Comment on FHFA Capital Re-proposal

~ jtimothyhoward

Yesterday I submitted my comment on FHFA’s May 2020 Fannie and Freddie capital re-proposal to its web portal, here. The full text of this comment follows.

 

The re-proposed “Enterprise Regulatory Capital Framework” for Fannie Mae and Freddie Mac put out for comment by the Federal Housing Finance Agency on May 20, 2020 takes a problematic capital proposal made by the agency in June of 2018 and, instead of improving upon it, makes it inarguably worse.

It is apparent that FHFA began with the intention of requiring Fannie and Freddie’s credit guaranty businesses to operate with the same 4.0 percent minimum capital requirement the Basel bank standards impose on commercial banks for the single-family first mortgages they hold in portfolio. FHFA then turned to the risk-based standard, where it added enough new capital cushions and elements of conservatism to the June 2018 version to make it require close to the same percentage amount of capital as the new, much higher, minimum.

I will not speculate on why FHFA chose to require that Fannie and Freddie hold far more capital than necessary to cover the risks of the one business—guaranteeing the credit of residential mortgages—they now are permitted to do. My comment instead elaborates on three points. First, that basing the companies’ capital on historical credit loss data will lead to percentage requirements that are far lower than those being proposed by FHFA. Second, that FHFA’s arbitrarily high capital requirements will force Fannie and Freddie to charge guaranty fees that are notably out of line with explicit or implicit credit pricing elsewhere in the market. And third, that competition from the Federal Housing Administration and commercial banks will make it extremely difficult for Fannie and Freddie to raise guaranty fees to levels that will provide an attractive return to potential new investors in the companies on the amount of capital FHFA seems intent on requiring them to hold. I close with some observations on how FHFA could, if it wishes, revise the May 2020 proposal to make it more reasonable and workable for the company, its investors, and homebuyers.

Fannie and Freddie’s capital must be based on data, not Basel risk weights

Prior to the 2008 financial crisis it was possible to argue that the Basel capital framework designed for international commercial banks also should be applied to Fannie and Freddie, since they competed directly with banks in the portfolio investment business. At December 31, 2007, commercial banks held $2.98 trillion of single- and multifamily mortgages and mortgage-backed securities (MBS) in portfolio, while Fannie and Freddie held a combined $1.45 trillion in single- and multifamily mortgages and MBS as portfolio investments, and earned the majority of their profits from this business. When Treasury put the companies into conservatorship, however, it required each to reduce its portfolio by 10 percent per year (later increased to 15 percent per year), to no more than $250 billion. They did that. At March 31, 2020, Fannie and Freddie’s combined portfolios totaled just $362 billion ($151 billion at Fannie and $211 billion at Freddie), or less than 3 percent of total single- and multifamily loans outstanding, and were being run as complements to their credit guaranty businesses. With Fannie and Freddie no longer investing in mortgages for profit, more than all of their former single- and multifamily loan and MBS holdings went to bank portfolios, which at March 31, 2020 totaled $4.62 trillion, for a 36 percent market share.

Today Fannie and Freddie have no business or activity in common with commercial banks. Banks are not in the credit guaranty business at all. Banks originate and service mortgages, which Fannie and Freddie do not do, and have never done. Banks also are deposit-based financial intermediaries, and in that capacity incur substantial liquidity risk (the threat of a “run on the bank”), interest rate risk (some long-duration assets are funded with short-term deposits and purchased funds), and credit risk on multiple asset types (with loss rates much higher than on single-family mortgages). Fannie and Freddie are not intermediaries, and do not have those risks. This absence of any business overlap removes all justification for applying banks’ Basel capital standards to Fannie and Freddie, particularly given the widely acknowledged weaknesses of the Basel framework.

Basel I was promulgated in the 1980s with the goal of creating a “level playing field” among large international commercial banks by bringing the capital standards of their regulators into closer conformity. Yet because banks have so many lines of business and risk types, the best any common bank regulatory standard can do is use broad and rough risk categories and percentages to arrive at a total capital level that seems adequate to cover all of a bank’s risks combined. Basel I attempted to do this with credit risk weights for five categories of assets (four for U.S. banks), applied to a base capital requirement of 8.00 percent.

At the time it came out, Basel I was criticized for having too few risk categories, and being based solely on credit risk. All bank loan types, except single-family first mortgages, are assigned a 100 percent risk weight. Loans to credit card holders have the same required capital as loans to corporations, even though U.S. banks’ historical credit loss rates for the former are seven times higher than the latter. And banks’ single-family first mortgages are given a 50 percent risk weight irrespective of their credit scores or loan-to-value ratios, and in spite of the fact that the large majority of these mortgages have 30-year maturities and are financed with deposits and debt with much shorter terms, thus exposing the banks to tremendous liquidity and interest rate risk. The United States’ thrift industry was based on this same “borrow short-lend long” model, and it failed catastrophically.

A 50 percent risk weight for all single-family first mortgages that ignores interest rate risk and differences in credit quality may be the best international banking regulators can do given the complexities and intricacies of the tens of thousands of banks in the world, but FHFA has no reason to impose this “one-size-doesn’t-fit-all” straitjacket on two companies that take only one type of risk on two types of product (single- and multifamily mortgages) in one currency in one market, and for which ample historical data exist.

FHFA also attempts to justify its 4.0 percent minimum capital requirement for Fannie and Freddie by citing what it terms “peak cumulative capital losses” at the companies of $167 and $98 billion, respectively, in the years following the crisis. These losses were ballooned by the more than $300 billion in non-cash expenses that FHFA, as conservator, required the companies to book based on its estimates or expectations, and over half of those expenses subsequently reversed and came back as income. Fannie and Freddie’s capital requirement must be based on actual losses, not artificial or inflated ones.

Data on commercial bank loan losses are readily available from the FDIC going back to 1992—sixteen years before the financial crisis. From 1992 through 2007, the average annual loss rate on all U.S. commercial bank loans was 72 basis points, and for their single-family first mortgages it was 13 basis points (less than 20 percent of the loss rate for total bank loans). Both of these loss rates have been higher since the financial crisis, with the average 2008-2019 loan loss rates rising to 107 basis points for all loans and to 68 basis points for single-family firsts. These higher more recent loss rates raise the averages for the full 28-year period (1992 to 2019) to 86 basis points per year for all bank loans, and to 37 basis points per year for banks’ single-family first mortgages.

With access to physical copies of annual reports from my time as CFO, I have Fannie single-family credit loss data since 1992 as well. During the sixteen years before the financial crisis—1992-2007—Fannie’s single-family mortgage credit loss rate averaged only 2.5 basis points. (Freddie’s pre-crisis loss rates should not be significantly different.) This rate also has averaged much higher from 2008 to 2019, at 31.5 basis points, pushing Fannie’s average single-family credit loss rate for the full 28-year period up to 15 basis points.

Two comparisons from these historical data stand out. The first is that during the past 28 years the average loss rate on all commercial bank loans of 86 basis points is 5.7 times as high as Fannie’s average 15 basis point loss rate on its single-family mortgages. The second is that the 37 basis-point average single-family first mortgage loss rate at banks over this period is 2.5 times Fannie’s 15 basis point average loss rate.

Over the past three decades, single-family first mortgages have accounted for about 20 percent of total bank loans. Since these have a 50 percent risk weight, and all other bank loans have a 100 percent risk weight, the average Basel risk weight for total bank loans is 90 percent. By simple extrapolation, if bank loans with a 90 percent risk weight have had an 86 basis-point annual loss rate over the last 28 years, the 15 basis-point annual loss rate on Fannie’s single-family mortgages for the same period should equate to a risk weight of 16 percent, not 50 percent. Even starting with the “rough justice” risk weight of 50 percent for single-family mortgages from the Basel standards, Fannie’s 15 basis-point loss rate compared with banks’ 37 basis points still would result in a risk weight of only 20 percent.

These data-based risk weights translate to capital in the range of 1.3 to 1.6 percent, which is little different from the 1.5 percent requirement for credit guarantees (or “trust assets”) in the “Bifurcated Minimum Leverage Capital Requirement” alternative from FHFA’s June 2018 capital proposal. FHFA must return to this alternative for minimum capital. It sets a reasonable floor for the risk-based standard—which as discussed below FHFA also must revise—and unlike the 50 percent Basel risk weight conforms with Fannie’s historical loss experience (and almost certainly Freddie’s as well).

Excessive Fannie and Freddie capital leads to severe pricing and market anomalies

Six years ago, FHFA was focused on, and concerned about, the market consequences of setting Fannie and Freddie’s guaranty fees too high. Acting Director Ed DeMarco had required the companies to increase their guaranty fees by 10 basis points in 2012, to “reduce [their] market share” and “encourage more private sector participation” (which also appear to be objectives of the May 2020 capital proposal). He had scheduled a further 10 basis-point increase for 2014, but incoming Director Mel Watt suspended it pending further review. That spring FHFA published “Fannie Mae and Freddie Mac Guaranty Fees: Request for Input,” in which it acknowledged the competitive impact of fee increases, saying, “Finally, it is noteworthy that increases in g-fees [guaranty fees] on higher-risk loans may result in originators insuring/securitizing some of these loans with Federal Housing Administration (FHA)/Ginnie Mae rather than one of the Enterprises. While this substitution would reduce the Enterprises’ footprint in the mortgage markets, it would not reduce the federal government’s overall footprint. On the other hand, increases in g-fees for lower-risk loans may make it more profitable for banks or other private market participants to retain these loans rather than selling them to the Enterprises.”

FHFA did not raise Fannie and Freddie’s fees any further following its 2014 guaranty fee review. In fact, after peaking that year at 60.5 basis points (including an extra 10 basis- point fee paid to Treasury, mandated by the Temporary Payroll Tax Cut Continuation Act, or TCCA, of 2011), the companies’ guarantee fees on new business averaged almost five basis points lower, at 55.7 basis points, between 2015 and 2019. But even at this lower level there were pronounced effects on the relative business shares of Fannie and Freddie versus commercial banks and the FHA, as FHFA had surmised. Between December 31, 2007 and March 31, 2020, the dollar amount of single-family mortgages guaranteed or owned by Fannie and Freddie rose by less than 20 percent, from $4.25 trillion to $5.06 trillion, while the share of its business with credit scores under 700 fell from 37 percent to 14 percent. In contrast, over the same period bank portfolio holdings of single-family first mortgages and MBS grew by almost 70 percent, from $2.29 trillion to $3.87 trillion. And the volume of Ginnie Mae securities backed by FHA or VA mortgages virtually exploded—increasing by 360 percent from $465 billion at December 31, 2007 to $2.14 trillion at March 31, 2020.

Fannie and Freddie’s guaranty fees today are based on FHFA’s “conservatorship capital” requirements, which are consistent with its June 2018 capital proposal. FHFA’s May 2020 proposal would raise the required capital on Fannie and Freddie’s September 30, 2019 books of business from $137 to $243 billion, or by 77 percent, relative to the June 2018 proposal. Such a massive hike in required capital, if passed on as higher guaranty fees, would greatly exacerbate the pricing disparities with the FHA and banks that already exist, resulting in an even greater skew in relative financing shares than has occurred to date.

The FHA’s new business in 2019 had an average loan-to-value (LTV) ratio of 91.6 percent and an average credit score of 670. The table of “Performing Loan Base Risk Weights” from FHFA’s May 2020 capital proposal assigns a risk weight of 119 percent—or 9.5 percent capital—to this combination of LTV and credit score if the loans are guaranteed by Fannie or Freddie. But Fannie and Freddie’s high LTV loans have private mortgage insurance (PMI), whereas the same loans guaranteed by the FHA do not. Removing the credit for PMI pushes the required capital for the FHA’s average 2019 business, if done by Fannie or Freddie, to 16 percent, plus a 1.5 percent buffer. The FHA’s statutory minimum capital requirement is 2 percent, and at the end of its 2019 fiscal year its total capital resources were 4.5 percent of insurance in force. FHFA’s May 2020 capital rule thus would require Fannie and Freddie to try to price its high LTV-low credit score business off nearly four times the capital the FHA now holds, and more than eight times its statutory minimum.

The May 2020 capital proposal would result in a similar market challenge with respect to commercial banks. Fannie and Freddie would be able to use their proposed 4.0 percent minimum capital only to make credit guarantees, for which their average net fee on new business in 2019 (after TCCA payments to Treasury) was 46 basis points. Banks can use their 4.0 percent minimum capital to buy mortgages with the same credit risk as Fannie and Freddie take, but then fund them with short-term, maturity-mismatched consumer deposits and purchased funds and earn a spread of over 300 basis points. Banks’ ability to earn income from both credit and interest rate risk-taking is an enormous advantage when overcapitalization pushes guaranty fees to levels that become disconnected from the risk of the underlying loans. Fannie and Freddie have no alternative but to attempt to charge those fees to earn a market return on their capital, whereas banks can, and do, accept modestly lower spread income and still retain or buy mortgages that are highly profitable for them.

There are market limits to increases in guaranty fees

There are limits to how much Fannie and Freddie can raise guaranty fees before they lose significant business to the FHA or commercial banks, and data from FHFA’s 2014 document “Fannie Mae and Freddie Mac Guaranty Fees: Request for Input” help define them.

In this document there is a table showing Fannie and Freddie’s target and charged guaranty fees on the business they did in the first quarter of that year, for each of nine combinations of LTV and credit score ranges. From the table it is possible to deduce that at this time the companies’ average required conservatorship capital was a little over 3.00 percent, and that they were targeting an after-tax return on equity (ROE) of 11.0 percent. Achieving this required them to charge an average guaranty fee of 72 basis points (including the 10 basis points for TCCA), but there was a marked difference between the 35 basis-point target fee for the least risky 20 percent of that quarter’s business and the 130 basis-point target fee for the riskiest 20 percent. (The target fee for the middle 60 percent was 65 basis points.)

How the companies actually priced those segments of their business is instructive. They charged 50 basis points for their least risky loans (15 more than the target fee), 58 basis points for the medium-risk 60 percent of their loans (7 less than the target fee), and only 76 basis points for their highest-risk loans (54 less than the target fee). The huge shortfall in the fee on the riskiest 20 percent of Fannie and Freddie’s business—and the modest underpricing of their business with medium risk—caused their average charged fee overall to be only 60 basis points, not 72. Consequently, their return on conservatorship capital for that quarter’s business was only 8.5 percent, far below their 11.0 percent target.

Looking back, it seems clear what happened. Fannie and Freddie’s average charged fee in 2013, including the 10 basis points for TCCA, had been 55.0 basis points. When it rose to 60.5 basis points in 2014, the companies’ outstanding credit guarantees fell, by 0.5 percent. Then as they cut their fees over the following three years, their business growth resumed. These volume effects, viewed in the context of the pricing grids, strongly suggest there may be something of a “pricing resistance wall” when Fannie and Freddie’s average guaranty fee rises above 60 basis points. Specifically, when the fee on lower-risk loans exceeds 50 basis points larger volumes of business shift to the banks, and when the fee on higher-risk loans exceeds 75 basis points similar volumes of business shift to FHA, or don’t get done at all.

Given Fannie and Freddie’s average net fee on new business in 2019 of 46 basis points, the capital required by FHFA’s May 2020 proposal would produce a sustainable ROE of about 8.0 percent, far below the 12.0 percent average ROE of commercial banks. The companies’ ROEs would rise to around 10.0 percent if the TCCA is allowed to expire in October of 2021 and they retain the 10 basis points they have charged for this tax over the past nine years. But this is not a sure thing. And in any event, guaranty fee increases much beyond their current total of 56 basis points (including the TCCA fee) seem likely to trigger competitive and borrower responses similar to what Fannie and Freddie experienced in the middle of the last decade.

For this reason, significant increases in guaranty fees do not appear to be either a sure or a sufficient means of remedying the damage to Fannie and Freddie’s business caused by the imposition of a 4.0 percent minimum capital requirement. To permit Fannie and Freddie to be competitive in the market, FHFA must lower that minimum to one better aligned with the companies’ historical credit losses, as discussed above, and also re-do the May 2020 risk-based standard to eliminate its excessive conservatism, whose purpose was to push required risk-based capital up to a level approximating the arbitrary Basel bank minimum.

FHFA must re-do, and greatly simplify and clarify, its risk-based capital standard

A properly designed, and transparent, risk-based capital standard for Fannie and Freddie would have three distinct and clearly identified components: (a) the amount of initial capital required to survive the FHFA-defined stress environment; (b) other required capital to cover operations and other risks, as well as model risk or imprecisions in the stress test, and (c) a level of “buffer capital” sized to ensure continued access to the debt and equity markets throughout the stress period. Once the risk-based standard has been specified, FHFA would set a data-driven minimum capital percentage to serve as a floor for the risk-based standard, which would be binding only under extreme or unusual circumstances.

FHFA’s calculation of the amount of initial capital in its June 2018 capital proposal suffered from having cushions and elements of conservatism suffused throughout the stress test in ways that made them difficult to discern or quantify. The most obvious was not counting guaranty fee income as an offset to credit losses, which is particularly punitive to affordable housing borrowers. The May 2020 stress test still does not count guaranty fee income, and adds even more elements of conservatism that raise gross required credit risk capital on Fannie and Freddie’s September 31, 2019 books of business from $127 billion in the earlier version to $152 billion. Included in the additional conservatism of the May 2020 proposal is a 15 percent risk weight (or 1.2 percent minimum capital requirement) on all loans guaranteed by Fannie and Freddie irrespective of risk, which if not rescinded would further penalize affordable housing borrowers by drastically reducing the amount of “excess” fees on low-risk loans available to be used as cross-subsidies for higher-risk loans.

In a re-specified risk-based capital rule, FHFA must begin with a “clean” stress test—drawing on Fannie and Freddie’s historical data to project the amount of initial capital required to cover all credit losses projected through the stress period, without cushions or add-ons. If guaranty fees generated during the stress test are not counted as offsets to credit losses, they must be counted in determining the size of the companies’ going-concern capital buffer, as discussed below. And while the calculation of required initial stress capital should be straightforward, FHFA should disclose the results of the stress tests run independently by Fannie and Freddie (in what FHFA calls the “advanced approach”) as well as its own results, to ensure consistency and transparency.

Other required capital must be clearly identified, described and defended. Aggregate required capital to cover cushions and add-ons for market, operations and other risks also must be in reasonable proportion to the amount of initial capital required to pass the stress test, so that Fannie and Freddie’s guaranty fees are driven principally by the credit risk of the underlying loans, not the cushions and add-ons.

In addition, FHFA must seriously reconsider its decision to base the companies’ risk-based standard on mark-to-market rather than original LTVs. The “collars” on market value LTVs in its May 2020 proposal do reduce some of the procyclicality of the earlier version, but they still subject the companies to very large increases in required capital during a severe downturn. The FHFA stress test assumes a 25 percent decline in home prices, and should anything approaching that occur there would be a period when home prices fall from above the “collar zone” to below it, subjecting the companies to the effects of a 10 percent rise in mark-to-market LTVs. That would increase their required risk-based capital by more than 1.0 percent, throwing them out of capital compliance. Unless FHFA switches to original LTVs, Fannie and Freddie would need to hold enough excess capital to cover this risk, making their effective capital requirement that much higher (in effect, a “hidden cushion”).

There are three separate capital buffers in the May 2020 proposed risk-based standard: a stress capital buffer (0.75 percent of adjusted assets), a stability capital buffer (keyed to FHFA’s definition of each company’s “market share”), and a countercyclical capital buffer (initially zero, but it could be imposed in times of stress). The stability capital buffer must be eliminated entirely, because it is based on an inaccurate definition of market share and a misunderstanding of the systemic risks that produced the mortgage and financial crises.

Today Fannie and Freddie “finance” very few mortgages, as they have been required to exit the portfolio investment business. Instead, they guarantee mortgage credit, allowing others such as capital markets investors and banks to finance them without having to worry about the risk of repayment by each individual borrower. For this service they receive a relatively small fee compared with the spread earned by the funder of the mortgage. It is not correct for FHFA to assert that Fannie and Freddie have a “44 percent share of the single-family mortgage market.” They do not. They operate only in the credit risk management segment of that market, along with private mortgage insurers who also earn revenues on many of the loans Fannie and Freddie guarantee. Weighting all mortgage market activities—origination, servicing, credit risk management and funding—by the revenues available to be earned in them, Fannie and Freddie’s combined total mortgage market share is only about 2 percent, well below the 5 percent threshold for FHFA’s punitive capital surcharge.

Moreover, it is a misreading of history to equate a large volume of credit guarantees by Fannie and Freddie with greater systemic risk. The huge jump in mortgage credit loss rates for banks, Fannie and Freddie during and after the 2008 crisis was caused by less credit guaranty business being done by Fannie and Freddie, not more. From the early 1990s through the mid-2000s, Fannie and Freddie’s dominance as secondary market credit guarantors enabled them to exert strong influence over national underwriting standards. But in the early 2000s, concerns by Treasury and the Federal Reserve over rapid growth in the companies’ portfolios led them to support the creation of an alternative, unregulated financing mechanism using senior-subordinated private-label securities (PLS) to compete with Fannie and Freddie. By 2005, issuance of PLS exceeded the issuance of MBS by Fannie, Freddie, and Ginnie Mae combined. At that point, Fannie and Freddie no longer could enforce their underwriting disciplines; originators could sell loans through PLS, whose issuers were not exposed to the losses on them and thus had no incentive to limit their risk. Undisciplined underwriting became the norm, leading to the boom and bust that followed. A proper reading of the financial crisis is that having companies that specialize in credit risk management, with their own capital at stake, playing the lead role in setting national mortgage underwriting standards is a clear benefit, and leads to lower, not higher, credit losses for the system as a whole. FHFA has this exactly backwards with its “stability buffer”.

The stress capital buffer is a valid concept, but it is a mistake to view this buffer for Fannie and Freddie as the equivalent of the “capital conservation buffer” proposed in Basel III for banks. The Basel III buffer was a response to the realization that during the financial crisis banks experiencing credit losses were subject to runs by depositors and holders of short-term certificates of deposit, which could cause a bank to become insolvent long before its credit losses did. That is a much lesser concern for Fannie and Freddie. They have relatively little debt compared with the volume of their credit guarantees, and even in a stress period their credit losses unfold relatively slowly, as evidenced during the 2008-2012 period.

Sizing the stress capital buffer at 0.75 percent of assets seems reasonable, provided that FHFA remedies an inconsistency in the construction of this buffer that exists not just in the current proposal but in the equivalent going concern capital buffer from the June 2018 version: Fannie and Freddie are required to have sufficient capital to remain as going concerns, yet the structure of their risk-based capital requirement assumes that they are not going concerns. Were the risk-based capital stress test to be done on a going-concern basis, (a) guaranty fees from loans that remain on the books during the stress test would count towards covering credit losses, (b) liquidated loans would be assumed to return as new business, with guaranty fee rates at the previous year’s new business average, and (c) the companies’ initial capital would be calculated based not on lifetime credit losses but on cumulative losses up to the point at which income from new business is sufficient to return each company to its fully capitalized level.

Along these lines, the stress capital buffer could be integrated into the risk-based capital stress test. Required gross credit risk capital would be the amount necessary to keep each company’s capital above 0.75 percent of adjusted assets (the stress buffer) throughout the stress period, while allowing capital to rebuild through assumed new business until each company once again is fully capitalized. But should FHFA elect not to follow this approach, it must at a minimum count guaranty fee income on existing business in its base stress test, just as the Federal Reserve counts bank income in the Dodd-Frank stress tests it conducts for large commercial banks. FHFA then would add the 0.75 percent stress buffer to the result of that test.

*                                                                         *                                                                      * 

It is clear that FHFA engineered its May 2020 capital proposal to inhibit Fannie Mae and Freddie Mac from fulfilling their charter purposes of providing “ongoing assistance to the secondary market for residential mortgages,” by requiring the companies to capitalize their credit guarantees in amounts grossly disproportionate to their risks, which in turn forces them to price that business at levels starkly at odds with the explicit or implicit pricing of mortgage credit risk by other sources of finance, notably the FHA and commercial banks.

Less clear is what FHFA seeks to achieve through this policy. Yet without changes to the May 2020 re-proposal along the lines of this comment, homebuyers will face unnecessarily higher costs and reduced availability of mortgages, and the mortgages that are made will pose much more risk to the financial system. Loans that could be safely guaranteed by Fannie and Freddie were they to be given reasonable capital requirements will instead go to the FHA—which has far less capital and is backed directly by taxpayers—and to banks, which are taking the same mismatch risk that caused the thrift industry to fail by funding long-term fixed-rate mortgages with short-term consumer deposits and purchased funds, at a time of historic lows in interest rates. Furthermore, overcapitalizing Fannie and Freddie to the point of inefficiency and non-competitiveness will make FHFA’s goal of attracting the new equity required to quickly remove them from conservatorship much more difficult, if indeed attainable at all.

198 thoughts on “Comment on FHFA Capital Re-proposal”

  1. Pingback: Then, and Now | HOWARD ON MORTGAGE FINANCE

  2. Tim – care to comment on FSOC’s Finding of the Enterprises’ Potential Stability Risk?

    The Council’s analysis suggests that risk-based capital requirements and leverage ratio requirements that are materially less than those contemplated by the proposed capital rule would likely not adequately mitigate the potential stability risk posed by the Enterprises.

    https://home.treasury.gov/system/files/261/Financial-Stability-Oversight-Councils-Statement-on-Secondary-Mortgage-Market-Activities.pdf?utm_medium=email&utm_source=govdelivery

    Like

    Reply

    1. Tim

      if you do comment, I would be interested in your take on “stability risk” as opposed to solvency/liquidity risk…and how that might be possible if GSEs don’t take fast moving deposits; perhaps the notion is that the GSEs would purchase and securitize less mortgages, leaving more mortgages within banking sector…but hasn’t that been the regulatory desire all along?

      rolg

      Liked by 1 person

      Reply

      1. The FSOC is chaired by the Secretary of the Treasury, and among its “heavyweight” members are the three main bank regulators: the Chairmen of the Federal Reserve and the FDIC, and the Comptroller of the Currency. Given that, it’s not surprising that the FSOC’s review of the activities of the secondary mortgage market would be from a bank perspective, and it is. Here is what they say about the proposed FHFA capital rule:

        “The proposed rule would require aggregate credit risk capital on mortgage exposures that, as of September 2019, would lead to a substantially lower risk-based capital requirement than the bank capital framework. Given that the proposed rule’s risk weights are highly sensitive to certain risk characteristics of the exposures, average risk weights and the required credit risk capital would change through the credit cycle. The Enterprises’ credit risk requirements, however, likely would be lower than other credit providers across significant portions of the risk spectrum and during much of the credit cycle, which would create an advantage that could maintain significant concentration of risk with the Enterprises.”

        Cutting through the blizzard of verbiage, the FSOC is saying that because the May 2020 FHFA capital proposal will result in Fannie and Freddie holding less capital than banks, that will give them a competitive advantage that will lead to a “significant concentration of risk within the Enterprises.” Apparently, none of the bank regulators understand or wish to admit that over the last three decades the average credit loss rates on the assets banks hold have been nearly six times the average loss rate of the one asset—residential mortgages—Fannie and Freddie are allowed to deal in. To be safe and sound, says FSOC, Fannie and Freddie must hold at least as much capital as banks.

        It’s hard to escape the conclusion that Calabria is using the FSOC report as cover for not making any significant changes in his capital proposal. He’s seen all the comments on the rule, and he’s not a dim person. He knows that 4 percent minimum capital is far more than the companies really need to cover the risk of guaranteeing residential mortgages. And his comments about “model risk” and the need for buffers are for an external audience: he also knows that the June 2018 version of the capital rule already declined to count the loss-absorbing capacity of the $20 billion per year the companies earn in guaranty fees (about a third of which they’ve received in cash, as loan-level price adjustments, so they’re sitting on the balance sheet, with no doubt as to their value). Yet he insists he must have even more of a capital buffer than that.

        None of this makes any financial sense (and you’ll note that neither FSOC’s statement nor FHFA’s press release about it contain any numbers; they’re just rhetoric). There is something else going on here. As I said in my comment letter, I’m not going to speculate on what that may be, but to me, the message Calabria is sending to potential new investors in the companies is, “As long as I’m their regulator, they’re going to be running in the mud with ankle weights.”

        I’ll be very interested to see how Fannie and Freddie, and their financial advisors, react to where Calabria appears determined to take them.

        Liked by 3 people

        Reply

        1. Tim,
          My concern all along after the re-proposed capital rule came out was that Calabria knew what he wanted for capital and nothing was going to change his mind. This meeting and his remarks seem to confirm this. It would appear that the comment period was merely a show. I hope I am wrong and he will listen to the majority of the comments calling for changing the proposal.

          Like

          Reply

        2. Tim

          Calabria re FSOC: “In other findings and recommendations related to the capital rule, the Council confirms the importance of ensuring that each Enterprise is capitalized to remain a viable going concern both during and after a severe economic downturn. A ‘claims paying capacity’ or similar standard is not appropriate for financial institutions of this size and importance.”

          so it is not relevant to attribute an insurance regulatory test (claims paying capacity) to MBS insurers like the GSEs (understanding the vastly reduced portfolio of mortgage loans compared to 2008 makes it appropriate to regard the GSEs as monoline insurers). as I recall, Met Life successfully opposed SIFI status due to its size as a large insurer…though not as large as GSEs.

          I respect prudence, but I usually want to understand its place in the tradeoffs involved in setting standards. it seems that according to FSOC and Calabria, the GSEs are too damn big…full stop…and the negative tradeoffs (increasing fees to a nation of home mortgagors and making it harder to capitalize the very companies that they state require it so badly) incurred to advance prudence (more capital) is not their problem.

          rolg

          Like

          Reply

          1. All Calabria is saying in the quote in your first paragraph is that Fannie and Freddie’s capital should be greater than the dollar amount required to survive the FHFA-designed stress test (i.e., their “claims paying capacity.”) Nobody disagrees with that. The question is: how much additional “going concern capital” should the companies be required to have in order to maintain the confidence of MBS investors that the credit guarantees they make on the mortgages they’re financing during a stress period will still be good? Calabria doesn’t even attempt to give an answer to that question. Nor does he appear to understand how FHFA’s “prompt corrective action” authorities work. Let’s say there IS a repeat of the 25 percent home price drop experienced between 2006 and 2011. Fannie and Freddie won’t be allowed to run their capital down to zero. They will have to either begin the stress period with excess capital (which I believe they always will hold), or go into the equity market for new capital to offset the large bulk of their credit losses. Otherwise they will become ‘significantly undercapitalized,’ then ‘critically undercapitalized,’ and FHFA will put them in conservatorship again.

            In the real world, the huge amounts of “buffer capital” Calabria keeps insisting Fannie and Freddie hold will be ON TOP of the excess capital they will hold and the new capital they will be compelled to raise during a stress period to remain functioning entities. I hope one of the investment advisors sits him down and explains to him how disconnected his conception of Fannie and Freddie’s “proper” capital structure is from market reality.

            Liked by 1 person

          2. The only conclusion is consent decree, remove NWS, retain earnings, no new capital, limited backstop until meet capital requirements many years later. ..

            Like

          3. @BIGe

            you are right that for anyone invested (either in shares or in policy commitment) in the GSEs, in order to keep your eyes on the prize it is necessary to look to the horizon with a long view. once the senior preferred is written down (as I suspect will happen before the collins scotus oral argument in order to settle and moot the case), and the GSEs are released into a consent decree, then this GSE govt-imposed nightmare will be on the path to being over. the functionality of the GSEs will be sub-optimal, but this will be just another example of how the perfect should not be the enemy of the good.
            rolg

            Liked by 1 person

        3. Mr Howard

          In the 12 yrs. plus trying to solve how much capital is required to withstand stress, my question to you is: has borrowing ability and capacity ever been addressed post conservatorship?

          Like

          Reply

          1. In a similar vein – has the gov’t ever had to show their work regarding the modeling of the losses that caused the GSEs to have to incur $320B in non-cash write downs from 9/08-12/11?

            In the name of the need for all the capital as proposed, it would seem the assumptions would be very important to understand how they modeled the underlying collateral. It seems getting to those losses in models would require some very dire assumptions at varying points in time, which of course never came close to the actual resolution of those loans, hence the reversal, NWS, et al.

            The question would be how outside of the realm of losses that had ever occurred were the assumptions used. Having transparency there to see what assumptions they made and if those assumptions were at all reasonable to other modelers outside of the gov’t. The lack of intellectual honesty is staggering.

            A second question I had was, how can the idea of a monoline insurer that can’t invest its premiums in the product it has most expertise in a portfolio be made attractive to outside investors?

            The entire concept of insurance is to invest the premiums to make a spread to the payouts, if the portfolio business is never allowed to be reinstated at the GSEs why would investors want to be involved with that type of capped upside and shrinking market share, due to overly punitive capital regime, that was based on what are effectively an interpretation of history that has more holes than some cheeses? The lack of intellectual honesty is, again, staggering.

            Liked by 1 person

          2. FHFA has not addressed in any detail the source of or reason for the $326 billion in non-cash expenses added to Fannie and Freddie’s books from the time they were put into conservatorship until the end of 2011, when they began reversing. The best it has done is a version of “well, we thought they were necessary or appropriate at the time.” This story is what I tried to counter in my amicus before the Supreme Court. There are three main prongs to my argument that the large majority of the expenses were artificial: (a) the evident advance planning that went into the companies takeovers, which were not justified by either their financial conditions or the law; (b) the unprecedented use of non-repayable senior preferred stock, linked to the dollar amount of booked losses, as the vehicle for their “rescue,” and, (c) perhaps most persuasively, the fact that all of the losses that were responsible for the December 2011 senior preferred stock outstanding were repaid in an 18-month period, which could only have happened if those losses were temporary or artificial. Based on Calabria’s reaction to the FSOC statement, though, he clearly intends to stick with his story that what FHFA called “peak cumulative capital losses” at the companies during the crisis (which included these book losses) are real, and thus a valid basis for requiring them to hold 4 percent minimum capital. And he, and FSOC, are simply silent about Fannie and Freddie’s actual, historical credit loss rates–including during the crisis– which don’t support or justify anything close to 4 percent minimum capital.

            Liked by 6 people

    1. There were six amicus curiae briefs filed today in support of plaintiffs in Collins et. al. vs. Mnuchin. They were from the Americans for Prosperity Foundation, the New Civil Liberties Alliance, the Pacific Legal Foundation, Institutional Investors in Fannie Mae, Thomas P. Vartanian, and the brief cited above, from Amici Curiae Scholars, a group of law professors.

      I’ve only read two of these so far (have been away for most of the day), and will get to the others as soon as I can. Readers who have read them and have comments they feel might be of interest to others are welcome to make them.

      Liked by 2 people

      Reply

      1. Tim

        I found all of the briefs to be helpful and well done, but the Amici Curiae Scholars brief certainly the least so. Essentially, this is not a legal brief, it doesn’t analyze the law in respect of the claim that the NWS is ultra vires (it doesn’t address the constitutional claim), it simply makes the unexceptional point that even as the govt increasingly must respond to financial crises (act as “financial firefighters” as they put it), the govt cannot do so in an illegal manner (govt must observe legal “guardrails”). in a sense though, perhaps this isn’t an unexceptional point. judges in circuits other than the 5th circuit have given the govt the benefit of the doubt in a situation involving a financial crisis (though the NWS was well after the crisis period), in large part imo because their eyes glaze over when financial matters are in dispute. these academics purport to be finance and financial regulatory experts, and so if they are very troubled by the NWS (they never come right out and argue that the NWS is ultra vires, just that they are very troubled), then some of the govt’s “trust us” presumption is challenged. if there is one brief you need not read, it is this one.

        rolg

        Liked by 1 person

        Reply

      2. Tim

        An amicus brief in favor of no party appeared late yesterday on the scouts docket filed by Bryndon Fisher et al, who have a case pending in the Court of Claims arguing that Ps claims are derivative and not direct: https://ecf.cofc.uscourts.gov/cgi-bin/show_public_doc?2013cv0608-74-0

        while this scotus amicus brief (https://www.supremecourt.gov/DocketPDF/19/19-422/154783/20200923221622980_Fannie%20and%20Freddie%20Collins%20Merits%20Amicus%20Brief.pdf) argues that collins claims should proceed as derivative claims (the succession clause should not constitute a bar due to fhfa’s conflict of interest), their argument is contrary to the holding of the 5th Circuit en banc…and therefore in my view, this amicus brief is antagonistic to the collins Ps case before scotus. while antagonistic, this brief is weakly argued imo, with no respectable discussion of the merits of the 5th circuit en banc holding that APA provisions provided Ps a direct claim, so I wouldn’t expect this amicus brief to be found persuasive by scotus.

        rolg

        Liked by 1 person

        Reply

        1. I’ve now finished reading the (seven) other amicus briefs filed yesterday, including the one by Fisher et al. I understand why they filed it–hoping to get a ruling on the derivative versus direct issue that’s helpful to their case in the Court of Federal Claims–but it doesn’t help with Collins, where as you say the characterization of the claim as direct was accepted without challenge by the Fifth Circuit en banc. Moreover, it seems to me that a direct claim that relies on the “zone of interests” test in the APA is a more reliable path to the invalidation of the net worth sweep than a derivative claim than comes up against the Succession Cause (where plaintiffs repeatedly have lost in lower and appellate courts previously). So for SCOTUS, this is a sleeping dog that ought to be allowed to lie. But there’s probably no harm done here, either; the lawyer who filed my amicus tells me that briefs of amici in support of neither side, as this one, typically are ignored.

          Of all the briefs, the one I thought was the most useful (other than mine, of course!) was Tom Vartanian’s. The government in the past has frequently claimed that HERA created in FHFA a “super-regulator” with powers not contemplated in any other regulatory statute–including the ability to act as a non-conserving conservator– and Vartanian has the standing, experience and credibility to demolish this argument, as I thought he did in his brief. I agree with your and VM’s assessment of the Scholar’s amicus–it wraps a general discussion of prior instances of emergency regulatory intervention around legal arguments that were made better in other briefs. And I thought the briefs by the various legal advocacy groups were useful, even though they did not really add any new arguments, just reinforced and amplified ones made in the Collins opening brief and previous filings in the case.

          Liked by 4 people

          Reply

          1. Tim

            I thought Vartanian’s brief was especially effective where he presented for comparison together the identical (in all material respects) language from HERA and the FDIC statute (p. 13). it is one thing to say the language is identical, but I thought it was quite effective to take the brief space to lay them out side by side (vertically).

            rolg

            Liked by 4 people

    1. This was filed electronically a day before the deadline; printed copies are being sent to the Court (and others) to arrive tomorrow.

      The amicus was done at the request of Collins counsel, with the goal of giving the justices a detailed explanation of why the government’s narrative about the net worth sweep is false. I was pleased to have been asked to do it. While the government knows that at this stage of legal proceedings in the APA case the plaintiffs’ version of the facts must be accepted as true–and it also contends in its legal arguments that FHFA’s motives for entering into the sweep are irrelevant–defendants nonetheless insist on repeating their false version of the facts in every pleading. I believe they do this in order to create the impression that they are the “wronged party,” in the hopes this will have a subconscious effect on judges’ legal judgements (which it seems to have done in the lower courts and most appellate courts). Even though that shouldn’t work at SCOTUS, putting the actual facts in an amicus brief for the Court is nonetheless a good idea in such an important case.

      Liked by 5 people

      Reply

      1. Tim

        absolutely. there is a subtle we vs. they dynamic that the govt has always tried to suggest to the judges, and the govt did it as well in its opening brief at SCOTUS in collins. we is the govt, that represents all taxpayers/citizens and that is fighting the good fight (and given the circumstances surrounding the NWS, the govt has to continually reinforce its false version of events in order to appear to fight the good fight). they are the hedge funds and greedy speculators. the govt would improperly (under the federal rules of civil procedure) introduce false factual assertions that would seek to curry the judges’ sympathy with the govt, have the judges in effect choose sides based upon group identification rather than legal merit, side with the we vs they. the only judge to call out the govt for doing this in oral argument was the great Judge Jones, in the 5th circuit collins argument, making it plain that the 5th C was going to accept Ps well-pled allegations as true at that stage of the proceedings (motion to dismiss). Ps counsel in the collins SCOTUS reply and opening brief had to call out the govt once again, pointing out how often the govt interjected factual allegations that are contrary to Ps allegations and which had to be ignored at this stage of the proceedings. Your amicus brief serves an important function in trying to keep the govt onsides, and keep the justices from being improperly influenced by govt false assertions of fact that the govt knows it should not be doing.

        rolg

        Liked by 4 people

        Reply

          2. That’s interesting on the cite of Freddie’s 2008 Q2 earnings release. In correspondence with a person at the firm who does the formatting and printing for SCOTUS, my lawyer at Alston & Bird mentioned that his staff was struggling a bit with the preparation of the “Table of Authorities” and the specific form of the cites for the referenced facts. They obviously missed on that one. I assume that will just be considered a “foot fault.”

            Like

    2. Tim,

      Very well stated and written! A beautifully written summary of what many of us knew to be the case.

      I am continuously surprised that the switch in Administrations (Bush —> Obama) which undoubtedly played a huge role in the implementation of the ’12 NWS, is ignored. Paulson was long shown the door, yet the Hydra he created was beautifully set up for another Administration under the guise of ‘unintended consequences’ to use for potentially targeted purposes (e.g. circumventing Congress’ Power of the Purse to fund Obamacare). Political motivations of the party in power are crucial to the implementation of the NWS, and even Mnuchin has publicly stated that F&F’s $$$ had gone to fund Obamacare.

      Had to turn away 3x and take a break from your excellently written amicus when you talked about, and quoted, Hank ‘The Tank’ Paulson. His actions, supported and propagated by subordinates, IMO are one of the clearest egregious examples of government interference, manipulation and illegality I have witnessed, and I consider myself a historian. As a Libertarian, Paulson showed such blatant disregard for the free market and even a semblance of laissez-faire economics that his actions were destined to lead to manipulation by another administration and malinvestment. He cannot claim ‘Idiot Savant’ status! His July 21, 2008 ‘Eton Park’ meeting designed to crater the Commons and Jr. Preferreds of F&F laying the groundwork for Conservatorship was simply over the top. You highlighted this well.

      Lastly, you did not dive into the fundamental ‘Receivership v. Conservatorship’ issue, especially the strict ramifications of each. Is this important/crucial in your mind? In His mind, Hank Paulson envisioned Receivership but went the Conservatorship route due to U.S. Treasury debt consolidation issues among others.

      Thanks again, VM

      Liked by 2 people

      Reply

      1. VM– I did consider a paragraph on receivership versus conservatorship, but decided against it because I thought it would have distracted from the flow of the narrative without adding enough to compensate. I felt I had to be economical on the time I spent on the conservatorship (and I still wrote a lot about it) because that’s not what’s being challenged in Collins; only the net worth sweep is. The fact that Paulson chose conservatorship for Fannie and Freddie is highly relevant (because it resulted in accounting actions whose unwinding led Treasury to impose the net worth sweep); that Paulson first considered receivership, while interesting, doesn’t add to that point, and may in fact distract from it. I also was mindful that Cooper & Kirk had addressed the receivership versus conservatorship issue from a legal standpoint their opening brief, and didn’t see much need to add to what they’d said.

        Liked by 2 people

        Reply

    3. Tim,

      I just wanted to thank you for taking the time to write and submit such an excellent, factually supported brief! I’ve followed your blog for years now and learned a lot from both you and ROLG.

      I became intrigued by this case in 2012 in a roundabout way, I was preparing to provide expert testimony on behalf of FNMA, a secured creditor in bankruptcy matter involving a debtor in Nevada (the assets were apartment complexes that were part of FNMA’s low income housing tax credit initiatives – LIHTC). Further, having been involved in corporate restructurings and litigation for nearly 30 years now, my initial inclination was and still remains that to the extent anything was necessary, a simple line of credit, or similar structure, from Treasury would have been more than sufficient to calm any actual market related concerns the GSEs may have encountered post the 2008 period. (I should probably be careful using the word “may” as it relates to the GSE cases…ie. Lamberth)

      As I dug in to the details of the GSEs role, the conservatorship and its origins, I became increasingly amazed at, in my opinion, the utter abuse of power by Paulson and disgusted by the government and FHFA’s willingness to push a false narrative. Your book, The Mortgage Wars, educated me as to the history of these agencies and political battles and differences in ideology surrounding these companies.

      Thanks again for all your efforts – it is appreciated. I truly hope the justices take the time to read and study your brief and keep their own biases out of the decision-making process.

      Liked by 4 people

      Reply

  6. Tim

    Justice Ginsberg’s passing is truly an end of an era. I can think of no individual in US history who did as much as she for women’s civil rights.

    The odds for Ps in Collins have improved as Justice Ginsburg would have been a govt vote. fhfa and DOJ are aware of this and, therefore, settlement odds have improved as well, imo.

    rolg

    Liked by 8 people

    Reply

    1. Tim

      I thought I would report to this blog’s readers on an esoteric area of SCOTUS practice: what is the legal effect of a 4-4 SCOTUS decision. this of course rarely happens.

      the answer if this happens in collins is that the 5th circuit’s en banc decision is upheld and is binding on the parties. since it is binding on FHFA and Treasury (and Ps), a 4-4 SCOTUS decision in collins would have the effect of reversing all other circuits holding to the contrary, such as the DC Circuit in Perry. (it does not serve as SCOTUS precedent that may be argued by other parties in subsequent cases, but that is a matter of indifference to the Ps in collins…a win is a win).

      backgrounder: https://constitutioncenter.org/blog/constitution-check-if-the-supreme-court-splits-4-to-4-does-anybody-win

      so a 4-4 SCOTUS decision results in an APA win and a half of loaf re constitutional claim. In effect, the govt needs to win 5-3 in collins…and that is a very tall order! again, since the govt knows this, I would be hard pressed to understand why settlement is not the next consideration for the govt.

      rolg

      Liked by 5 people

      Reply

      1. Thanks, that’s very informative.

        Precisely because this is so esoteric, though, while I agree it gives the government strong incentive to settle it still doesn’t give them the political cover I believe they seek (“Why are you giving $20 billion a year in income and more than $200 billion in claims to the companies’ assets away to greedy hedge funds who bought their shares on on the cheap after you put up $187 billion in taxpayer money to rescue them?”). To me, that’s what would be holding Treasury back from settlement–certainly before the election.

        Liked by 1 person

        Reply

      2. Could you clarify on the ramifications of a 4-4 split vote and the enbanc decision being upheld? Does this mean that the enbanc denial of backward-looking relief would also be upheld, and therefore result in a hollow victory for plaintiffs?

        Like

        Reply

        1. It would not be a “hollow victory.” On the constitutional claim, the Director of FHFA would be held to be unconstitutional–meaning that Calabria could be removed by the president at will–and plaintiffs would be denied the backward-looking relief they seek: the invalidation of the net worth sweep. But plaintiffs would prevail on their APA claim, meaning that they would be allowed to challenge the legality of the sweep, and the case would be remanded to Judge Atlas in the Southern District of Texas for trial on the facts, which plaintiffs almost certainly will win (although that will take some time).

          Liked by 2 people

          Reply

          1. From reports thet are coming out Trump will nomimate a replacement by the middle of next week. So by Dec 8th we may have 9 Supreme Court Justices again.

            Liked by 1 person

          2. Tim/J

            I don’t want to get too far into the weeds on this, but if there are only eight justices as of 12/9 (and by custom, any subsequently installed justice would not participate in the decision), and there is to be a 4-4 decision on the claims, one might posit that Chief Justice Roberts would be the most likely swing vote against Ps. while I would doubt this with respect to the APA claim, I would seriously doubt this with respect to the constitutional claim. and a win on the constitutional claim provides Ps an immediate victory on the merits, with a remand to a lower court solely to consider remedy.

            rolg

            Liked by 3 people

  7. Tim

    I listened to parts of the HFSC hearing with with partial attention. two things caught my attention, and I paraphrase.

    in response to a question about whether the (high) capital levels will raise fees (G fees), I thought I heard Calabria to say that no one will be required to pay a higher fee because the capital rule will be phased in over time. (I do believe that the capital markets will prefer to swallow a large overall capital raise in pieces spread over time, than fewer issuances compressed into an early timeframe, which “should” place less pricing pressure on each capital raise than otherwise, which “should” place less pressure to raise G fees than otherwise). I find this interesting insofar as this sounds like advice Calabria has received from or vetted with the GSEs’ bankers. so I am looking for a final rule with the same % levels but likely some tweaks (especially concerning CRTs), but phased in over whatever timeperiod the bankers have advised they can live with.

    the second comment was strange, as Calabria said he wanted the GSEs to substantially improve their corporate cultures, to become better corporate citizens, and this was an important change that needed to be accomplished before conservatorship release. what is he referring to? I have the impression that the GSEs are exemplary with respect to their employee practices etc. (it was the fhfa itself that was charged with having sexual harassment at the highest level of its organization)

    rolg

    Liked by 4 people

    Reply

    1. I viewed the hearing until about 2:00 o’clock, when I had to leave it. The one statement I heard from Director Calabria about capital and guaranty fees was during questioning by Congresswoman Velazquez (D-NY), when he told her flatly, and I wrote this down, “There is nothing in the rule that requires them to raise prices.” He didn’t add any qualifier at that time about this being because the capital rule will be phased in over time (although he may have said something to that effect after I left the hearing webcast). What he did say to Rep. Velazquez is that banks were required to increase their capital following the financial crisis, and that he’d seen no evidence of any impact on bank pricing as a result. (He did not mention that Fannie and Freddie had told FHFA, in their comment letters, that the capital rule as proposed would require them to attempt to raise guaranty fees by around 20 basis points.) Calabria on several occasions repeated the claim made in the May capital proposal that the higher capital amount in the proposal would increase Fannie and Freddie’s safety and soundness, and this would be good for affordable housing borrowers.

      My overall impression from the nearly two hours I listened to the proceedings was that Calabria didn’t sound like someone who was having second thoughts about the approach he’d taken to the companies’ required capital. But he also made the expected “we’ll look at all the comments” statement, while giving no indication (again, during the time I was listening) of how long that would take, or what action–re-proposal or final rule–might follow that, and when. On CRTs, I was pleased that he’s looking at that in the right way. Paraphrasing, he said, “A dollar of CRT is not worth a dollar of equity, but nor is it worth zero. Where is it in the middle? That’s an empirical question. We need to figure out what that number actually is.” (I did, though, have the reaction: “The companies, at FHFA’s urging, have been issuing securitized CRTs for seven years. It’s just now occurring to you that it would be a good idea to try to figure out what they’re worth economically?”)

      As to the culture change and “better corporate citizen” issue, I have no idea what Calabria is referring to. Perhaps he has addressed that in one of the many speeches he’s given since becoming Director, but if so it’s nothing that’s stuck with me.

      Liked by 1 person

      Reply

      1. I find “culture” comments very interesting due to little birdies chirping about Mnuchin leading Fannie one day and rather quickly if the unthinkable were to happen (that’s for another conversation). Where does a “culture change” start? At the top. Is Calabria planting the seeds? For him to put such emphasis behind these “culture” comments it only makes me wonder…

        Liked by 2 people

        Reply

        1. Calabria comments:

          Lastly I would also add–this is a little less visible but I would really emphasize it because it’s a big part of this–Fannie and Freddie have what I would consider some of the worst corporate cultures I’ve ever seen in corporate America. And fixing that is a fundamental prerequisite to getting out of conservatorship. These companies must be good corporate citizens if they’re to get out of conservatorship, and the truth is we have a lot of work to do on that front.

          Like

          Reply

          2. He banged on GSE culture in the context of irresponsible lending practices. No mention of the banks’ falsification of docs and the seventeen plus suits the banks settled in favor of the GSEs.

            Liked by 1 person

          4. This was well after I dropped off the live stream, and listening to the segment now, I’m flabbergasted. The corporate culture quote cited above came in response to a question from Rep. Loudermilk (R-GA), who asked Calabria “if the FHFA is incentivizing Fannie and Freddie to return to their pre-crisis behavior with the capital rule.” Rather than addressing and defusing the loaded premise, Calabria instead tossed gasoline on it, saying, “Just the opposite; we are trying to deal with making sure that they don’t go back to their previous behavior. Certainly as I’ve emphasized in a couple of conversations today the model of privatized gains and socialized losses that represents the government sponsored enterprises has deep structural flaws that are outside of my authority to fix.” He then made the remarks about Fannie and Freddie’s culture and corporate responsibility.

            It’s possible that Calabria was simply pandering to the Congressman, telling him what he wanted to hear. But it’s more likely that Calabria really believes what he’s saying, and that he has a fictional notion of what Fannie and Freddie’s pre-crisis behavior actually was. I left Fannie at the end of 2004, after watching our share of outstanding mortgages financed shrink by two percentage points because we refused to chase the very risky mortgages being originated for sale through private-label securities. I think it’s unfortunate that Fannie (and Freddie) didn’t do a better job resisting falling prey to the pressures from their shareholders to maintain their market shares in 2005, 2006 and 2007. But the reality is that Fannie and Freddie’s “pre-crisis behavior” was still doing their best to find the most creditworthy loans being originated during a time of unprecedented underwriting laxity. As I’ve noted many times (most recently in my SCOTUS amicus, that’s going to the printer tomorrow), the delinquency and default rates of the loans Fannie and Freddie financed before the crisis were one-third those of loans financed by banks, and one-tenth those of loans financed through private-label securities. Calabria has no clue as to what was going on in the market then; he’s just parroting the line being peddled at the Cato Institute at the time. And repeating the “private gains and public losses” line is fatuous: with the sole exception of Lehman Brothers, the banks and the issuers of PLS all got bailed out on very favorable terms by Treasury and the Fed, while Fannie and Freddie were nationalized and their shareholders effectively wiped out. The fact that the regulator of Fannie and Freddie either doesn’t know or refuses to acknowledge these things is deeply disturbing.

            Liked by 4 people

          5. Tim

            it was a long day already when Calabria talked about the GSE business model as “private gains and public losses”, which leads me to believe, unfortunately, that his guard was down and he was speaking honestly about his views. The Treasury’s investment in the GSEs is the best US government investment since the Louisiana Purchase, and the best investment by anyone since Manhattan was bought. Public losses, my eye.

            rolg

            Liked by 3 people

    1. Correct. Cooper & Kirk is submitting their brief of behalf of the Collins plaintiffs today, and I’m just finishing up (with the excellent help of a third-party law firm) the amicus curiae brief on behalf of the petitioners I’ll be submitting to the Court next Wednesday. Things are moving forward.

      Liked by 5 people

      Reply

        1. Excellent to have a date to look forward to! Previously, many people speculated a settlement before SCOTUS hears the case. Has that changed at this point or do you think a settlement will happen before Dec. 9? Is there a benefit to Calabria to let the case go to a final decision? He can’t think the government has a good chance of winning here after CFPB decision.

          Liked by 1 person

          Reply

          1. @Juice

            it is hard to predict settlement odds, but I believe all parties have sufficient respect for SCOTUS to try to settle before oral argument IF they are currently seriously contemplating settlement. in terms of taking up scotus time and using up one of a limited number of cert grants that scotus can give in a term, it is one thing for the parties to file for cert and conduct briefing before settling and mooting the case (very rarely done), and quite another to actually go though oral arguments (don’t recall an example). trials are often conducted and settled at the end before judgment once the parties have seen how their case and their adversary’s case match up, but the parties realize that scotus doesn’t consider itself to be a testing ground for the parties to determine the relative merits of their claims so as to finalize their settlement terms at the very last moment. briefing ends 11/23, so there is a short window for settlement to occur before oral argument, and I just don’t believe there will be settlement after 12/9. I have been wrong before.

            We are still in the early stages of briefing, but I found it interesting (as it relates to the possibility of settlement) that the govt has given up on its assertion that Ps APA claim fails because the conservator by statute only “may” preserve and conserve and restore to safety and soundness. while I thought this was never a winning argument, it did in fact win in Perry before the DC Circuit most prominently, and in other circuits that essentially mimicked Perry in their decisions. so an essential basis for the circuit split between collins and the other cases, the whole “may” textualist statutory interpretative theory that conservator did not in fact have a conservator duty under HERA, is not being presented to scotus. it is usually not a good thing for a party to drop one of the important arguments before scotus that circuit courts have decided in your favor…but the govt has other HERA text that it argued at circuit courts and did brief before scotus (most prominent, that to the extent Ps have a claim, it is derivative and under the HERA succession clause, Ps cannot assert a derivative claim during conservatorship, and Ps “direct” claim against govt is not authorized generally under sections 702-706 of APA).

            why do I find this interesting as it relates to settlement? simply, the govt believes an important basis for its wins in circuit courts will not win before scotus. its own view of its case has deteriorated. this of course has interesting implications for the ultimate scotus decision on the merits (if there were betting odds for the case on PredictIt, they would have gone up after the govt filed its opening APA brief), but it may indicate some opening that Ps might be able to tap into with a settlement approach pre-oral argument.

            rolg

            Liked by 2 people

  9. Tim- Given the developments since the capital rule was proposed and the responses to the new capital rule, do you have any thoughts on what the path forward may look like prior to and after the election? Do you think the Calabria will succumb to the desires by many in the industry for reduced capital requirements and an increased capital impact for CRTs? What do you a reasonable dollar amount would be for Fannie’s capital requirement?

    Lastly in Calabria’s interview last year when the capital buffer was increased, he said the next step would be an amendment to the underlying share agreement that includes “mile markers.” What do you think those mile markers will be?

    Liked by 1 person

    Reply

    1. I don’t have any good way of predicting what Calabria might do on the capital rule in response to the comments and criticisms he’s received on it. From the criticisms, including by Fannie and Freddie, he certainly now knows that maintaining the rule as is would present great challenges to the companies to competitively conduct the one business they’re permitted to do by charter as going concerns. But he may choose to say, effectively, “those are the standards I believe are correct, and if you can’t get investors to put in the required new capital through new equity issues you’ll have to attain the status of ‘adequately capitalized’ through retained earnings over time.”

      If Calabria agrees to alter the capital standards, I believe he will be guided by the comments and suggestions of Fannie and Freddie’s investment bankers, who are in a position to tell him what level of capital would be acceptable to potential new investors in the companies. Based on a variety of sources, I would peg that amount at no higher than 3 to 3.25 percent.

      On your amendment question, the one essential element will need to be an agreement from Treasury to cancel or unwind the net worth sweep and eliminate Treasury’s liquidation preference. Assuming this is done, the principal “mile marker” I would look for is a dollar amount or a percentage of adjusted assets of capital each company must attain before being released from conservatorship under a consent decree, at which point they could begin attempting to raise new equity.

      Liked by 1 person

      Reply

      1. Tim

        “…I would look for is a dollar amount or a percentage of adjusted assets of capital each company must attain before being released from conservatorship under a consent decree,..”

        just to be clear, I would envision a release from conservatorship at the time the consent decrees are entered into, not sometime during the operation of the consent decrees after a certain preliminary percentage of capital has been achieved. I have maintained that the GSEs can raise no capital while in conservatorship, and I believe the GSEs’ investment bankers will make that quite clear to Calabria. once conservatorship is exited and the consent decree phase begins, all of the uncertain HERA conservator powers will fall away (allowing stock to be sold), which means that FHFA would want to replace those HERA statutory ambiguities with contractual terms (which are hopefully unambiguous). so I expect the consent decrees for the GSEs to have many terms and conditions regarding GSEs’ operations, but insisting that the conservatorship remain in effect for any period of time after the consent decrees have started and until a capital level has been reached will just give Calabria’s successor as FHFA director the ability to reverse the entire process…which that new director would claim as a conservator power.

        rolg

        Like

        Reply

        1. I’m not suggesting that the conservatorship would remain after the consent decree; I’m suggesting that Calabria will pick a capital level the companies have to meet–perhaps their most recent Dodd-Frank stress test capital amount–before they can be released under a consent decree and begin raising capital. I think we’re saying the same thing in different ways.

          Liked by 1 person

          Reply

        2. @rolg

          Given the FHFA director’s authorities in 12 USC 4616, applicable while FnF have less than $152B in core capital (if that doesn’t get altered) and are thus classified “significantly undercapitalized”, I have a hard time seeing investors willing to put money in that doesn’t bring FnF all the way up to $152B. If the capital raise happens next year, it will need to be sized at around $100-120B to reach that number; plausible but difficult in my opinion.
          https://www.law.cornell.edu/uscode/text/12/4616

          The only way around this that I can see is for Calabria to put language in the consent order saying he won’t exercise those authorities (which include the ability to hand-pick the boards and direct the form and amount of future capital raises, along with a chilling catchall in (b)(7)), but a new FHFA director might be able to step in and say that FHFA can’t just give up its statutory authorities like that. Also, 4616 lets the director bar any dividends, bonuses, or pay increases to executives in that “significantly undercapitalized” state.

          Short version: I see lots of trouble ahead if FnF can’t get to $152B in core capital by the time Calabria is removed by Biden (assuming both that Biden wins and gains the ability to fire Calabria).

          @Tim

          1) All it takes to get to 3.25% is cutting the buffers in half, which is a relatively minor change imo compared to messing with the base numbers. I don’t know if Calabria will be able to back off the 2.5% base leverage requirement, though, because he might be doing a strict letter-of-the-law reading of HERA when it comes to the minimum capital requirement.

          2) Not doing a consent order until FnF hit the Dodd-Frank stress test numbers ($44B iirc) is dangerous because if Biden wins and can fire Calabria, that will happen before FnF can retain enough earnings. I would hope that instead of Calabria just sitting on his hands and waiting for enough retained earnings, he would take steps to allow a smaller capital raise, enough to reach the number he would want for release under consent order.

          I always saw consent order and a large capital raise as being near-simultaneous anyway. The purpose of the consent order would be to tie a future FHFA director’s hands if it came to that, not to place lots of restrictions on the companies.

          Like

          Reply

          1. Midas

            disagree. all 4616 says is:

            “(a) Mandatory supervisory actions
            (1) Capital restoration plan
            A regulated entity that is classified as significantly undercapitalized shall, within the time period under section 4622(b) and (d) of this title, submit to the Director a capital restoration plan that complies with section 4622 of this title and carry out the plan after approval.”

            and yes, the GSEs will have to submit capital restoration plans. I suspect these are ready, more or less, to be submitted by the GSEs working with their financial and legal advisors, with the target capital percentages as the final fill-in-the-blanks. this relates to a supervisory action by FHFA, not a conservatorship action. as far as I can tell, there is nothing that limits Calabria’s power to receive capital restoration plans, see that they are intended to be responsive to the final capital rule, and release the GSEs from conservatorship, subject to the restrictions and covenants included in the consent decree that operate as CONTRACTUAL rights of the FHFA that can be enforced under the consent decree, as opposed to conservatorship statutory powers of the FHFA that are so ill-defined as to make any capital raising impossible…and make anything done by Calabria reversible by any successor who succeeds to conservatorship powers.

            as to the 4616(b) specific actions that the FHFA director can take ((1) Limitation on increase in obligations
            (2) Limitation on growth, (3) Acquisition of new capital, (4) Restriction of activities, (5) Improvement of management)), I would expect that these would be possible consequences for any failure by the GSEs to execute on the capital restoration plans. we have already seen (4) insofar as the mortgage portfolio was massively reduced since 2008. and of course the GSEs can obtain judicial review of any such action by the fhfa director while significantly undercapitalized, under 4623. this is a much more acceptable regulatory regime for new investors than the conservatorship regime.

            rolg

            Liked by 1 person

          2. The easiest, face saving, move for Calabria is to include the unamortized fees as part of capital and slightly reduce the buffers. If he does this the capital raise will not be so big and difficult to achieve.

            Liked by 1 person

  10. From Mark Calabria’s testimony to the House Financial Services Committee tomorrow:

    “This May, FHFA took a critical step toward solving this problem when we released a reproposed capital framework for Fannie Mae and Freddie Mac. The framework targets an eventual 25 to 1 leverage ratio, or capital equal to roughly 4 percent of Adjusted Total Assets. This is the amount of loss absorbing capital that FHFA estimates each Enterprise will need to remain a viable going concern, both on its balance sheet and in the eyes of creditors and counterparties, amid a house price shock on par with the 2008 crash.”

    Sounds like the comments really made 0 impact.

    Liked by 1 person

    Reply

    1. I wouldn’t read too much into this. The paragraph you cite comes on page 16 of 17-page testimony, in which he couldn’t have ignored mention of the May capital proposal. It’s certainly possible that Calabria will stick with a 4 percent capital requirement in spite of all the (well supported) criticism he received on it, but in the alternative I would not have expected for him to signal he might back off that in advance of a Congressional hearing in which he very likely will be challenged on it. (I’ve submitted a couple of suggested questions for Calabria to Chair Waters’ staff, and I’m sure others have as well.)

      Liked by 1 person

      Reply

  11. Tim,

    A link is up for the listening sessions on the 10th and 14th about CRTs and affordable housing access, respectively. It appears that registration is required to view these, and someone told me that registration closes around 10:00 tonight (Central time).

    https://www.eventbrite.com/e/capital-rule-2020-listening-sessions-registration-116907321947

    There is also an option to request a 5-minute speaking slot, so if you are so inclined you can make your views heard.

    Like

    Reply

    1. Thanks for the tip on the need to register for both sessions by 10:00 pm today. I’ve now done that, and saw that each session is scheduled to run for six hours, until 4:00 pm. Given that, I’ll very likely hop on and off throughout that time, mainly to get a sense of the nature of the comments, and who from FHFA is responding and how. (I haven’t yet seen anything on who FHFA’s “listeners” will be.) I didn’t request to speak at either session.

      Like

      Reply

      1. I listened to part of today’s session and upon reflection I don’t quite understand the purpose. I didn’t hear anything that wasn’t already in one of the publicly submitted comments, and Monday’s session will likely be similar. Is this just lip service to those who wanted some more time to comment and (literally) have their voices be heard? Or are these actually helpful and I’m just not seeing why?

        Liked by 1 person

        Reply

        1. I listened to the session for the first hour-plus, and had the same reaction you did: the speakers weren’t saying anything they, or the institutions they represented, hadn’t said in their written submissions. I also found the format awkward. “Speakers” read their remarks to about a dozen FHFA staffers, who asked no questions and gave no reaction to anything that was being said. At the outset a member of FHFA’s office of general counsel said that FHFA would publish a summary memorandum of the proceedings (which helped me decide to bail early on the session), and added that neither during the session nor in the memorandum would they discuss the status, timing or outcome of the rule making.

          I had been hoping that some of the people who asked to speak would have some constructive ideas on how FHFA might design a capital crediting scheme that would result in close to “equity equivalence” for Fannie and Freddie’s use of CRTs, but none of the first few speakers even broached that topic, let alone offered suggestions or potential solutions–they instead focused on why they felt it was important for FHFA not to discourage the companies from CRT issuance. But in doing that, most of the speakers made the points that both the excessively high 4.0 percent leverage requirement and the presence of so many cushions and add-ons in the risk-based requirement served as disincentives for the companies to use CRTs, which I thought was helpful.

          Liked by 1 person

          Reply

          1. Tim/Midas

            Maybe Calabria is using these “listening sessions” as a morale improvement device at FHFA, as in “there will be more listening sessions until morale improves.”

            rolg

            Like

    1. There were 128 comments on the Fannie and Freddie capital proposal posted to the FHFA website, of which 80 were from individuals or institutions who had enough to say about it that they did so in a paper included as an attachment. Of those, my quick survey found that 9 were either supportive of the proposal, or (in the majority of the cases) felt that it did not go far enough.

      Looking at each of the 9, though, they’re the “usual suspects” who in the past have been reflexively critical of anything Fannie or Freddie do or have done, plus one. The individuals in the group are Chris Whalen, Norbert Michel, Douglas Holtz-Eakin and Tom Stanton, while the entities are the Mercatus Center (at George Mason), the American Enterprise Institute, the National Taxpayers Union, and the Competitive Enterprise institute. (The “plus one” is Sheila Bair, former head of the FDIC and now a Fannie Mae board member, who commented “in a personal capacity” and called the FHFA proposal “highly credible” and “brave,” while commending the Mercatus submission.) The theme that runs through all of these comments is that the closer FHFA gets to bank capital standards the better, although Whalen went so far as to state, “The fact that the FHFA thinks it necessary to put a quarter of a trillion dollars in combined capital behind the GSEs suggests that no amount of private capital will suffice to make the residential housing market truly safe and sound.”

      What I found to be much more significant was that the two trade groups one might have expected to be supportive of the proposal were either on the negative side of neutral (the American Bankers Association) or critical of it (the Mortgage Bankers Association). The comment from the ABA was fairly general, but it expressed a concern that FHFA had pushed Fannie and Freddie’s required capital so high that it might distort the market, saying, “While we believe the re-proposal addresses some concerns raised by ABA and others with regard to the previous proposal, the re-proposal raises concerns of its own, particularly with regard to the implications for the primary market and our members’ continued ability to sell loans to the GSEs in the revised GSE marketplace implied by the re- proposal,” adding, “We strongly urge the FHFA to provide more data about how key capital standards were arrived at, as well as a clear picture of the role FHFA expects the Enterprises to play going forward.”

      The MBA made this point directly: “The level of required capital implied by the framework is too high and may be determined too frequently by a leverage ratio rather than risk-based standards.” While most of the MBA comment was focused on the proposed treatment of credit risk transfers (CRTs) and multifamily loans—which the MBA said was too punitive in each case—it also criticized the complexity of the single-family standard, and said in summary, “FHFA should modify the proposed capital framework by simplifying key features and providing more information on others, recalibrating the quantity and types of required capital, and enhancing the recognition provided to transfers of credit risk.”

      And those were the most supportive of the comments FHFA got. In addition to the comments of Fannie and Freddie, which I summarized earlier, the large majority of the comments from community lenders, insurers, investment professionals and independent research groups were highly critical of the FHFA proposal, and hit on the same points: applying Basel bank capital standards to Fannie and Freddie is inappropriate because they’re not banks; the leverage ratio should only be binding in rare instances; there are far too many add-ons to the risk-based standard that make it not risk-based in practice, and FHFA has been too harsh in its treatment of CRTs. We’ll hear more from critics of FHFA’s CRT treatment in the “listening session” the agency has scheduled for this Thursday, while next Monday anyone concerned with the impact of the proposed standard on higher-risk mortgages will have an opportunity to have their voice heard when the subject of FHFA’s listening session is affordable housing.

      Liked by 4 people

      Reply

      1. Tim

        I can’t believe the disconnect between Fannie’s comment and Ms. Bair’s comment…in her “personal capacity” (Ms. Bair is a director of Fannie, to be clear). Ms. Bair went on to approve of another comment (George Mason Univ.) which would establish a leverage cap percentage of 5%. How can a director be so at odds with the company? Makes you wonder why Ms. Bair did not simply rely on the very capable Fannie senior management to comment, especially when her “personal” comment was so at odds with what Fannie senior management determined to be in Fannie’s best interest.

        rolg

        Liked by 2 people

        Reply

        1. I was very surprised by Bair’s comment, given her position on the board of Fannie (and also having served on the board of the Center for Responsible Lending). I would have thought that by now she might have learned more about the workings of Fannie’s business. There also was, to me, a striking incongruity in Bair’s comment as a whole. She seemed perfectly content to recommend an arbitrary and non-risk-based capital requirement of 5% for Fannie and Freddie’s business–despite the severe adverse impact it would have on their affordable housing loans–but then spent several paragraphs expounding on her notion that “the use of credit scores and loan-to-value (LTV) ratios as primary risk indicators disproportionately impacts these lower-income families, while relying on imprecise proxies for credit worthiness,” concluding with this entreaty: “I hope the FHFA and the Enterprises can do more work to eliminate discriminatory bias in the risk weighting of residential mortgages. I am hopeful that advances in technology and data analytics will eventually provide the means to reduce reliance on blunt instruments such as credit scores and LTVs with more nuanced and accurate assessments of risk–those based on a more holistic view of a borrower’s record of financial management and cash flows.” Reading that, I couldn’t help but wish that somebody would say to her, “Well, while we wait for the ability to cost-effectively do customized micro-analyses of the financial condition of millions of individual borrowers each year, perhaps in the meantime we shouldn’t burden affordable housing borrowers with a capital requirement that’s at least double what our existing, imperfect, analytic tools tell us it ought to be.”

          Liked by 3 people

          Reply

          1. Tim

            great comment, and I would make one final point and leave it at that. In the case of the GSEs, i have never seen a business model to manage and execute, or from my point of view an investment to analyze, that involves so many variables that require measured balancing and mutual accommodation. the statutory mandate of the GSEs is precisely to thread the needle, with a duty to serve low income housing, the need to act as a nationwide counter cyclical market maker, and (since they are privately financed) the need to achieve sufficient profitability in order to raise capital and execute their business model all at least somewhat in tension. these mission requirements tend to work somewhat at cross purposes, and an appreciation for how to achieve a dynamic harmony among all factors is necessary…and difficult, as we can see from some comments and, if I may say so, the proposed rule itself. Nuance is important and a blunt capital rule can’t achieve this kind of harmony (nor can ideologically motivated comments).

            rolg

            Liked by 3 people

          2. Tim,

            Thank you for all of your comments.
            Can you ponder on the ‘long game’ for Fannie & Freddie?
            By instituting and enforcing bank capital standards could the endgame be to potentially create entities that can be ‘seamlessly’ taken over, say by a consortium of banks? Or is it simply to create a ‘utility model’ whereby the costs/fees of obtaining a home go up, and F&F’s housing affordability mandate(s) go by the wayside?
            TIA
            VM

            Liked by 1 person

          3. My analysis of the current state of play on capital is that Calabria was convinced by the argument for applying bank-level capital to Fannie and Freddie quite some time ago, and also believed that if he did the companies would “only” have to raise their guaranty fees by 20 basis points or so to earn returns on that capital that would be attractive to new investors, and that increases of that magnitude would be easy because market interest rates frequently move by much more than 20 basis points, and the mortgage market still functions.

            He’s now learned from the comments on his capital standard that he was wrong on both counts. First, he (and many others) did not realize that while the bank capital argument may have been defensible when Fannie and Freddie competed with banks as portfolio investors in mortgages and earned most of their revenues in that business, now that they are almost exclusively credit guarantors the rationale for applying Basel bank capital standards to them has disappeared completely. Second, there is a difference between absolute and relative interest rate levels; raising all interest rates by 20 basis points may have relatively little market impact, but raising Fannie and Freddie’s guaranty fees by that amount while leaving all other rates unchanged could well make the companies uncompetitive, crippling their business.

            If I’m right on this, and I think I am, Calabria now has to figure a way out of the box he’s put himself in. I personally find it hard to imagine how he can stick with the 4 percent bank-like minimum capital requirement. The large majority of commenters have hammered him on that, and there is no substantively sound argument he can make to counter those criticisms. To answer your specific question, though, I don’t think he has a “long game” here; I think he took a shot at something he thought might work, now realizes it won’t, and is in the process of trying to figure out what to do next. I have no way of predicting what that will be.

            Liked by 4 people

          4. Tim

            I find it disturbing that Calabria’s public reason for reproposing the capital rule was that the 2018 proposal wasn’t issued in connection with a stated goal of conservatorship release, such that commentators would not direct sufficient attention to the proposal, and this somehow argued for reproposal to benefit the process. this was of course false. Calabria wanted to rewrite the proposal to make it much more capital intensive and fit within a banking regulatory paradigm, he just didn’t want to admit it. He wasted one year of precious time in the conservatorship release timeline and, whether he wants to admit it or not, his back is now up against a wall. an unforced error.

            rolg

            Liked by 2 people

          5. “My analysis of the current state of play on capital is that Calabria was convinced by the argument for applying bank-level capital to Fannie and Freddie quite some time ago…”

            Tim,

            In all seriousness, I never knew what the argument was that convinced Dr. Calabria. We all know that an argument must have at least two premises and a conclusion that follows from those premises. My take all along has been that Calabria subscribed to a single premise, which cashed out to his buying into a mere un-argued assertion that he was never interested in defending. Now he must defend his one premise thesis of 4% (or else push for retained capital).

            I try to make it a practice not to attribute to ill motive that which can be explained by incompetence. In this case, that has become nearly impossible to do. Calabria must see the logic of not applying bank-level capital standards to the twins, so the real reason for his resistance must be found elsewhere.

            Liked by 2 people

          6. Ron: Having observed and engaged with the anti-Fannie and Freddie crowd for over three decades, I have a different take from yours on this. “Bank-like” capital for Fannie and Freddie was the prime objective for this group in the capital legislation for the companies that began in 1990 and became law in 1992. (As I said in my book, “Our competitors and critics took the position that we should be required to hold the same percentage of capital as commercial banks, citing both safety and soundness and fairness considerations. But bank-like capital would have been anything but fair” [and I went on to cite the reasons why].) The only way were able to beat that was by having Paul Volcker endorse a risk-based standard for us and Freddie, and, importantly, explicitly say that bank-like standards were NOT appropriate for us. Still, when Fannie and Freddie legislation was being considered again in 2003, everyone in what I call the Financial Establishment remained united in their advocacy of bank-like capital for the companies, and their seeming failure during the financial crisis only strengthened that advocacy. If you were a free-market conservative economist like Calabria, you would have accepted the notion of bank-like capital for Fannie and Freddie as revealed wisdom without a second thought. I think he did; he locked in on it, and when he became director of FHFA he said, “that’s what I’m going to do.” And the pro-bank lobby would have cheered him on, telling him he was doing exactly the right thing if he wanted to be viewed as a tough safety-and-soundness regulator.

            Prior to the financial crisis, the overwhelming focus of the opponents and critics of Fannie and Freddie was on their debt-funded portfolio business. THAT’s where they claimed the “unfair advantage” was. And when Treasury forced the companies into conservatorship, the first thing it did was require them to start exiting that business, even though it had held up extremely well until that point, and in fact was serving as a source of revenue to offset the losses from their credit guarantees. Thanks to Treasury, the companies’ opponents got exactly what they’d been asking for. But they didn’t stop there; they immediately turned their guns on Fannie and Freddie’s credit guaranty business (which they previously had praised). They blatantly invented the fiction that Fannie and Freddie’s credit risk-taking had triggered the financial crisis (ignoring not only the relative mortgage delinquency and default rates of Fannie and Freddie versus the banks, but also the entire private-label securities fiasco), and insisted on “winding down and replacing” them with a bank-centric alternative. Throughout all of this, bank-like capital for Fannie and Freddie remained their rallying cry, and nobody stopped to notice that by the end of the twenty-teens the companies had effectively exited the one business they had in common with banks, thereby invalidating the only argument that could have been made for requiring them to be capitalized like a bank. Calabria wasn’t the only one that missed this; virtually the entire Financial Establishment did. But now that the lack of any defensible rationale for imposing bank-like capital on Fannie and Freddie has been widely acknowledged through the comment letters, there’s no going back to it as a serious proposal for Fannie and Freddie capital. I think Calabria was genuinely surprised by this, but it’s now his problem to deal with.

            Liked by 1 person

          7. Quick clarification (in response to a comment deleted for length) on my statement above that “nobody stopped to notice that by the end of the twenty-teens the companies had effectively exited the one business they had in common with banks, thereby invalidating the only argument that could have been made for requiring them to be capitalized like a bank.” I don’t mean that nobody noticed the companies’ portfolios had shrunken dramatically–that was obvious; what everyone missed was that their leaving the portfolio business invalidated the original rationale for applying the Basel bank capital standards to them.

            Liked by 3 people

          8. Tim

            There are three things that you would think Calabria would understand about the two companies he regulates. you would think Calabria had 1. looked at the GSEs’ balance sheet assets and liabilities, and understand that they are no longer in the mortgage portfolio business competing with banks (such that their regulatory capital regimes should be comparable), 2. looked at the quality of the mortgages that currently comprise the MBS that the GSEs guarantee, and compared them favorably to the mortgage quality at the time of the GFC, and 3. understand that Mnuchin has stated that he is comfortable with having the treasury line remain outstanding, subject to being compensated for this with a commitment fee. As I recall there is no discussion of these three facts anywhere in the capital proposal release, and they all bear directly upon any sensible formulation of a capital rule. this leads credence to the notion that this capital rule was baked well in advance in Calabria’s mind, and there was no effort to build a capital rule from the facts as they now are on the ground up.

            oh, and shouldn’t the FHFA listening tour have occurred before the proposed rule was released, and not well after?

            rolg

            Liked by 2 people

          9. Speaking of Mnuchin. Who’s really in charge here, Calabria or Mnuchin? Everyone wants to talk about Calabria but I think Mnuchin calls the final shots.

            Like

          10. It depends on the issue. Calabria is “in charge” of, and responsible for, setting the capital standard, while Mnuchin will have the final say in any negotiation that terminates the senior preferred stock agreement (unwinding or cancelling the outstanding senior preferred, and eliminating Treasury’s liquidation preference in the companies). And while Calabria continues to say it’s his responsibility to bring the companies out of conservatorship, the Senior Preferred Stock Purchase Agreements state explicitly that “Seller [Fannie or Freddie] shall not (and Conservator [FHFA], by its signature below, agrees that it shall not), without the prior written consent of Purchaser [Treasury], terminate, seek termination of or permit to be terminated the conservatorship of Seller pursuant to section 1367 of the FHE Act, other than in connection with a receivership pursuant to Section 1367 of the FHE Act.”

            Liked by 3 people

  14. Tim

    The Center for Responsible Lending comment (https://www.fhfa.gov//SupervisionRegulation/Rules/Pages/Comment-Detail.aspx?CommentId=15663) makes an interesting point on p. 16 regarding the FHFA proposed rule’s refusal to count some portion of future G fee receipts (contractually required to be made as long as loan is outstanding) as capital: “…if the GSEs created and sold interest-only (IO) strips of guarantee fee revenue, the proceeds would count toward capital (although given the GSEs would have transferred the prepayment risk to investors, if they kept their guarantee fee revenues and retained this risk they would need to discount the amount that counts as capital). Ignoring these fees in capital calculations encourages the GSEs to create IO securities and bear deadweight transaction costs.” Presumably FHFA would need to approve this form of transaction, but it makes perfect sense for this future income (92% of the mortgages continued to pay G fees during the GFC) to be monetized/hypothecated to create capital…and inversely, it makes no sense for some discounted portion of this contractual stream not to be counted as capital.

    rolg

    Like

    Reply

    1. I read that point in the CRL submission (which I thought was excellent overall), but I took it as being more rhetorical–as an argument for counting at least some portion of guaranty fees in the stress test that determines the capital requirement–than practical. And FHFA would not need to approve the transaction: it’s just selling the guaranty fee stream to a third party for a gain. This sale would generate a profit which, after taxes, would be retained earnings, and hence capital. The company selling the I/O would, however, retain the liability for covering credit losses, and I wonder how that would be handled from an accounting perspective. Moreover, if done on any significant scale it definitely would change the risk profile of the entity doing it; it would be locking in the present value of the guaranty fee stream, while letting the cost of credit losses and administrative expenses play out over time (at a prepayment rate that almost certainly would be different from the one assumed at the time the fee I/O was sold).

      Like

      Reply

      1. Tim

        just following up on the I/O strip sale of future G fees to create capital idea from CRL, and very back of envelope, Fannie reported net interest income of $21B in 2019. some of this is interest on portfolio mortgages, but most was for G fees. surprisingly I could not find out what the total for 2019 G fees were…maybe I am looking in all of the wrong places, as the song goes. but let’s just assume that Fannie wanted to hypothecate $10B of G fees for each year into the future that they could find investors to buy them. now, I have read a rule of thumb that mortgages are generally expected to last 6 years…one might think longer after this refi surge. but lets assume Fannie can sell 3 years of G fees in an amount of $10B/yr=a total stream of $30B over 3 years, which would be discounted but not greatly since interest rates are low and the discount period is short. If I am right, and I would look to you for guidance, Fannie could raise at least $20B of capital (after tax) simply by doing a G Fee Transfer (GFT as opposed to a CRT) with respect to a portion of its near term G fee income.

        rolg

        Like

        Reply

        1. Let me start with the data. Page 54 of Fannie’s 2019 10K has a table titled “Components of Net Interest Income” that breaks net interest income from the guaranty book of business into three categories: (a) base guaranty fee income, net of TCCA ($9.413 billion in 2019), (b) base guaranty fee income related to TCCA ($2.432 billion), and (c) net amortization income ($5.833 billion), for a total of $17.678 billion. (Net interest income from the portfolio was $3.284 billion, making total 2019 reported net interest income $20.962 billion)

          Of the three guaranty fee categories, only the first could be turned into an I/O, and sold for a fixed dollar amount. But the third category reflects the annual amortization of something that already IS a fixed dollar amount–namely the upfront loan-level price adjustments (LLPAs) Fannie has been charging on its riskier loans since the financial crisis. As of December 31, 2019, Fannie had $33.6 billion in unamortized premiums on its mortgages–the large majority of that from LLPAs. The Urban Institute comment authors have suggested that Fannie ask FHFA to allow the portion of those fees that are related to purchase loans (but not refinances) to be counted as capital, while an individual commenter, Patrick Quinn, made the same suggestion for all of Fannie’s deferred income on net premiums. I would pursue that alternative before I considered selling the annual guaranty fee stream.

          The advantage of trying to get some or all of the deferred premium income counted as capital is that it is a known, fixed amount; it’s cash that’s been received, and won’t change no matter how the loans with which it was associated prepay. If you sell guaranty fees as an I/O, you’re accepting a fixed dollar amount for a stream of income of unknown duration. That’s very risky, particularly if it’s your only line of business. And it’s even riskier today, with interest rates as low as they are. In the second quarter of 2020, Fannie’s base guaranty fee income, net of TCCA, was $2.677 billion. Annualized, that’s $10.7 billion, compared with $9.4 billion for full year 2019. Fannie is putting on a ton of new credit guaranty business at these low rates, and I suspect it will be on the company’s books for a very long time. If you package these guarantees in an I/O, an investor will want to price it conservatively (i.e., at a low multiple of current annualized income). If I were Fannie’s CFO today, and someone on my staff–or an investment banker–came to me with the idea to sell some of our base guaranty fee income as an I/O to generate capital, it would take a lot to convince me that this was in the best economic interest of the company, even factoring in the capital impact.

          Liked by 1 person

          Reply

          1. Tim

            thanks for reply. I agree that cash already taken in (deferred premium income) should be the first target for capital treatment. I recognize that the GFTs, if you will, will be pricing dependent, but investors are searching for yield and in this low rate environment there would be no better time to price such a transaction…plus, if you believe corporate rates will go up in future, you can tax arb by bringing income forward. I would only do this for a portion of the G fee stream and only if my prediction of prepayment speeds is accommodated by the buyers, of course, but this type of cash generation/capital building could facilitate the initial equity offerings. you were probably a tough nut for a banker to crack as CFO…

            rolg

            Like

          2. On a possible deal like this, it’s not being tough; it’s being rigorous. For the I/O sale, the two key issues I’d want to zero in on are the pricing of the transaction, and its impact on the company’s valuation. My instinct is that both would be problematic, although I’d be open to being convinced otherwise. The pricing problem is that for the last three years (2017-2019), Fannie has been amortizing its mortgage premiums to about a 6-year average life. In the first half of 2020, that’s dropped to under 5 (4.8 years to be precise). My expectation is that guaranty fees put on today will be worth much more than a 6-to-1 multiple, but I doubt that’s where the bids would be. And that leads to my second point. With Calabria’s proposed capital rule, Fannie has an ROE problem. The sale of a guaranty fee stream as an I/O helps the “E,” but at the expense of the “R.” That is, the market will give no credit for the earnings that stem from a one-time gain on sale of the guaranty fee stream, but the subsequent reduction in projected earnings from the absence of the (sold) guaranty fees WILL result in a lower stock price, unless Fannie’s P/E ratio rises because of the transaction (which it has no reason to). There is some multiple of the sold guaranty fee stream that will make the positive “E” effect greater than the negative “R” effect, but I strongly suspect that multiple is not obtainable in the market. That’s what I’d be evaluating, though, if a deal like this were brought to me.

            Liked by 1 person

          3. Tim

            thanks for that clear explanation. I guess some of my thinking regarding a GFT involves the benefit that might possibly be obtained by minimizing the GSEs’ unique political risk from a valuation analysis. I expect that when the GSEs emerge from their equity capital markets hibernation, investors will at least initially penalize the GSEs’ P/E ratio when compared with peer financial institutions, given the tumult of the conservatorship experience. assuming that the GSE issuer and buyer agree to pricing on the GFT I/O (and while I don’t understand I/O pricing, there is apparently lots of data and modeling that buyer and seller can look to), then political risk should be minimized in the pricing of this contractually obligated future G fee income stream that has been securitized (or simply assigned to a trust with pass-through certificates) in a GFT. If I am right, an equity investor in the GSEs will fear political action that might disrupt the GSEs’ future income generation, and therefor discount the P/E ratio, whereas a GFT investor owns a contractual stream of income that has already been “put into the books.”

            rolg

            Like

    2. In the executive summary of the comment by the Center for Responsible Lending, the authors say, “The proposed rule is thus critically flawed as written. We recommend that FHFA:

      1) Refrain from adopting bank capital rules for the GSEs;

      2) Count a portion of guarantee fee revenue as capital for risk-based capital requirements;

      3) Treat properly discounted CRT as a component of required credit risk capital;

      4) Eliminate the punitive stability capital buffer and the countercyclical capital buffer;

      5) Lower the leverage ratio to the alternative proposal from the 2018 proposed rule of 1.5% for trust assets and 4% for retained portfolio; and

      6) Regulate the GSEs as utilities to promote affordability and more equitably serve low- to moderate borrowers and families of color, as well as to promote safety and soundness of the GSEs.”

      Like

      Reply

      1. I recommend that people read the full comment by the Center for Responsible Lending (co-signed by thirteen other organizations). It’s only 20 pages long, and is not too technical. CRL is one of the few commenters that do not have a financial stake in the subject on which they are opining.

        Like

        Reply

        1. Tim – can you list for your readers, out of the 128 comments submitted, which you think are “must reads” other than ones you have already mentioned?

          Like

          Reply

          1. I wouldn’t call the comments I’ve recommended “must reads;” instead, they’re ones where a reader has cited its summary points, and I’ve suggested that anyone who wants to understand and evaluate the comment ought to read it as written. The only comments I’d say are really “must reads” are those submitted by Fannie and Freddie. I realize that some will find them too long and technical to hold their interest, but if you’re seeking to develop an informed opinion about how and when Fannie and Freddie might emerge from conservatorship and become fully recapitalized, it’s essential to know not just what Calabria has proposed for Fannie and Freddie’s capital, but also how the companies view that proposal, and what suggestions they’ve made for improving it (or remedying its defects). The key going forward will be whether Calabria is willing to get close enough to what Fannie and Freddie are asking for to give the companies’ managements confidence that the final capital standard is one they can live with, and for which they can put together the comprehensive and convincing roadshows necessary to bring in the volumes of new equity they’ll need to resume operations as independent shareholder-owned companies. If you don’t know where the two sides are now, you won’t be able to handicap the chances of a successful outcome in this process.

            Beyond that, I would suggest that readers go to the FHFA comment site (which you can reach by going up to the very top of my current blog post, and clicking on the word “here,” in red italics), and scroll through the list of comments, looking for entities or organizations who you either recognize as being potentially influential, or you believe have credibility. I would read the comments of entities you feel you might disagree with as well as those with whom you are likely to be sympathetic, so you can get a sense for the relative strength of the two arguments. Doing an exercise like this should give you a pretty good idea of what Calabria will have to deal with as he decides where to go from here.

            Liked by 1 person

  15. Tim

    I am just now reading Thomas Hoenig’s (George Mason University Mercatus Center) comment (https://www.fhfa.gov//SupervisionRegulation/Rules/Pages/Comment-Detail.aspx?CommentId=15588), where he blithely states on p.5: “Some commentators may question whether setting the minimum leverage ratio at 4 percent would provide sufficient returns to attract private investment. This should be carefully evaluated, but it is doubtful that it would inhibit investor interest. For example, based on 2019 financial reports, if enterprises were required to maintain a higher 5 percent leverage ratio while earning a 1 percent return on assets (similar to the return earned in the banking industry), returns on equity would be roughly 20 percent, which is competitive with other industries’ returns. Thus, the tradeoff between more capital and greater returns should not necessarily inhibit investor interest.”

    Either this is absurd or I don’t understand the GSE business model. If the GSEs are to earn 1% on assets (which are almost entirely generating G fees, as portfolio mortgage holdings continue to be reduced), then the GSEs would have to charge 100bps as a G fee (roughly double current amount). Is this not right? Hoenig’s bio states that he was a Vice Chairman of the FDIC and President of the Kansas City Federal Reserve Bank. Does he not know that banking and financial insurance are not the same?

    Something is amiss here, and it might be me.

    rolg

    Liked by 1 person

    Reply

    1. Welcome to the world of Fannie and Freddie’s ideological critics, who offer full-throated critiques of and prescriptions for the companies’ business, without having the most minimal understanding of how they actually work. Note what Hoenig is saying here–IF the companies had a 1.00 percent return on assets, they would produce an ROE of 20 percent on 5 percent capital. That’s neither information nor analysis; it’s grade-school math: 1.00 divided by 5.00 equals 0.20. Had Hoenig even skimmed Fannie’s 2019 earnings press release, he would have noted that it earned $14.2 billion on $3.503 trillion of assets. That’s an ROA of 40 basis points, not 100. And if you were to dig into Fannie’s 2019 earnings results, you would note that they were increased by a $4.0 billion benefit for credit losses–a continuation of the unwinding of the excessive loss reserving done by FHFA in 2008-2011 to boost Fannie’s draws of senior preferred stock from Treasury–which soon will disappear. Without this benefit, Fannie’s “normalized” 2019 earnings would have been about $11 billion, for an ROA of 32 basis points. On 5.0 percent capital, that’s an ROE of 6.3 percent, not 20.

      It’s remarkable how simple Fannie and Freddie’s business can be if you don’t bother to learn any of the facts about it.

      Liked by 3 people

      Reply

  16. Housing Policy Council:

    “Our own work suggests that the 4 percent leverage requirement appears to be excessive relative to the actual credit risk assumed by the Enterprises. Appendix A details this analysis, which is based on the loans in Fannie Mae’s Single-Family Loan Performance Dataset as of December 2018. Based on the composition of Fannie Mae’s portfolio, if there were to be a repeat of the 2008 crisis, a 4 percent leverage ratio applied to the single-family business would result in Tier 1 capital covering lifetime portfolio losses by 4-5 times. This assumes all losses are recognized immediately and there is no offsetting benefit from net revenues before credit provisions, an unrealistically severe stress scenario. Net of risk-sharing by CRT, we estimate this coverage of stressed losses improves to 5-7 times. This is a level of capital redundancy that is excessive, if not highly punitive.”

    Edward J. DeMarco
    President, Housing Policy Council
    (Former Acting FHFA Director)

    Liked by 1 person

    Reply

    1. This comment by DeMarco–recommending a leverage requirement for Fannie and Freddie lower than the 4.0 percent proposed by FHFA (he suggests is should be 3.0 percent)–is not as surprising as it seems on the surface, for a couple of reasons. First, the entity he heads, the Housing Policy Council, does have a membership, and DeMarco needs to reflect their interests. Second, as a number of commenters have pointed out, a fixed leverage ratio that exceeds the risk-based requirement provides an incentive for taking excessive risk, and also serves as a disincentive to issuing CRT securities. This latter point is of particular importance to DeMarco, who spends ten pages in his letter extolling the virtues of CRTs, and arguing that FHFA should treat them more favorably. As was the case with the JP Morgan Chase letter, however, DeMarco offers no specific suggestions for how FHFA might come up with an accurate formulation for the “equity equivalency” of securitized CRTs, which should be the agency’s goal.

      Liked by 2 people

      Reply

  17. Tim

    It looks like HFSC Chairwoman Waters wants a listening hearing (at which I would think Director Calabria will speak) as well:

    “September 16 at 12:00 PM – The full Committee will convene for a virtual hearing entitled, “Prioritizing Fannie’s and Freddie’s Capital over America’s Homeowners and Renters? A Review of the Federal Housing Finance Agency’s Response to the COVID-19 Pandemic.”

    https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=406860

    rolg

    Liked by 1 person

    Reply

    1. This will be a hearing about the 50 basis point refinance fee, which in my opinion was conceived and rolled out in a manner almost guaranteed to invite political opposition (particularly having it apply to loans already originated but not yet delivered to Fannie or Freddie). The Waters hearing is likely to put a sharp focus on Fannie and Freddie’s affordable housing loan pricing in general. I don’t know who the participants in this hearing will be–logically they would include Director Calabria, and possibly the CEOs of Fannie and Freddie and the heads of a couple of affordable housing groups. If Calabria testifies, as I expect he will, I’ll be very interested to hear how he describes, and defends, the fee.

      Liked by 1 person

      Reply

      1. Tim

        You once referred to Calabria’s ideology, and I believe that a libertarian economist might very well have an orientation that discounts the GSEs’ duty to serve low income housing. In front of Chairwoman Waters, he will be exposed to a very different ideology, and I can’t help but think that this will affect FHFA’s consideration of many comments to the proposed capital rule. I don’t see much change coming from FHFA to the 12/1 deferred date of the new “covid” refi fee, but there may be some carryover effect to the proposed capital rule. with Broadway still closed, one must find great theater where one can…

        Liked by 2 people

        Reply

        1. I agree with you on both points. Calabria is causing the guaranty fee problem all by himself, with his unjustifiable insistence on jacking up the companies’ capital to a minimum of 4.0 percent, irrespective of risk. And as I noted earlier, I think he genuinely didn’t understand that Fannie and Freddie can’t just raise their guaranty fees at will. He’s in danger of presiding over a failed recapitalization if he doesn’t find some way to replace his libertarian ideology with financial market reality.

          Liked by 2 people

          Reply

  18. Freddie Mac:

    “We recommend a Tier 1 (in contrast to core) capital ratio to on-balance-sheet “held” assets of 4.00% and a Tier 1 capital ratio to the unpaid principal balance (“UPB”) of guaranteed assets of 1.50%.”

    Liked by 1 person

    Reply

    1. Freddie Mac’s comment letter recommends that FHFA return to the “Bifurcated Alternative” for minimum capital specified in its 2018 proposal–1.5 percent of credit guarantees and 4.0 percent of on-balance sheet assets–with the added change that this requirement must be satisfied by Tier 1 capital rather than core capital (Tier 1 is a somewhat more restrictive definition, in that it deducts certain types of deferred tax assets from core capital). Without the Tier 1 specification, this is what I recommended in my comment letter as well; it’s the obvious and most easily defended way for FHFA to walk back its proposed “bank-like” 4.0 percent minimum capital requirement that has come under heavy criticism from commenters, including Fannie and Freddie, for not taking into account the differences between the companies’ mono-line and low-risk credit guaranty business and the much more complex, and debt-funded, credit intermediation business of commercial banks.

      Interestingly, Fannie Mae did not make a similar recommendation in its comment letter to FHFA, which it also submitted yesterday. Both Fannie and Freddie focused most of their comments on changes they propose to the risk-based standard to make it align more closely with the historical risks of the mortgages they guarantee–and said that the minimum (or leverage) requirement should be lower than the risk-based requirement in most circumstances–but rather than make a specific recommendation for the minimum, Fannie said only, “Given the importance of the relationship between risk-based capital and leverage ratio requirements, Fannie Mae also recommends that FHFA continue to assess the relative calibration of these two types of requirements as it finalizes the Enterprise capital framework.”

      I read both companies’ comments, and found them similar in most respects but different in a few others, including tone. Both Fannie and Freddie made very clear that they believed the May 2020 capital proposal was too disconnected from the actual risks of the business they were doing, and gave concrete examples of where and why this was the case, and what the business consequences would be if this were not changed. Fannie said that to meet the proposed requirements, it “estimates that single-family guaranty fees would need to increase by approximately 20 bps, on average, compared to those charged in 2019,” while Freddie said “we estimate that the proposed capital framework may result in the need to increase Freddie Mac single-family guaranty fees on average across the portfolio by 15-35 bps.” To make the capital standard more manageable, the companies agreed on a number of desirable changes: eliminating the 15 percent risk weight minimum on all loans; eliminating the 20 percent risk weight for cross-holdings of MBS; replacing the 10 percent floor and modifying the 10 percent “haircut” on credit-risk transfer securities; replacing the stability buffer with a data-based systemic risk buffer, and reducing the fixed (and duplicative) charges for operations and market risk. Both companies also argued for a five-year phase-in of the new capital rules, so that restrictions on dividends and executive compensation would be less likely as they raised new capital. Freddie argued for the 75 basis-point static stress buffer to be replaced with one linked to the Dodd-Frank stress test (which if implemented now would lower Freddie’s charge to 42 basis points), while Fannie said it could live with the fixed 75 basis points. Fannie, on the other hand, wants a tighter collar on the changes in mark-to-market loan-to-value ratios (which would address a concern I raised in my comment), while Freddie was silent on this issue.

      The difference in the tone of the two comment letters was subtle, but to me noticeable. Freddie’s was much longer (69 pages, without introduction and appendix, compared with Fannie’s 33 pages), and contained considerably more detail and specificity on where and why the FHFA proposal was off base. I actually liked that, but I did think it might be a tad aggressive for a public comment from a regulatee to a regulator. It made me wonder whether this difference in approach was due to the fact that Fannie’s executives were in closer contact with Calabria and his team–and thus able to make their more pointed comments privately–whereas for Freddie the comment letter was their “best shot” at making their views known.

      Liked by 1 person

      Reply

      1. Tim,
        Were you planning on attending the FHFA’s Listening sessions on either Sept. 10 or Sept. 14.? It sounds like the are enabling commentators on the re-proposed capital rule to elaborate on their comment letters. The session on the 10th is for discussion on Credit Risk Transfers and the 14th is for discussion on affordable housing access. Not sure if this allows a commentator to elaborate on their total comments or just these two subjects.

        Like

        Reply

      2. Tim

        thanks for your review of the GSEs’ comment letters. I thought Freddie’s was more comprehensive, which might lend credence to your thought that perhaps Fannie might have more informal access than Freddie. of course, these comments run the risk of having Calabria think to himself, “just 15-35bps increase in G fees, dang, I was shooting for something a little higher…”

        rolg

        Like

        Reply

      3. Tim

        now reading the GSEs’ proposed cap rule comments with as much comprehension as my regulatory capital-deprived mind can muster, this quote from Freddie’s comment (p. 9) captured my attention, and will surely capture the attention of those discussing the low-income housing duty to serve mandate on the FHFA “listening call” on 9/14: “we estimate that the proposed capital framework may result in the need to increase Freddie Mac single-family guarantee fees on average across the portfolio by 15-35 bps. As noted, segments of our portfolio exhibit varied price elasticity. In order to maintain an appropriate return, an increase of 20-50 bps could be required on the higher-risk segments of our acquisitions to offset the loss of higher returns and volume on our lower-risk segment, affecting low-income, affordable housing”. in effect, the banking industry will keep more lower risk loans yielding it higher profits, and leave the GSEs to buy more of the higher risk loans with low income borrowers bearing much of the ultimate cost of providing an acceptable return to investors under a FHFA-mandated excessively high capital level standard.

        rolg

        Liked by 1 person

        Reply

        1. This is one of the problems with attempting to increase guaranty fees significantly from this point, and I touched on it briefly in my comment, when I referenced the Fannie and Freddie pricing grids FHFA published for the first quarter of 2014. To earn an 11 percent after-tax ROE on its business (at a time when the corporate tax rate was 35 percent; today it’s 21 percent), the companies had to charge 35 basis points on the least risky 20 percent of their business and 130 basis points on their riskiest 20 percent. In an attempt to “cross-subsidize” their higher risk (mostly affordable housing) business, they charged 50 basis points on their lower-risk business, but because of market (and affordability) constraints they were only able to charge 76 basis points on their higher-risk business–not 135–and their overall average fee ended up much lower than required to hit their ROE target, producing an actual ROE of only 8.5%.

          The 2014 fees were consistent with FHFA’s “conservatorship capital” standards (essentially what would have been required by its June 2018 capital proposal). If the companies were struggling to earn a market return on their affordable housing business then, imagine what would happen if–as proposed in May–their overall capital requirements were raised by 77 percent. (They get a break from today’s lower corporate tax rate, but because everyone else does too that won’t help much on the market constraint.) I don’t believe Calabria, or the FHFA staff, understood these pricing dynamics when they decided to apply a 4.0 percent bank mortgage portfolio capital requirement to the companies’ credit guaranty business–and then added cushions and conservatism to their risk-based standard to push its required capital up as well–but I suspect they do now. And they may hear more about this issue at the affordable housing “listening sessions,” although most of the people who will speak there don’t understand it either, which is why Fannie and Freddie’s comments, public and private, are so important. They live with this problem every day.

          Liked by 1 person

          Reply

    1. I recommend reading the full Urban Institute comment, but for those who don’t wish to, here is the summary of the authors’ key points:

      1. Too much of a Basel-like framework was added to the rules without recognition that the GSEs are not banks (they are monoline guarantors) and that the Basel framework is itself an overly complex consensus among international regulators.

      2. Non-risk-based components of capital requirements play an outsize role. We estimate that less than 40 percent of the risk-based measure is risk based; the other 60 percent consists of addons and minimums. Furthermore, the absolute leverage ratio, which is 100 percent non–risk based, is binding much of the time.

      3. The stability buffer imposes a high tariff on market shares, making it more difficult for the GSEs to play a countercyclical role.

      4. In general, risk-based capital is aligned with loan risk, with the exception that purchase money loans are disadvantaged relative to refinance loans, with the former being overcapitalized by 65 basis points.

      5. High-risk purchase money mortgages are excessively disadvantaged and will lead to a market shift toward the Federal Housing Administration (FHA). This could be ameliorated by allowing the loan-level price adjustment “reserve account” to be counted as capital.

      6. The countercyclical mark-to-market loan-to-value (MTMLTV) ratio adjustment is novel and works well looking backward. But going forward, the adjustment will lead to distortions, especially if prices continue to increase because of a lack of housing supply.

      7. Securitization-based credit risk transfer (CRT) does not receive adequate capital relief in the risk-based capital structure. This is true for both CRT deals and Freddie Mac K-Deals.

      In their conclusion the authors also say, “the first fix has to be lowering the Tier 1 leverage ratio to no more than 2 percent, so that it is less likely to be the binding constraint.”

      I agree with most of the points and analyses in this comment. And it constitutes yet another serious substantive criticism to FHFA’s May 2020 proposal from a credible source, which in the aggregate the agency will be hard-pressed to ignore.

      Liked by 2 people

      Reply

      1. Could you elaborate on what this means?

        “5. High-risk purchase money mortgages are excessively disadvantaged and will lead to a market shift toward the Federal Housing Administration (FHA). This could be ameliorated by allowing the loan-level price adjustment “reserve account” to be counted as capital.”

        I don’t see any reference to this in FNMA 10-K, but it’s possible I just didn’t know where to look.

        Like

        Reply

        1. There is an indirect direct reference to the loan-level price adjustments in Fannie’s 10Ks and 10Qs, in the discussion of deferred amortization income in the section “Components of Net Interest Income,” which is a subsection of the “Consolidated Results of Operations” discussion. At the end of the second quarter of 2020, Fannie had $32.5 billion of deferred amortization income on its balance sheet, the large majority of which came from the loan-level price adjustments (LLPAs) the company has been charging since the financial crisis on most of its higher-risk loans. While these payments are received in cash, they are not booked as income right away; they are amortized over the expected lives of the loans with which they are associated.

          The Urban Institute authors mention counting LLPAs as capital twice in their paper, but only briefly–once as point 5 of their summary (which you cite), and again in their Recommendations and Conclusions section, where they say, “…the capital requirements on purchase loans should be lower, and more credit should be given to mortgage insurance. One way to do this is to count the loan-level price adjustments on purchase loans towards Tier 2 capital.”

          At June 30, 2020, purchase loans made up 45 percent of Fannie’s single-family book. I would think, however, that because purchase loans tend to have higher LTV ratios than refis, more that 45 percent of Fannie’s LLPAs would be associated with purchase loans. Let’s say it’s 60 percent; that would mean UI is suggesting that FHFA count about $20 billion of Fannie’s LLPAs as Tier 2 capital. But they don’t elaborate on how. I didn’t think it was permissible to do that under generally accepted accounting principles (GAAP), but it’s possible the UI authors know more about this than I do (or that GAAP in this area has changed since I was Fannie’s CFO). This is what the authors are referring to, though.

          Like

          Reply

      1. That’s correct. This comment is signed by the CEO of JP Morgan Chase’s Home Lending group, and it notes in the summary that, “we focus our comments on the importance of preserving a capital framework that facilitates the Enterprises maintaining a robust CRT program in the final rule.” But then, at least to my reading, it doesn’t offer any new or useful advice as to HOW to do that.

        Bank regulators do not give capital credit for CRT securities issued by banks (which very few advocates of CRT credits for Fannie and Freddie ever point out), and one reason they don’t is that it’s very difficult to come up with a measure of “equity equivalency” for CRTs. It’s clearly not one-for-one (i.e., $1.0 billion of CRTs issued reduce required equity capital by $1.0 billion), because equity can be used to cover credit losses from any mortgage from any year, whereas CRTs are linked to the loans in a specific pool (and the vast majority of CRT coverage is never needed and expires unused). Moreover, CRTs pay down over time, leaving credit losses that occur after the paydown uncovered. Finally, if a credit guarantor is using CRTs to reduce its equity capital requirement in good times, during a stress environment—when CRT buyers flee the market—it will need to significantly boost its guaranty fees and add more equity to back the new loans it’s guaranteeing, and if this new equity is not available new credit guarantees will drop off sharply. A responsible regulator will need to solve each of these “real world” problems in coming up an equity equivalency standard for CRTs, and the impassioned advocacy of CRT issuance expressed by Chase in its comment letter doesn’t provide FHFA much help with that.

        Liked by 1 person

        Reply

        1. Tim

          the FHFA proposed capital rule comments are coming in waves as just a few business days remain for commenting. I am actually heartened by what I am reading. In particular, I found the UI comment very insightful and balanced, which surprised me since I remember watching a stream of an UI-sponsored “post conservatorship financing” conference with Parrott/Goodman leading and featuring a few CRT investors which would have led one to believe that CRTs should be the primary financing source post-conservatorship. Having lived in GSEland for over 6 years as an investor, though a mere eye blink compared to you and many readers, I sense a “sea-change” in perception of the proper future for the GSEs…in essence, we have some GSE-antagonists, for lack of a better term, who believe that if we are going to release and privately finance the GSEs (a position they would have disagreed with as a matter of first principles), then let’s do it smartly and effectively. If I am remembering correctly, there have been really no commentators who have advised Calabria that his work is done, just finalize the proposed rule. If the GSEs don’t themselves comment in next few days, I would take that as a favorable sign…that based upon conversations, it would not be necessary. we shall see.

          rolg

          Liked by 1 person

          Reply

          2. This should not come as a surprise to anyone, given that there are only two business days left in the comment period. (Had Calabria intended to extend it, he would have done so some time ago.)

            Liked by 1 person

  21. Bill Ackman’s comment:

    The GSEs’ historical required capital levels of 45 basis points would have been nearly sufficient during the Global Financial Crisis absent over-provisioning and the issuance of MBS backed by subprime and Alt-A loans. Ackman’s recommended required capital of 2.5% would be over five times this amount.

    Liked by 2 people

    Reply

    1. This is another “real world” comment, from a well known and highly successful investor who believes that if Calabria insists on imposing capital requirements designed for bank mortgage portfolio holdings on Fannie and Freddie’s credit guaranty business the companies would not be able to raise the capital required to bring them out of conservatorship in a reasonable period of time. Ackman criticizes the proposed 4.0 percent minimum capital figure as not being truly risk-based, noting that if you consider their current books of business compared with what they had prior to the crisis–which included large concentrations of Alt-A (low or no-doc loans) and interest only ARMs that they no longer help finance–a 2.5 percent capital ratio would be more sufficient to survive the 25 percent decline in home prices FHFA has set as its threshold stress environment. And I was glad to see Ackman reinforce the point I made in my comment about going concern capital: as we saw after the 2008 crisis and as we’re now seeing in the Covid-19-related contraction, Fannie and Freddie tend to do MORE business during stress periods. For that reason, it is nonsensical to calculate their capital requirements as if they were liquidating concerns, and then to compound that error by not counting guaranty fee income on loans that remain on the books during the stress period. Finally, as much as I support the concept of a true risk-based capital requirement, I must say that I am sympathetic with Ackman’s argument that if FHFA persists in using mark-to-market LTVs in its risk-based capital stress test, the pro-cyclical effects on required capital that would result (even with FHFA’s proposed home price dampeners) during periods of stress would make a fixed 2.5 percent capital requirement for all of the companies’ business seem to be a better alternative, for both investors and homebuyers.

      Liked by 2 people

      Reply

      1. Tim,

        Let’s say that Calabria decides to answer Question 26 (“Should there be any sanction or consequence other than payout restrictions triggered by an Enterprise not maintaining a capital conservation buffer or leverage buffer in excess of the applicable PCCBA or PLBA?”) with a clear “no”, which includes removing all langauge from the capital rule that is contrary to or ambiguous with respect to this answer.

        Also, let’s say that Calabria makes it quite clear, by adding appropriate language to the rule, that the amount of capital that is kept in the buffers (as long as it is above zero) is solely at the discretion of the companies and will carry no consequence whatsoever outside of payout restrictions.

        In this scenario, would you consider the capital requirement to be 2.5% and not 4.0%? Would this be good enough, in the sense of not letting the perfect be the enemy of the good, or is there still too much wrong with the rest of the rule for it to be workable?

        Liked by 1 person

        Reply

        1. @midas/Tim

          I think this is the easiest, quickest, most face-saving escape route for Calabria after he hears privately what MS and JPM really think of the proposed capital rule. there are conceptual errors galore in the proposed cap rule, but for FHFA to simply answer its own question 26 to make it clear that the only “hard” cap test is the 2.5% figure (and is it too much to ask for a little more leeway on the payout breakpoints?) is quick and easy, and can be accomplished without calling much political attention to the change. my god, if Calabria had to fix his conceptual errors, given his pace, we will all be waiting for the cows to come home.

          rolg

          Liked by 2 people

          Reply

          1. Midas79 and ROLG:

            I have three responses to the hypothetical that FHFA clarifies its question 26 by stating that it will take no prompt corrective action if Fannie and Freddie’s capital were to remain below 4.0 percent but above 2.5 percent, but only impose the restrictions on executive compensation and common and preferred stock dividend payouts that are specified in the regulation (or reduced to lower percentages, per ROLG’s suggestion).

            The first is that if I were CEO of Fannie or Freddie, I would seek to hold more than the 4.0 percent total capital requirement, because I would want to be able to compensate my executives competitively in order to attract and retain them, and also would believe that my common stock would receive a higher earnings multiple, and I could sell more non-cumulative preferred stock, if my shareholders weren’t subject to frequent suspensions of their dividend payments. Second, if I were a major mutual fund manager, I would be very reluctant to invest in the common or preferred shares of Fannie or Freddie if I thought they periodically would be subject to these dividend interruptions. But my final comment is that it really doesn’t matter what I think; what matters is how Fannie and Freddie’s current CEOs, and real institutional fund managers, would react to the construct you describe and seem to recommend. You might be correct that they will react more favorably than I would. This difference of opinion is what makes a market.

            Liked by 3 people

          2. Tim

            in my mind, this falls into the “don’t let the perfect be the enemy of the good” category. you are not going to get perfect with respect to balancing capital levels with mission performance from Calabria. it will be hard enough to get good. where Calabria has been hugely constructive is his consistent recognition, since his 2015 paper with Krimminger, that the conservator has a duty to rehabilitate under HERA. so at this point, a good capital regime will be good enough.

            rolg

            Liked by 1 person

          3. ROLG–I interpret your “don’t let the perfect be the enemy of the good” statement as a reaction to my not endorsing your and Midas79’s recommendation that FHFA allow Fannie and Freddie to operate with less than 4.0 percent but more than 2.5 percent capital with limits on compensation and dividends but no regulatory sanctions as “the answer” to the problem created by Calabria’s May 2020 capital proposal. I would only point out that I have not endorsed ANY recommended solution, nor have I proposed one myself. And I don’t intend to–at least not at this point.

            The goal of my FHFA capital comment was to identify the problems created by applying the Basel capital standards for bank portfolio holdings of mortgages to Fannie and Freddie’s credit guaranty business, to note that because of competitive factors it was unlikely that increases in guaranty fees would be either sure or sufficient solutions to the proposed overcapitalization, and then to point out ways in which the both the minimum and risk-based requirements could be reduced without compromise to safety and soundness, to the benefit of all Fannie and Freddie stakeholders. I’ve now done what I wanted to, which was to put the relevant economic, financial and market facts on the table–in what I hope is an understandable way–for the companies, the investment community and FHFA to take into consideration as they engage in the process of figuring out how to get out of the box Calabria’s capital standard has put them in. I very much hope they’re able to come up with something workable.

            Liked by 2 people

          4. Tim,

            This was mainly brainstorming on my part, and I like to bounce ideas off of knowledgable sources, such as you, to see what the strengths and weaknesses are. I appreciate your responses. What prompted this particular thread was the idea that if a 2.5% capital requirement is workable and 4.0% isn’t, is there an acceptable number in between, and if so how can Calabria accomplish that with only minor changes, i.e., ones not big enough to necessitate another re-proposal of the rule?

            You make a good point that even if the rule’s stated requirement is 2.5%, the de facto requirement is higher because of investor demand for dividends. With a $200-250B market cap, a 2-3% common dividend averages out to around $6B per year. Dividends on the existing preferred shares are $2B per year, but that can be taken away by offering them a conversion to common stock, allowing for the issuance of more preferred shares. Let’s say one way or another, preferred shares will carry a $2B total annual dividend.

            On $20B of annual income (Fannie and Freddie combined) that’s $8B in payouts (executive bonuses are a drop in the bucket), or 40% of income. If that is sufficient then the companies only have to maintain 50% of the buffer, which will grow over time by what they don’t pay out. Treating a 40% payout ratio as a de facto hard requirement, that’s 3.25% of assets (2.5% base + 50% of the 1.5% buffer) and not 4.0%. From your past criticism of Watt’s capital rule, though, 3.25% is likely too much for you anyway.

            In my capital rule comment letter I recommended that the restriction table be changed to allow a 40% payout ratio when the buffer is only 25% full, which would make the de facto requirement 2.875% (2.5% base + 25% of the 1.5% buffer) instead. I view this as somewhat unlikely, but it presents a way that Calabria can lower the de facto requirement by making a minor change.

            Your point about dividend interruptions is also a good one, and one I hadn’t considered. The mere possibility of those makes raising capital much more difficult, and my scenario has the companies operating on the bleeding edge of the payout restrictions, at least in the short term. I recommended a 3-year exemption to payout restrictions to allow for a large capital raise to get the companies up to the 2.5% standard and 3 years to fill the buffer as much as possible before having to worry about the restrictions; this could alleviate that problem.

            Liked by 2 people

          5. I thought the suggestions you made in your comment letter were good ones. And you made them to the right audience–FHFA, and the principals (who I’m sure will be reading the comments submitted) who will be determining the terms of the recap, including the final capital rule.

            And I’ll add a point about the deferral of the 50 basis point refinance fee until December 1, which may run against the grain of opinion. I think this will put more pressure on Calabria to be accommodative in the capital rule. By the time we get to December, more than 25 percent of Fannie and Freddie’s credit guaranty books will have repriced this year at fees in the mid-40s (net of the TCCA fee), and these loans will stay on the books for a very long time because they’ve been made at such low interest rates. That will significantly limit the ability of Fannie and Freddie to produce an acceptable near-term ROE for new investors if the companies’ required capital stays anywhere near 4.0 percent. Fannie and Freddie will know that, Morgan Stanley, JP Morgan and Houlihan Lokey will know that, and somebody will make it clear to Calabria. Your move, Director.

            Liked by 2 people

  22. Review by Andrew Davidson & Co:

    CONCEPTUAL FLAWS OF THE RE-PROPOSED RULE
    The proposed rule appears to be based on three flawed concepts. First, it seems that FHFA believes that the Enterprises function like banks and should have bank-like capital. SECOND, that private capital can fulfill its countercyclical role within the housing finance system without government support. THIRD, that adding on buffers and minimums produces a better capital rule.

    It recommends withdrawal.

    Liked by 1 person

    Reply

    1. This is an excellent comment. Davidson makes virtually all of the points I tried to make in my comment, and adds analytical detail to them. He stresses that Fannie and Freddie are not banks, and that Calabria’s version of safety and soundness–which is to add a lot more conservatism and cushions to their risk-based standard, and underpin it with a bank-like 4 percent leverage ratio–breaks the link between capital and risk, and ignores the impact that this excessive required capital will have on the companies’ ability to carry out their statutory mission. Davidson points out that the FHFA proposal includes no discussion of the impact its required capital will have on Fannie and Freddie’s guaranty fees and market share, and he makes his own estimates, noting that fees based on capital required by the 2020 proposal would cause the companies to lose low-risk business to banks and high risk business to the FHA (which I agree with).

      Davidson will not be the last person to make these points to FHFA. They’re correct, and reflect the fundamental and undeniable flaws of the approach Calabria has chosen to take with the re-proposal. As more and more commenters–including, I believe, Fannie and Freddie–make the same points, it will be very interesting to see how Calabria chooses to respond to them.

      Liked by 2 people

      Reply

      1. Tim,
        When I read the Davidson comment letter, I thought how well thought out and fact based his comments were, similar to what you commented as well. My thoughts when I read this and many other comment letters, is that the re-proposed capital rule has many flaws and letters such as these that are factually based should make the FHFA think hard and long about changing the re-proposed rule. The effects that the re-proposed rule will be substantial and any reasonable person should be able to see this.

        My next thoughts were, will Dr. Calabria take note and make these reasonable changes. The proposed changes or comments that you and Davidson and others make would substantially change the amount of capital that he is proposing to retain. I am reasonably sure that he was aware of the effects of the capital he was proposing and how the calculations were derived. With this in mind, do you think after taking all of the time that FHFA took to think out this proposal ( with a direct purpose in mind to require bank like capital and ultimately reduce their portfolios), will he make the the changes that many have requested and look like he did not think of all of these issues? I’m concerned that his mind was made up on what he wanted the capital to look like and no one will change this. Maybe the many comments will make him think again. I certainly hope so!

        Liked by 1 person

        Reply

        1. Or just maybe he will adjust based on comments from well respected individuals like Mr Howard and it will “appear” that he is being flexible and willing to work with others??

          Like

          Reply

          1. A couple of reactions to these comments. I believe Calabria came to his position as Director of FHFA as a small government, free market ideologue (with my favorite definition of an ideologue being a person who has the answer to your question before you’re able to ask it), thinking, “I’ll impose bank-like capital on Fannie and Freddie to make me look like a tough safety-and-soundness regulator, and the companies then can do whatever they want to raise their guaranty fees to earn a market return on that capital.” I don’t believe he understood that there were competitive and political limits to how high Fannie and Freddie could raise their fees (and I also think he didn’t care much about the impact it would have on low- and moderate-income homebuyers, because “it’s the free market”).

            He’s now learning–from commenters on his capital rule and from the reaction to what I understand is his initiative to add a 50 basis-point fee to Fannie and Freddie’s refinance loans during the pandemic–that there ARE limits to what the companies can do with their fees. IF these result in potential new investors balking at committing anything close to the amount of capital required to have a successful recapitalization of Fannie and Freddie in the public markets–which I don’t know will be the case, but suspect will be–he will have two choices: he can either pull some of the excessive conservatism and cushions out of his May 2020 capital proposal, or he can say, “This is the capital standard Fannie and Freddie have to meet, and if they can’t meet it quickly through public equity offerings they’ll have to meet it slowly through retained earnings.” I honestly don’t know which he’ll pick, but if he digs into his ideological position it will be the latter.

            Liked by 2 people

      1. @BIGe/Tim

        it is clear that the proposed rule is is ideologically driven, with very little sensitivity to facilitating a capital raising. however, there were more than 100 questions asked (and many responded to in the comments), which leads to believe that there may be some willingness to move off of the ideological position, at least somewhat. I don’t expect a categorical move away the bank/Basel framework, but there may be enough wiggle room created by responding to the comments…assuming the questions were asked in good faith and not for optics only.

        rolg

        Liked by 1 person

        Reply

        1. For BIGe: Calabria has said many times over the past year and a half that the process for releasing Fannie and Freddie is not “calendar dependent.” To pick just one example, at last year’s MBA conference he told the attendees, “the path out of the conservatorships will depend not on the calendar but on Fannie and Freddie meeting the mile markers we set out for them.” One of those “mile markers” is their required capital, and if Calabria doesn’t reduce it below the current 4 percent-plus, and investors balk at putting new equity in the companies at the sub-par ROEs those capital levels would produce, then the only option Fannie and Freddie would have for exiting conservatorship would be through retained earnings.

          For ROLG: Calabria has boxed himself in with the emphatic defense FHFA made for applying the Basel bank capital standards for on-balance sheet mortgages to Fannie and Freddie’s credit guarantees; that’s reduced his options for responding to the comments FHFA’s been receiving about it. (I doubt, for example, that he’ll be receptive to Andrew Davidson’s recommendation: “withdraw the proposal and redraft the rule.”) This is where Fannie’s comment will be critical. It’s already said in its second quarter 10K and conference call that it has significant problems with the capital rule as it stands. Potential new investors in both companies will have taken note of that. In my opinion, the recommendations Fannie makes for changing the rule (to something the company thinks it can live with) will constitute the minimum Calabria will need to do in order for investors to put new equity into either company. Once we see Fannie’s comments–which will be within the next two weeks–we’ll be able to begin assessing how Calabria is likely to react to them.

          Liked by 1 person

          Reply

          1. Tim

            I agree that Fannie’s comment (and Freddie’s, if it comments…and I would think that if Fannie comments, then Freddie will comment) are very important. apart from the GSEs having the far superior understanding of their own markets and business models as compared to FHFA (listening to the FHFA cap rule webinar, I got the distinct impression that the FHFA staff were mostly DC-based wonks without any deep business or capital markets experience), the GSEs’ comments can be thought to likely represent the best advice their financial advisors have been giving the GSEs with respect to the capital markets and the feasibility of raising equity capital. So the GSEs’ comments will be the most relevant.

            which raises an issue…will Calabria think that he will be viewed as a “captive regulator” if he takes the GSE comments into account, or will he acknowledge that he is actually being blessed with the best advice he could possibly receive?

            rolg

            Liked by 1 person

          2. I think Calabria is going to have to choose between the conflicting prongs of his ideology: limited government and free markets. Well before he’d become director of FHFA, Calabria had fully bought into the argument made by the opponents and competitors of Fannie and Freddie that their federal charters allowed them to operate under capital standards that gave them an unfair advantage over banks and other sources of mortgage finance. The remedy for this, for the limited government crowd, was to revoke the companies’ charters, make them fully private, and require them to hold the same amount of capital as “private” banks (putting aside the fact that banks’ business would be very different without federal deposit insurance). As I noted in my comment to FHFA, prior to the financial crisis this was at least a defensible (although still a weak) argument, because Fannie and Freddie competed directly with banks as portfolio investors in mortgages. Today they no longer do, but their opponents, critics and competitors–along with Calabria– don’t seem to have realized that without a portfolio business the rationale for a bank-like capital standard for the companies has disappeared. They’re still insisting on that, but as we’re seeing in the comments, more and more people are saying, “Wait, this doesn’t make any sense; if you force Fannie and Freddie to hold portfolio-level capital but only allow them to do credit guarantees, that wrecks their business model, and they won’t be competitive.” It has nothing to do with fairness, or “limited government,” as it once might have.

            The free-market prong of Calabria’s ideology, on the other hand, insists that unfettered market forces are the most reliable and unbiased way to allocate capital in the economy. What will he do, then, if as appears likely the “limited government,” bank-like capital standards he is insisting upon imposing on Fannie and Freddie encounter the judgment of the free market that two companies limited to the credit guaranty business and required to hold 4 percent-plus capital aren’t economically attractive entities worth investing in? Does he go with the market’s judgment and lower the capital requirements, or does he stick with his capital requirements in spite of the market’s verdict? There seem to be much better arguments for the former. I would think his financial advisor, Houlihan Lokey, will favor this route, as will Fannie and Freddie’s advisors, Morgan Stanley and JP Morgan. On top of that, a recapitalization of Fannie and Freddie solely through retained earnings, and without significant participation from new equity investors, will widely be viewed as a failure, which will not reflect well on Calabria. And there really are no good arguments for digging in on the bank-like capital standard, once that’s been subjected to close scrutiny as is occurring now (and should have happened long ago). It will, though, be Calabria’s call to make.

            Liked by 3 people

          4. Tim

            you have mentioned all three financial advisors, and I would like to point out a major difference among them: Houlihan is being paid (relatively small potatoes) for time, and MS and JPM will be paid (relatively ginormous potatoes) for results. this directly affects the advice they will give. IMO, while Houlihan will give its best advice to FHFA, it will do so sotto voce. on the other hand, MS/JPM will pull no punches in giving advice to the respective GSEs, and will bang the table, at least in private. Money does this to people. I am hopeful that some of this bang the table advice gets fed to Calabria privately, but also publicly via the GSEs’ comments to the proposed cap rule.

            rolg

            Liked by 1 person

          5. I understand the differences in the roles, capabilities and motivations of the different financial advisors. The complication is that the advisor with the least knowledge of the companies and the biggest incentive to soft-pedal good advice has been retained by the party with the largest knowledge deficit and seemingly the least incentive to take advice. Morgan Stanley and JP Morgan will be “preaching to the converted,” and won’t need to pound the table for Fannie and Freddie. The challenge will be conveying the “pound the table” knowledge and sentiments from the the second group to the first. I suspect the way this will be done is through MS and JPM talking to Houlihan Lokey, and Fannie’s CEO Hugh Frater talking to Calabria (I don’t know much about the relationship between Freddie CEO Brickman and Calabria).

            Liked by 1 person

    3. Tim

      Considering Calabria trashed Watt’s capital proposal, do you believe there will be another proposal if a new president is elected and the FHFA director can be replaced after the recent SOCTUS rulings? It seems like capital requirements can keep changing each time there is a new administration or director and it is not even possible to come up with a capital rule that is acceptable by the players in the industry. How can companies operate if there is an unknown risk that capital requirements can change every 4-5 years?

      Like

      Reply

      1. I think it’s too early to speculate about what might happen to the capital rule if there is a change in administration next year–and then, at some point, the FHFA director. The 2008 HERA legislation does give the director of FHFA the ability to change Fannie and Freddie’s minimum and risk-based capital requirements, but I would expect this authority to be exercised only rarely, or under highly unusual circumstances. Mark Calabria is doing it now because the companies’ capital requirements had never been updated pursuant to the directive in HERA to do so, some 12 years ago.

        What makes the question you’ve asked topical is the volume and scope of the criticism being leveled against Calabria’s May 2020 capital proposal. If Calabria can amend this proposal so that it does not force Fannie and Freddie to price their credit guarantees at noneconomic and uncompetitive levels, then I wouldn’t expect a new director to issue a new capital rule. If, on the other hand, Calabria insists on holding the companies’ minimum and risk-based capital requirements at 4.0 percent-plus, then a new FHFA director, once named, may well elect to issue a new, and more reasonable and workable, rule.

        Like

        Reply

  23. Dem senators on Banking committee sent a letter to FHFA:

    “We further request that FHFA and, as appropriate, the Enterprises, provide their analysis of the rule’s projected effects on various populations of homeowners and renters, including the options available to households and at what price, as well as the many participants in the broader housing market. This includes the effects on small lenders and the affordable rental housing community.”

    How likely GSEs will make a public comment?

    Like

    Reply

    1. This letter from Senate Democrats–which also requests that FHFA extend the comment period on the FHFA capital proposal because of its importance to the housing finance system, its complexity (it’s 424 pages long, and extremely detailed) and the pandemic—echoes the concern of a growing number of commenters that raising Fannie and Freddie’s required capital by 77 percent from what many believed already was an overly conservative requirement from FHFA’s June 2018 proposal could have severe negative effects on the cost and availability of mortgages for homeowners and renters. The Senate Democrats would like FHFA, and also Fannie and Freddie to the extent they feel free to do so, to give their analysis of how this capital rule will affect the guaranty fees for various loan types, and through these pricing effects the impact on credit guaranty affordability for a range of borrower segments. This is an entirely reasonable request, particularly of FHFA, which is the entity making the capital proposal (and claiming, without numerical evidence, that the new rule would be beneficial to affordable housing).

      Fannie already has said it will comment on the FHFA proposal. During its July 30 earnings conference call, CFO Celeste Brown said, “We believe the new proposed capital rule could have significant consequences for our business model, capital planning and ability to attract private investment if implemented as currently proposed. We plan to submit a public comment letter with our recommendations for the final rule.” I expect Freddie will comment as well, and very much look forward to reading what each company has to say.

      Liked by 3 people

      Reply

      1. Thank you Tim, ROLG and all the other frequent commenters. I appreciate the time you put into this blog. I believe it is the best source of information regarding the GSEs and their future on the internet.

        Liked by 1 person

        Reply

        1. Jeff–

          Thank you for your kind comment. I find the time commitment–which has now lessened compared with the earlier years of the blog–to be worth it, particularly if we’re able to add some light to the heat generated elsewhere in the dialogue about the futures of these two critically important companies.

          At the moment it’s relatively quiet here, pending the August 31 deadline for comments on the FHFA capital rule. But I would encourage readers to monitor the submissions to the agency on the rule, to get a sense for what FHFA is hearing about it. (I found the comment submitted by Muirfield Capital this Wednesday to have been both thoughtful and persuasive). The next steps in the recap process will be heavily influenced by the total amount of capital FHFA will require the companies to have, and the more excess or unnecessary capital they have to raise the more difficult it will be to achieve the recap quickly and successfully. The broad negative reaction to the proposed 50 basis point “refi surcharge” that in my view is directly linked to Fannie and Freddie’s expected higher capital requirements should be a wake-up call to those (perhaps including Director Calabria) whose response to criticisms of the proposed 4.0 percent minimum capital requirement for the companies has been, “oh, we’ll just raise guaranty fees.” While this may seem simple in theory it decidedly is not in practice. Not only are there economic and competitive limits to fee increases, which I addressed in my FHFA comment, we’re now seeing that there may be political limits as well. Things are getting interesting.

          Liked by 4 people

          Reply

        1. It’s correct that FHFA won’t be able to say what Fannie and Freddie’s final fees–including add-ons to recoup the cost of the periodic commitment fee–will be, but it nonetheless would be valuable for FHFA to give the Senate Banking Committee its view on how its proposed capital requirement would affect guaranty fees, before the commitment fee add-on.

          Treasury will set this commitment fee, and because there is no direct comparator to it anywhere else in business or finance–it’s not directly comparable to a catastrophic risk premium, nor to a fee for a standby line of credit–Treasury will have considerable discretion as to how and where it sets it. But the fee SHOULD be linked to both the risk of the facility ever being needed–which will depend on the quality of the business Fannie and Freddie have, and the amount of first-loss capital they hold in front of the backstop–and the cost to Treasury of providing that credit (which will be very low: just its cost of funds if and when the backstop is drawn upon, with no need for a “reservation of funds” fee because Treasury has essentially unlimited borrowing capacity on demand). Using this model for setting the periodic commitment fee, I would think that once the companies fully meet their capital requirements it should be no more than 25 basis points per year on the dollar amount of the Treasury backstop (NOT the companies’ outstanding MBS). Assuming the backstop is equal to the remaining amount of funding available under the Senior Preferred Stock Agreement–and the amount may be less–for Fannie Mae this would be 25 basis points on $113.9 billion, or $285 million per year. Against its current total MBS outstanding (single- and multifamily), that would be less than a basis point per year. Of course, this fee should and would be higher prior to Fannie hitting its target capital amount.

          Like

          Reply

          1. Tim –

            Is it possible that the commitment fee could be set up such that it acts like the NWS? Let’s assume that the shareholders won and were able to reverse the NWS and reduce the liquidation preference to zero, and the companies were released from conservatorship. Is it possible for a new Administration to impose a commitment fee that takes all profits from the companies each quarter?

            Like

          2. These days it’s risky to say that anything is “not possible,” but no, that won’t happen. One reason is the language in the Fannie and Freddie Senior Preferred Stock Purchase Agreements, which states, “The amount of the Periodic Commitment Fee shall be mutually agreed by Purchaser [the companies] and Seller [Treasury], subject to their reasonable discretion and in consultation with the Chairman of the Federal Reserve…” Fannie or Freddie never would agree to a net worth sweep-like fee for funding under the SPSPA.

            Liked by 1 person

    2. (Bloomberg) — Fannie Mae and Freddie Mac are planning to charge an additional fee on most mortgage refinance loans that could raise costs for borrowers trying to take advantage of historically low rates in an uncertain economy.

      The mortgage giants, which have been under government control since 2008, announced the plan late Wednesday, saying the new 0.5% fee is meant to mitigate their risk in light of the Covid-19 pandemic. It would apply to most refinances involving the companies.

      Like

      Reply

      1. I saw this, and also the reaction of Dave Stevens (former head of the Mortgage Bankers Association) that “FHFA and the GSEs are essentially providing [families affected by the pandemic] the middle finger in order to protect billionaire bond investors by adding a 50bp fee on refis.”

        While I didn’t know this fee was coming, I’m not surprised by it—something along these lines was hinted at by Fannie in its second quarter 2020 10Q and its earnings conference call. And my response to Stevens’ reaction is, “Dave, this fee is a direct consequence of something you’ve been advocating for two decades: the deliberate and unnecessary overcapitalization of Fannie and Freddie intended to drive business to banks and other sources of mortgages. Be careful what you wish for.”

        There is little question that this 50 basis-point fee is related to the FHFA capital rule, and in my view it’s a signal that at least for now Director Calabria does not intend to back off much, if at all, on his insistence that Fannie and Freddie hold 4.0 percent capital against their credit guarantees. As I noted in the current post, “Given Fannie and Freddie’s average net fee on new business in 2019 of 46 basis points, the capital required by FHFA’s May 2020 proposal would produce a sustainable ROE of about 8.0 percent, far below the 12.0 percent average ROE of commercial banks.” To make this ROE attractive to potential participants in their recapitalization, Fannie and Freddie have no alternative but to try to raise fees. And what’s happening now? As Fannie said in its 10K, its book is turning over rapidly at LOWER, not higher, guaranty fees because of refinances triggered by pandemic-induced declines in interest rates. Here is what Fannie said in its second quarter 10K:

        “Because we expect mortgage rates to remain low through 2021, we anticipate a large and growing portion of our book of business, originated in a historically-low-interest-rate environment, will have less incentive to refinance, slowing the pace at which loans in our book of business turn over in future years. A slower turnover rate in our book of business would reduce our ability to increase our revenues by increasing guaranty fees, as any such change would take longer to meaningfully increase the average charged guaranty fee on our total book of business.”

        There is little doubt that the 50 basis-point upfront fee is an attempt by Fannie and Freddie (and approved by FHFA) to get at least some additional revenue out of this wave of refinances in anticipation of much higher required capital. But one thing the fee won’t do is allow the companies to recapture the extra 10 basis-point annual TCCA fee they’ve been charging borrowers for the past nine years and passing on to Treasury; if those fees are locked in on refis before the TCCA expires next year, so too is Treasury’s claim to them. To get their own average net guaranty fee up, Fannie and Freddie will have to wait until higher fees on purchase money mortgages, and a greatly reduced volume of post-2020 refis, edge their average fee higher. Potential investors in Fannie and Freddie almost certainly are aware of this dynamic. They are being asked to invest huge amounts of new equity into two companies that, with the current FHFA-proposed capital requirements, will have below-market and uncompetitive ROEs for a very long period of time, with few alternatives for raising them more quickly. And no, Dave, you can’t blame Fannie and Freddie for attempting to get out ahead of this problem; that’s on FHFA, and those, including the MBA, who support what Calabria wants to do with their capital.

        Liked by 6 people

        Reply

    1. This is an issue that’s been getting a lot of attention, but in my opinion it does not have significant implications for Fannie and Freddie’s securitized CRT programs going forward. It’s arisen because the CRTs issued in the first couple of years of Fannie’s (and presumably Freddie’s) programs are what were called “fixed severity” securities–that is, if a mortgage defaulted, the investor in the CRT was obligated to reimburse the issuer a given percentage of the UPB of the defaulted loan, as defined in the prospectus for that security. (CRTs issued in later years, and currently, pay out based on actual loss severities). The problem with the structure of these early securities has become apparent with the forbearance program from the pandemic: once the forbearance period reaches six months a loan is technically in default, and that triggers payment of the fixed severity amount to Fannie or Freddie, even if the loan subsequently becomes current and the companies suffer no real losses.

      Investors in these early deals, which are mainly hedge funds, say this is a technical error, not intended when the securities were issued, and either the companies or FHFA need to step up and remedy it. The problem with this position, of course, is that most everyone believes that if the hedge funds were on the favorable side of this “technical error,” it is a virtual certainty that they would say, “a contract is a contract, and you (the issuer) must honor it.” That does tend to weaken their position. But in any event, this is a problem that has no direct application to the CRTs the companies have been issuing for the past several years.

      Liked by 3 people

      Reply

        1. It’s a recollection from all the reading I did on Fannie’s CAS program–including the prospectuses–when I first started writing about their securitized CRTs back in 2016.

          Like

          Reply

    2. ZANDI:

      https://files.acg-analytics.com/wl/?id=O4Ktphbap2yYUkz2f6xZYOPhBgDTQ7GE

      “The GSEs’ current guarantee fees imply capitalization of close to 3%, which is more than adequate to ensure that they remain going concerns under severe stressed economic scenarios. This would have been sufficient for them to remain going concerns through the financial crisis, and considerably more than would be needed today given their mix of business.”

      Liked by 1 person

      Reply

        1. The link is to an article put out by the Urban Institute earlier this week, critiquing the May 20 FHFA capital proposal. Its authors are Jim Parrott, nonresident fellow at the Urban Institute and co-owner of Parrott Ryan Advisors; Parrot’s new partner Bob Ryan, who from July 2015 through September 2018 was Acting Deputy Director for the Division of Conservatorship at FHFA, and Mark Zandi, Chief Economist at Moody’s Analytics. Parrott and Zandi have done papers for the Urban Institute before, but this is the first that includes Ryan as a co-author.

          On the Urban Institute website, the abstract of the paper reads, “In this brief, the authors summarize and critique the FHFA’s recent capital proposal for Fannie Mae and Freddie Mac, concluding that it misapplies the bank capital regime in a way that would ultimately take the GSEs and the housing finance system in the wrong direction, unnecessarily leading to higher mortgage rates, riskier GSEs, and a less stable housing finance system.” And in the paper itself the authors describe the FHFA capital rule as “beginning with the capital the banks are required to hold and setting the GSEs’ capital rules so that they need to hold approximately the same amount of capital, regardless of the risks the GSEs are taking.”

          I obviously agree with those points, and am glad the Urban Institute is making them. It’s noteworthy, though, that these and other criticisms of the capital rule came in an article, and not a formal comment letter to FHFA. The Urban Institute did not submit a formal comment for FHFA’s June 2018 capital rule. Instead, three individuals from its Housing Finance Policy Center—Ed Golding, Laurie Goodman and Jun Zhu—submitted a comment under their own names, without mentioning their affiliation. I found that odd, but now wonder if the Urban Institute might do something similar this time as well, or if it will just let this article stand as its point of view on the rule.

          Liked by 2 people

          Reply

          1. Tim

            I found the Parrott, Ryan and Zandi piece to be informative and well done. https://files.acg-analytics.com/wl/?id=O4Ktphbap2yYUkz2f6xZYOPhBgDTQ7GE. It is, I suppose, criticism that Calabria should take to heart given its source (meaning, from opponents, generally, of privatization who seem to have the same reaction to the proposed capital rule as proponents of privatization).

            I invite you to react to the following assumption, loss of market share of 10-14% due to excessive capital level requirement:

            “Under the FHFA’s proposed capital rule, we estimate that the privatized GSEs would lose 10 to 14 percentage points of origination market share on average through the business cycle. Approximately two-thirds of that would go to portfolio lenders, whole loan buyers, and perhaps some private-label securitization, as pricing for the lowest-risk loans converge with that offered in those markets. And about one-third of the loss would be from their higher-risk loans going to the Federal Housing Administration, particularly borrowers whose incomes are below 80% of average median income and first-time homebuyers with incomes of less than 100% of AMI.” pps 3-4.

            I ask in particular because as we read this, Morgan Stanley and JP Morgan are fine tuning their financial modeling of the GSEs in connection with the preparation of the capital restoration plans. If MS/JPM incorporate this assumption as to market size going froward as well, it will significantly (and adversely imo) impact the feasibility of their capital raising mandate.

            This will all be presented to Calabria in due course, hopefully before the capital rule is finalized. bankers have a way of assigning blame, especially when it is to sources (market conditions is oft used) other than themselves. one wonders how much of a surprise all of this will come to Calabria for him to learn that he is being held up as the principal impediment to a successful privatization.

            rolg

            Liked by 2 people

          2. When I read the prediction in the Urban Institute paper that the May 2020 FHFA capital rule would cause Fannie and Freddie to lose “10 to 14 percentage points of origination market share,” I had two reactions: (a) the percentage reduction almost certainly came from the economist of the group, Mark Zandi, and I don’t know how he came up with it, and (b) it’s the first time I recall seeing the term “origination market share.”

            To make sense out of this, you have to start with the second point. As I noted in my FHFA comment, the measurement of market share for the mortgage market is complicated by the fact that it has four main segments: origination, servicing, credit risk-taking and funding. Fannie and Freddie now effectively operate in only one of those segments, credit risk-taking, and there they share the credit enhancement function (and revenues) on all loans with LTVs over 80 percent—about one-third of their business—with private mortgage insurers. So, there’s really no clean way to allocate “market share” on a high-LTV loan guaranteed by Fannie or Freddie, with PMI, that is purchased for portfolio by a bank. FHFA claims that loan is “financed” by Fannie or Freddie, but that’s simply wrong. The “market shares” are split, in ways that are not easy to track, but that provide the most revenues to the final investors.

            “Origination share” seems to be the Urban Institute’s way to try to get around this problem. It’s essentially asking, “Who gets the ‘first touch’ on a new loan?” Does it go to Fannie, Freddie or the FHA for a credit guaranty, to a bank either as an aggregator or an investor, or somewhere else (such as a private conduit)? It’s important to bear in mind, however, that every loan that gets a credit guaranty from Fannie, Freddie or the FHA still has to be funded by a final investor. A focus on “origination share,” while useful in some respects, obscures this vital point.

            Between the end of 2007 and March 2020—when Fannie and Freddie’s guaranty fees went from the low 20s to the high 50s (in basis points)—Fannie and Freddie’s combined “origination share” of single-family first mortgages still rose by 5 percent (from 42 to 47). Banks’ origination share also rose by 5 percent (from 13 to 18), while their funding share—whole loans acquired at origination plus MBS acquired in the secondary market—rose by a much larger 13 percent (from 23 go 36). And Ginnie Mae’s origination share rose by a mammoth 15 percent (from 5 to 20). All these increases in origination share, however, came at the expense of the private-label market, which now has an origination share of effectively zero. This means that if Fannie and Freddie try to raise their guaranty fees from where they are now by another 10 to 20 basis points, as a result of much higher (unjustified) capital required by FHFA, they WILL lose origination share; the only question is how much.

            In my comment to FHFA, I was content to simply make the case for why there would be a drop in Fannie and Freddie’s origination shares if they attempted to raise their guaranty fees much higher than they are now, but I didn’t attempt to quantify it. Is Zandi’s 10 to 14 percent share drop a reasonable estimate? Yes, I think probably so, and it could even be understated. I believe we’re close to a “tipping point” for Fannie and Freddie on guaranty fees. As I discussed in my comment, bank portfolios can do “blended pricing” for both interest rate and credit risk when buying mortgages for portfolio, whereas Fannie and Freddie can only price the credit risk, while FHFA is proposing to require the companies to price their high LTV loans off nearly four times the capital the FHA now has. And I would add that a focus on origination share changes leaves out the third outcome of excessive Fannie-Freddie guaranty fees: less business will get done. That won’t show up in the share data (although it will in single-family mortgage totals), and it’s an important effect.

            Finally, to your last point, I agree that having the 10 to 14 percent market share loss out there as a prediction from the Urban Institute should be helpful, although I think more for Calabria than JP Morgan or Morgan Stanley, who will have been focused on this issue already. They well understand that the interactions between Fannie and Freddie’s capital, guaranty fee pricing and guaranty volumes are keys to their future profitability, and hence their market value as investments.

            Liked by 1 person

          3. Tim

            as to your question why UI wont submit this paper as a formal comment to the proposed rule, I can only guess that UI is wary of being accused to be lobbying, which is a questionable activity for a 501c3 (permitted up to a point). assuming Calabria, who comes from the nonprofit world, understands this, one would hope that he is willing to give this paper as much credence as any formal comment.

            rolg

            Liked by 1 person

          4. The Parrot, Ryan and Zandi paper won’t be the last to make the point that Calabria’s decision to impose a bank capital standard on Fannie and Freddie is without justification and contrary to the readily observable risks of the one business they’re permitted to do, and if insisted upon will have easily predictable negative consequences for mortgage rates, mortgage availability and systemic financial risk. I suspect he’ll get the message. And I also wouldn’t rule out Laurie Goodman and her UI colleagues doing a substantive analytical comment similar to what they did on the previous FHFA capital rule.

            Liked by 2 people

  25. Tim

    I have had a conversation with midas79, who posts on this blog periodically, who points out that a Mr. Sugarman at FHFA had this to say during the recent FHFA webinar on the proposed capital rule:

    “The way buffers work is that it’s not a capital requirement. Rather the enterprises need to hold the prescribed buffer amount, or we start to limit the capital distributions such as dividends and stock repurchases, and we also limit discretionary bonuses to executives.” p. 11 see https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/642020_transcript.pdf

    now, I will be the first to admit that FHFA is confusing regarding the buffers; see Question 26 in the proposed rule and my comment letter to FHFA regarding it: https://www.fhfa.gov//SupervisionRegulation/Rules/Pages/Comment-Detail.aspx?CommentId=15531.

    are the buffers a capital requirement that need to be met upon pain of regulatory action, or an inducement for GSE management to carry more capital than actually required by the rule in order to avoid dividend and bonus restrictions? the answer to this question is very important for the initial capital raises that will be necessary to at least meet the risk/leverage capital requirements, imo.

    I have to believe that GSE lead underwriters, MS and JPM, are pounding FHFA for clarification on this point behind the scenes, but if you take what Mr. Sugarman said at face value, that buffers are not a capital requirement, then the capital market might take a more sanguine view of this rule.

    rolg

    Liked by 2 people

    Reply

    1. I don’t find the ambiguity or confusion around the structure of FHFA’s May 2020 capital proposal that you seem to. Both the minimum and the risk-based capital requirements have two components: a base capital requirement and a prescribed buffer. If either company’s total capital falls below the percentage set by either the minimum capital requirement (2.5 percent) plus buffer or the risk-based capital requirement plus buffer, it becomes subject to restrictions on executive compensation and dividend payments, with the severity of the dividend restrictions depending upon the extent of the shortfall in buffer capital.

      There is nothing in the proposed rule that indicates that FHFA will subject either company to prompt corrective action unless the base capital requirements are breached. FHFA does, however, state its expectation for how the companies will behave under this capital structure, saying, “FHFA expects that each Enterprise generally will seek to avoid any payout restriction by maintaining regulatory capital in excess of its buffer-adjusted risk-based and leverage ratio requirements during ordinary times,” adding, “it would not be consistent with the safe and sound operation of an Enterprise for the Enterprise to maintain regulatory capital less than its buffer-adjusted requirements in the ordinary course except for some reasonable period after a financial stress, pending the Enterprise’s efforts to raise and retain regulatory capital.” And lest anyone miss the point, there is this: “FHFA could, depending on the facts and circumstances, determine that it is an unsafe or unsound practice, or that it is inconsistent with the Enterprise’s statutory mission, for an Enterprise to maintain regulatory capital that is less than its buffer-adjusted requirements during ordinary times. If FHFA were to make that determination, FHFA would have all of its enforcement and other authorities, including its authority to issue a cease-and-desist order, to require the Enterprise to remediate that unsafe or unsound practice—for example, by developing and implementing a plan to raise additional regulatory capital.”

      I think the potential new large institutional investors understand how this capital rule will work, and in my current post I’ve tried to give them some facts about the competitive and pricing implications of forcing Fannie and Freddie to operate with a 4 percent-plus capital requirement. If I were a mutual fund manager looking at Fannie and Freddie as an investment, I would be pushing FHFA very hard to give real relief on the capital front by making definite and substantive changes to the rule that bring required credit guaranty capital into much closer alignment with the risks of the underlying loans–otherwise much of the business will go elsewhere. I also would think that there is nothing FHFA, its predecessor OFHEO, or Treasury have done in the last 28 years that would be grounds for my being “sanguine” about the possibility of Fannie and Freddie being allowed to operate with less than the base plus buffer amounts of capital for any length of time during a normal market environment. But we’ll see what the investors themselves say, and do.

      Liked by 4 people

      Reply

  26. Thanks again for all of your analysis Mr. Howard. Its great to get informed analysis that regular folk can examine.

    I am wondering how the recent decision by SCOTUS to review both claims will impact other litigation in lower courts (Sweeney and all) – if in fact it does impact those claims. Do you or perhaps others have any thoughts on this? For example, does it impact the timelines for other litigation?

    Cheers

    Liked by 1 person

    Reply

    1. In my opinion the decision by SCOTUS to grant cert in the Collins case will have no impact on the Sweeney case in the Court of Federal Claims, nor on the remand of the breach of contract and implied covenant claims in what used to be called the Perry Capital (which has since liquidated) case to Judge Lamberth in the D.C. Circuit—whether on their substantive matters or their timing. The Collins case obviously is on hold until SCOTUS decides it. The other active case I’ve been tracking is the appeal of Bhatti to the Eighth Circuit Court of Appeals, and there the Seila Law ruling by SCOTUS is supportive of, and will be helpful to, plaintiffs’ argument, but here too is unlikely to have any significant effect on the timing of that case.

      Liked by 1 person

      Reply

      1. @path/Tim

        the Collins unconstitutional structured claim is the principal claim to follow, even more than the Collins APA which will be argued before scotus at same time. if Ps win APA claim, which comes up on a granted motion to dismiss, then the APA claim will be remanded to district court for a trial as to whether conservator exceeded his authority re NWS, which from start to exhaustion of appeal will be at least two years. Fairholme in court of federal claims and the implied covenant breach case before Lamberth are on similar timelines. If Ps win the Collins unconstitutional structured claim before scotus, the Ps win now (likely announced late spring 2021), and the case is remanded to determine relief. The Collins unconstitutional structured claim is the horse that has jumped into the lead…and imo is the claim with the best chances for success.

        rolg

        Liked by 2 people

        Reply

  27. Tim

    FSOC apparently is looking at the secondary housing finance market. while not asking you to speculate, is this the kind of announcement that might lead to an analysis whether to designate the GSEs as SIFIs? a skeptical mind might presume that FSOC is carrying water for FHFA’s proposed capital rule, perhaps justifying the high level of capital as a reason not to designate as SIFIs.

    rolg

    Liked by 1 person

    Reply

    2. I have little doubt that Calabria is looking for support for his notion of greatly overcapitalizing Fannie and Freddie. There is a group of critics of the companies who have long advocated applying the SIFI designation to them, and I suspect Calabria is playing off that.

      SIFI, as you know, stands for “systemically important financial institution.” In the segment of the market in which Fannie and Freddie operate–providing credit guarantees on residential mortgages–they are that; their guarantees are attached to close to half of all residential mortgages outstanding today. So, what is the right policy response? This is where the dialogue gets disjointed. Critics of the companies use the SIFI designation as an excuse to pile so much capital onto them that they can’t function. As I attempted to explain in my comment to FHFA, however, that just drives the business into weaker, and riskier, hands, which is worse for the financial system.

      The right answer to the “SIFI” issue is to require Fannie and Freddie to hold enough capital that they can comfortably withstand whatever level of market stress any other providers of mortgages can withstand, but not significantly more than that. But I don’t know how many of the voting members of the FSOC understand this (I’m quite confident that Calabria does not) or think this way, so I don’t know how this review will come out.

      Liked by 1 person

      Reply

  28. A masterpiece! Leaves no room to justify the FHFA proposed capital.
    Thanks Mr Howard for your commitment to excellence in all your work.

    Liked by 2 people

    Reply

  31. Tim,

    Just like everyone else, “Thank you!” for your work on behalf of Fannie Mae.

    This article was so good, that I felt compelled to send it to a number of individuals including 13 partners of Milbank, a reporter from the American Banker, J.P. Morgan (since they are working for Fannie Mae), and both of the State of Illinois senators.

    Have a great day!

    IAmJ_1

    Liked by 1 person

    Reply

  32. Tim, another great piece of work. Thanks again for the well directed and thorough analyses.

    Given recap is a key directive and that preferred shares are priced way less than par today, there is up to $20BN (par value less current value) sitting on the table waiting for a formal announcement to acquire back the jr preferred. Why can’t/wouldn’t the GSEs or Treasury not start buying back the preferred today at 35c on the dollar? No law stopping such right? No congressional approval for treasury action like this especially given recent COVID leeway? Wouldn’t a “financial advisor” suggest that sooner rather than later?

    Like

    Reply

    1. @stuart

      imo there is all the reason in the world to retire the existing junior prefs, which are expensive by today’s rate environment. but using precious capital by buying them back is not Plan A given the capital building constraints the GSEs are under. I expect the big junior pref holders would hold out for well more than 35%, but would be willing to continue with an investment in the GSEs (via an exchange into common) when there is some reasonable assurance that the recap has lifted off the runway.

      rolg

      Like

      Reply

    2. I made a decision some time ago to leave the topic of capital account management advisory to the investment banks Fannie and Freddie hire for that purpose; they have considerably more expertise and current market knowledge than I do.

      Liked by 1 person

      Reply

  33. Thanks for publishing your opinion on the risk-based capital rule, Tim. Your comments are perfectly rational and fairly easy to understand, which makes me wonder why FHFA and Calabria can’t wrap their minds around the simple dynamics of risk-based capital, or come to grips with what actually happened during the financial crisis, and how the whole system was put at risk, disabling effective controls of the mortgage market by Fannie Mae through the misuse of private label securities.

    Liked by 2 people

    Reply

  34. Thank you for being a voice of reason!

    You suggested counting future revenue from the G-fees. With all the various moving pieces, is there a short-hand calculation you would do to quantify this?

    The concept makes a lot of sense, but your submission left me wondering how this could be done (and what the magnitude of such an adjustment might be).

    You made a great a case on the historical loss data. I hope your comment receives the FHFA scrutiny it deserves!

    Liked by 3 people

    Reply

    1. To make an accurate projection of the impact of counting Fannie or Freddie’s guaranty fee income in a stress test, you need two pieces of information: the average net guaranty fee (the guaranty fees received by the companies, less administrative expenses attributable to them) for each of the “risk buckets” being subjected to the stress, and the average prepayment rates for those buckets. We don’t know the first (although Fannie, Freddie and FHFA will) and the second will be dependent on the parameters of the stress test specified by FHFA (principally the path of interest rates).

      But a couple of years ago–before I did my comment on the first FHFA capital proposal, submitted in September of 2018–I did an analysis of the guaranty fee income on Fannie’s December 31, 2007 book of business, which went through the financial crisis (and formed the basis for the stress test being conducted now). I did the analysis by annual book of business (not risk bucket), for which the average net guarantee fees were available, and Fannie published the liquidation rates of each of these books, so I could calculate their annual prepayment rates. The result of that exercise was that guaranty fees lowered the loss rate of Fannie’s December 2007 book of business by about 75 basis points. I noted in my comment, though, that since that time guaranty fees had almost doubled, so it would be reasonable to expect that in a stress test run on today’s books of business counting guaranty fees would lower the credit loss rate by 125 to 150 basis points.

      This is a significant impact, but then high guaranty fees ARE able to absorb a considerable amount of credit losses before a company has to tap its capital. Not counting them greatly overestimates the company’s vulnerability to credit losses–and overstates the amount of capital required to keep it safe.

      Liked by 1 person

      Reply

      1. Tim

        just to tie things up for a capital-constrained legal mind, would this reduction in credit loss rate of 125-150bps, attributable to including g fee income to reduce loss exposure on this test run of yours, imply a reduction of required capital of 1.25%-1.50%

        rolg

        Liked by 1 person

        Reply

        1. Yes, it would, although given that the guaranty fee income is dependent on prepayment assumptions, it would be reasonable to apply some haircut to it, to account for the uncertainty of the projection. But not 50 percent, and certainly not all of it, as is the case now.

          Liked by 2 people

          Reply

          1. Tim

            one more question along these lines. If FHFA were to adopt some sort of incorporation of G fees into its capital rule, would that have the effect of lowering the requisite percentage capital levels (or could they stay at proposed percentages and simply help the GSEs satisfy them in any capital calculation)? I am curious about the optics. TIA

            rolg

            Liked by 1 person

          2. Incorporating guaranty fees in the stress test would lower the amount of capital required to pass it. This is different from “counting guaranty fees as capital.” It’s a recognition of the reality that having guaranty fees that absorb credit losses protects the capital base: the higher the guaranty fee revenue, the less capital is needed to successfully withstand a period of stress losses.

            Liked by 2 people

  35. This is a well reasoned transparent expose of behind-the-scenes positioning of the various players in this long saga. Now we simply need our gov’t to do what’s right.

    Liked by 1 person

    Reply

  36. Thank you for this precise and extremely well reasoned comment, Tim! One can only hope it is seriously considered and doesn’t fall on ‘ideological/political’ deaf ears.

    Liked by 3 people

    Reply

  38. Tim

    Great comment and a masterful tutorial.

    “Between December 31, 2007 and March 31, 2020…the volume of Ginnie Mae securities backed by FHA or VA mortgages virtually exploded—increasing by 360 percent from $465 billion at December 31, 2007 to $2.14 trillion at March 31, 2020.”

    I distinctly remember Mnuchin saying in Congressional oversight hearing testimony that he wanted to take a holistic view of “housing finance reform”, and make sure that any action taken with the GSEs does not ignore, or exacerbate, issues at FHA. Wise mindset, but I wonder if Mnuchin is aware of the above datum. Leaving FHFA/Calabria to set a capital proposal in isolation for the GSEs seems to fall right into the trap of trying to regulate in piecemeal fashion so as to create larger unintended adverse consequences for Treasury with FHA. One hasn’t accomplished much if one has recapitalized the GSEs with a G-fee schedule that only shifts problems away from the private capital entities that are best positioned to deal with them, all at further risk to the public fisc.

    rolg

    Liked by 3 people

    Reply

  42. Thanks Tim for your sound, well reasoned comment. Hopefully they will listen as so much is as stake for the future of homeownership in the US!

    Liked by 1 person

    Reply

Leave a comment