422 thoughts on “The Director Digs In”

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2. Effects of Recapitalizing Fannie Mae and Freddie Mac Through Administrative Actions
   CBO, 8/2020

   https://www.cbo.gov/publication/56511#_idTextAnchor037

   CBO’s Modeling of the Recapitalization Options

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3. Tim,

   If our fears turn out to be true:
   1. The current and future Admins will leave the status quo.
   2. We will lose the court cases.

   Why do you think Mnuchin put as one of the conditions for release from conservatorship settlement of the lawsuits? By the time anything is done to get the companies out all the lawsuits would have been dealt with. Why put a condition that will not be relevant?

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   1. First of all, I don’t believe that either of your fears will turn out to be true (I’ll discuss why in the post I’m intending to publish next week). As for making resolution or settlement of the lawsuits a condition of the companies’ release from conservatorship, that’s just stating the obvious. The net worth sweep was put in place to prevent Fannie and Freddie from retaining capital, and it was done when the goal was to wind them down and replace them. Now that both Treasury and FHFA have concluded that the “wind down and replace” alternative is neither feasible nor desirable, in order for the companies to emerge from conservatorship as independent shareholder-owned entities the net worth sweep must end and Treasury’s liquidation preference must be cancelled. Those can happen either if plaintiffs prevail in the Collins case (“resolving” it), or if the government settles with plaintiffs and ends the sweep and liquidation preference on mutually agreed-upon terms. At that point Fannie and Freddie can go to the market to raise the additional equity needed to meet their capital requirements, and once they do they can return to paying dividends on their common and preferred stock.

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      1. Tim,

         What exactly is the $5B retention related to ‘direct claims’? Who/what do these claims specifically affect?

         VM

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         1. I do not know the basis for the $5 billion allowance for direct claims; perhaps one of our readers does.

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            1. Tim

               from the perspective of a GSE shareholder, the only thing this letter agreement needed to say is that the capital cap from the prior letter agreement has been lifted. everything else in this letter agreement is meaningless eye wash. so as to the question what the $5B allowance for direct claims refers to, my answer is, “who cares?”

               as you have noted, it won’t bind a future T secretary and FHFA director. what is so frustrating is that after the FHFA and the GSEs have hired financial advisors (and FHFA has paid Houlihan millions of dollars as per their public retention terms), and the administration worked on a plan for over year, in which Craig Phillips focused solely on the GSEs and finished his work, T and FHFA decide to prepare another report to congress over the next 9 months. You have to laugh to keep from crying.

               rolg

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            2. ROLG,

               While I agree with you wholeheartedly in terms of sentiment, I think we should all be curious at where the USG/Treasury/FHFA have already conceded a liability associated with “direct claims” as opposed to their continued insistence that shareholders present ‘lack of standing/indirect claim’ issues. No one seems to know where or what the $5B ‘direct claim’ is ‘attached’ to.

               VM

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            3. I think that $5B allowance for direct claims refers to perry capital lawsuit.

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            4. I thought I read somewhere it was to cover the maximum amount of court losses. TP might’ve addressed it too in his video. 4.5 billion?

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            5. I finally was able to watch the Pagliara video this evening, and he said (I’m paraphrasing) that the $4.5 billion was related to one piece of litigation that is the only one that “challenges the conservatorship itself.” But the only litigation in that category is Washington Federal, and the prayer for relief in the original suit filed on June 7, 2013 (and repeated in the amended complaint filed on March 8, 2018) is, “Determining and awarding Plaintiffs and the Classes damages suffered by them in virtue of the Defendant’s taking and/or illegal exaction in the amount of $41 billion, or some other amount to be determined at trial.” So Washington Fed is clearly not what’s being reserved against in the January 14 letter agreement. We need another candidate.

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      2. Tim

         all litigation claims (except Bryndon Fisher’s) are direct claims. I think this is a just a seat of Treasury pants estimate of the total amount of litigation claims that Treasury on 1/14/21 thought can remain if a conservatorship exit is to be executed…again, this binds no one in the future and is meaningless because facts, circumstances, and the relevant decision makers will change. My newfoundlands exhibited greater insight than is displayed in this letter agreement.

         rolg

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         1. This is starting to seem like a variant of how companies set up reserves for tax strategies challenged by the IRS–dollar amount of the claim times a subjective assessment of the probability of success of that claim. If so, (a) it’s not remotely objective (it’s an outgoing Treasury Secretary setting probabilities on lawsuits he’s leaving to his successor to resolve), and (b) it’s meaningless in any event, since it’s only one party to the suit making the assessment. But perhaps I’m missing something.

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4. Click to access Buying_a_dollar_for_less_than_25_cents.pdf

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   1. In this latest piece Gary makes a compelling case for the intrinsic value of Fannie and Freddie’s junior preferred stock, then asks why, given all of the positives he lists, the preferred is not trading higher. Why indeed?

      My answer would be that in the twelve-plus years since the companies were taken over by Treasury, virtually nothing that has happened to them has followed either precedent or expectations, defying prediction. A variant of the unique “Fannie rules” that apply to this company can be traced back at least another 25 years. (One that I’m intimately familiar with is having the Chief Accountant of the SEC announce in December of 2004 that Fannie had not properly implemented two accounting standards–SFAS 133 and SFAS 91–while declining to explain to either Fannie or its outside auditor, KPMG, which specific aspects of SFAS 133 they got wrong. That posture by the SEC Chief Accountant was, and remains, without precedent.)

      I agree with everything Gary says about the Fannie and Freddie preferred, but Mr. Market has deep knowledge and a very long memory. “Fool me once….”

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      1. Tim

         The GSE recap/release/reform process needs a catalyst, very much like a chemical reaction where a solution requires the addition of an ingredient to crystallize. In the case of an administrative solution, that catalyst would have been the courage of one’s conviction after having achieved that conviction through a consultative period of analysis. This was lacking.

         In my view, the necessary catalyst will be a SCOTUS decision that provides Ps a win on one or both of the Collins claims. First, the finality of SCOTUS as the court of last resort acts as a catalyst to action, as there is no longer any kicking the can up the judicial pyramid. But just as importantly, second, the GSE recap process requires a legal (indeed, I would say moral) judgment that the US government erred in adopting the NWS. It is difficult to proceed to a solution among contesting parties where one party is convinced the other party is at legal (moral) fault, and that party at fault will not admit it (and since the fault results in such a big dollar number, will never admit it). Once SCOTUS provides the catalyst by resolving the issue of fault with finality, then a solution will crystallize.

         rolg

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         1. The need for a ruling from SCOTUS (as political “cover”) prior to Treasury either backing off on its fictions about the purpose of the net worth sweep or canceling the sweep and relinquishing the liquidation preference was a minority view prior to January 14, but now is gaining adherents. Funny how that works.

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5. Tim, would you mind commenting on this fascinating interpretation of the LAs here? https://twitter.com/UrbanKaoboy/status/1351185902207426563

   The gist is that Mnuchin felt handcuffed by litigations and set up the LAs in such a way that all stakeholders are incentivized to quickly get to global settlement. Of course the wrinkle is it still requires Yellen’s approval (as exercising warrants is a precondition), and we don’t know what Yellen’s thinking is.

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   1. I normally do not comment on speculative pieces, but I’ll make an exception for this one in order to make a broader point.

      Many, and perhaps the majority, of the speculations about why the January 14 letter agreements are really good news for a rapid resolution of the conservatorships are flawed both on the substance–they involve a misunderstanding of something fundamental about the companies or their capital structures–and the politics (they assume a degree of consensus or co-ordination that isn’t there). An example of a fundamental understanding is the notion that converting Fannie or Freddie’s senior preferred to common will add to the companies’ capital (it won’t; it will just dilute their existing and future common, and give rise to more litigation). This article by Michael Kao (who I don’t know) at least is built on a sensible financial proposition: the idea that new issues of common will be matched, by Treasury, with cancellations of the senior preferred on a dollar-for-dollar basis. But I still can’t see the politics of this working. With Mnuchin unwilling to be responsible for cancelling the senior preferred himself, why would Janet Yellen take on this commitment, while locking into an arrangement designed by Mnuchin? Assuming that she’s engaged in this issue at all (which she may not yet be), why wouldn’t she instead say, “Let’s see how the Supreme Court rules, then I’ll figure out the best way to finally address the Fannie and Freddie conservatorships in a way that meets MY objectives, not Steve Mnuchin’s?” So, I’ll give Mr. Kao good marks for financial savvy and creativity but mark him down on political realism, and say that what he proposes is unlikely to be what ends up actually happening.

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      1. Thanks Tim.

         Please correct me if I’m wrong, but can’t SPS convert to JPS, then all JPS convert to common to boost CET1?

         Lets assume Yellen DID agree on the “global settlement then recap” strategy. It’s clear from Mnuchin’s position this would be the best move to make, instead of doing anything major last minute that could potentially destabilize the one bright spot we have in the economy.

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         1. The APA challenge to the net worth sweep in the Collins case, soon to be decided by the Supreme Court, would result in the elimination of the senior preferred entirely. Given the likelihood of a ruling in favor of the plaintiffs on this issue, they have no reason to “settle” by agreeing to allow the government to convert the SPS to common (and certainly not to junior preferred). If plaintiffs lose at SCOTUS, then the incentives would change, but we’re not there yet–and hopefully we’ll never get there.

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      2. I believe your view is more realistic. So what is the most likely outcome from your perspective?

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         1. I’ll address that in my next post, which I’ll likely put up sometime next week.

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      3. Tim,

         Three things about a senior pref conversion:

         1) It wouldn’t dilute future commons because this conversion would have to happen first. The specter of it is enough to prevent new common sales anyway.
         2) It actually would increase FnF’s capital levels from the hugely negative numbers they are now to slightly negative (CET1) to somewhat positive (core capital) because the seniors, as cumulative prefs, don’t contribute to any of the forms of capital while common shares do.
         3) What litigation would arise from this? If it’s a takings case UST’s liability is limited to what the property owners (shareholders) lose; what UST gains is immaterial. That would cap any damages award at the 1.8B existing shares times the drop in price between the conversion and the lawsuit, which at this point is at most $3.4B using today’s prices. I don’t see a maximum liability of $5B or so (adding in a generous percentage for possible interest or punitive damages), many years out due to how slow the courts move, causing UST to lose any sleep over a transaction that would stand to net them tens of billions in the short to medium term. In fact, the specific use of $5B in the letter agreement as the threshold below which UST doesn’t need lawsuits settled in order for FnF to raise capital leads me to believe they don’t care about any future lawsuits below that level of potential damages. The same reasoning applies to any potential takings lawsuits over the warrants as well.

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         1. Midas: You’re raising an issue that seems to be causing considerable confusion among a lot of followers of Fannie and Freddie, so let me try to clarify it, not just for you but for the broader audience. I’ll use Fannie as my example, although the same will apply to Freddie.

            Each of Fannie’s quarterly earnings press releases–available on their website–includes either one or two tables at the end titled “Condensed Consolidated Statements of Changes in Equity (Deficit).” The most recent shows that at September 30, 2020 Fannie had $20.69 billion in total equity. This total has six components–senior preferred stock ($120.84 billion), (junior) preferred stock ($19.31 billion), common stock ($687 million), accumulated deficit (a negative $112.68 billion), accumulated other comprehensive income ($120 million), and Treasury stock (a negative $7.4 billion).

            What would happen to capital if Treasury were to convert its senior preferred stock to Fannie Mae common stock? You’d move $120.84 billion from the senior preferred stock column (making that zero) to the common stock column (making that $121.53 billion), while leaving total equity unchanged, at $20.69 billion. But Treasury would own billions of shares of Fannie Mae common stock (with the exact number depending at the share price at which the senior preferred was converted), massively diluting the ownership of current–and future–holders of common.

            Now consider the alternative requested by the plaintiffs in their “prayer for relief” in the Collins case. They are asking that quarterly net worth sweep payments in excess of a 10% per annum dividend on the previous quarter’s outstanding senior preferred be characterized as paydowns of the principal of that senior preferred. Doing that over time reduces both Fannie’s and Freddie’s senior preferred stock to zero (and leaves a credit balance, likely to be paid to the companies as credits against future federal income tax payments owed). What would happen in Fannie’s “Condensed Consolidated Statements of Changes in Equity (Deficit)” in that case? The senior preferred would go to zero, and, because the senior preferred is being repaid, the negative accumulated deficit of $112.68 billion would change to positive retained earnings of $8.16 billion. Once again, total equity would be unchanged, but Fannie would be free of the $120.84 billion in senior preferred (and its associated liquidation preference) at no cost.

            Were FHFA, as conservator of Fannie, to agree to convert Treasury’s senior preferred to common while the Collins case is still pending before the Supreme Court, that certainly would result in immediate lawsuits, since FHFA would be giving to Treasury a highly valuable ownership stake in Fannie that it would not have if plaintiffs prevail in the Collins case. If plaintiffs lose Collins, then the dynamic will be different. But for now, converting Treasury’s senior preferred to common (a) would not increase capital, (b) would massively dilute Fannie’s common stock, and (c) would result in immediate litigation by existing holders of Fannie common.

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            1. Tim,

               Thanks for addressing this. You’re right that this subject causes considerable confusion.

               Balance sheet stockholder equity isn’t what matters here, but instead the definitions of the three different forms of capital in Calabria’s capital rule: core capital, Tier 1 capital, and CET1 capital. The seniors count towards none of these, while common shares count towards all three. Therefore I disagree with (a).

               You could argue that the Tier 1 and CET1 capital requirements are subject to removal by a new FHFA director, but even if Calabria’s capital rule (and Sections 4(b) and 5.15 in the letter agreement) is undone, the core capital requirement, which determines Fannie’s capital classification under HERA, remains. Fannie itself reports core capital as being hugely negative in its 10-K filings. In fact, if Calabria were to reinstate capital classifications under HERA today, Fannie would have to be classified as “Critically Undercapitalized”, even with its nominal positive stockholder equity on the balance sheet.

               Converting the seniors to commons has the exact same effect on all forms of capital that cancelling them does. As you correctly point out, the only accounting difference is that the amount of senior prefs on the balance sheet would be added to additional paid-in capital (because common stock par value is zero) rather than retained earnings. The key is that HERA includes additional paid-in capital as part of core capital. Thus the conversion *would* add $193B to core capital, just like the cancellation.

               (b) is correct, and (c) is correct but irrelevant given how little liability (less than $5B) Treasury truly faces from such an action. Those lawsuits won’t affect any part of the recap and release process as evidenced by last week’s letter agreement.

               I still don’t understand how this conversion would dilute *future* commons. New investors won’t buy common shares while the seniors or warrants exist due to the possibility of they themselves facing such massive dilution later. Instead it is Treasury’s commons, whether gained by senior conversion, warrants, or both, that would be diluted by the capital raise. Last year I had heard that Craig Phillips cited an internal valuation of the warrants at Treasury at something around $60B, so Treasury is no doubt aware that their shares will be diluted at some point.

               You also assume that the Supreme Court even has the ability to cancel the seniors. The GSEs were not allowed to voluntarily pay down senior pref liquidation preference increases due to draws (which comprise $192B of the $193B on the balance sheet) while the funding commitment exists (which it has all along), so that remedy violates the original contract, which isn’t being contested. Why would the Supreme Court, or more likely the Fifth Circuit if Collins gets remanded back down to determine the form of backward relief, choose a remedy that violates the original contract when the other one (seniors stay intact, Treasury sends $125B to the GSEs) conforms to it?

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            2. Midas: I’m not going to argue with you. I’ve given my analysis and my reasoning, which I believe are correct. You obviously are welcome to your own opinions.

               For other readers, I’ll make a couple of additional points. Fannie DOES report its core capital as “hugely negative;” it’s dominated by the $112.7 billion accumulated deficit I noted in my prior comment. For Fannie to become a viable entity, that deficit has to be eliminated. The best way for this to happen is for plaintiffs to prevail in the Collins case, and for the sweep to be unwound. (And, yes, it will be the District Court of the Southern District of Texas that will make that determination, following a legal ruling on the APA claim by SCOTUS.) I and many others believe it is much more likely for the remedy for an APA violation to be an unwinding of the sweep, rather than for Treasury to make cash payments to the companies totaling more than $120 billion–particularly if Treasury and FHFA want them to ultimately emerge from conservatorship.

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            3. Tim,

               Thank you for the discussion and letting me express my views here. Being argumentative was not my aim; apologies if it came across that way.

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6. Tim

   there is some question in my mind as to the enforceability of many of these letter agreement provisions if SCOTUS gives Ps a win…which can lead to a T obligation owed to the GSEs in an amount in excess of the senior preference amount both FHFA and T presume to be outstanding. put another way, if the 3rdA is found to be invalid which gives rise to a massive T obligation (in an amount in excess of the preference amount which was presumed to be outstanding), are these letter agreement provisions what FHFA as conservator would have negotiated? when there is a massive misunderstanding of fact between the parties, agreement provisions based upon this massive misunderstanding of fact often are subject to attack. Yes, more litigation if these provisions are not revised in a post-SCOTUS win negotiation.

   rolg

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   1. Letter agreements between a Republican Secretary of the Treasury and Director of FHFA are not binding on a subsequent Treasury Secretary and FHFA Director serving under a Democratic president, although the latter two parties would in most cases need to execute new letter agreements to change the provisions of the ones signed this month. (And when they do re-do the agreements, they ought to correct a glaring mistake in the current ones, in which the letter intended for Fannie–citing its $25 billion Applicable Capital Reserve Amount–is signed by Calabria as conservator of the Federal Home Loan Mortgage Corporation, while the reverse is true of the letter intended for Freddie. Sloppy work.)

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      1. Tim

         Oh, I agree this letter agreement is some kind of (imo obnoxious and incoherent) placeholder that has no preclusive effect on subsequent fhfa D and T secretary…but the clearer this letter agreement is understood to be operating under a massive fictitious assumption regarding the senior preferred the better. and it is my expectation that at some point after SCOTUS’s Collins decision, there will become a new operating assumption regarding the senior preferred.

         rolg

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      2. Tim,

         In an earlier post, you stated that you have positions in Fannie Mae. Can you disclose again what those positions are? Is it in the commons or the JPS?

         Thanks,
         Zak

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         1. I have positions in both Fannie Mae common and preferred. As I’ve noted in the past, both holdings are legacies of my time as a Fannie Mae executive. I held nothing but common shares until August of 2009, when I sold half my common shares (at a price of $1.93 per share) and used the proceeds to buy the Series N preferred (at a price of $3.40 per share), chosen because it was the last I issued as CFO of Fannie. I’ve done no trading in either Fannie common or preferred since then (and do not own, and never have owned, any shares of Freddie).

            I’ve never disclosed the dollar amounts of my Fannie holdings–and do not intend to–but I have said that they were a very small percentage of my and my family’s net worth. They still are. The flip side of that, though, is that I have very large unrealized losses in my Fannie common. And for me, one of the negatives of having the conservatorships of Fannie and Freddie drag on as long as they have is that my self-imposed ban against trading in Fannie shares has prevented me from using any of my capital losses in Fannie common to offset capital gains elsewhere. So this seems like a good time to publicly give myself permission to sell some Fannie common for tax purposes should I have a good reason to. My “no net sales” of Fannie discipline began with the issuance of the “Report of the Findings to Date” of the “Special Examination of Fannie Mae” by OFHEO (FHFA’s predecessor agency) on September 17, 2004. A sixteen-year lockout period for net sales seems long enough to have made the point I intended to make with this discipline. I still would not do short-term trading in either the common or the preferred, however.

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7. Tim–On Nov 10th you commented, “I do not know what Biden thinks about the ‘recap and release’ of Fannie and Freddie, or whether he even is aware of the issue (although I suspect he is). My point is that once the net worth sweep (and Treasury’s liquidation preference) is either canceled in settlement or ruled invalid by SCOTUS–and I believe one of those WILL happen–there is no defensible rationale for keeping the companies in conservatorship. Given their financial health and earnings power it is clear that they have been ‘conserved,’ and that the next step is to return them to private ownership. The alternative would be to nationalize them, which I do not believe Biden would support, nor would a divided Congress be able to legislate.” How might this comment change now that the Democrats have both houses, though marginally?

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   1. The Democrats’ narrow majority in the Senate doesn’t affect my outlook for Fannie and Freddie at all, since I don’t anticipate there being a legislative solution. And I have not yet attempted to gain access to any members of the Biden economic team, since I know they have a lot on their plates at the moment. I intend to begin making inquiries about the right “entry points” to the team sometime after the inauguration.

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      1. Tim

         I must say you have been very prescient on your analysis of the evolving state of play. bravo! there is a lot of fluff, as I see it, in the last letter agreement which a Collins win will render surplusage. the underlying issue imo was the difficulty of raising sufficient capital to meet MC’s capital targets without being able to use a consent decree to replace conservatorship in connection with the first offering (since I feel rather certain that FAs have advised that no money can be raised if after closing GSEs remain in conservatorship )…and I suspect that consent decrees were something that SM didnt buy into, with Pimco and Blackrock whispering in his ear. If MC’s replacement is willing to reduce capital levels, then you can have a large stock offering, after a period of capital retention, at the closing of which T exercises its warrants and conservatorship is exited, all at a simultaneous closing. in effect, MC’s excessive capital levels met SM’s unwillingness to agree to an elimination of the SP and entry of GSEs into consent decrees, and the collision made a real path to recap impossible. so now the GSEs are set to be put on a path should the new fhfa director and Ms. Yellen choose to pursue it, and I think the collins scotus decision will grease those skids. turns out that MC and SM were not capable of acting in the GSEs’ best interests, as opposed to their own as they perceived them. should have known.

         rolg

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         1. Why did Mnuchin agree publicly to the higher capital rule if he knew it would become an obstacle?

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            1. Mnuchin didn’t have any choice. Calabria had the statutory authority to set Fannie and Freddie’s capital requirement, and he was bound and determined to make it “bank-like,” irrespective of the consequences. One of those consequences was complicating the recapitalization to the point where Mnuchin could not get comfortable with the role Calabria was asking him to play, which was to give up the net worth sweep and allow Calabria to try to negotiate a consent decree with Fannie and Freddie that would have locked in his (Calabria’s) vision of the companies, before the end of the Trump presidency. Mnuchin wasn’t willing to play Robin to Calabria’s Batman.

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8. “It’s been a while since I’ve seen any writings about Fannie or Freddie from Ms. Wachter.”

   NAR just featured a white paper she co-authored (https://narfocus.com/billdatabase/clientfiles/172/21/4233.pdf) about the GSEs as public utilities with SIFMU designations.

   I read it today and it seems to share several points you have made about the GSEs (capital rule, stress losses, ROEs, G-fees and market share, etc.).

   Would be curious if you have a reaction to the paper or the concept in general.

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   1. @Patrick

      I would only add that Sen Sherrod Brown, who may become the new chair of the SBC, once mused aloud during a hearing that the utility model for the GSEs was the way to go. whether that involves a duopoly (Fannie and Freddie)/monopoly (Frannie) one might wonder, but not sure how multiple guarantors beyond F/F could work in that model. for example, public electric utilities have local geographic dominance. doesn’t make sense for multiple locally dominant mbs guarantors. my own view is that any congressional/administrative solution to the GSEs are either a long way off or will not occur in our lifetimes. in the meanwhile it is on to scotus for a collins decision. maybe a favorable scotus decision will precipitate a resolution.

      rolg

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   2. Long-time readers of this blog (which I find hard to believe is about to complete its fifth year of existence) may recall that one of first posts I did, on March 31, 2016, was a submission for the Urban Institute’s “Housing Finance Reform Incubator,” in response to its invitation for “short essays about the future of housing finance reform.” Mine was titled “Fixing What Works,” (accessible under the heading of “Reference Documents” on the right-hand side of the blog, near the top), and in it I advocated the adoption of a utility model as the most effective way to channel the value of Fannie and Freddie’s charter to low- and moderate-income homebuyers, while also allowing shareholders to earn a reasonable return on the capital they provide to back the companies’ risks and protect taxpayers. From a quick scan of the Wachter article it seems that she shares this view, which I find encouraging. I also note that Section 5, “FHFA’s Capital Proposal,” of the paper she co-authored has a good analysis of the negative effects Director Calabria’s arbitrary 4 percent bank-like minimum capital requirement will have on Fannie and Freddie’s ability to price their affordable housing business economically and competitively. I find that even more encouraging, and it makes me a supporter of Wachter’s candidacy to replace Calabria at the new administration’s earliest opportunity.

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      1. Tim

         seems to me after reading the piece, that a utility regulatory model would not require congressional legislation.

         you already have a duopoly; if capital levels are reduced by administrative rule, then the sort of balancing off i) return to shareholders ii )protect taxpayers and iii) provide mortgage funds across cycles to achieve liquidity and provide low income support could be achieved. I dont know of anything in HERA that would prevent a prudential regulator from pursuing a utility model. of course, the senior preferred would need to be dealt with to raise funds.

         I realize that the Yellen T is to report to congress by 9/2021 about alternatives, but if this utility model is put forth as the chosen one, what is to prevent a Wachter fhfa from running with it if congress dilly dallies?

         rolg

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         1. This was one of the main points of “Fixing What Works”–reforming, recapitalizing and releasing Fannie and Freddie as regulated-return utilities did not require legislation, but could be done administratively. That was true then, and remains true now.

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            1. Tim, thank you for your leadership in past years. Now that a new administration is about to start, I was wondering whether you could write a new post on ways forward like a letter to Biden, Meese, and Yellen. (Don Layton has a similar article.) I believe government needs first to change its attitude before a win-win resolution.

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            2. I’ve been thinking that as the 5th anniversary of this blog (February 1, 2021) approaches I would do a post that summarizes the current state of play, then looks forward to how the conservatorships of Fannie and Freddie might get resolved under a Biden administration. I haven’t yet begun working on that, however.

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9. https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-and-Treasury-Allow-Fannie-Mae-and-Freddie-Mac-to-Continue-to-Retain-Earnings.aspx

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   1. I was not expecting much from Treasury and FHFA prior to the end of the Trump administration, but the letter agreements announced today did even less for the companies than I thought they might, while adding several additional impediments or constraints, a couple of them curious.

      The one element almost everyone was anticipating was an increase in the retained earnings cap. FHFA and Treasury will increase the caps for Fannie and Freddie “up to their regulatory minimums, including buffers, as prescribed in the FHFA Enterprise Capital Framework finalized in December 2020.” Treasury’s liquidation preference would increase dollar-for-dollar as long as the cap is in place, and once the companies reach their minimum capital requirements (which were a combined $265 billion at June 30, 2020, and will be higher now and in the future because of book growth) “the GSEs will resume quarterly dividend payments. The dividend amount at that time will be equal to the lesser of 10% of the liquidation preference of Treasury’s senior preferred stock, or the incremental increase in the GSE’s net worth in the prior quarter.”

      That’s the good news. Treasury then specified that “there will be no exit [from conservatorship] until all material litigation relating to the conservatorship is resolved or settled, and the GSE has common equity tier 1 capital of at least 3% of its assets,” and added that during the period in which the companies are building capital to the 3% threshold and still in conservatorship, “Treasury will allow each GSE to issue common stock upon the achievement of future conditions: first, Treasury must have exercised in full its warrant to acquire 79.9% of the GSE’s common stock, and second, all material litigation relating to the conservatorship must have been resolved or settled. Treasury will permit up to $70 billion in proceeds of stock issuances by each GSE to be used to build capital.”

      It’s curious that Treasury would set the same dollar maximum for external capital for both Fannie and Freddie, despite the large size disparity in their minimum capital requirements. Three percent of Fannie’s adjusted total assets at June 30, 2020 was $116 billion; three percent of Freddie’s was $83 billion. With a $70 billion cap on both companies’ external capital raises while in conservatorship, Fannie would need to retain at least $46 billion in earnings (and more with growth) to meet the 3% capital threshold, while Freddie only would need to retain $13 billion. It’s also curious (to me, at least) that Treasury would think either company could raise $70 billion in outside capital while still controlled in conservatorship by a hostile FHFA director.

      The other elements of the agreement had been rumored: a modestly lower portfolio cap, operational protections for small lenders, a formal cap on multifamily lending, and limits on certain types of higher-risk mortgages.

      To me, the big negative in this agreement is the commitment not to release the companies from conservatorship, even under a consent decree, until they build their capital to 3% of adjusted total assets. I’ll be very interested to see how the investment community reacts to that. I may be wrong, but I think it will be very difficult for either company to sell any significant amount of new shares while still in conservatorship.

      As to the “what needs to happen next,” certainly Fannie and Freddie must get a favorable ruling from the Supreme Court in the Collins case–either on the constitutional claim or the APA claim– that ends the net worth sweep, and I think they also must be given a new FHFA Director, who will not insist on requiring them to get three quarters of the way to a bank-like level of minimum capital–in spite of the fact the credit risk of the one asset they are able to finance is a fraction of the credit risk of the mix of assets banks finance–before they can be released from conservatorship.

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      1. Tim

         “It’s also curious (to me, at least) that Treasury would think either company could raise $70 billion in outside capital while still controlled in conservatorship by a hostile FHFA director.”

         curious to me too.

         it’s on to SCOTUS. if/when Ps get a favorable ruling from SCOTUS on at least one of the claims, then this agreement becomes more fragile…treasury won’t be a “creditor” anymore once Collins plays out after a favorable SCOTUS ruling (all of the fairness to taxpayers language will be risible)….though Calabria’s replacement may think it is just fine.

         seems to me that Sen Warner wrote this while Mnuchin was packing his bags.

         rolg

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         1. If that is the case, why is Maxine Waters putting out a statement that it’s a “bailout of hedge funds”? If that were true, I would think there is some clear path to recap and release here that we don’t see? Or is she just completely mistaken?

            Link to her statement below…

            https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=407081

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            1. It appears as if Ms. Waters staff either did not read or did not understand the letter agreements or the joint FHFA/Treasury press release explaining them. There is nothing remotely resembling a “bailout of hedge funds” outlined in or even suggested by the agreements.

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         2. 1. By raising the cap on capital treasury can’t touch the dividends as it lays in escrow, or is at least accounted for and not swept into a black hole. By doing it this way rather than with full write down, isn’t equity value suppressed, which is good for secondary offering? Yet capital increases. How else could commons be suppressed while equity builds, assuming that was Tsy’s goal in order to attract new money? If the sequence were write down first then capital raise, would new money be as interested at higher pps. Explosion through implosion?

            2. Given the potential danger of an economic downturn and housing crisis, a fast recap is desirable. Does the rising SPS liquidation preference bring pressure to bear to reach settlement with jps / derivative claims, which would in turn coincide with write down? (Tsy has direct claims slush fund of 5 billion.)

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            1. My interpretation of Treasury raising the retained earnings cap to 4 percent of Fannie and Freddie’s adjusted assets while adding these retained earnings dollar-for-dollar to its liquidation preference is that this was Mnuchin’s way of passing the problem of what to do about the senior preferred on to his successor, Janet Yellen. The impact on the companies’ common stock price from this decision was a by-product of it, not a reason for it. No new equity can be raised before investors know the future status of the senior preferred. It should be eliminated entirely pursuant to a ruling by SCOTUS in favor of the Collins plaintiffs, but in the unlikely event that it isn’t it will be up to Secretary Yellen to decide what to do with it. (And I wouldn’t take the September 30, 2021 deadline given her by Mnuchin too seriously; that was a parting shot intended to convey a sense urgency to the issue, coming from a man whose definition of “reasonably fast” turned out to be a period of time exceeding four years.)

               In my view the speed of the recap will depend on two factors: when and how the senior preferred is dealt with, and whether the FHFA capital rule is made more reasonable by Calabria’s successor (whenever he or she is appointed and in place). Nothing will happen until the senior preferred is either eliminated or amended, and once that occurs the speed of the recap will be driven by the amount of capital that needs to be raised, and whether the companies’ issuing it are viewed by potential new investors as attractive investments (which they are unlikely to be if the Calabria capital rule remains in place).

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            2. “No new equity can be raised before investors know the future status of the senior preferred…. Nothing will happen until the senior preferred is either eliminated or amended…”

               Tim,

               Of course a deal with investment banks will coincide with full write down. Notwithstanding, does full write down need to be announced prior to a deal being consummated? In fact, would not doing so raise equity value (pps) to the detriment of IBs?

               Also, it occurs to me that if settlement doesn’t occur prior to SCOTUS ruling, SCOTUS ruling in P’s favor will raise common pps by an order of magnitude, again to the detriment of IBs.

               I see pressure from all sides to resolve this prior to SCOTUS, but what do I know?!

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            3. Settlement of the lawsuits would require agreement between plaintiffs (representing both preferred and common shareholders) and the government. The fact that we did not see a settlement prior to the change in administrations means the two sides could not agree on the terms. My analysis is that plaintiffs are very confident that they will prevail on the APA claim at SCOTUS (i.e., that SCOTUS will not reverse the finding of the Fifth Circuit en banc that the net worth sweep was ultra vires under HERA), and as a result are not willing to settle for much less than they have asked for in their prayer for relief in the lawsuits; the Mnuchin Treasury wanted much more than that in order to be seen as voluntarily giving up on the sweep and its liquidation preference, so no deal was made. I don’t see any reason why this dynamic would change under a Yellen Treasury. She has every reason to wait to see how SCOTUS rules (she has “no dog in the fight”), then once she knows the outcome she can decide whether and how to respond. In contrast to your seeing “pressure from all sides to resolve this prior to SCOTUS,” I don’t see pressure from either side to do so.

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            4. Tim,

               This will be my last post on this.

               We agree two things are needed, new money and an attractive public offering. We should also agree that the latter is curtailed by massively increasing valuation prior to IPO. Therefore, the conundrum is, how can both conditions be met? Abductive reasoning leads me only to one viable solution, an escrow lockbox for retained earnings with only one key to unlock the box – a *simultaneous* settlement plus new investors with sufficient bucks lined up and ready to go. The two must be occur concurrently, not sequentially, for reasons already cited.

               Your major premise is that because there was no settlement, plaintiffs were not willing to accept Treasury’s offer. You bring force to your premise by pointing to the amount of time Treasury had to bring together such a deal but without success.

               However, you do acknowledge that it was feasible to close such a deal in the past few months, and I agree. BUT, if such a deal was ready to be consummated either prior to or after the election, isn’t it reasonable that given the timing of the change in administration and all the politics around the GSEs, it would be politically prudent to let Yellen execute the deal with fluidity from the Mnuchin treasury, assuming she’s willing, rather than have it look like a republican “cramdown” from the Trump administration? In other words, if there was a deal ready to go, why would it not be better to have waited for Yellen to execute if Mnuchin learned she would be agreeable?

               I don’t think Yellen and Mnuchin are political ideologues. Their ability to agree is much more tenable, and given the manner in which the Treasury statement was crafted, it seems apparent there’s general alignment between the two.

               In a word, I find no other viable solution to the conundrum and striking a deal in the last few months does not seem ripe in retrospect.

               Again, that’s all I care to say.

               Thanks for this forum.

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            5. Ron: I think you may have misinterpreted my last comment. I don’t believe there is, or was, a “deal ready to go.” And I think the notion of a simultaneous settlement and massive private placement of equity with new investors is a fantasy (cooked up by holders of Fannie and Freddie junior preferred stock hoping for a quick way out of a “quagmire” trade), with neither any observable evidence nor a defensible rationale to justify it. Treasury has limited new equity investments in the companies to $70 billion for as long as they remain in conservatorship, and has not authorized FHFA to release them from conservatorship until their tier 1 capital equals or exceeds 3 percent of adjusted total assets. Even if Fannie were to receive an injection of $70 billion in new equity tomorrow, it is still, under Treasury’s letter agreement with FHFA, three to four years away from being able to emerge from conservatorship. Who, exactly, are the investors who would put that amount of money into Fannie while it still could remain under the control of a FHFA director, who thinks it shouldn’t exist at all, for three to four more years? No, the far more defensible interpretation of Mnuchin’s action (or rather, inaction) last week is that he wasn’t able to figure out a way to deliver on his promise to “get [Fannie and Freddie] out of government control…reasonably fast,” and has kicked the can to Janet Yellen, making it her problem.

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10. A bloomberg headline from 1.12.21: *TREASURY OPPOSES REDUCING U.S.’S $220 BILLION STAKE IN GSES

    Looks like there will be no write down.

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    1. This is the article:

       https://www.bloomberg.com/news/articles/2021-01-13/trump-team-s-final-act-on-fannie-freddie-leaves-fates-to-biden

       The authors (Joe Light and Saleha Moshin) state that officials from Treasury are briefing congressional staff on a likely fourth amendment to the PSPA that would increase the retained earnings cap, attempt to codify certain “reforms” to the companies’ business practices (although these could be changed by a different agreement between FHFA and Treasury later on), and offer guidelines for accomplishing the release of Fannie and Freddie from conservatorship in the future. Since this essentially was my expectation I’m not surprised by it, although we should learn more details from Treasury and FHFA in the next day or two.

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       1. Tim-

          The article includes these two sections. Can you comment on what you think they mean and how they could impact the future of Fannie/Freddie and potential capital raises:

          1. “People briefed on the plans said it wasn’t clear how much capital the companies will be permitted to keep but said the changes were framed as an end to the so-called net-worth sweep, ”

          2. “Whether to modify the Treasury’s senior preferred stake is under consideration at the White House, said one person familiar with the matter.”

          Thanks!

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          1. I’m guessing here (and we should know shortly), but I would think Treasury and FHFA would want to raise the retained earnings cap to a level which, once reached, would allow the companies to be released from conservatorship under a consent decree, at which time they could accelerate their recapitalization through external equity raises (assuming that at some point before then the net worth sweep either is invalidated by SCOTUS or dropped voluntarily by the Biden Treasury). Although that’s not really “ending the net worth sweep,” Treasury and FHFA could claim that it is.

             On the issue of modifying Treasury’s senior preferred, that has been “under consideration” for months if not years, and since Treasury and FHFA haven’t agreed on whether or how to do that before now, I don’t know what would cause them to agree on it today or tomorrow. But again, we’ll know soon.

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             1. Tim,

                What does “retained earnings” even mean apart from having paid down 180 billion? In other words, either we’ve paid down zero or we’ve paid down everything (if not then some or overage). It seems to me that a path to increased retained earnings is only intelligible in the context of at least an implicit senior preferred write down due to an implicit “paid in full.” If we don’t have that, then raising the cap on retained earnings seems almost worthless.

                Furthermore, this quote seems to suggest that what I find implicit could end up becoming explicit:

                “Whether to modify the Treasury’s senior preferred stake is under consideration at the White House, said one person familiar with the matter.”

                Would appreciate your thoughts.

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             2. Ron: “Retained earnings” means not remitting them to Treasury through the net worth sweep, but leaving them on the balance sheet to build capital. Once Treasury gets them it becomes complicated getting them back. And I’ve always said that for the companies to return to private ownership the net worth sweep must be unwound–in the manner sought by the plaintiffs in Collins–and Treasury’s liquidation preference eliminated. It’s becoming increasingly clear that Mnuchin won’t do either one of these (leaving them to SCOTUS or, in the unlikely event it does not rule for the plaintiffs on either the constitutional or APA claim, the Biden administration), so a higher retained earnings cap at least is something.

                On your second point, the use of the word “modify” for the senior preferred effectively rules out canceling it, and even the reference to its modification is nonspecific, rumored rather than reported, and described as merely “under consideration”.

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11. Tim, Bloomberg mentioned Susan Wachter as a possible Calabria replacement under the Biden administration. Curious if you have any thoughts about her since much of her thinking about GSE reform is public.

    She appears to be pro the utility model, less stringent capital requirements, and agrees in private equity capital taking the place of taxpayer risk.

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    1. It’s been a while since I’ve seen any writings about Fannie or Freddie from Ms. Wachter. What I recall from her earlier pieces on the companies is that they were “okay”–not ideological, which is good, but also somewhat theoretical and academic, which can result in policy or regulatory prescriptions that are not well suited to the unique charter and business of the companies. If she were to get the position of Director of FHFA, however, I suspect she would be open to some “on the job learning” in a way that Mark Calabria so clearly was not.

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       1. https://books.google.com/books?id=k-PfDwAAQBAJ&pg=PR18&lpg=PR18&dq=franny+meg&source=bl&ots=CbbR-_dhVn&sig=ACfU3U14d-YwgHJXzpSHWTU1r4QHf1mXvA&hl=en&sa=X&ved=2ahUKEwjXyajplJfuAhVqJTQIHV-LCVIQ6AEwA3oECA8QAQ#v=onepage&q=franny%20meg&f=false
          A book, ”The Great American Housing Bubble,” co authored by Wachter and Adam Levitin, explains their position, and recommends Franny Meg, a utility model, to replace Fannie and Freddie. .

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          1. The preface to this book–reproduced at the beginning of the link above–gives Wachter and Levitin’s thesis of the cause of the mortgage crisis, which I think they’ve pegged correctly. That’s a big plus, because if you set out to fix a problem it’s essential to have properly diagnosed it to begin with. I’m not wild about the “Franny Meg” idea (a combination of Fannie and Freddie), but the recommendations of significant but not excessive capital, selective use of risk-sharing techniques, and a paid-for federal backstop all could be adapted for the two companies that exist today, without the legislation required to combine them.

             It’s interesting that at the beginning of the preface the authors describe themselves as “an odd couple…a law professor and a real estate economist separated by a generation….Adam knew something about the mechanics of securitization and foreclosures, and Susan knew quite a bit more about real estate economics.” In my earlier comment about Ms. Wachter I described her previous work on Fannie and Freddie I was familiar with as “somewhat theoretical and academic.” It appears that the collaboration with Mr. Levitin has improved her real-world orientation and experience, which also is a big plus if she were to become Director of FHFA in the Biden administration.

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             1. Tim

                I read a lot of Levitin’s writing (Georgetown Law Prof) when I was doing research into the rep/warranty lawsuits that the monoline insurers brought against the banks. He knows his stuff. as for Wachter, I have only seen her give testimony at congressional hearings…she reminds me some of a think tank Calabria, without the libertarian bias.

                rolg

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             2. Very intelligible and encouraging assessment. Made my otherwise meh day.

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12. Part of 2019 Treasury’s housing finance reform plan

    Preconditions for Ending the Conservatorships

    The guiding principle for ending the conservatorships should be that each GSE should remain in conservatorship until FHFA determines that that particular GSE can operate safely and soundly and without posing an undue systemic risk. The specific preconditions for FHFA considering a particular GSE’s exit from conservatorship should include, at a minimum, that:

     FHFA has prescribed regulatory capital requirements for both GSEs;

     FHFA has approved the GSE’s capital restoration plan, and the GSE has retained or raised sufficient capital and other loss-absorbing capacity to operate in a safe and sound manner;

     The PSPA between Treasury and the GSE has been amended to:
    (i) require the GSE to fully compensate the Federal Government in the form of an ongoing payment for the ongoing support provided to the GSE under the PSPA;
    (ii) focus the GSE’s activities on its core statutory mission and otherwise tailor Government support to the underlying rationale for that support;
    (iii) further limit the size of the retained mortgage portfolio of the GSE;
    (iv) subject the GSE to heightened prudential requirements and safety and soundness standards, including increased capital requirements, designed to prevent a future taxpayer bailout and minimize risks to financial stability; and
    (v) ensure that the risk posed by the GSE’s activities is calibrated to the amount of the remaining commitment under the PSPA;

     Appropriate provision has been made to ensure there is no disruption to the market for the GSE’s MBS, including its previously issued MBS;

     FHFA, after consulting with the Financial Stability Oversight Council (“FSOC”), has determined that the heightened prudential requirements incorporated into the amended PSPAs are, together with the requirements and restrictions imposed by FHFA in its capacity as regulator, appropriate to minimize risks to financial stability; and

     Any other conditions that FHFA, in its discretion, determines are necessary to ensure that the GSE would operate in a safe and sound manner after the conservatorship, including as to the GSE’s compliance with FHFA’s directives or other requirements and also as to the build out of FHFA’s supervisory function.

    Treasury recommends:
     Pending legislation, FHFA should exercise its authority as conservator to begin the process to end each GSE’s conservatorship in a manner consistent with the preconditions set forth in this plan. (administrative)

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    1. Conspicuously absent from this “to do” list is having Treasury end the net worth sweep and cancel its liquidation preference in Fannie and Freddie, so that once released from conservatorship under a consent decree from FHFA and with Treasury approval, the companies can raise external equity in order to meet their new capital standards over a reasonable period of time.

       Everyone knows what needs to be done; the question now is, will Secretary Mnuchin do them in the six business days he has left as Treasury Secretary, or will these two essential elements of “reform, recapitalization and release” carry over into the new administration?

       Mnuchin’s statements and actions (or, rather, inactions) in recent months and weeks have made it hard for me to envision how or why he would end the sweep and cancel the liquidation preference before he leaves. But, to put it mildly, this has not been a normal transition period. Just as there was no precedent for what occurred last week, there is no precedent for what might occur this week. As President Trump has been fond of saying, “we’ll see what happens.”

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13. Wrong. Please remove the post.

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14. Judge Stephen S. Schwartz takes over Fairholme case from Sweeney. He was a law clerk to Judge Jerry Smith of the Fifth Circuit.

    Fed Claims court official document.

    Click to access 13-465-0469.pdf

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    1. Fed Claims court official document.

       Click to access 13-465-0469.pdf

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15. Charlie Gasparino tweeted that 1. PSPA still in play but is focused on capital requirements and DoJ apparently will need to sign off on any 4th Amendment. 2. Mark Zandi is on a short list for FHFA Director if SCOTUS rules director is removable by president at will in Collins.

    Tim or ROLG, What are your thoughts on either point? Zandi as director is a bit scary, but didn’t he also submit comments on the capital rule that were more in-line with lower capital? Would seem to fit into the 1st point about capital requirements being part of PSPA 4th amendment. Would the amendment be an attempt to lock in high capital requirements outside of HERA to prevent the next admin/FHFA director from lowering them? That is, in exchange for the amendment ending the NWS and possibly eliminating the liquidation preference, the companies, FHFA and Treasury agree to meet the higher capital requirements regardless of a future FHFA capital rule that may attempt to lower them. Would that be possible? Seems to negate FHFA as an independent agency. They would be beholden to Treasury. The next FHFA director (and the GSEs) would be stuck needing a 5th amendment with the next Treasury Secretary to get out from under it and lower the capital requirements. Thoughts? I feel like we are going to get an 4th amendment we may not like.

    Cheers,
    Fishermanjuice

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    1. There are many rumors swirling around about a potential Fourth Amendment and what might be in it. Other than a higher retained earnings cap (or an indefinite suspension of the net worth sweep), I don’t have any good information about what else might be included in any amendment agreed to prior to January 20. On your capital question, no, the current FHFA Director cannot bind what a future director might do on Fannie and Freddie’s capital requirements.

       As to the rumor that Mark Zandi might be on a short list for FHFA Director in the Biden administration, he wouldn’t be the worst choice. He at least has an understanding of the credit and financial dynamics behind Fannie and Freddie’s risk-based capital rule, and also of the problems caused by a capital standard that is disconnected from the economics of the companies’ credit guaranty business, as the current Calabria standard so obviously is.

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       1. Would it be fair to say that some of the blame for the GSE problems in 2008 were related to Moody’s and the rating agencies in which Zandi was at the helm.

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          1. Zandi wasn’t “at the helm” of Moody’s in 2008; he was their chief economist.

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       2. Tim-

          It sounds like “higher retained earnings or suspension of NWS” means there’s little hope that a writedown of Sr Preferreds is likely to be part of a 4th amendment. Is that fair to say? If that’s the case, how are the GSEs ever expected to raise private capital?

          Thanks

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          1. Less than one month ago, the acting solicitor general appeared before the justices of the Supreme Court and argued on behalf of Secretary Mnuchin that the requirement for Fannie and Freddie to pay all of their earnings (estimated at close to $20 billion per year) to Treasury in perpetuity was legal and proper. Given what’s happening with the president right now, it seems unrealistic to think that Mnuchin would ask permission to give up that income stream voluntarily, and even more unrealistic to think that if asked president would agree to do so. Stranger things have happened in this administration, though.

             I’m going to wait until January 20 to see what a possible Fourth Amendment to the PSPA might include before doing any analyses of the path forward for Fannie and Freddie out of conservatorship and towards recapitalization. But as I’ve said earlier, I think there WILL be such a path, although it may require a favorable ruling from SCOTUS in the Collins case (which I expect) to create the impetus to follow it.

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             1. Tim, this would contradict Calabria repeatedly making the point that a 4th would make the legal cases “go away.” I believe he even explicitly said in one forum that he hoped to cancel the NWS via 4th. I think its fair to assume Mnuchin supported Calabria being chosen to head FHFA, and that they are on the same page re: what needs to be done?

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             2. Tim

                I am unclear whether this means anything or not, but the acting SG did not argue for US in Collins before SCOTUS. It was Hashim M. Mooppan, who was acting as “Counselor to the Solicitor General” for the case, but who is a deputy attorney general in the civil division of the DOJ…one of the crew of DOJ that argued the lower court cases. now the SG is part of the DOJ, but the SG office usually guards its prerogative to argue SCOTUS cases closely. this may or may not indicate any position the SG office has on the case.

                my best guess is that T wants some sort of sign off, on legal matters, from the DOJ re any 4thA…that a 4thA would not contravene any laws binding on T. as to policy, it would be an abdication of authority if T wanted policy approval as well.

                one further small point: the govt did not argue that the NWS was “legal and proper”…it dropped the “may” argument before SCOTUS; it argued that these Ps could not bring this case under the statute, as to APA claim, and was mostly sniffing around the remedy as opposed to the merits portion of the unconstitutional agency structure claim.

                rolg

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    2. @juice

       Gasparino is a waste of time, to put it mildly.

       rolg

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16. R. Christopher Whalen wrote:

    https://www.theinstitutionalriskanalyst.com/post/joe-biden-must-fire-fhfa-director-calabria

    He suggests next President to fire FHFA head for CAUSE.

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    1. Excellent article. Thank you for the reference.

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17. Tim,

    You and your readers might like to know that Gary published this piece just recently. http://delawarebayllc.com/images/The_notion_that_the_government_has_not_been_repaid_is_ludicrous.pdf

    A selectively edited version was to appear in today’s Wall Street Journal!

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18. “If Calabria is replaced by a Biden Administration, you believe they would be willing to lower the capital requirements. Do you really think that the administration would be willing to lower capital requirements for FNF and take a potential political hit for requiring lower capital?”

    Mel Watt said 2.5%. At one time he would’ve danced alone. It wasn’t until Mnuchin that we got Calabria’s 4%. Also, Biden will be more in favor of housing initiatives. Pretty twisted ending to this saga.

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    1. Ron: The saga hasn’t ended, and where we seem to be now isn’t that surprising.

       You (and other readers) might want to go up to the beginning of the blog, then scroll down to where on the right side there is a listing of Top Posts. Click on the one titled “The Beginning of the End,” which I wrote in April of last year. In it, I identified the “strange bedfellows” of Steven Mnuchin, Larry Kudlow and Mark Calabria, who as a group were charged by the White House in March of 2019 to find a way to bring Fannie and Freddie out of conservatorship. As I discussed in the post, there was a clear conflict between the objectives Kudlow and Calabria had for Fannie and Freddie and what investors would require to make a recapitalization successful. I postulated that as the process unfolded, market reality, economics and Treasury’s stake in the companies (through the warrants) would prevail over the ideological objections of Kudlow and Calabria, and the recap and release would go forward.

       What’s happened, of course, is that nobody’s changed their objective. Mnuchin and Treasury still want to deliver on their promise to recapitalize Fannie and Freddie and release them from conservatorship, but Calabria (and presumably Kudlow as well) insists that this happen with the companies carrying heavy capital and regulatory burdens that make them unattractive as investments. That has made the recapitalization much harder—Mnuchin and Treasury don’t get a clean “win” for giving up the senior preferred and the liquidation preference, because the actual release has been pushed so far out into the future owing to the excessive capital requirements—and we remain at an impasse, at least for now.

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       1. Tim,

          By twisted ending, I didn’t mean to suggest it’s yet over, though we must be further along than “The Beginning of the End.” What I meant by a twisted ending to the saga is that the ball will once again be back in the Dems’ court. I don’t think anyone would’ve imagined that four years ago. Obama stated that it was time to “turn the page on Fannie and Freddie” and now their release will occur under his second in command. Who would’ve thunk it? Oh, the irony!

          But yes, I always recognized the incongruity of Calabria and Kudlow trying to work with investors. Where we might part ways is on Mnuchin. I think four years ago Mnuchin was serious about doing all the right things. But as I’ve said here and elsewhere, something happened. He immediately dialed back his recap and release talk early into his term, and through the 11,000 documents he always had requisite political cover he needed – had he *truly* wanted to push recap and release through. We can’t deny that he availed himself to none of the incriminating proof. He also could’ve exposed the 4% myth on national television and the internet in at least two ways. First by proving that the initial bailout was a contrived story about undercapitalization, and secondly by pointing out that the GSEs aren’t banks. Not only did he do neither, he instead needlessly assumed the defense of the Treasury all the way to SCOTUS (even after losing at the 5th Circuit).

          In a word, that Calabria and Kudlow aren’t friends doesn’t suggest to me Mnuchin is a friend. I’m glad to see him go. He had great potential but in the final analysis he willfully failed. He was part of the problem, not the solution. Now what have I missed? 🙂

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          1. I have a different view of Mnuchin. I think he came in believing this was a financial problem to solve, which, given his background at Goldman, he was well qualified to do. As he got into it, though, he was “swamped” (in both senses of the word) by the politics, and he hasn’t been able to figure out how to overcome that. He’s still got four and a half weeks, but it seems like he’s run out of enthusiasm as well as ideas.

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             1. I love the play on words, Tim.

                That’s a charitable interpretation and I can’t disprove it. You could be right. I surely hope you are.

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19. Tim, enjoy your blog and insight. All things being equal regards MC capital requirements, if FNMA was stand-alone with no PSPA or NWS, could/would the company be profitable enough to garner a P/E? Seems to me with its wide moat the company would have value if properly managed. Would you care to comment?

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    1. Fannie has a P/E now, and it’s less than 1. The company’s third quarter 2020 earnings were $4.23 billion, or $16.92 billion annualized. As of September 30, 2020, Fannie had 1.158 billion shares of common stock outstanding, but Treasury also holds warrants for another 4.6 million shares, resulting in 5.76 billion fully diluted shares outstanding. Fannie’s third quarter earnings per share (annualized) thus are $2.94, which at yesterday’s closing common stock price of $2.40 makes for a for a price-earnings (P/E) ratio of 0.82.

       Why is Fannie’s P/E so low? Four reasons. First, Treasury holds $120.8 billion in senior preferred stock in Fannie, that if converted to common (which I believe is highly unlikely, but it has been discussed) at today’s share price would result in an additional 50.3 billion shares of common outstanding but no new capital; second, at December 31, 2020 Treasury will have a liquidation preference in the company’s assets of $142.3 billion; third, Fannie currently has $19.1 billion in junior preferred stock, which at some point will likely either be paid off or converted to common in order for the company to add new, lower-cost noncumulative preferred to its capital structure, and finally FHFA’s final capital requirements have left it more than $150 billion short of being classified as fully capitalized.

       Of these four reasons, the existence of Treasury’s $120.8 billion in senior preferred stock and $142.2 billion liquidation preference is clearly the most important factor holding down Fannie’s common stock price (and P/E). That’s why press articles speculating on the elimination of the net worth sweep and the liquidation preference have such pronounced market effects. If and when the senior preferred and liquidation preference are eliminated, Fannie’s stock price will then be driven by the market’s assessment of (a) how many new common shares will need to be issued before the company can fully meet its capital requirement; (b) how much of an impact will FHFA’s new capital requirement, other regulatory actions and the payment of a commitment fee for Treasury to leave its Senior Preferred Stock Agreement in place (which it will need to do in order for the yields on Fannie’s MBS to remain near current spreads to Treasury securities) have on the company’s sustainable earnings power, and (c) how will the market evaluate Fannie’s political risk in general (pre-conservatorship, Fannie’s P/E averaged only around 60 percent of the market multiple, largely, I believe, because of the perception of political risk, which won’t have diminished following the experience of the past twelve years).

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       1. Tim

          I agree with your assessment of the capital markets process, which for the GSEs will be somewhat unique for mature and highly profitable companies. it is almost like a venture capital raise, where the early investors are betting that the “process” will come to fruition. with a venture capital investment, the “process” is all of the tech/business model/operations execution risks which need to be gotten right. with the GSEs, the business is humming and the investment merit, taken in isolation apart from capital needs, is evident. but the GSEs’ “process” at risk is the regulatory obligation to raise all of the required capital. of course the GSE FAs are confident since the more to raise, the more fees to reap, so they are in it for the long run. it is my view that given the investment merit of the GSEs, the capital raise will be successful although, like in the venture capital scenario, early investors will demand their discount. there are many things unnecessary with the capital rule, but at the right price early investors will discount the risk that the capital raise won’t be successful, and follow on investors will require lesser discounts as the process moves along. this all assumes that Mnuchin gets off the pot.

          rolg

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          1. Two comments. First, it seems as if Mnuchin has set at least a rough “percent of fully capitalized” threshold that must be achieved through retained earnings before he would authorize FHFA to release Fannie or Freddie from conservatorship under a consent decree. The companies cannot raise external capital until that (unknown) threshold is attained. Second, I think most observers underestimate the amount of uncertainty imposed on Fannie’s future earnings by both the final capital requirement and the regulatory hostility of the Calabria directorship. He truly does not like the companies (witness his “worst corporate cultures in America” comment), and does not want them to do well. That makes the discount required to sell new equity considerably higher than it would be otherwise.

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20. FHFA Proposed Liquidity Requirements

    https://www.fhfa.gov/SupervisionRegulation/Rules/Pages/Enterprise-Liquidity-Requirements.aspx

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    1. I have (obviously) not read the full proposal, but this is more over-regulation on the part of FHFA, which will drive up Fannie and Freddie’s costs for only tiny incremental safety and soundness benefits.

       For the hundredth time, Fannie and Freddie are not banks. They don’t have deposits, and 90 percent of their assets are perfectly matched mortgage-backed securities, or MBS, which have zero liquidity risk. (Prior to the crisis 25 percent of the mortgages Fannie financed were held in portfolio, at the end of September 2020 only 5 percent were.) Pre-crisis, with a much higher percentage of loans in portfolio, Fannie had pledged to hold sufficient liquidity to survive for three months with no access to the debt markets (and in fact held that amount). While its debt spreads to Treasuries did widen out, it never suffered a liquidity crisis; its problems were credit-related. So now, with much smaller portfolios, Calabria finds it necessary to impose much more onerous liquidity requirements in the name of “safety and soundness.” There is no economic justification for it.

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       1. Doesn’t Calabria have large Wall Street firms advising him?

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          1. FHFA has retained one investment bank, Houlihan Lokey, to advise it on Fannie and Freddie-related issues. But if your question is, “wouldn’t the financial advisor tell FHFA if its liquidity proposal was unnecessarily severe,” my answer is no, I don’t believe it would. That’s a judgment call they would defer to the regulator.

             And to be clear, my criticism of Calabria is that he is not even trying to find the balance point between safety and soundness and leaving Fannie and Freddie with a workable business model. His “price” for agreeing to release them from conservatorship is that they will have to be capitalized like banks, and apparently also have liquidity requirements more severe than banks (again, I’ve yet to read the full liquidity proposal).

             I personally think this decision by Calabria has been a serious impediment to coming up with a workable release proposal. For Fannie to get from its current capital level of $20.7 billion to the $171 billion Calabria insists it have to be considered fully capitalized as of June 30, 2020 (and the capital number will be higher now, due to growth), there’s too long of a “runway” during which it only would be able to use retained earnings to get to a capital percentage where Mnuchin would feel comfortable allowing FHFA to release them from conservatorship, even under a consent decree. But without being released, they can’t raise equity externally to get to the release point more quickly. Add three other realities to this mix–investors may not be wild about investing the required amount of new equity in two companies whose director seems committed to handicapping their business with excessive capital and regulation; Treasury would need to price its PSPA commitment at today’s very low capital levels, making the cost onerous and a drain to retained earnings, and the likelihood that Mnuchin is reluctant to take the political hit of giving up Treasury’s claim to the net worth sweep and liquidation preference voluntarily (and now may need President Trump’s explicit permission to do so)–and you have a recipe for the sort of wheel-spinning that seems to be occurring now.

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             1. Tim,
                If Calabria is replaced by a Biden Administration, you believe they would be willing to lower the capital requirements. Do you really think that the administration would be willing to lower capital requirements for FNF and take a potential political hit for requiring lower capital?

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             2. You have to start with the objectives of the administration, and the FHFA director it appoints. I don’t know what President Trump’s objectives were for Fannie and Freddie (if he had any) when he appointed Calabria, but Calabria was known to have had an ideological opposition to the companies’ existence long before he became the director of FHFA. His capital requirements are designed to effectively sideline Fannie and Freddie as functioning entities, in favor of the “purely private” lenders Calabria favors. If the Biden administration would like Fannie and Freddie to help sustain the mortgage market by providing secondary market liquidity at reasonable prices, it will need to appoint a director who shares this goal.

                Calabria was required by HERA to produce a risk-based capital requirement for the companies. As I explained in my comment letter and in many instances elsewhere, what he produced was not risk-based. It was arbitrary (to be “bank-like”). He added a large number of cushions and elements of conservatism to the stress capital amount (the capital required for the companies to survive a 25 percent nationwide decline in home prices, without counting on any of the guarantee fees they receive on their MBS, even those fees they’ve already collected and have on the balance sheet), in order to push the “risk-based” number above the arbitrary bank-like minimum. Even the American Bankers Association and the Mortgage Bankers Association said the Calabria standard was unjustifiably high. So a new FHFA director wouldn’t be “lowering” Fannie and Freddie’s capital; it would be giving them a standard that provided an exceptionally high degree of protection to the taxpayer, while still allowing the companies to price their business competitively, to the benefit of homebuyers and the economy. That’s eminently defensible.

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21. https://video.foxbusiness.com/v/6216725015001/?playlist_id=938507328001#sp=show-clips

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    1. I don’t watch Fox Business, but this clip was eye-opening, and not in a good way. While Charlie Gasparino was droning on and on, and saying absolutely nothing, the screen showed a large chart of (alternately) Fannie’s and Freddie’s stock prices moving from the red to the green at the time of Gasparino’s tweet, and–for anyone dim enough to miss the message–at the end of the segment, Liz Claman said, “Well, the stocks are on the move on Charlie’s report.” As I said below, you pay attention to these stories at your own peril.

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22. Tim,

    Any insights about Gasparino’s tweet today? So far you have been thoroughly right about the lack of incentives for Mnuchin to enact the consent order before leaving, but any chance that the NWS goes away before February even if there is not a formal consent decree as such?

    Thanks as always for your time.

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    1. The tweet was, “SCOOP—Wall street bankers have met with @US Treasury in recent weeks to discuss GSE reform including creation of a framework for eventual recap and release from conservatorship. The framework could be announced through an amended PSPA or regulation.”

       A meeting between bankers (presumably those hired by Fannie and Freddie) and Treasury isn’t something we’ve heard about before, but the meeting apparently took place some time ago, and the rest of the tweet is devoid of any specifics. So, no, I don’t read anything into it, other than that people who either want or don’t want a deal on the net worth sweep to be struck before the inauguration are working their press contacts to try to create pressure for their desired outcome, and those who have been covering Fannie and Freddie seem to be enjoying competing with each other in moving the prices of the companies’ shares through vague and generally unattributed reporting. I would be wary of speculative press stories at this point.

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23. Tim and Rolg
    Can you comment what is going on in Judge Lamberth court? What can we expect next?

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    1. Judge Lamberth approved a scheduling order this past July that outlined a series of deadlines for the completion of fact discovery (January 22, 2021), plaintiffs’ and defendants’ expert witness discovery (July 26, 2021), class certification (July 16, 2021) and motions for summary judgment and the related responses (November 5, 2021). Assuming the case is not dismissed in summary judgment, “Trial is set for May 16, 2022, or at the Court’s earliest convenience thereafter….”

       As slow as this is, I suspect Lamberth still will conclude his process before Judge Sweeney in the Court of Federal Claims can conclude hers (which could include the Washington Federal complaint, if its appeal of Sweeney’s jurisdictional ruling is successful).

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       1. Can Collins be the fastest? It may conclude before end of 2021. Sweeney has interlocutory appeals going on.

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          1. My bet would be that Collins WILL be the fastest. There is some chance that it could get wrapped up by late spring of 2021 if SCOTUS upholds the decision of the Fifth Circuit en banc that the director of FHFA is unconstitutionally structured, but then reverses the Fifth Circuit and awards plaintiffs the retroactive relief they seek, which is revocation of the net worth sweep. Even if this does not happen, it in my view is highly likely that SCOTUS will uphold the Fifth Circuit’s finding that FHFA violated the plain terms of HERA when it agreed to the net worth sweep, and remand that case to the Southern District of Texas for trial on the facts. I expect this trial would end–or be settled by the government (to avoid the facts being made public, including Treasury’s internal memos admitting that it proposed the sweep to keep Fannie and Freddie from retaining their earnings, which it had lied about to the media)–before either Lamberth or Sweeney conclude their cases.

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             1. I agree with this, but Collins if remanded on the statutory claim may not require a trial…there is a lot of deposition testimony and documentary evidence from Fairholme that can form the basis of a summary judgment motion, which would be quicker than a trial.

                rolg

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