-quality books of business. But in just a month that dynamic has changed–because of the impact of a pandemic that no one had factored into the equation. And that leads to my last point, or rather question: irrespective of the performance of the CRTs issued against the last few years’ books of business–which we won’t have a good idea about for several months or quarters– how will this performance be assessed for, and factored into, the pricing of future CRTs? Because of the pandemic, the losses experienced by the companies, and potentially transferred to CRT buyers, likely will be far higher than CRT investors were expecting; will this worse performance be viewed as an outlier, and discounted, or will it affect pricing of all CRTs for the foreseeable future? I hate to keep saying the same thing, but it will be a good while before we know that either.

          Liked by 1 person

          1. Tim

            what kind of transparency is there to judge the successful completion of CRT offerings? if an offering fails to be subscribed, will we know that? are CRT issuances only announced when closed, or is there a future offering calendar so that we can determine whether an offering has been pulled?

            rolg

            Liked by 1 person

          2. I’m not sure what process Fannie or Freddie follow in bringing their CRTs to market, but my assumption is that they would structure and price their deals based on the indications of investor interest they get from their main investment bankers. So if they either get a “no bid” from the bankers, or the pricing indications they receive aren’t to the companies’ liking, they won’t go forward with an issue. I don’t think you’d see a failed deal. And that means if we don’t see any CRT deals in the next few months, it will be either because there aren’t any bids for them, or the price at which investors would take them are too high for the companies to accept. On your offering calendar question, I know FHFA has set an objective for Fannie and Freddie to issue CRTs against a set percentage of the coming year’s new mortgage credit guarantees (of certain types and characteristics of mortgages), but to my knowledge neither company has published an issuance calendar. We’ll know the deals can’t be sold if none of them print.

            Liked by 1 person

          3. I can tell you CRTs are the worst performing structured product today – there are 0 bids for them.

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          4. That’s no surprise at all. The existing CRTs were priced under one set of (favorable) credit loss expectations, and now are being evaluated in a totally different, likely much worse and certainly much more uncertain environment.

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          5. Hi, Tim. Can you quantify foreclosures and evictions moratorium for 60 days effect on the GSE’s? They are going in with record low delinquencies, and the time value of money is low now. It doesn’t seem like this will be a major issue. But what’s your opinion on this?
            Thanks.

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          6. Calabria was on CNBC briefly (I believe) today. He said this (at about 2:30, regarding providing forbearance to in need borrowers and still funding MBS payments): “So at this point with F&F, for the delinquencies that we’re expecting to see, if this is a short term event, say 6-8 weeks, we believe that F, F and the servicers are equipped financially to be able to get through this time. If this goes beyond that then we may be having to look for public assistance from Congress, from the Fed, but at this point in the short run we think we’re there.” (The video is top search result in CNBC App if you search for “Calabria”.) I note: The timeframe Calabria cites here corresponds to the delay in the capital rule comment period that was cited in a Bloomberg Article yesterday, where Calabria was quoted as saying the FHFA would delay seeking comment on the new capital rule until “probably the second half of May”.

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          7. The effect on Fannie and Freddie’s delinquencies, defaults and foreclosures of the nation’s widespread efforts to “flatten the curve” of the spread of Covid-19 will depend on a host of factors that are unknowable at this time, including how long extreme “social distancing” measures remain in place, the impacts these and other virus-spread inhibiting measures have on income and employment, and the policy responses taken to combat those impacts. I know people are looking for predictions, but at the moment there are no sound bases for making any.

            Regarding Mark Calabria’s announcement yesterday that that FHFA was delaying putting its revised capital rule out for comment until the second half of May, I thought the rationale he gave for the delay—that FHFA’s teleworking environment would make it harder to evaluate the comments it expects to get—wasn’t very convincing. If that were the issue, why not just put out the rule when it’s ready, and extend the comment period? I also wondered about Bloomberg’s report that, “The reproposal will look a lot like the previous version, [Calabria] says, adding that the goal will be to have a rule that makes the companies ‘economically attractive’ while also being sufficiently capitalized to survive in a stressed environment.” In my view the previous version decidedly did NOT make the companies “economically attractive,” and if the new rule looks “a lot like the previous version” I’m not sure why it would either. But now I’m going to have to have to wait another two months, along with everyone else, to evaluate this.

            Liked by 2 people

          8. Tim

            just a couple of thoughts:

            as to CRTs, traders/bankers have a view of new financial products, and if they hurt early adopters they will have a short longevity. burn me once, shame on you, burn me twice, shame on me. CRTs are a very modeled investment, and if the model proves wrong early on, it is hard for the product to survive. banking careers aren’t made on a bleeding edge of innovation.

            as to the huge rise of jobless claims that we will soon see, I speculate that they will be concentrated in industries particularly sensitive to social distancing, such as hospitality/restaurants/events etc, where the unfortunate people harmed by this draconian response to the virus are mostly not mortgagors. GSE delinquencies will rise but I dont see a tsunami…and I see a relatively swift rehiring when the all-clear is given (and I suspect the election calendar will affect when that all-clear is issued)…and I note that Wuhan is reopening for business after 3 months.

            rolg

            Liked by 1 person

          9. Sitting down here on the Caribbean coast of Mexico–although with the State Department’s announcement today that American citizens staying or living abroad “soon” must make a decision to either return to the U.S. or stay where they are indefinitely, I’ve booked a flight for my wife and me to come back to the D.C. area on Monday–I’m constantly reminded by conversations with my friends from around the globe that we’re far more interconnected than we were even a dozen years ago, and that countries are dealing with this threat in different ways and with different senses of urgency. The economic impact of Covid-19 has a global dimension that may not neatly align with the U.S election cycle. I’m by nature optimistic, but I still am far from having a good sense for how the crisis that suddenly has engulfed us ultimately will play out.

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    1. First of all, I thought this was an excellent analysis. On balance, I agree with both of your principal conclusions: that a majority on the Court will rule the “for cause” provision in the CFPB statute to be unconstitutional, and that a (perhaps different) majority will propose as a remedy that this clause be severed from the statute. But this second conclusion gives me a little pause. It’s clearly the most defensible of the decisions the Justices could make, but it too has problems. You state that “the four ‘liberal’ Justices…will want severance when it comes to remedy,” but I wonder about that. Justices Ginsburg and Sotomayor each noted that the CFPB’s current structure reflected Congress’ intent to try to protect consumers from political influence, and and I think they would agree with Seila Counsel Shanmugam’s argument that a CFPB insulated from Congressional but not Presidential influence (the result of severing the “for cause” provision in the statute) would have been the last thing Congress would have wanted. This makes me wonder if the liberal justices might try to get one of their other colleagues to agree with Amicus Clement’s suggestion–which you quoted at length– that the Court DIG (dismiss as improvidently granted) the case. I wouldn’t bet that way, but it wouldn’t totally shock me.

      As to your view that a majority on the Court also will grant Seila retroactive relief by invalidating the civil investigative demand issued by the (unconstitutionally structured) CFPB, this for me falls more into the category of a hope than an expectation. As you point out in your piece, the issue never was discussed directly, and even when Seila Counsel Shanmugam had an opportunity to remedy that in his two-minute summation at the end, he didn’t. He began by saying, “Just three points on jurisdiction, the merits and the remedy, respectively,” but he never got to the remedy. He spent all of his time on the first two points (I thought too much time on the second), and then said, “The judgment of the court of appeals should be reversed,” without a word about remedy. If the remedy were his top priority, I don’t know why he wouldn’t have addressed that first, or certainly at some point in his closing argument.

      Liked by 2 people

      1. Tim

        With respect to DIG, clearly SCOTUS should have selected Collins rather than Seila to grant cert, sInce fhfa would have argued for constitutionality unlike the CFPB, so there would have been adversity and no reason to consider DIG. granting DIG is infra dig to SCOTUS and rarely granted, and while it is something the “liberal” justices would welcome, the other five justices would want no part of that; they have been looking impatiently for a suitable case on the question of Article II power and the administrative state (especially Gorsuch), and they went straight to the first one that made it to their cert petition list.

        What the Collins amicus brief in Seila pointed out was that it is not a question of choosing prospective or retrospective relief, both are analytically distinct and both can be granted. From Collins viewpoint, as long as retrospective relief is granted, Collins would be indifferent to prospective relief. on the other hand, Seila counsel seemed to very much not want the question of prospective relief granted (the question of severance was added by SCOTUS in granting cert, as Seila did not petition for it to be considered), likely because the funder of the litigation has a policy preference to see no cfpb. (indeed, I think there will be an interesting conversation between Gorsuch and Kavanaugh on whether severability will be given).

        This bespeaks the different stances in the two cases: Collins is a case about remedy (invalidating NWS), and the constitutional claim is an avenue to secure the remedy. Seila is a case about policy (against insulated agencies with excessive power), and the Seila CID is an avenue to secure the policy change. So Collins has to hope that when the majority opinion is drafted, the Bowsher and Lucia cases are given their due.

        rolg

        Liked by 2 people

        1. The conservative justices’ interest in strengthening the power of the executive branch was evident in the argument, hence the high probability of a finding of unconstitutionality and also a majority vote for severance. Whether anything is done retroactively in line with Bowsher and Lucia seems the only plot line still in doubt, and we’ll have to wait three months-plus to learn how that one ends.

          Liked by 2 people

  7. Judge Rules Ken Cuccinelli Unlawfully Appointed Head Of Immigration Agency
    Hayley Miller
    HuffPostMarch 1, 2020, 3:04 PM EST
    A federal judge ruled on Sunday that Ken Cuccinelli was unlawfully installed as the acting director of the U.S. Citizenship and Immigration Services.

    President Donald Trump’s appointment of Cuccinelli, who also serves as the acting deputy secretary of the Homeland Security Department, violated the Federal Vacancies Reform Act of 1998, U.S. District Judge Randolph Moss declared in his 55-page decision.

    Only an official designated as “first assistant,” as defined by the FVRA, can assume the role of acting USCIS director when the vacancy arises, according to the ruling. Cuccinelli initially was appointed to the new position of principal deputy director. At the same time, the USCIS order of succession was revised to include the principal deputy director as a first assistant. Both of these changes occurred after the vacancy had arisen.

    “Cuccinelli may have the title of Principal Deputy Director, and the Department of Homeland Security’s order of succession may designate the office of the Principal Deputy Director as the ‘first assistant’ to the Director,” Moss wrote. “But labels — without any substance — cannot satisfy the FVRA’s default rule under any plausible reading of the statute.”

    Policies put in place under Cuccinelli, including reducing the time granted for asylum seekers to schedule “credible fear” interviews during expedited deportation proceedings, are now VOID, Moss ruled.

    Liked by 1 person

    1. @mark/Tim

      just to be clear, Ps who wanted to challenge the new DHS asylum policy challenged the appointment of the acting director that implemented that policy under a federal statute (vacancies act), so that his lack of authority rendered invalid the new asylum rule, and this federal judge agreed. this constitutes “backward relief” in the context of the constitutional remedy that Collins is seeking though its petition for cert, currently on hold at scotus.

      the read through is that if an appointment is invalid under a federal statute and the proper remedy is backward relief, then a fortiori backward relief should be available for a violation of the appointments clause of the constitution, and a further read through would be that if this is so for a constitutional appointments clause violation, so should backward relief be afforded in the case of a violation of potus’s separation of powers executive power (removal power) (collins).

      now, of course, scotus tells federal district judges what the law is and not vice versa, but it is helpful to see this case decided this way.

      rolg

      Liked by 2 people

          1. @William

            me too!

            I will post something in a day or two, but if you look at this transcript through a Collins lens, you will note that while the big issue in Collins is the availability of backward relief for a constitutional separation of powers violation, and whether prospective relief by way of severance of the single director removal for cause statutory provision avoids the question of whether the court should invalidate the past action that Ps seek to void (the CID in Seila, the NWS in Collins), this was not the focus of the Seila oral argument….except that there was a discussion as to whether the current cfpb director (who professes being subject to a term subject to at will potus removal notwithstanding that the statue states otherwise) ratified the Seila CID…and the whole question of ratification presumes that the CID needed ratification…which presumes that if single director removal for cause is unconstitutional, then the Seila CID is void so that it requires ratification. and reading through to the fhfa director and the NWS, ratification would presumably require the establishment of a new administrative record, which would now require the airing of facts that would show that the NWS was not necessary, so vacateur of the NWS with the possibility of ratification by the fhfa director is not something to be feared by GSe investors.

            so something of a messy argument, but my bet is a 5-4 ruling that single director removal for cause is unconstitutional (with Justice Roberts concurring with the view that insulation from both Potus at will removal AND Congressional appropriation is constitutionally problematic…all good since same facts as fhfa), and that the removal provision is severed from the Dodd Frank statute going forward, especially since Dodd Frank has a separability provision…which is fine since re fhfa, HERA contains no separability provision.

            so cautiously optimistic…as I am often criticized for being.

            rolg

            Liked by 1 person

          2. ROLG,

            SCOTUS justices seemed to all get hung up on “How do we draw the line” regarding when a single director for cause removal is vs is not constitutional. They mentioned the severability in Dodd Frank, which as you know does not exist in HERA. What are the chances that SCOTUS grants Cert in Collins as a way to help draw a fine line in when it is vs is not constitutional?

            Cheers,
            Justin

            Liked by 1 person

          3. @juice

            where to draw the line was a problem for proponents of single director removal or cause. amicus clement and house counsel were having a hard time convincing scotus to i) forget about it (dismiss as improvidently granted cert…DIG), this is just a political internecine fight between potus and congress to which soctus need not get involved, ii) water down the meaning of for cause…but just how far and how much exactly? and iii) uphold provision, but then where is the limiting principle, and cant this be used as a cudgel by congress to hammer potus, converting the cabinet to all holdovers from last potus. seems to me that there are 5 votes for this line drawing exercise to be drawn at single director at will with only multi-member commission for cause removal.

            rolg

            Liked by 1 person

          4. I am weighing into this late (due to a very full schedule from around noon to 10:00 pm yesterday), and by the time I was able to read the transcript there already were two good pieces on it—one by Adam Liptak in the New York Times and another by Amy Howe in SCOTUSblog—that came to the same conclusion as ROLG expresses above (and which I share): that the likely outcome of the Seila Law case is that the justices will uphold the ruling that a single director of a federal agency removable by the President only for cause is unconstitutional, and find as a remedy to severe that provision in Dodd-Frank, without granting plaintiffs the retroactive relief they requested.

            But as ROLG notes, there is no severability clause in HERA, which complicates the analysis of how the Court’s likely decision in Seila Law will affect Collins. I don’t have any legal insight into that, although I did note—as was true in lower court arguments—that there seems to be a visceral reluctance among judges (in Seila Law, it was Justice Ginsburg who expressed it) to grant retroactive relief on an issue where the outcome would have been the same even had the head of the agency in question been dismissible by the President (as is true for the net worth sweep). In my view the justices will need a strong legal argument to overcome that reluctance, and allow them to rule for plaintiffs on the remedy in Collins.

            Liked by 1 person

          5. @Tim

            I dont know if the CID will be invalidated or not, and when I read through transcript again, I will be looking for that. it is clear that all 4 judges who would hold the provision constitutional will vote for severance, and Kavanugh is on record when a circuit judge that this was his preference, but in that case PHH obtained the relief it was seeking under the statute, so PHH did not have to find its remedy through the constitutional violation, so that Kavanugh’s view on backward relief is opaque, at least to me. I have a sense that Kavanaugh will be driving this bus (with Thomas and perhaps others very much against severance).

            rolg

            Liked by 1 person

          6. @ROLG

            Tomorrow, judge Sweeney scheduled a conference with all participants in the cases. Are they going to be discussing Seila and scheduling that results? How do you think that discussion will go?

            Cheers,
            Justin

            Like

          7. @juice

            it is my understanding that Judge Sweeney decided not to decide the Washington Federal case if govt was going to seek interlocutory appeal of Fairholme, and the WashFed attorneys called a time out on this, saying their case is distinct and different from Fairholme and the judge should proceed to issue her opinion on WashFed. so I believe this conference is purely about Fairholme, what govt will do (and govt would rather slow go everything at this stage), and whether any of this impacts WashFed. nothing to do with Seila/collins

            rolg

            Like

    1. Calabria’s comment about there likely being “not that big of a windfall” was in response to a statement by the interviewer that shareholders would stand to benefit “substantially” from Fannie and Freddie’s release from conservatorship. Given that context, I don’t accord it much significance.

      The rest of the interview was, in my view, at best a mixed bag. His statement that FHFA would be “reproposing the capital rule soon–in the coming weeks, months” seemed to be a backing away from his earlier statement that the revised rule would be submitted for comment during the first quarter. And Calabria again said that FHFA “can’t fix the [Fannie and Freddie] business model; there are real fundamental flaws of the model that only Congress can fix.” He reiterated his view that he ought to be able to charter more credit guarantors, and that their securities should have an explicit government guaranty. He also said that “the primary purpose of Fannie and Freddie is countercyclical liquidity,” which decidedly is a minority viewpoint–the companies’ primary purpose is to put high-quality credit guarantees on thirty-year fixed-rate mortgages, at all points in the cycle, so that international capital markets investors will channel funds to the U.S. housing market. Calabria has to know by now that criticisms of the companies’ business model and pledges to try to change it legislatively won’t be helpful to the capital raising effort, so one can only conclude that he believes he needs to “stand his ideological ground” irrespectively, and let the chips fall where they may.

      Liked by 2 people

      1. Calabria seemed to leave the “treatment/use” of the warrants as a “subject to discussion/consideration @Treasury” item. Then again, too early for him to really start showing his hand. I’m probably reading too much into it.

        Like

        1. Near the end of the interview, Calabria noted that Treasury had compensated itself for its role in the conservatorships (although he didn’t put it that way) by taking warrants for 79.9 percent of Fannie and Freddie’s common stock, and a liquidation preference in them equal to the maximum dollar amount of outstanding (non-repayable) senior preferred stock and owed but retained net worth sweep payments. Calabria lumped all three of these–the senior preferred, the liquidation preference and the warrants–into his statement that it was up to Mnuchin to decide how much of them Treasury will want to “sell or forgive.” Because of the generality of the statement, the fact that Calabria was saying the obvious with respect to the senior preferred and the liquidation preference (the former must be unwound and the latter canceled for the companies to emerge from conservatorship as private shareholder-owned companies) and because he was speculating about what someone else (Mnuchin) might do, I think it would be a mistake to infer anything meaningful about the future status of the warrants from the Calabria interview.

          Like

      2. Tim

        re the fhfa delay in proposing the new capital rule, even though fhfa is an “independent” agency, do you think it likely that fhfa is circulating a draft among fsoc, treasury, White House etc as a matter of courtesy? I trust that you would understand the manners of DC in this regard. I say courtesy since I am unaware of any statute that would require fhfa to consult with any other governmental office in connection with proposing a rule within its jurisdiction (and frankly I tend to doubt this courtesy has been extended since I would think that would have led to a leak by now).

        rolg

        Liked by 1 person

        1. I don’t know that there IS a delay in the reproposing of the capital rule; I only was observing that it seemed to me from Calabria’s language that there probably was. As to the process FHFA is following, I don’t have any specific information about it, but I would expect there to be at a minimum informal discussions between FHFA staff and leadership and their counterparts at other administration agencies–including Treasury, FSOC and the National Economic Council–about the key elements of the rule, and also the capital percentage the rule produces. FHFA will have the final say, but I believe it won’t want to be surprised by the reactions or criticisms of any of the other federal agencies.

          Liked by 1 person

        2. I get the sense that Calabria likes to stand on the pedestal and when it gets into the shareholder/recap part he likes to pontificate and feel like he’s part of the process….I can just picture the UST people watching the video cringing

          Like

          1. Now that fhfa has Houlihan as financial advisor, fhfa is looking for a legal advisor: https://beta.sam.gov/opp/ae3496ac109b4c09a91af6cd4cce8099/view?keywords=&sort=-modifiedDate&index=&is_active=true&page=1&date_filter_index=0&inactive_filter_values=false&organization_id=300000069

            calabria needs to learn that part of the value added of financial and legal advisors is to be the “bad dog” in the room…so the principal can say they made us do it that way, that was the advice they gave etc. saying it is up to treasury, while true, is not necessarily politic. I suspect calabria will get up to speed on the true role played by advisors.

            rolg

            Liked by 2 people

  8. Michael Bloomberg is supposedly advocating for a merger between Fannie & Freddie. I hadn’t heard that suggestion before. Is it a bad idea Tim?

    Like

    1. The notion of merging Fannie and Freddie has been broached a number of times, including in a proposal made about four years ago (right after I began doing posts on this blog) titled “A More Promising Road to Mortgage Reform” by Jim Parrott, Lew Ranieri, Gene Sperling, Mark Zandi and Barry Zigas, which I understand Bloomberg cites specifically. I was very critical of the “More Promising Road” for a number of reasons, and it was never followed, so I’m a little surprised to see it reemerge here. I suspect it’s the doing of advisors to Mr. Bloomberg, who I don’t think has much if any first-hand knowledge of how the companies function. He recently was quoted saying that the financial crisis was caused by Fannie and Freddie making loans to low-income homebuyers, which is lifted directly from the American Enterprise Institute playbook used widely, unfortunately, by members of what I call the Financial Establishment. Should Bloomberg end up being the Democratic candidate for president, it will be very important for people (including me) to try to get real facts about Fannie and Freddie into his hands, so that the policies he advocates for the companies are ones he personally has analyzed, understood and approved.

      In answer to your specific question, I’ve always thought there were advantages to having two entities with specialized federal charters for providing cost-efficient credit guarantees to residential mortgages. Product innovation, customer orientation and cost efficiency are among the benefits of having two such companies, and the danger of a “race to the bottom” in underwriting is mitigated by (a) the value of the charter itself (neither company will wish to jeopardize it), and (b) the existence of prudential regulation, which the Federal Housing Finance Agency should be able to provide.

      Liked by 1 person

      1. Tim

        here is the reference that Bloomberg 2020 makes to Parrott et al (GSEs eventually wholly-owned by government): https://twitter.com/joshrosner/status/1229769259749904384?s=21

        this reinforces the importance for GSE shareholders of a favorable outcome at scotus re Seila, which then can be used by Ps in Collins to invalidate the NWS…which would make this potential second act at a government takeover of GSEs very, very, very expensive.

        while this is the first reference to GSEs in this potus election cycle, it may very well be the last. perhaps this Bloomberg 2020 piece may be a blessing in disguise, and serve to reinforce for calabria/mnuchin that time is of the essence if they really want to release GSEs from conservatorship.

        rolg

        Liked by 1 person

    1. This is an excellent analysis. If the Supreme Court does decide the Seila Law case in the plaintiffs’ favor, and grants the retroactive relief sought, that could indeed give Treasury sufficient political cover–by making it all but certain that Collins will be decided similarly–to embolden it to go ahead and initiate settlement talks in the net worth sweep cases. This would open up the way to an acceleration of the process for recapitalizing Fannie and Freddie, providing FHFA does its part by putting out a reasonable capital rule for comment by the end of this quarter.

      Liked by 3 people

    2. The following was posted at the SCOTUS today:

      19-7 SEILA LAW LLC V. CONSUMER PROTECTION BUREAU
      The motions of petitioner Seila Law LLC for enlargement of
      time for oral argument and for divided argument, and of United
      States House of Representatives for leave to participate in oral
      argument as amicus curiae and for divided argument are granted,
      and the time is divided as follows: 20 minutes for the
      petitioner, 20 minutes for the Solicitor General, 20 minutes for
      the Court-appointed amicus curiae, and 10 minutes for the United
      States House of Representatives.

      Like

      1. those seeking CFPB declared unconstitutionally structured get 40 minutes, split equally between P and SG since they differ on remedy, and 30 minutes for those seeking CFPB declared constitutionally structured. I expect the latter will get most of the questioning on constitutionality as former will get all of the questioning on remedy.

        rolg

        Liked by 2 people

  9. Tim

    I recall Calabria recently mentioning (and I am paraphrasing) that some of the GSE credit risk characteristics are starting to increase in a way similar to that preceding the great financial crisis. I have taken a look at Fannie’s 2019 financial supplement (https://www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2019/q42019_financial_supplement.pdf) published today, and I really see no evidence for this (see for example p.15, which I think shows stability rather than increasing risk). Curious about your take.

    rolg

    Like

    1. The “significant” credit risk characteristic that I recall Calabria having called attention to in the past was the percentages of new business Fannie and Freddie were doing that had debt-to-income (DTI) ratios above 45 percent. In 2017, 11 percent of Fannie’s new business fell into that category, but in 2018 25 percent did. We now have full year 2019 data, and the percent of Fannie’s business with DTIs over 45 percent is back down to 19 percent.

      I’ve noted in the past that DTIs by themselves are not a predictive indicator of overall credit risk; you have to look at other “compensating factors” of the loan, such as LTVs or credit scores. For Fannie, the average credit score of its new business in 2019 was 749 compared with 743 in 2018, and the average LTV was 76 percent versus 77 percent the previous year. So, no, the data don’t suggest that Fannie’s credit risk has been increasing, let alone “in a way similar to that preceding the great financial crisis.” And the delinquency data Fannie has been publishing in its monthly summaries–and which it summarized in the fourth quarter 2019 financial supplement–bear this out.

      But…we are about to see less favorable credit results in Fannie’s (and Freddie’s) quarterly financial reports. For each of the last eight years, Fannie has shown a “benefit for credit losses,” as it has been steadily drawing down on the outrageously high loss reserves FHFA built up for it between the time the company was placed into conservatorship and the end of 2011 (when that reserve stood at $72.2 billion). Over those eight years Fannie has taken a total of $26.1 billion into net income as a result of this positive benefit for credit losses–with $4.0 billion of that coming in this past year. (Without this benefit for credit losses, Fannie’s 2019 net income would have been $11.0 billion, not $14.2 billion.) Fannie’s total loss reserve is now “only” $9.0 billion, so there is much less potential for further loss reserve drawdowns in the future. In addition, Fannie noted in the 2019 10K it released today that in the first quarter of 2020 the implementation of the Current Expected Credit Loss (CECL) standard would reduce its net income by $1.1 billion after tax (meaning that the pre-tax addition to the loss reserve will be about $1.4 billion). For the full year 2020, therefore, we almost certainly will see a much lower benefit for credit losses than was recorded in 2019, and maybe even a small (negative) provision for loss, despite the fact that Fannie’s credit performance should remain extremely strong.

      [3:45 postscript]: I just read the transcript of Fannie’s earnings call this morning, and noted that CFO Celeste Brown said that the CECL accounting charge will be made directly to retained earnings, and not run through the income statement. Based on that, I would say that while Fannie’s benefit for credit losses in 2020 will very likely be less than it was in 2019, it should still be a benefit, and not a reduction to earnings, as I speculated it might be in the paragraph above.

      Liked by 2 people

  10. Tim

    from IMF: Trump Proposes a Hike in Fannie/Freddie Guarantee Fees
    pmuolo@imfpubs.com

    Although the White House wants to recapitalize and release Fannie Mae and Freddie Mac from conservatorship, it’s proposing to hike the guarantee fees the GSEs charge by 10 basis points, a move that would increase the cost of borrowing for consumers.

    The 10 bps hike was buried in Trump’s new budget, released Monday morning, under the section labeled “Major Savings and Reforms.”

    G-fees currently average about 55 basis points, 10 bps of which cover funding of the Temporary Payroll Tax Cut Continuation Act of 2011, which is set to expire next year.

    If the White House gets its way, the additional 10 bps charge would start in fiscal 2021 and run through 2025, raising an additional $34 billion for the U.S. Treasury. The Trump administration states the increase “would help to level the playing field for private lenders seeking to compete with the GSEs.”

    since this 10 bps hike will only replace the expiring 10 bps hike relating to the payroll reduction tax, I see this as a nothing burger. am I missing something?

    rolg

    Like

    1. I wouldn’t call the proposal to put a 10 basis point tax (that’s what it is) on Fannie and Freddie’s credit guarantees a “nothing burger.” The original TCCA in 2011 was a bad idea, and extending it would be equally bad. But I don’t know how serious any of the senior people in the administration are about this. It easily could be the same sort of anti-Fannie and Freddie proposal the Office of Management and Budget staffers have been putting in each president’s budget for the last forty years. And as for the statement that the tax “would help to level the playing field for private lenders seeking to compete with the GSEs,” someone ought to tell the authors that there are no private entities in, or seeking to enter, the conventional mortgage credit guaranty business. The effects of this proposed tax would be that (a) all mortgage borrowers would pay it, (b) Fannie and Freddie would do somewhat less business than they would have done without the 10-bp tax, (c) Treasury would get the revenue from all new Fannie and Freddie guarantees, and (d) lenders who originate and hold mortgages in portfolio would put the extra 10 basis points in their pocket, as they’ve done with the original TCCA fee.

      Liked by 2 people

      1. Tim

        I worked with HL on a couple of bankruptcies. very capable, pure advisory, no capital markets, so it makes sense for them to advise FHFA, which takes them out of the underwriting syndicate since they would have no participation there. indeed, it makes sense that the other very good advisory firms that have capital markets capability, like Perella, were not picked….while this is speculation, this might indicate that the prospect of an underwriting commish was real enough for them to dissuade them posing for the conflicting rep. upon further review, the contract is for an initial year at $9.5MM, extendable…to provide a roadmap…gee, wonder if moelis blueprint might be helpful?…this may be the easiest $9.5MM anyone has ever made.

        rolg

        Liked by 1 person

        1. I agree with you about the easy money. Here’s the “advice” I would give if I were at Houlihan Lokey:

          – To Treasury: get with plaintiffs’ attorneys, and negotiate an unwinding of the net worth sweep and a cancellation of your liquidation preference on terms acceptable to them, before a court forces you to do it under less favorable circumstances.

          To FHFA: Get your foot off the companies’ air hoses, and promulgate a true risk-based capital standard without the excessive conservatism and cushions the big banks want, and

          To Fannie and Freddie: keep doing what you’re doing (provided FHFA allows you to), build up enough capital through retained earnings to meet your new critical capital requirements, and then draw upon your knowledge of your business to put together a killer roadshow that will convince the investment community to give you the equity you need to meet your new risk-based capital requirement, free yourselves of the restrictions of your consent decree and, in the words of Pinocchio, “become a real boy” again.

          Can you just wire me the money now?

          Liked by 2 people

          1. Tim,

            Just to enhance my understanding here:

            You have used the phrase “new critical capital requirement” twice, but from what I understand of HERA the critical capital level is set in stone.
            https://www.law.cornell.edu/uscode/text/12/4613

            Instead, I believe that it is the minimum capital level that Calabria will get to decide, by section (c), overriding the statutory minimum in section (a).
            https://www.law.cornell.edu/uscode/text/12/4612

            While this might seem to be semantics, I think it is of critical importance (no pun intended). If Calabria decides to try and have FnF conduct an SPO while they are Significantly Undercapitalized (i.e. don’t meet Calabria’s minimum capital requirement), it could very well fail because new investors are hard to entice while Calabria has such sweeping authorities, which include being able to hand pick the boards of directors by section (b)(5)(C).
            https://www.law.cornell.edu/uscode/text/12/4616

            I have always thought that the way to square the circle is to have FnF conduct an SPO large enough to meet Calabria’s minimum capital requirement, getting them up to at least Undercapitalized, with Calabria and Mnuchin agreeing to release them upon completion. However, if Calabria sets the minimum capital level high enough (Watt’s alternatives were $103.5B and $139.5B), that could require a $100B SPO. Is my logic sound here? If so, how does that affect your view of the recap and release process?

            Liked by 1 person

          2. First of all, I had not been aware that the flexibility FHFA has to update its minimum capital (or leverage) requirement for Fannie and Freddie did not extend to a similar flexibility to update the critical capital requirement (in order to keep it at half the minimum), but based on the language you’ve cited it appears that’s true. And in that case the capital threshold for putting the companies into conservatorship–and by inference taking them out again–would remain at 25 basis points of trust assets and 1.25 percent of non-trust assets. Using their third quarter balance sheet totals, that’s only $12.9 billion for Fannie and $8.8 billion for Freddie. Fannie may well have $13 billion of capital when it publishes its full-year 2019 financials at the end of next week (or the following Monday), and Freddie may have $8.8 billion a quarter or so later.

            These (considerably) lower critical capital levels may accelerate the potential recapitalization timeline for the companies relative to what it might have been had the critical capital levels been $30 billion for Fannie and $20 billion for Freddie, but perhaps not by much. I was viewing the companies’ hitting their critical capital levels as being the earliest date at which Calabria might consider releasing them from conservatorship under a consent decree. But in any event Fannie and Freddie won’t be able to raise new capital until the net worth sweep is ended and Treasury’s liquidation preference is cancelled, and for that reason I doubt Calabria would release them before that time, even if they’ve met these lower critical capital numbers. So effectively, the critical event for any potential secondary public offering of equity–intended to enable the companies to reach their new minimum capital requirement–would be the date the net worth sweep is unwound and the Treasury liquidation preference is canceled. And Fannie and Freddie would remain under the terms of their consent decree until they accumulated sufficient capital, through retained earnings and any additional offerings of equity, to meet their new risk-based capital requirements (and they would be well advised to continue building a cushion of excess capital well after that).

            Liked by 2 people

    1. This is a “tweak” to what FHFA calls the “minimum financial eligibility requirements” for the lenders with whom Fannie and Freddie do business. Its main change is to require (only) the companies’ non-depository lenders (not bank or bank-owned lenders)) to hold more capital against the dollar amount of servicing they do on Ginnie Mae loans. While these changes will make Fannie and Freddie’s non-depository lenders somewhat stronger counterparties, (a) the changes in my view are not significant enough to cause to FHFA to change the counterparty risk “haircuts” it applies to these lenders, and (b) the treatment of counterparty risk in any case is not one of the main drivers of Fannie and Freddie’s risk-based capital. This new regulation, therefore, should have no perceptible effect on the companies’ required capital.

      Liked by 1 person

  11. FHFA announced a realignment. The announcement mentions a new hire in a supervisory role. That new hire was formerly a FBR Research Analyst. This seems like a not negative development. I mean, obviously this person would have a quite informed view on how investors will look at the GSEs. This is the press release (Paul Miller is the former FBR Analyst mentioned).
    https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Announces-Realignment-of-its-Agency-Structure.aspx

    Liked by 1 person

    1. I agree with you: appointing a security analyst who followed Fannie and Freddie for 20 years (more or less) to be FHFA’s Deputy Director for Enterprise Regulation is a positive development, compared with the alternative of hiring someone not familiar with the companies’ unique structure and business. It’s also a plus that FHFA’s new Associate Director for Enterprise Regulation, Scott Valentin, worked with Miller.

      Miller’s experience with Fannie and Freddie came when he worked for a firm in the Washington D.C. area called Friedman, Billings, Ramsey (FBR). FBR was founded in 1989 by those three principals, and I knew two of them–Eric Billings and Russ Ramsey– quite well (Eric and Russ have been on the mailing list that announces new posts on my blog since I first began writing it four years ago, although they’re now at different firms). Miller was at FBR following Fannie at least for my last five years as CFO there, but I don’t recall having had any direct contact with him, as I had with the analysts at other investment banks. That’s probably because of my relationships with Eric and Russ; I spoke with them, and left the interactions with Miller to my (very able) head of Investor Relations and her staff. For this reason, though, I don’t have any clear impressions of the quality of the work Miller did on Fannie and Freddie during the time I was there, or afterwards. But if it had been problematic (as was the case with some analysts) I almost certainly would have heard about and remembered it. So, I would say that having Miller, and by association Valentin, heading regulation at FHFA will be a clear positive.

      Liked by 4 people

      1. Tim

        thanks for that background on mr. miller. I do recall FBR being one of the best investment banking firms for DC- based finance (not trying to damn with faint praise), and so this certainly appears to be a competence-based hire, as opposed to what often goes around in the agencies.

        rolg

        Liked by 2 people

        1. FBR had a very good reputation, with mortgage finance being one it its specialties. It did, though, get a bit “out over its skis” doing IPOs of subprime lenders and REITs during my last couple of years at Fannie–2003 and 2004. I still recall a lunch I had at the Four Seasons in Georgetown with one of the FBR principals about joining the board of one of those companies. I politely declined.

          Liked by 1 person

    2. The name change from Division of Conservatorship to Division of Resolutions gives me great hope that Calabria is intent on ending the conservatorship.

      Liked by 1 person

      1. I think there is little doubt that Calabria intends to begin a process to release Fannie and Freddie from conservatorship. The questions that remain to be answered are: (a) what will be the exact steps in this process (i.e., will they be released under a consent decree once they’ve met their new critical capital requirement, rumored to be announced soon); (b) will the companies be given a risk-based capital standard and regulatory scheme that are attractive enough to the investment community to cause it to put sufficient new equity in Fannie and Freddie to allow their recapitalization and release to occur relatively quickly (rather than slowly, through retained earnings only), and (c) will Treasury unwind the net worth sweep and cancel its liquidation preference in the companies–either on its own or because it has been required to do so by a court–and, if so, when will that happen, and how will it be done?

        Liked by 6 people

  12. Anyone want to try to explain this Stay ?

    “In the interest of judicial economy and preserving the parties’ resources,” Chief Judge Sweeney entered a series of single-sentence orders today staying consideration of the government’s omnibus motion to dismiss in all of the cases before the U.S. Court of Federal Claims “pending the determination of further proceedings in Fairholme Funds, Inc. v. United States, No. 13-465C.”

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    1. @big

      this is a nothing burger. 13-465C is the case J Sweeney just decided (that I call Fairholme), granting P’s derivative claims against the govt on 12/6/19. at that time she asked the parties to propose a scheduling order for next steps forward. on 1/10 and 1/24 the govt proposed (and Ps did not oppose) a motion for extension of time to submit scheduling order. on 1/24 govt admitted that its delay was attributable to expecting but not receiving scotus grant in collins (at which point govt would have asked for stay of proceedings in 13-465C).

      govt stated on 1/24 “Good cause exists for the requested enlargement. As explained in our previous filing, the Government’s consideration of a proposal for further proceedings involves the Office of the Solicitor General, which is responsible for determining whether, and on what issues, an appeal may be taken in this case. We expected that decision-making process to be informed by the Supreme Court’s actions with respect to the petitions for writ of certiorari in Collins v. Mnuchin, No. 19-422 and Mnuchin v. Collins, No. 19-563. Those petitions were calendared for the Supreme Court’s conference on January 10. The Supreme Court did not grant the petitions at that time, and the Government expected that the petitions would be relisted for the next conference on January 17. As of today, however, the petitions have not been relisted, and the Government therefore expects that the Supreme Court will maintain the petitions on its docket without taking action in the near future. It therefore seems unlikely that the petitions will be granted with sufficient time to be heard and resolved this Term (i.e., by June 2020). Given these recent developments, the Solicitor General has not yet reached a final decision regarding any potential appeal, and, in consultation with the relevant components of the Department of Justice, is engaging in the decision-making process as expeditiously as possible.”

      so Sweeney has given parties until 2/7 to proceed (whether by scheduling order or appeal) and she has simply said in the case before her that is still undecided, which I call Washington Federal (13-cv-00385) challenging the conservatorship itself, that she won’t be rendering an opinion in that case on govts motion to dismiss until she know what the parties are doing in Fairholme.

      rolg

      Liked by 3 people

      1. I have been asked elsewhere how can govt appeal Judge Sweeney’s order to deny govt’s motion to dismiss in Fairholme (which is an interlocutory rather than final order, and usually only final orders are subject to appeal). the short answer is that govt can try.

        rolg

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        1. final point on this nothing burger. I suppose DOJ/SG were waiting to see if scotus would grant cert petitions in collins and, if it did, try to appeal the Fairholme interlocutory denial of govt’s motion to dismiss past the appeals court of federal claims to consolidate all three claims among the two cases. if so, that is no longer an option at this point, and now the DOJ still has to decide whether to try to appeal to court of federal claims appeals court an interlocutory order which is not usually appealable. if I am not mistaken, J Sweeney must grant permission to appeal an interlocutory order.

          rolg

          Liked by 1 person

        1. David Thompson gave a comprehensive and accessible overview of the status of and next steps for the court cases we’ve all been following: the APA and constitutional claims in Collins—which the Supreme Court has put on hold pending a March 3 argument before it in a related case (Selia Law), while adjudication of the APA issue proceeds in the Southern District of Texas—the claim for breach of the implied covenant of good faith and fair dealing remanded to Judge Lamberth in the District Court for the District of Columbia, and the derivative takings claims pending before Judge Sweeney in the Court of Federal Claims.

          I would encourage readers to listen to the transcript of the call themselves. It’s only half an hour long, and David’s discussion is thorough, informative, and accessible to a generalist audience. For those looking just for a main “takeaway,” though, I would say it is that the administration is not likely to get certainty about the legality of the net worth sweep and Treasury’s liquidation preference in Fannie and Fannie before the end of this year, so if it wants to put in place an irreversible process for releasing Fannie and Freddie from conservatorship before the election—after which both FHFA Director Calabria and Treasury Secretary Mnuchin may no longer hold their current positions—it will need to initiate settlement discussions with plaintiffs without that legal certainty, and successfully conclude them by November.

          Liked by 3 people

  13. Tim,

    I would love to be able to post this to Linked In (I already posted it to Facebook.) Is there any way to to that? I would love to enlighten the public more and your history of this situation should be cast far and wide, in my humble opinion. Thank you for the work you are doing. It is much appreciated.

    Like

  14. Tim

    Thanks for this. I found in private practice that inertia was the strongest force in the universe, especially with respect to litigated matters, where lawyers go into litigation mode (war analogies come to mind) and wish to show no signs of “weakness” such as to contemplate settlement, and the principal absents itself from decision making because the legal process is arcane, opaque and “best left to the lawyers”. This is the situation with the GSEs, where DOJ is running the show and Mnuchin is more than busy attending to such other matters as tariffs, sanctions and pesky congressional oversight.

    This litigation inertia is enabled by motion practice relating to the proper statutory interpretation of HERA and the constitutionality of FHFA’s structure, all very complicated legal matters “best left to the lawyers”. What is required to break through this litigation inertia and force Mnuchin as principal to use his banker’s judgment even in this highly political setting is precisely something far less conceptual, opaque and esoteric…such as the prospect of a >$100B judgment entered against the United States, forcing Mnuchin to bear the burden of Hank Paulson’s misadventures. I am not aware of a larger financial judgment ever having been entered against the United States in its history and, based upon Judge Willet’s opinion and the facts as they have emerged in the Fairholme discovery, this judgment is exactly what will ensue. Yes, this judgment would still be subject to eventual scotus review, but a massive financial judgment dropped in Mnucin’s lap should have the effect of forcing the principal to realize that the process is no longer “best left to the lawyers”.

    rolg

    Liked by 1 person

    1. I agree with you, and it’s one reason I said in the piece that it would have been preferable for the legal settlement process to have occurred before FHFA came out with its proposed capital rule. Based on Director Calabria’s public statements, I’m concerned that his revised capital rule will be guided more by ideology and politics than finance and economics, and that this will make the path to a successful recapitalization of the companies more difficult. Of course, there will be a comment period before a final rule is adopted (I will be one of the commenters, and I know the affordable housing groups will weigh in as well), but it would have been better had the reality-based exercise of a settlement of the lawsuits happened first.

      Liked by 2 people

    2. Why would the Plaintiffs settle now? I think a settlement should have occurred a year or two ago. If the winds of Victory are blowing in the direction of the Plaintiffs after many years of wrangling- isn’t it best to play this out in the Courts?

      Liked by 1 person

      1. If the plaintiffs can get what they’re asking for as a judgment given to them in a settlement, they save time, legal fees, and the potential (however small) for a favorable lower court verdict to be overturned or the judgment reduced on appeal or by the Supreme Court. But the plaintiffs will make that call.

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      2. David/Tim

        my own view is that any litigation settlement should be done in connection with an amendment to the Senior Preferred Stock Agreement and an exchange offer made to the junior preferred holders. one large comprehensive deal.

        for example, lets assume that treasury might be willing to cancel its senior preferred in connection with a litigation settlement but is not as willing to provide a credit against future taxes in respect of the some $25B in dividends made to treasury in respect of the senior preferred beyond the “10% moment” (point in time when the senior preferred would have ben retired in accordance with its original terms). this forgone $25B in future tax collections is what I call “hard money”. a negotiator would try to find if there can be substituted for this hard money something resembling “soft money”.

        one source of soft money is treasury’s warrant position, what it might be able to monetize down the road at the end of the privatization of GSEs and full withdrawal of the government’s investment. Treasury is likely to be more willing to forgo $25B in (speculative) future value of the warrants as opposed to forgoing receipt of more certain GSE tax payments…so for example that if the treasury warrant position is valued by mutual agreement at $75B, it would cancel one third of its warrant position.

        GSE common shareholders would favor this, but junior preferred holders would derive no value from an enhancement of the common stock value…unless junior preferred holders are made an exchange offer for common at the valuation of the common prior to any cancellation of treasury warrants.

        it has been my experience that if you are trying to settle a complex situation it is best to put all of the issues on the table and solve them all at the same time…you will be able to find more items that can serve as possible trading chips if you find more issues to solve at the same time. things actually become easier rather than more difficult.

        rolg

        Liked by 1 person

    3. It strikes me that if rolg is correct and Mnuchin must avoid a massive financial judgment on his watch, and yet moving forward with recap steps prior to election is also a political risk, then the most likely course is to do nothing so long as courts do not reach any judgments prior to the election.

      Like

  15. This is an excellent historical summary. Thank you. I do think, in light of the discovery documents that have been released, that the warrants are suspect along with all the other manipulations Paulson and Geithner imposed. I don’t think Treasury is going to get nearly as good a settlement today as it could have gotten two years ago. We’ll see.

    Liked by 3 people

    1. I’m still waiting to see Judge Sweeney’s ruling as to whether her court has jurisdiction for hearing the suit brought by Washington Federal. If she denies the government’s motion to dismiss that case, the warrants may be play in settlement talks, since Washington Fed is the only suit that challenges the conservatorships. Note, however, that Washington Fed does not ask for the warrants to be cancelled; it asks for monetary damages ($41 billion) for all of the financial harm from the conservatorships. Still, that would be a “handhold” for getting some concessions on the warrants in a settlement.

      Liked by 2 people

      1. Mr. Howard, i often wonder if the reason the warrants have not been challenged is due to not being exercised thus not being ripe. “a claim is not ripe for adjudication if it rests upon contingent future events that may not occur as anticipated, or indeed may not occur at all.” Though the statute of limitations appears to have expired for new suits I am wondering you thought if exercised would there be a legal argument that the legal clock starts when exercised, because this matter is now ripe?

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        1. I’ve seen comments on other forums–and also get comments on this blog (which I delete)–expressing puzzlement about why I’m a fan of the warrants. I’m not. I believe Treasury improperly and probably illegally granted them to itself as part of an overall set of confiscatory actions intended to keep what had been two healthy companies, Fannie and Freddie, in conservatorship indefinitely (which so far has worked), and I wish the granting of the warrants had been challenged legally before the statute of limitations had expired. But as an analyst I also have to be realistic: I do not believe there is a direct path now to invalidate the warrants (although as I note above the Washington Fed case, if accepted by Judge Sweeney, may give plaintiffs leverage to get them modified in a settlement).

          The point you make about ripeness has come up before, and I haven’t changed my view on it. The warrants conveyed economic value to Treasury on the day they were granted, a fact Fannie and Freddie both reflect in their quarterly financial statements, because they calculate their earnings per share using the number of shares that will be outstanding after warrant conversion. The warrants are so far in the money (with a strike price of one one-thousandth of a cent per share) that I do not believe the “ripeness” argument will apply.

          Liked by 1 person

          1. Tim,

            Regarding your last paragraph, I’m not addressing the ripeness question directly but rather the value you cited with respect to the Treasury and the referenced EPS relative to traded shares plus warrants.

            If the warrants, with respect to original intent and fair play, are akin to the value of a term life insurance policy (a hedge against the death of the GSEs), then the warrants always have value as long as death of the GSEs looms. As long as the GSEs are on life support, then yes, the insurance policy has value (and EPS are further diluted). The value can be considered a potential value – – but a potential value that would be predicated upon the death of the GSEs. Yet once the patient is restored to full health, the insurance policy hedge against death would no longer be needed.

            My point is, how is it unreasonable to value the warrants *only* in light of the potential chance of death (for no such policy can be exercised unless the patient dies)? If the patient exits the hospital (of the Hotel California), then wouldn’t the need for the insurance policy have expired? The reason being, the Treasury would no longer be at risk.

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          2. Ron: As you probably know, in this blog I have a policy not to engage in discussions about the warrants. It is a very emotional topic for investors who have a lot at stake in their holdings of Fannie and Freddie common stock—Treasury obtained the warrants improperly or illegally (I concur), so how can I possibly not agree with their argument for why they should be cancelled, or if exercised be subject to a legal action? My analysis is that Fannie and Freddie investors did not challenge Treasury’s warrants within the statute of limitations, and that as a consequence Treasury now is able to do with these warrants as it wishes, although if the Court of Federal Claims takes jurisdiction over the Washington Federal case investors will have some ability, in a negotiated settlement, to affect the terms of that exercise. I wish it were otherwise, but that’s how I see it. (And, consistent with my policy, this will be the last comment I’ll accept in this string about the warrants.)

            Liked by 1 person

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