The Director Digs In

~ jtimothyhoward

On May 20, the Federal Housing Financing Agency (FHFA) released its re-proposed capital rule for Fannie Mae and Freddie Mac. The new standard was bank-like both qualitatively—expressing required capital amounts not as percentages but as “Basel risk weights”—and quantitatively, requiring the same 4.0 percent minimum capital for the companies’ credit guaranty business as banks must hold for the mortgages they retain in portfolio (and on which they take liquidity and interest rate risk as well as credit risk). In addition, FHFA added a number of new cushions and elements of conservatism to the June 2018 risk-based standard to bring its required capital up to a level approximating the proposed new minimum. Under the May 20 proposal, total combined required capital for Fannie and Freddie as of September 31, 2019 was 71 percent above the June 2018 requirement. 

FHFA requested comments on the May 20 proposal, due on August 31. The majority of the 80 detailed comments posted to the FHFA website were critical, and most critics made the same four points: that (1) Fannie and Freddie were not banks and did not have the risks that banks do, so applying Basel bank capital requirements to them was not appropriate; (2) a 4.0 percent minimum capital requirement that generally would be binding on the companies gave them a perverse incentive to take risk, and discouraged the use of credit risk transfers (CRTs); (3) the large amount of add-ons and conservatism in the risk-based standard made it not risk-based in practice, and (4) FHFA had not given sufficient capital credit for the use of CRTs.  

Tellingly, even the American Bankers Association and the Mortgage Bankers Association were critical. The former said, “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.” And the MBA stated flatly, “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.”

I had speculated in an earlier post (Now We Know) that Director Calabria might not be receptive to suggestions that he change either the structure of the May 20 capital rule or its required capital levels. Two recent developments indicate that this indeed will be the case. First, in testimony before the House Financial Services Committee on September 16 he defended the 4.0 percent minimum capital number, made no mention of any criticisms of it or the risk-based standard, and gratuitously said about the companies’ managements, with no context or elaboration, “Fannie and Freddie have what I would consider some of the worst corporate cultures I’ve ever seen in corporate America.” Then, shortly after this hearing  we learned that Calabria had sought, and received, an endorsement of his capital rule from the Financial Stability Oversight Council (FSOC), a group of financial regulators chaired by the Secretary of the Treasury and including three more bank regulators—the Federal Reserve, the Comptroller of the Currency and the FDIC—as well as FHFA, four other regulatory bodies (the SEC, the CFPB, the CFTC and the NCUA) and “an independent member with insurance expertise.”  

In a four-page statement issued on September 25, the FSOC said, “The proposed [FHFA capital] 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…which would create an advantage that could maintain significant concentration of risk with the Enterprises.” And Calabria himself summarized the FSOC findings (in remarks he gave at the FSOC meeting) by saying, “As the Council found, risk-based capital and leverage ratio requirements materially less than those in the proposed rule would likely not adequately mitigate the potential stability risk posed by the Enterprises. Indeed, more capital might be necessary. 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. The Council also affirms the necessity of a dedicated capital buffer that is tailored to mitigate the potential stability risk posed by an Enterprise.”

There is little question that the Director intends the FSOC review to serve as a rebuttal to the major substantive criticisms made of the May 20 standard, and thus a rationale for not changing it (with the exception of credit for CRTs, which he may make more generous). The FSOC endorsement, however, has two disqualifying weaknesses. The first is its source. It is hardly news that a group dominated by bank regulators would prescribe bank-type and bank-level capital for Fannie and Freddie. They have done so for at least three decades, and I strongly suspect that there is little institutional recognition at any of the FSOC-member institutions that the one (weak) rationale that used to exist for applying bank-like capital requirements to the companies—that they, like banks, held large amounts of mortgages in portfolio, funded by debt—no longer is true. And that leads to the second disqualifier of the FSOC statement: it contains almost no documented facts, and literally no risk-related data; its conclusions and recommendations all stem from unsupported assertions and generalities.

Actual mortgage market and credit risk data paint a much different picture of Fannie and Freddie’s potential risks to the financial system than Calabria and the FSOC have put forth. To begin with, they reveal how low single-family residential mortgage credit losses are in a normal environment. Between the time Fannie was spun out of the government in 1968 through the year before the financial crisis, 2007—a near four-decade period that includes six recessions—the highest the company’s single-family credit loss rate (net credit losses as a percentage of total mortgages owned or guaranteed) ever got was 11 basis points, in 1988. And during the fifteen years I was Fannie’s CFO, from 1990 through 2004, its average annual credit loss rate was only 2.5 basis points per year. But then the bottom fell out, for all mortgage lenders, in 2008. What happened?

There have been two periods in the past 100 years when a sharp and protracted decline in U.S. home prices has occurred nationwide. The first was during the Great Depression, when home prices are believed to have fallen by about one-third (reliable data for this period do not exist), and the second was between mid-2006 and mid-2011, when home prices fell by about 25 percent. Each episode was the consequence of unique and identifiable circumstances.

The home price decline during the Depression was triggered by the collapse of the stock market, a national unemployment rate approaching 25 percent, and the failure of many regional banks. This last was problematic because the predominant mortgage at the time was a balloon loan which had to be repaid or refinanced within 3 to 5 years; with so many banks failing there were few lenders able or willing to roll over the maturing loans, leading to widespread defaults. The government responded by creating the FHA, the 30-year fixed-rate fully amortizing mortgage, and Fannie Mae. These innovations kept the mortgage market stable and home prices rising, with no annual declines, for almost 70 years.    

Advocates of bank-like capital for Fannie and Freddie’s credit guaranty business pretend not to know what triggered the collapse in home prices in the mid-2000s, but the record is clear. Disastrous decisions by Treasury and the Federal Reserve in the early 2000s first to not regulate subprime lending practices and then to promote the development of a private-label securities (PLS) financing mechanism that put few if any restrictions on the risks of the loans it accepted led to a collapse in underwriting standards and near-unlimited access to mortgages for unqualified borrowers, which in turn fueled an unsustainable boom in home sales, construction and prices. When the PLS market finally collapsed in the fall of 2007—and banks effectively ceased mortgage lending because of soaring delinquencies—housing sales and starts plummeted, and home prices fell by 25 percent peak-to-trough before they could stabilize.

As after the Depression, policymakers responded to the causes of the meltdown. The Fed and Treasury acknowledged that their deregulatory posture was an error. And Congress in 2010 passed the Dodd-Frank Act, requiring lenders to apply an “ability to repay” standard to mortgage borrowers, and through its qualified mortgage standard effectively prohibited the riskiest mortgage products and loan features that proliferated during the PLS bubble. Reflecting these reforms, the credit loss rate on loans Fannie has purchased or guaranteed since 2009, which now make up 95 percent of its current book of business, has averaged 2.7 basis points over the last five years—virtually the same as during the 15 years before PLS became the predominant source of mortgage financing a decade and a half ago.

This quick review of history highlights three important points: first, the fundamental credit quality of the single-family mortgage is very high; second, the stress test used to determine Fannie and Freddie’s new capital requirement is extremely severe, and absent a repeat of the pre-crisis policy mistakes highly unlikely to recur; and third, because of the first two points there is little justification for the amount and type of capital buffers, add-ons and conservatism in the capital rule proposed by FHFA and endorsed by the FSOC, particularly when one considers the loss data and the realities of the companies’ business, as Calabria and the FSOC conspicuously do not.

FHFA’s May 20 capital proposal gives two dollar amounts for Fannie and Freddie’s “net credit losses”—that is, stress test losses after private mortgage insurance, but before any credits from securitized risk transfers—on their September 30, 2019 books of business: $109.1 billion and $134.9 billion. The latter figure, however, incorporates FHFA’s proposal to set a floor of 1.2 percent on credit losses for all loans, and thus is an inflated number. Assuming that $109 billion (or 1.80 percent of adjusted assets) is an accurate estimate of the lifetime credit losses Fannie and Freddie would incur today in response to a 25 percent decline in home prices (and it may still be high), FHFA adds another $124.8 billion through various cushions and buffers to get to the risk-based capital requirement of $233.9 billion (3.85 percent of adjusted assets), then a further $9.0 billion through the 4.0 percent minimum capital requirement, which was binding on September 30, 2019, to reach a total capital requirement of $242.9 billion for the companies.

As numerous commenters on the capital rule pointed out, the $133.8 billion in combined cushions and add-ons to the risk-based requirement in the May 20 rule exceeds by a large margin the $109.1 billion in worst-case credit losses being cushioned or added on to. FHFA and the FSOC claim this is necessary to cover risks other than credit—market, operations, and model or measurement risk—and to enable the companies to survive the stress period as going concerns. But here the disconnect with market reality becomes untenable.

Beginning with the June 2018 version of the Fannie-Freddie capital rule, FHFA consistently has refused to acknowledge that the companies’ guaranty fees constitute revenues capable of absorbing credit losses. While some version of discounting the value of guaranty fees may be reasonable in a stress test conducted on a liquidating book of business (which is how the risk-based capital requirement is derived), ignoring guaranty fees in assessing a company’s ability to survive a stress period as a going concern is nonsensical. Those fees will be there, and moreover many of them (in Fannie’s case, over 40 percent) already have been received in cash, as loan-level price adjustments on higher-risk loans, and literally are present on the balance sheet.  

In the second quarter of 2020, Fannie and Freddie’s combined guaranty fees, excluding the TCCA fees payable to Treasury, totaled $7.6 billion, or more than $30 billion annualized. After deducting annualized administrative expenses of $5.4 billion, Fannie and Freddie’s net guaranty fees currently are running at a rate of $25 billion a year. If the $109 billion in combined lifetime stress credit losses FHFA is projecting for Fannie and Freddie follow the same annual pattern as the losses from Fannie’s 2007 book—which is the one subjected to the financial crisis—they would look like this over the first five years: $7.4 billion, $14.5 billion, $24.5 billion (peak in year 3), $19.4 billion, and $14.4 billion. Note that each year’s loss is less than the companies’ current amount of annual net guaranty fees (although year three just barely), and that over the full five-year period the companies would have earned guaranty fees of $125 billion while suffering credit losses from their pre-stress period books of $80.2 billion, leaving their capital accounts not just intact, but increased. (Credit losses at both companies from new business put on during the first five years of the stress period would be only another $8.0 billion if they followed the post-2007 pattern.) That is their business reality.

Contrast this with the unreality of the FHFA capital scheme, endorsed by the FSOC. FHFA projects credit losses of $109 billion from a stress scenario that is highly unlikely to occur, ignores the fact that as the going concerns FHFA (properly) insists the companies be they would be able to cover these stress losses with guaranty fees, and then requires them to protect against “other risks” with a dollar amount of capital, $134 billion, greater than the projected stress credit losses themselves. Yet what, besides going concern risk, might those other unquantified risks be? Unlike commercial banks, Fannie and Freddie do not have the interest rate risk of funding 30-year mortgages with short-term debt; they have virtually no liquidity risk (the threat of deposit flight, or an inability to roll over debt); their market risk is low because their guaranty fees are locked in up front and tend to be recaptured (and can be increased) when mortgages refinance, and they now hold few securitized mortgages in portfolio; their business is not operationally complex and the operations risk they do have is not correlated with credit risk, and finally, in their one line of permitted business their credit losses occur with considerable advance warning, and even in a worst-case scenario are spread out over many years.

When I worked with former Fed Chairman Paul Volcker on the risk-based standard that became the basis for Fannie and Freddie’s 1992 capital legislation, he often expressed his strong view that the capital standard for any regulated financial institution must not go so far in pursuit of a subjective safety and soundness goal that it impeded the ability of a regulated entity to conduct its business on an economic basis. Director Calabria, to my knowledge, has never addressed this balance issue in any form or forum. Instead, for whatever reason he seems determined to subject Fannie and Freddie to a bank-level capital requirement that does not remotely align with the risks of the mortgages they guarantee, despite what he now knows the consequences of this will be: distorted credit pricing, greatly hindered competitiveness, a significant reduction in the volume and breadth of the companies’ business, and quite possibly discouraging investors from supplying the equity required for them to become fully free of the regulatory restrictions imposed upon them more than a dozen years ago. 

The fact that Director Calabria has been able to obtain the support of the Financial Stability Oversight Council for his May 20 capital proposal may give him temporary regulatory cover for making only modest adjustments before the rule becomes final, but it does not change the reality that the standard is seriously misguided, and inconsistent with readily available historical and market data. And that inevitably will limit its lifespan. At some point Fannie and Freddie will have a regulator who does not insist that they be arbitrarily and punitively overcapitalized, and understands that hamstringing the operations of two companies at the center of a $10 trillion market critical to the health and growth of the U.S. economy, for no demonstrable reason, is disastrous public policy. For this reason, even if the May 20 FHFA capital standard goes into effect as proposed, it is highly unlikely that Fannie and Freddie will have to recapitalize solely through retained earnings, over a period as long as ten years. They will be given a sensible and workable capital requirement long before then.

422 thoughts on “The Director Digs In”

  1. Business Insider:

    Fannie Mae is asking key employees to be prepared to work through the holidays as the mortgage giant plots a potential 11th-hour release from government …

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    1. It’s no secret that Director Calabria wants to release Fannie and Freddie from conservatorship. This Business Insider article indicates that Fannie’s management is working with Calabria to see if this can be engineered before the end of President Trump’s term. (Freddie apparently was not on board with whatever Calabria has in mind, hence CEO Brickman’s recent resignation). As always, however, the key to release under a consent decree will be whether Treasury Secretary Mnuchin is willing to voluntarily relinquish the net worth sweep and Treasury’s liquidation preference in the companies. So far, he hasn’t been. But it could be an interesting several weeks between now and the 20th of January.

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      1. Tim

        yes, Mnuchin is in control, and nothing happens without his approval. but I have thought that a 4thA occurring before 1/20/21 was more realistic than both that and a set of fhfa/GSE consent decrees as well. this reporting indicates to me that the possibility of consent decrees before 1/20 are being seriously contemplated and prepared for…this preparation would not be necessary for only a 4thA. this seems significant to me.

        rolg

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        1. There is an article in the Wall Street Journal this morning by Andrew Ackerman which states, “Treasury Secretary Steven Mnuchin suggested in an interview with the Wall Street Journal that he is unlikely to support a legal move–called a consent order–to end the government conservatorships of the mortgage-finance companies before President Trump leaves office.” This may be wrong, but it’s consistent with past reporting, and previous statements by Mnuchin. It implies that a pre-January 20 Fourth Amendment to the PSPA would include an increase in the dollar amount of earnings Fannie and Freddie are allowed to retain, rather than remit to Treasury under the net worth sweep, and perhaps some other elements, but that both the sweep and liquidation preference would remain in effect into the Biden presidency.

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  2. Tim- any thoughts on the comments by Mnunchin staring he is likely to alter the 3rd Amendment and that the Admin hasn’t done enough yet with F&F? He wants to “set them on the right direction.” The timing on the comments are interesting given oral arguments this morning.

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    1. The full set of quotes from Mnuchin in the Bloomberg article do not appear to give much hope for a comprehensive reworking of the Fourth Amendment to the Senior Preferred Stock Agreement before the change in administrations.

      To the contrary, three statements or points indicate that Mnuchin is likely to adopt the approach of “declaring victory and leaving.” Bloomberg quotes him as saying, in the past tense, “the one area I feel like we didn’t make enough progress is on Fannie Mae and Freddie Mac.” Bloomberg also has Mnuchin returning to a theme he seemed to have abandoned two years ago, saying “he still believes Congress should pass legislation to reform the housing finance system,” quoting Mnuchin as saying “we’re going to create a blueprint” [for legislation], and noting “he had spoken to both Republicans and Democrats in the past few weeks.” Finally, Mnuchin’s comments on the Supreme Court’s hearing of the Collins case were not indicative of someone in the midst of negotiations to settle it: “If they rule in Treasury’s favor it simplifies things….If they rule against it’s still going to end up in litigation.”

      I wish it were different. But we’ve now gone from there being no good signs of movement toward a voluntary cancellation of the net worth sweep by Treasury to overt statements from the Secretary that affirm the sweep indeed will remain in force–although probably with a higher cap for the companies to retain earnings without having to remit sweep payments to Treasury–through January 21, 2021.

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      1. Not that Joe would ever leave anything out, but he chose not to include this quote:

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          1. Tim,

            Picking up on that, the most curious thing to me about the four year delay is Mnuchin upon taking office impugned the previous administration for funding other programs with revenue generated by the NWS. He then acted in kind.

            Given the 11,000 documents I never saw optics or lack of political cover an obstacle to doing what he saw (announced!) was plainly right. Yet soon after his Maria interview he dialed back comments and began to let, at least in appearance, Calabria take center stage.

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      2. Tim, respectfully that is a pretty negative read on some comments that can be widely interpreted. While the sweep won’t stop in a “Big Bang” the PSPA could be amended allowing for release based upon certain milestones being achieved. We have no idea how onerous or quickly those milestones could be attained. Putting Mnuchin’s comments in context with a timeframe for release is important. What am I missing?

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        1. ml1993: What you’re missing are any particulars: that is, what specific initiative or set of initiatives do you envision Secretary Mnuchin announcing prior to January 20, and what past actions or statements of his might be viewed as evidence for them? It’s one thing to say, “Oh, he’ll do something;” identifying what that something or set of things is, and why it or they might happen, is a different matter.

          As to a timeframe for release, Mnuchin quite recently said that he is looking for significant progress from the companies in building their capital from the $35 billion they have now towards the $283 billion FHFA insists they would have needed to be considered fully capitalized at June 30, 2020 before they would be eligible to be released from conservatorship under a consent decree. I agree that this is “pretty negative,” but the negativity is coming from Mnuchin, not me.

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          1. Tim

            Mnuchin has been doing a lot of tawkin’ lately, and none of it will mean feces to a tree if he doesn’t start doin’, but I have seen video lately of Mnuchin saying that somewhere between current GSE capital (which he incorrectly labelled as zero) and the GSE required capital amount per the capital rule, the GSEs may be released from conservatorship pursuant to consent decrees.

            as much as anyone, I am disappointed with Mnuchin’s production; I never knew GS bankers to overpromise and underdeliver, and I have worked with more than a few. moreover, I hate that our political institutions have become so dysfunctional and disrespectful, and I certainly would never contemplate that Mnuchin would allow Collins to proceed to scotus argument with any prospect of consummating a transaction after scotus argument and before 1/20/21; but he has also recently said that it is likely that there will be an amendment to the PSPA.

            so yes, talk is cheap, especially out of Mnuchin’s mouth, as we await the famous final scene, but perhaps it will be a case of better late than never.

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          2. Color me naive, but to me it makes perfect sense for Mr. Mnuchin to tread light (and late) on a GSE decision which is certain to upset powerful congressional and monied interests. Presidents conduct what are often distasteful pardons during their final hours in office because the backlash can interfere with other, prior, more important business. Mnuchin is at this very moment working a budget compromise AND a stimulus deal with massive implications for the economy, not to mention his legacy. If GSE announcements can be postponed a few weeks, it makes sense to postpone. What does not make sense is for Mr. Mnuchin to say at this stage of the game that he intends to modify the PSPA’s, and then not deliver.

            Thank you Mr. Howard for your brilliant analysis over the years.

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      1. I found this to be a very good summary and analysis of the oral argument in Collins, by a savvy and experienced legal observer of the Court who, because she is not steeped in the Fannie and Freddie history, is able to bring a fresh and objective perspective to the case. Well worth reading.

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          1. The “acting director” issue continues for me to be the biggest puzzle of the oral argument. It isn’t just Ms. Howe who treats an assumption–that the acting director of an agency purposefully structured to be insulated from political interference would himself or herself not be subject to the same “for cause” removal restriction as the director, when the statute does not say this–as if it were accepted fact. Most of the justices did this as well. The question is why?

            I normally don’t speculate, but I do have a theory on this, and it’s one that also answers why SCOTUS granted cert in this case in the first place. It clearly wasn’t because of the APA issue. That was an interlocutory appeal, and as everyone including Ms. Howe has noted, the justices spent very little time on this issue. Cert was granted shortly after the Seila Law case addressing the constitutionality of the director of the Consumer Financial Protection Board (CFPB) was decided, so the constitutionality issue in Collins was clearly the justices’ interest: would the decision SCOTUS just made to invalidate the independence of the CFPB director also apply to what seemed to be a similar structure at FHFA?

            So here’s my theory. Conservatives in Congress have been against the independence of the CFPB director since the agency was created. Seila Law gave the conservative majority on SCOTUS an opportunity to rule that the structure of the CFPB director was unconstitutional, which they did, but in so doing they left some “hard questions”–what other single-director agencies might be subject to the same determination, and on what basis–still to be answered. Collins was a vehicle for doing that….or not doing it. I am suspicious that the embrace of the “acting FHFA director IS removable” assumption by the justices is a convenient excuse to postpone having to answer in Collins the questions raised by Seila Law, by agreeing to rule against Collins plaintiffs because it was an acting director removable by the president that made the decision on the net worth sweep. This would get the conservative majority what it really wanted–a change in the directorship at the CFPB–while deferring, perhaps indefinitely, the hard questions raised as a consequence of that decision.

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          2. Would SCOTUS allow themselves to be distracted by a technicality about Acting Directors possibly not being subject to the same rules as a Director? They know the facts of the case, can’t they do what’s right instead of searching for ways to abdicate their role as justices?

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          3. The theory I’m advancing is that the justices weren’t “distracted by a technicality” relating to the removability of an acting FHFA director; they are seizing on the interpretation posed by the court-appointed amicus Aaron Nielson (who previously clerked for Justice Alito) that the acting director IS removable by the president as a pretext for being able to avoid having to address the constitutionality of the FHFA director. This is, however, just speculation on my part.

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          4. Tim

            I do agree the acting D removable at will hypothetical had a long run, much longer than it should have, though it seems to me that ACB pointed out the difficulty of this hypo, even assuming scotus so found in its favor, after 2014 when the D was confirmed.

            it really is a weak argument that an acting D of an INDEPENDENT single director agency is subject to potus’s removal at will when the statute doesn’t say so. an exception with respect to an INDEPENDENT single director that the acting D is removable at will would require clear statement in the statute. if you actually read what the statute says about the acting D’s term carefully, it says that the acting D’s term continues until a replacement D is senate confirmed. nothing about potus removal at will. I would argue that there is no removal power at all given this language.

            govt’s whole argument comes from a law review article that bases its entire reasoning on the notion that the statute requires potus to “designate” an acting D (a designated appointee is supposed to be removable at will under this law review article’s theory). but how does potus have unfettered power to direct the replacement D when the acting D has to be chosen from 3 nominees handpicked by the vacated D, the guy potus clearly could not remove at will. this is not unfettered potus control over a single director agency for purposes of the Take Care clause of the US constitution.

            the covid questioning protocol can let a wrongheaded hypo like this run longer than it might normally because first, each justice gets 2 minutes uninterrupted (and normally justices feel free to interrupt each other to kindly suggest what they think of another justice’s point) to pursue something like this hypo, and then any justice who would slap the hypo down out of hand has to hold his/her tongue as the questioning cue falls to the next junior justice. the 5thC en banc majority rejected this acting D argument with little discussion, and I believe there are more justices who are pro-Willett than contra-Willett.

            if you want to count justices, I dont see Kavanaugh, Gorsuch, Alito and Thomas buying into the hypo in the slightest. I think Roberts is unlikely as well though with Roberts one never knows anymore, and then you have ACB…and it seemed ACB raised the hypo when it was her chance to question more to expose the hypo’s flaws. yes, the justices have concern with the reach of the Seila holding (see eg Kagan’s Social Security administration question), but the acting D argument is not going to be the off ramp they will want to use if there ever is a case involving the SSA.

            rolg

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          5. I didn’t find Justice Barrett’s point about the confirmation of a FHFA Director in 2014 to be persuasive, nor was I convinced (sorry David) by the argument that each quarterly net worth sweep payment gave rise to a new and valid complaint by plaintiffs. I thought counselor Mooppan had the better argument here: that the original agreement between Treasury and FHFA in August 2012 was a contract–and that subsequent quarterly payments were merely the implementation of the terms of that contract (with the required quarterly approvals from FHFA covering only whether those payments should be made to Treasury in cash, rather than being added to its liquidation preference)–and that the companies’ obligations to make sweep payments in perpetuity can only be changed by a new agreement between FHFA and Treasury.

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          6. Tim

            the whole hypo is a red herring. it is a losing argument that rightfully lost at the 5thC en banc. if you grant that the acting D is removable at will, then we can debate until the cows come home what that entails. it is a losing argument on the merits.

            while I would prefer to win at scotus on both claims, I see no one positing that Ps will lose at soctus on the statutory claim…no stupid hypos discussed relating to that claim. and that would still be a winner take all win for Ps, albeit after some summary judgment motion practice at the federal district court level that will recite all of the villainy of the govt at the time of the adoption of the NWS…not what I think the govt would want in any event.

            rolg

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          7. I agree that plaintiffs are (highly) likely to win on the statutory claim, after remand to the Texas district court. Both I and Ms. Howe are dubious that plaintiffs will win on the constitutional issue–but we only have to win one.

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  4. Tim-
    1st time commenter- thank you for this forum. As a legal scholar, I was enamored with Justices’ stance from the get go. I listen to most SCOTUS cases, and usually they will not give you a good feeling as to how they may potentially rule. THIS ONE IS DIFFERENT. From the start, I could tell they are actively looking for the remedy.
    Their line of questioning to the Government lawyers, was unbelievable. They already have a good feel as to how they are going to rule. Not much talk on APA- meaning they got a good hold on it. I would love to hear your feelings on this.

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  5. Tim

    my initial reaction to the SCOTUS Collins oral argument was that it was about as favorable to Ps as could be expected from a SCOTUS oral argument…understanding that gleaning a decision outcome from oral argument can be fraught with disappointment. I was surprised that more than one justice posed the hypo as to what should we do if we find the acting director who signed the NWS was removable at will. I think that is a weak argument, but since it was argued by both the SOJ and the amicus it had to be explored. however, justices often pose a hypothetical inquiry so as to think through what are the ramifications of going down that rabbit hole, and I cant say that I found that by posing that hypo there was any particular enthusiasm expressed for the merits of the claim that the acting D was in fact removable at will.

    as to your thought that Treasury wanted to gauge the tenor of the SCOTUS hearing before making any 4thA etc decisions, I dont know that this hearing would put Mnuchin confidently over the edge if he is looking for a gentle push, but I dont think this was a hearing that would argue for Treasury to reconsider any decision to proceed with a 4thA etc prior to 1/20/21, if that is in fact where it is heading.

    rolg

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    1. I’m still going over my notes, but my reaction to the oral argument wasn’t as positive as yours seems to have been. I thought it started out very well for plaintiffs, with the justices posing very skeptical questions, and follow-ups, about counselor Mooppan’s arguments on the anti-injunction and succession clauses barring plaintiffs’ challenge to the net worth sweep. But the justices seemed more receptive to the arguments made by amicus Nielson that I was expecting them to be–particularly on the issue of whether an acting director of FHFA (which DeMarco was when he agreed to the sweep) was removable by the President other than for cause, and whether that weakened, or invalidated, plaintiffs’ constitutional argument. The justices then were pretty tough on David Thompson on the acting director point, as well as the issue of whether voiding the net worth sweep was an appropriate remedy, even if the acting director had been protected from removal.

      As you say, many of the questions may have been “devil’s advocate” arguments, but I ended the session feeling there was well under a 50 percent chance that plaintiffs would get retroactive relief from SCOTUS on the constitutional claim, and that while SCOTUS very likely would uphold the decision of the Fifth Circuit en banc that the net worth sweep was a violation of the APA, it would not change the Fifth Circuit’s ruling that the case should be remanded to the Southern District of Texas for trial on the facts.

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      1. Tim

        now let me be a bit speculative. you will notice that SCOTUS spent very little time on the merits of the APA claim that the NWS is ultra vires, much more time on the constitutional claim. in his opening the assistant SG mentioned the anti-injuction clause and that the APA itself doesn’t support the APA cause of action, which implicates the APA claim, but there wasn’t much follow up by the justices on the APA claim (and indeed, those provisions implicate the constitutional claim as well). now why would there be so much more focus on the constitutional claim than the APA claim? one answer might be that the justices think the constitutional claim will decide the case. Now if the justices thought the NWS would be validated, either in part because the acting fhfa D was removable without cause, or in whole because the Seila holding doesn’t apply to Collins, then you would think the justices would have spent much more time on the APA claim than it did. now, one may think that the APA claim is so powerful for Ps that no time needed to be spent on the APA claim, but I think that if there was any possibility that the constitutional claim wouldn’t be fully upheld then the APA claim would have garnered more focus.

        rolg

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        1. The first three justices to ask questions (Roberts, Thomas and Breyer) as well as others did ask about the APA claim, and they seemed uniformly skeptical that the succession clause would bar plaintiffs’ challenge. They were less obvious about the applicability of the anti-injunction clause, but I thought that was because it was not purely a matter of law; it also could turn on the facts, which SCOTUS had not been asked to address (because the Fifth Circuit en banc had remanded the case to the Southern District of Texas for trial on those facts). My analysis of that segment of the argument is that the justices are in broad agreement as to what to do on the APA claim–uphold the Fifth Circuit en banc decision, and remand–so they then spent most of the rest of their time on the constitutional question, which is much more problematic for them. A number of the justices seemed genuinely troubled by the precedent they would be setting were they to grant retroactive relief to plaintiffs. Would ALL actions of an unconstitutionally appointed director (still within the statute of limitations) be challengeable? Is the single head of ANY agency unconstitutionally appointed, and would all of their actions be reversible? (You heard the questions.) They seemed to be looking for reasons to uphold the Fifth Circuit en banc decision, which explains to me why they spent so much time on the constitutional issue.

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          1. Tim

            then why so much focus on the acting D point? because the justices are boxed in by Seila, where they already granted backward relief for a single agency D removable only for cause. so the justices are probing for distinctions in Collins from Seila, and the most salient difference (which is why govt/amicus latched onto it) is the acting D signed the NWS. what you didnt hear much questioning about is whether an independent agency like fhfa (and Thompson referred to this statutory provision on at least three occasions with statutory section references) can have an acting D be removable without cause. certainly doesn’t say that in the statute. the justices were clearly probing for differences from Seila, but the only analytic hook would seem to be that the acting D can be removed without cause and I dont think you can point me to an actual discussion as to the actual merits of this acting D can be removed at will claim (as opposed to its implications if hypothetically it was adopted).

            Thomas did point to another difference, an agency contract (collins) vs an agency enforcement action (Seila), but that went nowhere.

            rolg

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          2. I thought the focus on the FHFA director being acting was just what you said: to give the justices a reason not to have to apply Seila Law to Collins. I think we’re in agreement there, but my conclusion is that a majority of the justices don’t want to rule for plaintiffs on the constitutional claim, and the acting director point seems to be the easiest path that gets them there.

            Liked by 1 person

          3. Tim

            we do agree that the justices were trying to distinguish Seila with the acting D removable at will claim, but if scotus really is taking this claim seriously, you would think they would have examined the actual merits of the claim seriously as opposed to just its hypothetical implications as to remedy. where did a justice ask whether an acting D of an independent agency can be removed at will (when the statute doesn’t so prove explicitly)? I dont remember any serious discussion of the merits. the govt/amicus certainly argued it but I dont remember any analytic engagement on it. to be clear, I believe that if an agency is independent by statute, and the acting D provision doesnt discuss removal (but limits appointment to one of three handpicked deputies selected by a director not subject to removal), and the federal vacancies act doesn’t apply (which Thompson addressed), then I am hard pressed to see how scotus finds that the acting D can be removed at will. this is a high analytic hurdle and I saw no attempt by any justice to surmount this hurdle on the merits. No engagement by scotus on the Swan case which govt argued in briefing, which Thompson distinguished in any event in the orals.

            rolg

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          4. So to tie this discussion up, I infer from the justices’ not digging deeply (or much at all) into the notion that the acting FHFA director is removable by the president at will that they want to use this “weak reed” as a vehicle for drifting to a decision not to apply Seila Law to Collins. What do you infer from it?

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          5. Tim

            I infer that scotus is probing to see if they can distinguish Seila (which only invalidated a low level investigation) from Collins (which is a big ticket money case). there is really only one analytic hook…the acting director…and scotus was probing whether they should hang their analytic hats on that hook if it has any implications on the remedy (whether hypothetically it upholds NWS, or hypothetically voids only all dividends since 2014 when D was senate confirmed etc). there was some discussion that the treasury secretary being subject to potus removal at will and signing the NWS was enough, but I didnt see that going anywhere. they discussed the acting D remedy implications without, to my recall, discussing the merits of the acting D removable at will argument to any length. whatever they took away from that hypothetical analysis (and I would point out that I dont remember Gorsuch, Kavanugh, Alito and Thomas particularly interested in this hypothetical), they will return to chambers to consider the actual merits of the acting D removable at will argument…and I dont see the merits of this argument, not even a thin weak reed. indeed, the failure at orals to discuss the merits of the acting D argument seems to me to be diagnostic as to where scotus will end up on it. ACB did pursue the hypothetical but I couldnt tell how important this was to her.

            rolg

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          1. Your question was “what do we need from SCOTUS to keep fighting.” The Fairholme and Washington Federal cases before Sweeney are regulatory takings claims, which would be unaffected even in the unlikely event SCOTUS decides against plaintiffs on both the constitutional and APA claims. The remand to Lamberth for trial on breach of contract and breach of implied covenant of good faith and fair dealing issues would also continue. Cases that directly address issues decided by SCOTUS–like Bhatti in Minnesota and Rop in Western Michigan–would end in the event of an unfavorable SCOTUS ruling.

            Liked by 1 person

  7. Tim

    I want to alert you and your readers to a development last night that may affect who takes the potus oath of office on 1/20/21. no, I am not kidding. see https://www.scribd.com/document/487348469/TX-v-State-Motion-2020-12-07-FINAL#from_embed

    until now, trump administration election challenges have been ineffectual, a sort of traveling minstrel show featuring Rudy and Sidney. this has now changed. Texas has filed an action with SCOTUS seeking to have the electoral college votes of Pa., Mich., Ga. and Wisc be appointed by the appropriate states legislatures, as opposed to those votes of EC voters certified by the secretaries of state based upon the election.

    Texas alleges that the elections conducted in the defendant states violated the Electors Clause of the US constitution, which provides that “state legislatures” shall prescribe voting procedures for potus election. Texas claims that those defendant states violated this US constitutional requirement when the states, acting other than through their respective legislatures, changed the electoral processes within the states. This is a claim of ultra vires elections in those states.

    Under Bush v Gore, SCOTUS found that federal law (the Electors Clause) is implicated when states conduct elections in violation of their own state law….that even though the violation is of state law, since it implicates the validity of the potus election, SCOTUS was presented with a federal question that it had the jurisdiction and the obligation to decide.

    Moreover, under the US constitution, SCOTUS has exclusive original jurisdiction involving a case by a state against one or more states.

    So SCOTUS MUST decide whether the Texas motion states a claim for which SCOTUS can grant relief…and given the Bush v Gore precedent, I believe SCOTUS WILL have to decide the case on the merits.

    the EC meets by federal statute 12/14/20. the potus inauguration by US constitution is 1/20/21. Texas is asking for straightforward relief…an order requiring that the defendant state legislatures appoint the EC voters in the respective states (this is the 18-19th century practice). of course, their votes for potus may be different than what would obtain if the current slates of EC votes vote in the EC as per election results.

    obviously, this is a big deal for all of us from a civic POV, but it also involves one of the predicates relating to our analysis of Collins/4thA/consent decrees etc…namely the identity of potus on 1/21/21.

    rolg

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    1. just one more point about this Texas action. in order for SCOTUS to get involved, Texas’ claim must be “consequential”. it must allege that the violations of state law incurred in Ga., Pa., Wisc and Mi. had an outcome determinative bearing on the potus election. Texas’ paper goes to great length to allege this.

      rolg

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    2. It took me awhile to find any mainstream news sites that made mention of this suit filed by the Texas AG directly to the Supreme Court, seeking to invalidate the election certifications of four OTHER states, and have those states’ (Republican) legislatures instead appoint their presidential electors, to the benefit of President Trump.

      I try very hard to keep partisan politics away from this site, but I have to say that this strikes me as the most brazen attempt to overturn the results of a democratic presidential election ever. The president was claiming fraud months before the election took place. He and his legal teams have had more than a month to find evidence of election fraud, and as many state courts have noted, they have not even been able to come up with fact-based allegations of fraud, let alone evidence of it. The president’s attempts to convince the legislatures of Georgia, Michigan, Pennsylvania and Wisconsin to overrule the votes of their states’ residents have also failed, so now we see a “hail Mary” suit filed by the Texas state Attorney General, asking the Supreme Court to invalidate the votes in these four states, after their own legislatures declined to do so.

      I’ll give the president this: he said he would get the election to the Supreme Court, and he’s found a way to do it. I don’t know enough about SCOTUS procedural practice to know whether it will simply decline to hear the case, or whether it will hear it and then dismiss it. But one of those two will occur. In my view there is zero uncertainty about the identity of the POTUS on January 21.

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          1. Tim

            it’s more a question of the rule of law than representative democracy. scotus will hear the case. it is required to jurisdictionally and pursuant to precedent. if it finds that the manner in which the election was conducted in these four states constituted material deviations from their respective state law (a big if), I cant think of a reason why it wouldn’t rule in favor of Texas (following Bush v Gore), by mandating that the respective state legislatures which have violated their state laws to appoint the EC voters. but as we have found out, predicting “big stakes” litigation results is a mean and perplexing business. scotus may find the various violations of state election law to be not material, or in the aggregate not consequential. but if you think this is a frivolous suit, I think you will find that you are mistaken.

            rolg

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          2. I didn’t say the suit was frivolous. To the contrary, it’s deadly serious; it’s seeking to overturn the result of a democratic election, to the benefit of an incumbent who lost by more than 7 million popular votes. But as I said, I’ll take your bet, and with that we’ll close off discussion on this topic–at least until we know what SCOTUS has done with it.

            Liked by 1 person

  8. Tim- Bank of America came out yesterday and said that if the GSEs were released from conservatorship with a govt backstop that there would be no disruption to the MBS market. If other banks/banking groups start to affirm this position, would that provide the political cover you are looking for release?

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    1. These are two separate (although linked) issues. I didn’t see the B of A report, but I believe that any plan to release Fannie and Freddie from conservatorship will need to include a provision requiring the companies pay an annual commitment fee to keep Treasury’s stock purchase plan in place (after all existing senior preferred stock has been canceled or eliminated). The market disruption some analysts are worried about would arise if investors perceive that the credit quality of Fannie and Freddie’s MBS post-conservatorship was inferior to what it is now, and MBS-Treasury spreads widened significantly as a result. Formalizing the Treasury backstop would in my view be sufficient to keep spreads between the companies’ MBS and Treasury close to their current levels. But this also adds another variable to the release process–the size of the annual SPSA commitment fee. It will be determined by Treasury, and if the fee is set too high it will be yet another hurdle for the companies to have to overcome in their return to shareholder ownership. (The fee will either cause Fannie and Freddie to raise guaranty fees to compensate for it–which will likely slow their business growth– or it will come out of their net income, reducing the rate at which they can recapitalize with retained earnings.)

      The “political cover” issue is one I associate with Treasury’s giving up the net worth sweep and eliminating its liquidation preference. I have long felt that Treasury would not do either without an actual or highly likely loss in a high-profile lawsuit. It may well get that cover after tomorrow’s oral argument in the Collins case in the Supreme Court. If it does, though, the question then will become: what specific objective would Treasury believe it is accomplishing by giving up the sweep before it absolutely has to?

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  9. Tim

    it certainly appears that Collins will be argued Wednesday, which means, above all else, that I will owe you a drink.

    but beyond that, the question remains whether Mnuchin and Calabria will reach some sort of 4th A transaction before 1/20/21. you have suggested that Mnuchin may find political cover from the tenor of the scotus oral argument, and you may be right. my view of human nature, and Calabria in action, leads me to believe that fhfa is not ready for a transaction such as the 4th A yet…fhfa is not ready to present a consent decree for Treasury’s sign off. why does Treasury have to sign off on the CDs? I would presume that the CDs would present a pathway for the GSEs to be released from conservatorship (if the GSEs perform under the CDs then they will be released from conservatorship), and since Treasury has to sign off on a release from conservatorship, if Mnuchin doesn’t provide this sign off now, via approval of the CDs which self-execute into release, then it would remain within Secretary Yellen’s prerogative to withhold consent later. It seems to me that given that counselor Phillips finished his two years of work at Treasury over a year ago, Treasury should be ready to sign a 4th A for its part, if fhfa is ready to produce the CDs. My bet is that Calabria thinks his real deadline is 1/20/21…and one can reasonably wonder whether he can get it done by then.

    Will scotus still decide Collins if there is a settlement after oral argument? I feel rather strongly the answer is no. assuming that the settlement entails a stipulation dismissing the P Collins complaint in federal district court, I dont see how scotus retains Article III power to decide a case or controversy at the time it would render a decision…even after the case has been “submitted” to scotus after briefing and oral argument. I have seen others, such as the estimable Prof. Richard Epstein, take the other side of the question.

    rolg

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    2. I think we all may need more than one drink before this process sorts itself out.

      I have been trying to envision what sort of definitive agreement to release Fannie and Freddie could be struck before January 21, and am having difficulty coming up with anything I can argue is plausible. It may just be me, and my focus on the capital rule, but I keep coming back to the fact that IF the capital rule were sensible–and allowed the two companies to do a reasonable amount of profitable business and earn returns on their required capital that new investors would find attractive–then a recapitalization along the lines of the Moelis proposal would be achievable. But we don’t have that. We instead have a final capital rule deliberately designed to make the companies price their business non-competitively, and at the same time spend four to five years building up this excessive amount of new capital through retained earnings before they could leave conservatorship under a consent decree, only to then face uncertain prospects of success from external capital raises before they can fully escape the grasp of their regulator-conservator. What’s in it for the companies to “consent” to that? And if the companies aren’t going to be released within some reasonable time frame, why would Treasury give up the net worth sweep, even if it thinks it will lose the Collins case at SCOTUS, when it could give Calabria what he needs through the end of his term (in the unlikely case he survives that long), just by removing the cap on the amount earnings the companies can retain without having to pay them to Treasury (while at the same time allowing Treasury’s liquidation preference to build)?

      There is a deal here waiting to be had, but it seems to me that Calabria, Mnuchin, the companies and their shareholders (both the plaintiffs in the lawsuits and potential new investors) have different and competing objectives, and no one views it as their responsibility to attempt to reconcile or overcome them. That’s why nothing has happened for four years, and probably won’t for the next two months either.

      I hope I’m wrong, but if so I haven’t been able to figure our where or how.

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      1. Tim,

        As you pointed out there are very different objectives among the parties involved. Still, many of the key elements for the GSEs to exit conservatorship didn’t even exist merely two years ago. The government, be it FHFA or Treasury, seems to me not only needs political cover, but also financial motivation such as exercising the warrants to generate maybe $100B+ (by some estimates, along with the 4th, CDs, IPO, in a coordinated manner) for Treasury in the first year of Biden’s administration to justify the end of conservatorship.

        Who will or can make this pitch to Biden’s financial team?

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      2. Tim

        The Trump administration issued a plan, and Otting said Mark and Steve were on board. this was over a year ago. the first step of the plan, stopping the sweep albeit with the senior preference increasing, was a good first step and augured well for the development and consummation of the plan. since then, we have glacially slow, uncoordinated movement. why so? from an organizational perspective, Calabria and Mnuchin are peers (though one may well wonder whether either of them would agree with this for their own reasons), and there is no one driving the execution of the plan. One would think that would be potus himself, but tweeting about the secondary mortgage finance market doesn’t play well, so there has been no direction from anyone in a position to direct.

        one would think Mnuchin would want Treasury as an institution not to suffer a NWS defeat. one would think Calabria would realize that if there is a 4thA and consent decrees are entered into in connection with settling Collins, his chances to persist as fhfa director would be enhanced…he would be in a position to carry out a plan that is fully fleshed out (even if one would object to various terms of the plan), rather than be in a twilight zone and simply sitting at his desk waiting for the scotus decision that formally seals his exit at the next potus’ whim.

        I still rather expect Mnuchin and Calabria to arrive at some 4th A/consent decree action before 1/20/21…but that presumes a level of competence and teamwork that has not been displayed to date.

        rolg

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        1. It’s useful, in my opinion, to begin by attempting to specify what each party’s objectives might be for releasing Fannie and Freddie from conservatorship. I think FHFA Director Calabria has two: to eliminate the net worth sweep–which he believes is illegal–and also to use his authority to set capital requirements to ensure that when the companies do exit conservatorship their structure and roles will conform to his vision of how they should operate: with a much lower market profile in normal times, and then to be available in times of stress to provide support to the mortgage market that fully private sources of credit are either unwilling or unable to. Treasury Secretary Mnuchin’s objectives are to deliver on the promise he made four years ago to get Fannie and Freddie out of government control, and to do so in a way that is consistent with Treasury’s long-standing institutional views of how they should be operated and regulated. He also should want to maximize the value of the warrants Treasury holds for Fannie and Freddie common stock, but with his tenure as Secretary about to end that may no longer be a prime objective for him. Plaintiffs in the net worth sweep lawsuits obviously want to sweep to be eliminated, but they also should want Fannie and Freddie, post-conservatorship, to operate as efficiently and effectively as possible, so as to increase the value of the preferred or common shares they own in the companies. New investors who will be asked to supply capital to the companies want them to have a competitive business model, and be able to provide an attractive return on equity. And Fannie and Freddie also want the net worth sweep to be eliminated, and to have as few structural, capital, and regulatory burdens as possible so that they can be released from conservatorship relatively quickly, and be in a position to return to carrying out their statutory mission of providing mortgage credit to a wide range of borrowers on a cost-effective basis, while making money for the investors who have committed capital to them.

          In reviewing this list of objectives, the “spanner in the works” is Calabria’s insistence on using the capital-setting process to change Fannie and Freddie’s role in the market. It makes the recapitalization process much longer and more difficult, reduces the incentive of new investors to (ultimately) supply the equity required to fully capitalize them, lowers the value of Treasury’s warrants for the companies’ common stock, and reduces Fannie and Freddie’s incentive to agree to the restrictions Calabria very likely will insist upon as conditions for any consent decree that would trigger their release from conservatorship. With a more reasonable and workable capital requirement, there would be a much easier path to a “recap and release” deal that could get the support of all parties. As I’ve noted elsewhere, I’m struggling to see how a deal can emerge from the conflicting objectives and incentives that exist now.

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          1. Tim

            well put, but let’s take it a step further. you would think Calabria, having pushed through his capital rule (and withstanding the onslaught of public proposed rule comments to the effect that he was overbearing), would want to put himself in the best position to implement the rule. after 1/20/21, he is subject to being fired. so what to do? if after a scotus collins decision applying Seila to Collins, he cannot resist; but if there is a settlement with no scotus decision, he can assert publicly (as he has in the past) that he intends to serve out his term…leading the new potus to (perhaps) think twice (and assumming Calabria isn’t locked out of his office, resist). Mnuchin, as head of FSOC, seems to like Calabria’s capital rule.

            So you would think it is full steam ahead, Calabria and Mnuchin shoulder to shoulder.

            I just think they cant get out of each other’s way. amateur hour.

            rolg

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      3. Tim:

        Your analysis starts with the capital rule and flows forward, but what if you inverted the analysis to start with Calabria/Mnuchin and work backwards? i.e.:

        “… why would Treasury give up the net worth sweep, even if it thinks it will lose the Collins case at SCOTUS, when it could give Calabria what he needs through the end of his term (in the unlikely case he survives that long), just by removing the cap on the amount earnings the companies can retain without having to pay them to Treasury (while at the same time allowing Treasury’s liquidation preference to build)?”

        Although this permits Calabria to build capital over time (assuming the accounting treatment of higher retained earnings with no corresponding entry for the higher liquidation preference is legitimate), it also renders it impossible for Calabria or the GSEs to raise external private capital of any kind.

        Just removing the caps only gets Calabria half of what he wants/needs, and also does not fulfill Mnuchin’s plan of having the GSEs privately owned eventually (without action from a future Treasury).

        Therefore, regardless of the capital rule, shouldn’t there be a real deal to be had on the NWS?

        Your analysis of the broader situation has been spot on so far; hope you don’t mind a little push back on this one area.

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        1. If we start with Mnuchin, you have his recent statement before the House Financial Services Committee that “there could be a scenario where at some point between basically the zero capital [Fannie and Freddie] have and the full capital requirement….they would be released subject to a consent order.” As of September 30, 2020 Fannie had $20.7 billion in capital, whereas its “full capital requirement” at June 30, 2020, per FHFA, was $171 billion. That’s a $150 billion difference (now actually somewhat more, given the growth in Fannie’s outstanding business since mid-year). How much progress towards full capitalization would Fannie have to make before, under Mnuchin’s construct, it would become eligible to be released under a consent decree? Fifty billion? Seventy-five billion? Whatever the amount is, it would have to come from retained earnings, since no investor would put equity into a company still in conservatorship.

          Calabria can’t release Fannie and Freddie from conservatorship–whether outright or under a consent decree–without Treasury’s approval. And Mnuchin has just said that Fannie and Freddie are years away from getting that approval. So what “deal” could the two of them strike before January 21? Might there be a sort of “conservatorship light” the companies could operate under until they reach a certain capital milestone, at which point a true consent decree releasing them from conservatorship could take effect? That’s pure speculation on my part, but even this doesn’t really qualify as “getting them out of conservatorship” during this administration.

          I know people are hoping for a pre-inauguration deal between Mnuchin and Calabria, but given their respective objectives, interests and recent statements, I haven’t yet been able to figure out what that deal might be.

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  10. Tim,

    I have been a silent reader of your blog all of these years, so thank you very much for all the effort and diligence you put without any monetary benefit in return.

    Given that the likelihood of a settlement before 9th dims by the hour, I was curious to hear your views (and rolg’s as well) on the probabilities of the different outcomes in the hearing (say, xxx% chance of plaintiffs winning with relief, xxx% chance of FHFA not being found unconstitutionally structured, etc., whatever). I know it is quite difficult to handicap this kind of events, but I would be grateful to read your (and rolg’s) best shot.

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    1. There are three issues to be decided at SCOTUS: whether the director of FHFA is unconstitutionally structured, being removable by the president only for cause (as the Fifth Circuit Court of Appeals en banc found); if so, whether plaintiffs in Collins should be granted the retroactive relief they seek–nullifying the net worth sweep (reversing the decision of the Fifth Circuit en banc), and whether the net worth sweep violates HERA and thus must be invalidated under the Administrative Procedures Act (again, upholding the decision of the Fifth Circuit en banc).

      We should have a better, and perhaps a much better, idea on each of these after Wednesday’s oral argument. Going in my expectation is that SCOTUS is very likely–on the order of 90 percent–to agree that FHFA is unconstitutionally structured and that FHFA’s imposition of the net worth sweep was a violation of the APA, but whether plaintiffs are granted retroactive relief is closer to a jump ball. My handicapping on these may well change after Wednesday, however.

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      1. Beauty/Tim

        I agree with Tim as to the merits. as to relief, scotus has a way of remanding to lower court in a directional but rather inscrutable way…telling lower court to decide case in accordance with opinion. so I could see scotus granting backward relief without specifying exactly what this is in dollars and cents, as it is the district court’s obligation to get into the nasty bits of specifying relief in detail based upon further party briefing, and so you have a decision that is a win for Ps without being precisely sure how much of a win it is…which is sort of less than a full loaf but enough to implement the recap/release process. as Tim says all ears to the orals.

        rolg

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      2. It seems like a bit of a stretch that even if they found FHFA to be unconstitutionally structured they would by default rule the NWS illegal. Wouldn’t they have to prove that the President disagreed with its implementation?

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        1. No, I don’t think so. The Supreme Court addressed this issue in Seila Law, and I thought the justices were fairly clear in indicating that the Court will not require plaintiffs to demonstrate that an action of an unconstitutionally-appointed director would have been decided or implemented differently had he (or she) been removable other than for cause by the president.

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          1. Tim thanks for the reply. Where would they draw the line though? Could all actions from FHFA be ruled illegal?

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        2. Andrew

          under article III of US constitution, the judicial power is extended to federal courts to decide cases and controversies. you need a party to bring a suit. so if some party brings an action that is not barred why the statute of limitations then the subject matter of that action might be voided. but scotus has made it clear in Lucia that giving backward relief is important for a P to bring a constitutional claim. once that claim has been decided, backward relief may not be similarly on offer for the next P.

          rolg

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  11. Pingback: Good recap of GSE story – Part III | Timeless Investor

  12. Tim- What are your thoughts on Adolfo Marzol leaving FHFA on the 18th? Any indication that a deal won’t be made between Treasury & FHFA on a new PSPA?

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    1. I was surprised that Adolfo went to FHFA in the first place. I didn’t correspond with him much after he joined–he insisted on following strict communication protocols–so I really don’t know why he decided to leave now, although I suspect the election may have had something to do with it (he’s a prototypical Cuban-American diehard “R”). I had been hoping that having him at FHFA would inject an element of business reality and market sensitivity into FHFA’s capital rule making, but it clearly did not: Calabria gave the marching order, and Adolfo seems to have marched.

      Re a potential amendment to the PSPA, my response can be found a short scroll down the page.

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  13. The Honorable Dr. Mark A. Calabria
    Director
    Federal Housing Finance Administration

    Dear Director Calabria:

    It is my understanding that despite requests from my staff for you to testify before the Committee on Financial Services in December, you have chosen to make yourself unavailable until sometime next Congress. Considering the Federal Housing Finance Agency’s (FHFA) release of the final rule entitled “Enterprise Regulatory Capital Framework Final Rule” on November 18, 2020, [1] as well as recently reported efforts to rush Fannie Mae and Freddie Mac (collectively, the Enterprises) out of federal government conservatorship,[2] along with conversations the Secretary of the Treasury recently confirmed to the Committee that he is having with you on this topic,[3] I believe it is critical that you testify before our Committee as soon as possible. Just a few months ago, you testified before our Committee and reassured Members that the process for releasing the Enterprises from conservatorship would be “process driven, not calendar driven.”[4] However, finalizing a new capital framework and making significant changes to the Senior Preferred Stock Purchase Agreements or otherwise making plans for a release in the middle of a national pandemic and recession appears to be purely “calendar driven” as your time as the Director of FHFA and that of the Trump Administration is winding down. You have a duty to be transparent with Congress regarding any steps you are taking to implement such a major decision that could seriously compromise the stability of the housing market and overall national economy. Therefore, I want to be clear that it is my expectation that you should not take any further steps in this regard until you have come before our Committee.

    Our country is in the middle of a pandemic and economic downturn that has over 2.8 million homeowners in forbearance,[5] with 3.8 million homeowners estimated to be in some stage of delinquency,[6] and an administrative foreclosure moratorium standing between millions of homeowners, [7] potential bankruptcy, and even homelessness. Further, as this turmoil rages on, affecting borrowers of color disproportionately, [8] your agency’s response to the pandemic has been criticized as falling short.[9] And yet, rather than focusing on responding to the pandemic, FHFA has been focused on finalizing a rule establishing a new, complex capital framework for the Enterprises with little analysis and that is expected to disrupt historically low interest rates, increase the cost of lending for borrowers, and push millions of credit-worthy borrowers out of affordable lending options.

    On November 3, 2020, the American people spoke with their votes at the ballot box and delivered a clear mandate. As such, it is incumbent upon you to recognize the will of the American people and cease and desist from finalizing any “midnight rules” or other administrative actions until President-Elect Joseph R. Biden is sworn into office on January 20, 2021 and his Administration can review. Such rulemaking and actions undermine our country’s regulatory process, and indeed our democracy, by rushing through controversial policies that could have sweeping effects on families and our economy without transparency, rigor, and legitimacy. Moreover, because President Trump and your agency had barred access to President-Elect Biden’s transition team unnecessarily for 20 days, flouting precedence and undermining our democratic traditions, any actions taken by your agency before inauguration will be met with heavy scrutiny and may be overturned under the Congressional Review Act during the next Congress.

    I believe that it is entirely inappropriate for you and your agency to be focusing on releasing the Enterprises from conservatorship during the pandemic with the assistance of a lame duck Treasury Secretary. At the very least, the Congress and the American public deserve transparency from you. On behalf of current homeowners, renters, potential homebuyers, and more than 19 million prospective millennial homeowners,[10] I urge you to fully engage with Congress by testifying before our Committee and to immediately halt your efforts to raise the Enterprises’ capital requirements and to release them from conservatorship. You should instead focus on ensuring that renters and homeowners are receiving the help they need during this pandemic. I look forward to working with you to find a mutually agreeable time for you to testify before the Committee.

    Sincerely,

    MAXINE WATERS
    Chairwoman
    ================

    Are FHFA / GSEs not helping borrowers in this crisis?

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    1. I doubt that either Director Calabria or Secretary Mnuchin will pay much attention to Chair Waters’ request to “immediately halt your efforts to raise the Enterprises’ capital requirements and to release them from conservatorship” during the remaining days of the Trump administration. Calabria has already issued his final capital rule, and Mnuchin will not feel constrained by the objections of Ms. Waters in whatever he decides to do before he leaves office with respect to the Senior Preferred Stock Agreement or Treasury’s statutory “final say” on how and when Fannie and Freddie may be released from conservatorship by FHFA (although is not at all clear to me what Mnuchin might be considering in either area).

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          1. BIGe

            I wonder if this is more a question of interpersonal relations than anything else at this point. Calabria states he wants to fill out his entire term as FHFA director. one might acknowledge that FHFA director is his dream job. this will be easier to do if collins is settled than if it goes to decision. Mnuchin knows and controls this. the SG will at some point return to private practice but he wants the SG as an institution that argues before scotus to maintain goodwill. getting a cert grant and concluding oral argument only to moot the case is not SG SOP. Mnuchin knows and controls this. I dont doubt Mnuchin cares about the Treasury as an institution, but isn’t this really about whether Mnuchin respects and wants to cut Calabria the individual and the SG as an institution a break? where I come from, mooting a scotus case after orals is disrespectful if it can be easily avoided, but if Mnuchin wants this to happen while he “contemplates”, so be it. but if one has made the policy determination that the GSEs should be recapped (check), and one understands as an experienced mortgage banker that the senior preferred have to go in order to refinance (check), and if one understands that the Treasury has been repaid more than in full as per the original terms of the investment so as to justify the elimination of the senior preferred (check), then I wonder whether there is some perverse interpersonal issue might be at play to justify further delay? while we can all talk about policy until the cows come home, I have found that sometimes interpersonal relations have an extraordinary underlying explanatory power.

            rolg

            Liked by 2 people

        2. Rule of law guy, is it possible that negotiations are already going on, through back channels, or by some other means, between for example plaintiffs lawyers and treasuries legal counsel? Is it possible, as you might say that both sides are trying to stare each other down and are waiting till the last possible moment, before December 9th, hoping to get the best deal?

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          1. @Brian

            it has recently been reported from an anonymous source that treasury and fhfa have been working on a PSPA amendment. beyond that, I can only speculate as to what’s going on. as far as I am concerned, capable lawyers and clear thinking clients could have put this deal away a long time ago.

            rolg

            Liked by 1 person

      2. Thanks all! An excellent, well-reasoned discussion. With Fannie about to reach the $25B cap in December and the Freddie $20B probably by the end of March there is certainly going to be a 4th amendment – how far it goes is another matter. Would it be possible for it to also cancel the seniors, but say little or nothing about the timing of a consent decree other than what has been said and leave that open for the next administration?

        Thanks again!

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        1. I agree that a Fourth Amendment to the PSPA is highly likely, if only, as you note, to raise the cap on the amount of earnings Fannie and Freddie are allowed to retain under the net worth sweep. How far beyond that a Fourth Amendment might go is anyone’s guess.

          This also might be a good spot to emphasize an important difference between a Fourth Amendment, settlement of the lawsuits, and a consent decree. A Fourth Amendment would be negotiated between Treasury and FHFA, settlement of the lawsuits would the product of negotiations between the plaintiffs and the government, and a consent decree would be an agreement between FHFA and Fannie and Freddie, with Treasury’s approval required if it involves authorization to end the conservatorships.

          There was a time when some observers thought that all three negotiations could be combined into one global plan to release and recapitalize the companies under an agreed-upon sequence of steps, and possibly a set timetable, as envisioned by the Moelis plan. I believe there is now very little chance of that happening prior to the inauguration. The main reason, in my view, is the Calabria capital plan, which leaves too many uncertainties as to when and how the companies could reach the 4-plus percent capital level required for them to operate as “normal” companies, unconstrained by whatever restrictions Calabria might insist upon in a consent decree. So now we’re looking at these three actions individually, with much more uncertainty as to how they ultimately will fit together. My feeling is that a Fourth Amendment is the most likely, because of the pressure to deal with the retained earnings cap (with the scope of the amendment to be determined); a settlement of the lawsuits will not occur before next Wednesday’s oral argument in Collins at SCOTUS (after which the path to resolution of the suits will depend on the parties’ reactions to what is said and perceived during the session), while a consent decree between Fannie, Freddie and FHFA is the least likely, and furthest off, of the three.

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  14. Wed, December 2, 2020, 3:49 PM EST
    (Bloomberg) — Treasury Secretary Steven Mnuchin said he’s made no decision on actions that might be taken at the end of the Trump administration to free Fannie Mae and Freddie Mac from U.S. control, while raising the possibility that the companies could be released before they are fully capitalized.

    Mnuchin, speaking at a Wednesday House hearing, said he has had discussions about possible moves with Federal Housing Finance Agency Director Mark Calabria, the companies’ regulator. But Mnuchin said he hasn’t made up his mind on whether to do anything, while reiterating that he opposes ending Fannie and Freddie’s federal conservatorships until they have “significant” capital buffers to protect against losses.

    “Let me just be clear,” Mnuchin said in testimony before the House Financial Services Committee. “Despite the fact that the director and I are having conversations, we’ve made no decisions at Treasury whatsoever yet. We are contemplating.”

    During the House hearing, Mnuchin said the companies could be released from U.S. control before reaching the capital requirement under a consent decree. In such a scenario, the companies would technically exit conservatorship but still have restrictions on some business activities.

    “There could be a scenario where at some point between basically the zero capital they have and the full capital requirement, there would be a consent order,” Mnuchin said. “They would be released subject to a consent order.”

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    1. I was not able to watch today’s House Financial Services Committee oversight hearing, but as one who for some time has been saying that I could not make any predictions about whether there might be a settlement of the lawsuits prior to the December 9 oral argument at SCOTUS because Treasury Secretary Mnuchin was the person who would determine that, and I had heard or read nothing about where he stood on the issue, even I was surprised to read that he “hasn’t made up his mind on whether to do anything.” Mnuchin was the person who first raised the hope that the long-running conservatorships of Fannie and Freddie might soon end when he said over four years ago, “we gotta get [Fannie and Freddie] out of government control…and in our administration it’s right up there in the list of the top ten things we’re going to get done, and we’ll get it done reasonably fast.”

      For over a year, FHFA Director Calabria has been telling anyone willing to interview him that his top priority is to remove the companies from conservatorship. Calabria, however, cannot do that himself. By the terms of the Senior Preferred Stock Agreement, which a previous director of FHFA signed, Fannie and Freddie cannot be released from conservatorship without the approval of the Treasury Department, and release from conservatorship has no meaning unless Treasury renounces–or is told to relinquish–the net worth sweep. I would have thought, therefore, that very early on Calabria would have engaged with Mnuchin to assess where he stood on these two “critical path” issues. Secretary Mnuchin’s comments today make me wonder if that in fact has happened. Calabria certainly seems to have gotten very far out over his skis on his plans for Fannie and Freddie’s release if Mnuchin still doesn’t know what he thinks about it.

      I don’t know where we go from here, but one thing I do know is that we should not expect to hear of a last minute settlement of the Collins case prior to oral argument at SCOTUS next week. That show will go on.

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      1. Tim

        I have been in situations where public disclosures dont “exactly” match reality (at the direction of the discloser who, incidentally, was paying my bills)…and my job was to determine whether the disclosure was misleading, or just not complete…and if not complete, whether the omission was materially misleading in the context of what was disclosed. big bucks have to be earned. perhaps you we’re in a situation where you disclosed less than you could, less than would have been optimal for the recipient of the disclosure, for prudential reasons. anyhow, time will tell, but I got the distinct sense that Mnuchin was a man telling less than he knows.

        rolg

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        1. I’ll watch the hearing when I can (although not tomorrow, due to other commitments); for now, though, I’m going off the written report. Perhaps the hearing will contain statements or nuances that will help me determine where Mnuchin might be on this. Still, I’ll stick by my immediate reaction that there is no realistic chance of a settlement pre-SCOTUS hearing.

          I also noted Mnuchin’s comment of “there could be a scenario where at some point between basically the zero capital they have and the full capital requirement…they would be released subject to a consent order.” It’s very unlikely that Fannie or Freddie could go to the capital markets while still in conservatorship. If the “some point” between what the companies have now and full capitalization is the mid-point, you would be looking at four to five years of retained earnings before equity issues could get them the rest of the way there. All that because of an unrealistically high capital requirement. The Calabria-Mnuchin “plan” seems neither consistent nor well thought through.

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          1. Tim-

            In particular, how does one square his words about the need for capital, protect the taxpayer and release while at the same time defend the NWS before SCOTUS? I understand rhetoric and DC politics but this is getting real strange.

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          2. This has been the conundrum since the beginning of the Trump administration. Treasury Secretary Mnuchin took the opportunity of the transition to take a different position on how to resolve the conservatorships of Fannie and Freddie–moving from the “wind down and replace” of the Bush 43 and Obama administrations to a strategy of “reform, recapitalize and release”–yet he and Treasury never changed the way they talked about, and defended in the courts, the net worth sweep. But the existence of the net worth sweep makes recapitalizing and releasing Fannie and Freddie impossible. So, how does Treasury pivot from defending the legality of and rationale for the net worth sweep to giving up voluntarily the economic rights to the companies’ net income and $200 billion-plus worth of assets the sweep produces in order to move “recap and release” forward? I’ve never understood how it would do that–which is why I’ve kept saying it would need the “cover” of an actual or highly probable loss in one of the lawsuits against the sweep–and I think the best explanation for why Mnuchin and Treasury still haven’t delivered on their promise to get Fannie and Freddie out of conservatorship “reasonably fast,” after four years, is that they haven’t been able to come up with a way to do it either. So here we sit, with the clock ticking towards a change to yet another new administration.

            Liked by 1 person

          3. Tim-

            Secretary Mnuchin is the named defendant before SCOTUS next Wednesday. If argued, and under a government loss scenario next June, who shoulders the burden of the government embarrassment that the NWS was deemed illegal by SCOTUS? Mnuchin? Yellen? SG? Furthermore, doesn’t this fact alone (which never comes up in committee hearings) also provide some “cover” for Mnuchin to act? Lastly, while there may be a PSPA amendment post hearing and before Jan 20, that doesn’t shut down the possibility of SCOTUS still ruling on matters of law as it relates to single director removal at FHFA, does it?

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          4. If there is embarrassment associated with a ruling that invalidates the net worth sweep (or remands it to the Fifth Circuit for trial on the facts), it will be to Treasury as an institution, and to the extent it extends to any specific individuals it will be Secretary Geithner and the senior Treasury staffers whose names are on the memos produced in discovery, which show conclusively that the sweep was not adopted for the reasons Treasury gave publicly. Mnuchin has no direct connection with the sweep, other to have defended it on behalf of the institution he heads. On the other hand, if Mnuchin is the one to voluntary give up the sweep, that action WILL attach to him, and no one else. I wouldn’t call that “cover.” As to whether a PSPA amendment post-SCOTUS hearing and pre-inauguration causes the Collins case at SCOTUS to be mooted, that would depend on the precise elements of the amendment, which we won’t know unless and until one comes out.

            Liked by 1 person

          5. Tim/MFS

            the last time the great Mnuchin spoke in front of congress, he said he was “contemplating”, after the FHFA director visited him twice to “discuss” l’affaire GSE. I infer from this that Mnuchin perceives he has options, which is not surprising as GS alums view the world as an option carousel. of course, one option is to do nothing and let scotus decide matters (probably late spring ’21 as opposed to summer ’21 btw), but one might consider other options that relate to matters that involve FHFA more than Treasury. I say this since the PSPA endows Treasury with many consent rights, and requires Treasury to sign off on any conservatorship release which otherwise is purely in the purview of the FHFA director. so while it would appear simple enough to conclude that if there is to be a recap the senior preferred must go, it is more complicated for Mnuchin to be charged with giving consent to a release process that will outdate his occupancy as Secretary, though not necessarily Calabria’s occupancy as Director…and about Calabria’s occupancy the scotus collins case has direct bearing. so the more I think about this situation the more I consider it to be perplexing and not quite as straightforward for Mnuchin as a simple nuke-the-senior preferred scenario. and I expect whatever timeframe Mnuchin elects as his relevant decision period (whether ending on 12/9 or 1/20), I suspect that he will take the full time allotted.

            rolg

            Liked by 1 person

  15. December 1, 2020 – CEI’s online discussion about the major issues of the case with one of the most cited law professors in the U.S., Richard A. Epstein, whose seminal book Takings: Private Property and the Power of Eminent Domain, will play a central role in this decision. He was joined in conversation by CEI Senior Fellow and finance expert John Berlau, Attorney Devin Watkins, and President Kent Lassman.

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  16. Hi Tim,

    You’ve mentioned before that you didn’t think Sec. Mnunchin had the political cover to make substantial admin changes (including stopping the NWS and declaring the Sr. Preferreds paid) and therefore had little incentive to do so. Do you think the comments by Senator Crapo today give him that cover now?

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    1. I didn’t watch the Senate Finance Committee hearing, and haven’t seen any good reporting on Crapo’s (or Mnuchin’s) remarks, so at this point don’t have any analysis of what was said at the hearing today.

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      1. Tim

        Sen Crapo: “Secretary Mnuchin, as you know, housing finance reform remains a top priority of mine, and last year I released a housing reform outline which builds upon many of the same principles from previous efforts.

        “While my preference was for Congress to pass a bipartisan deal, it is long past time to make the hard decisions and address this last unfinished business of the financial crisis.

        “Because of that I would encourage you and the Director of the FHFA to continue to take important steps that move the system in the right direction. The status quo is not acceptable. ”

        https://www.banking.senate.gov/newsroom/majority/crapo-statement-at-cares-act-oversight-hearing

        rolg

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        1. I don’t read anything new into the Crapo statement, and it’s also not the sort of political cover I view Treasury to be looking for in order to unilaterally end the net worth sweep and eliminate its liquidation preference in Fannie and Freddie.

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          2. What’s new here is the context. It’s one thing to say “encourage you to take important steps” a few years ago but different now because of the widespread understanding of what those important steps currently would be.

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          3. For Bird: It’s very hard to read Crapo’s vague exhortation to “continue to take important steps that move the system in the right direction” as a clarion call for ending the net worth sweep.

            For ROLG: At this point, the only remaining “cover” opportunity I see is a strong indication from the Justices at next week’s oral argument that the government will lose on one or both issues being considered by SCOTUS. But that would leave Treasury with settling a case post-oral argument, which happens only rarely.

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          4. Tim

            I would think the SG would feel like a bag holder if there is a settlement between 12/9 and 1/20, but I am not sure Mnuchin will care that much once he repairs poolside to LA. The SG is a former partner at Sullivan & Cromwell, Goldman Sachs main law firm, so I imagine it would be SOP for Mnuchin to make his decision when he wants to, and leave it to the lawyers to deal with any aftermath.

            rolg

            Liked by 2 people

          5. Do you think the release of previously redacted statements in the Washington Federal case today provides political cover? Certainly explains the “mafia” reference from judge Sweeney. Honestly makes me a bit queasy reading it.

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          6. No. In fact, I think if anything the release of the previously redacted information in the Washington Fed filing will work the other way. If Treasury either waits until oral argument or until SCOTUS renders its opinion in Collins, it would be giving up the net worth sweep pursuant to a ruling on the law–either anticipated or actual. Voluntarily giving up the NWS following the revelations in the Washington fed filing would be perceived as doing so in response to facts averse to it–i.e., “Yes, you caught us; we bullied them into conservatorship then lied about it.” Treasury would NOT do that. The virtue of having SCOTUS do the “dirty work” is that the case never gets to the facts, and they don’t get exposed to a wide audience. (As to the “revelations” in the unredacted Wa Fed filings, the lawyers have known about them for years, as have people close to the cases. The reason they’re not widely known is that when Judge Sweeney granted plaintiffs discovery in her Court of Federal Claims, Treasury insisted on an extremely restrictive protective order that kept this information away from the general public, except as released and authorized by Sweeney. Through this maneuver, Treasury has largely been successful in shielding itself from criticism for what it did to Fannie and Freddie, and why.)

            Liked by 1 person

          7. Tim – It was interesting to me that the BOD was apparently under duress when they agreed to the conservatorship back in 2008. I continue to wonder how it can be that if you hide the facts and thus statutes of limitations then lapse, how one can expect to believe in the judicial system with such obvious foul play.

            Liked by 1 person

  17. Tim,

    As a result of the final capital rule requiring both GSEs to hold unnecessarily high capital reserves, is Treasury’s 79.9% holding of warrants justified anymore? Could it be challenged in court based on the final capital rule?

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    1. The final capital rule has no effect on or implications for Treasury’s warrants for Fannie and Freddie’s common stock. Treasury may do as it wishes with these warrants (prior to September 7, 2028, when they expire), and while a move to exercise them could always be challenged in court, I do not know of any legal reason that might make such a challenge successful.

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    1. From Fannie and Freddie’s perspective, Deese will be an unambiguous upgrade from Larry Kudlow as the director of the National Economic Council. Kudlow had been a fiery and outspoken opponent of the companies for forty years. (I still remember Kudlow as deputy to Office of Management and Budget Director David Stockman during the Reagan administration. Stockman had put him in charge of trying to get Congress to try to pass what he called a “user fee”– and we called a “homeownership tax”–on Fannie and Freddie’s debt. Kudlow had forbidden Fannie’s chairman David Maxwell to lobby against user fees. David, as he should have, ignored Kudlow’s request, and Kudlow found out about it. Kudlow called David when he was away at a top management retreat, which I attended. David took Kudlow’s call in an adjoining room, and we all could hear Kudlow screaming at him, “I TOLD you not to do that!” After disengaging, David walked back into where we all were and said, “That man is crazy.”)

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      1. Tim

        interesting recollection. Deese comes now from Blackrock, a cushy place for a D to park oneself during an R administration, but my fear is he has picked up the Blackrock gospel much like Bright and other GSE-antagonsits, anti-GSE recapitalization and conservatorship release and pro federal guarantee. as Biden fleshes out his cabinet, this is beginning to look like Obama’s third term…and the NWS happened in the middle of Obama’s two terms, so en garde.

        rolg

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        1. Deese was Global Head of Sustainable Investing at Blackrock, which is about as anodyne a position there as likely exists, and quite far afield from those who’ve been pushing for formal guarantees for Fannie and Freddie MBS. In my view this is at worst a “no harm, no foul” appointment, considering who else might have been chosen for the role. I’d put the Yellen appointment at Treasury in the same category.

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          1. Tim,

            Agree with ROLG that what is shaping up is essentially a 3rd Obama term. That is no bueno IMO.

            There was a recent video feed by Bill Ackman. Would like your comment on Ackman’s views (note: Ackman addressed only Commons perspective, not JPS). It is less than 6 minutes. Any thought on the recent Commons run vis-a-vis the JPS, and could this video account for it? TIA.

            VM

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        1. Tim-

          It’s worth repeating the Churchill quote that “never was so much owed by so many to so few”. Thank you for your blog, your book and your Amicus!

          My college aged kids now have a whole new understanding of this other well known quote. “It has been said that democracy is the worst form of government except all the others that have been tried”.

          The GSE saga is now generational, a long struggle for you as well to be sure, but your efforts are not in vain and very much appreciated!

          Liked by 4 people

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  21. Tim,

    According to our friends over at the WSJ, Biden has selected Janet Yellen as the incoming Treasury Secretary. Any initial thoughts you wish to share?

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    1. She was well thought-of and relatively non-controversial when she was Chairman of the Federal Reserve, and before that when she was Vice Chair of the Fed under Ben Bernanke. She’s not ideological, and if she has any views on Fannie and Freddie I don’t know what they are.

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    1. If I were at Fannie I wouldn’t go down that road. But I also would be inclined to view the FHFA capital rule as an interim problem, and thus not make any structural changes to the business in response to it. It’s so extreme and indefensible that I would count on being able to get it changed by a new director appointed during the Biden administration.

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      1. Tim I’m surprised you’re taking this position now after what we witnessed with the Obama administration. Why would a Biden administration ever allow a conservatorship exit when his predecessor fought so desperately and persistently not to?

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        1. The “position” I took in the comment you’ve responded to had to do with the capital rule, not the conservatorship, and I conditioned it by saying “if I were at Fannie.” And to reiterate, if it were me, I would not make permanent structural changes to the company–such as spinning off the multifamily business–in response to a capital rule promulgated by an ideological director who is using the rule to try to reshape the companies’ business to suit his view of what their role in the market should be; I would count on the Biden administration appointing a replacement FHFA director, probably within a year, who would not oppose their mission, and instead set a capital requirement that would protect taxpayers but not decouple capital from the risk of the loans Fannie and Freddie are guaranteeing.

          As to the conservatorships, I’d suggest you scroll down to the third part of a comment I made on November 10 (at 9:15 am), where I explained my view of the evolution of Treasury’s objectives for resolving them. To briefly recap, during almost all of the Obama administration, Treasury’s goal was to “wind down and replace” Fannie and Freddie, as had been the original intent when the companies were nationalized under the administration of Bush 43. Only when it became clear to nearly everyone that there was no chance of replacing Fannie and Freddie in legislation did Treasury shift to beginning to contemplate their exit from conservatorship (under terms it and FHFA would set). While it’s tempting to say, “Obama the Democrat wanted this, and Trump the Republican wanted that,” I think the issue is more complicated, and that Treasury, as an institution, has been the driving force behind the policy toward the companies under both parties, going all the way back to the Reagan administration.

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          1. Tim

            many people reading this blog, myself included, are (we believe) rightfully apprehensive of a Biden potus with respect to the GSEs. after all Biden was the VP when the NWS was implemented. this is not to say that politics drives GSE outcomes, but it must be acknowledged that the current fhfa director that you have apparent antipathy for is the only fhfa director who has correctly interpreted the statutory duty of the conservator under HERA. all others have been functionaries afraid of taking an independent stance for fear of casting their shadow. while I take your on-point recommendation not to adjust business direction solely based upon a shift of political wind, sometimes the devil you dont know is the devil you dont want to know. the issue is complicated for sure and institutional memories are long, but at this point the most prominent hurdle to a resuscitated GSE is not the R capital rule but the D NWS.

            rolg

            Liked by 2 people

          2. I understand the apprehension many (and I suspect most) of the investors in Fannie and Freddie common and preferred stock have about a Biden presidency. But there almost certainly will be one. As for Director Calabria, I do not have an “antipathy” towards him; I disagree with his decision to use his capital-setting authority to force Fannie and Freddie to grossly overcapitalize their business, and his insistence on ignoring economic and market reality in favor of transparently false rationales in defense of this action. I believe his stance on capital is extremely damaging to all of the companies’ stakeholders, and wish to see it reversed by a director appointed by Biden. I do not have the same fear of “the devil I don’t know” as you seem to, but even if I did, it wouldn’t matter; I believe it’s a virtual certainty that Calabria will be replaced relatively early in a Biden presidential term.

            I agree with you that Calabria opposes the net worth sweep and wishes to end it. I applaud that. If he can get Secretary Mnuchin to agree to voluntarily cancel the net worth sweep and relinquish Treasury’s liquidation preference in the companies—which I’ve been skeptical he will, but don’t rule out entirely—then he might be able to engineer an end to the conservatorship, under a consent decree, before the end of President Trump’s term. For holders of junior preferred stock in the companies, this would be (close to) the end of the story. But common stock holders, and those who would like to see the U.S. secondary mortgage market financing system operate to the benefit of homebuyers rather than banks, still would have two companies whose value is greatly held down by a director who opposes them ideologically.

            We should know in the next two and a half weeks if we’ll have a Fourth Amendment that locks in Fannie’s and Freddie’s path out of conservatorship. If we don’t, though, I have a more optimistic view than most that the companies still will be released from conservatorship under a Biden administration. I think it’s inaccurate to call the net worth sweep a “Democratic” policy. Yes, it happened during the administration of a Democratic president, but it was a reaction by Treasury to having run out of time to execute the plan to “wind down and replace” Fannie and Freddie that had been put in place by Treasury during the Republican administration of President Bush.

            I was essentially absent from the mortgage reform dialogue for its first five years: until October of 2012 I was tied up in litigation over false charges of accounting fraud, and until the end of 2013 I was finishing up and publishing my book. When I began to get myself plugged back in, I was astounded to learn that people I’d known for years, and whose work I respected, had either implicitly or explicitly endorsed the Corker-Warner bill for replacing Fannie and Freddie, which was flawed to the point of unworkability. When I asked how they could support something like that, they told me they didn’t feel they had any choice. They said that when reform discussions began, you could not get a seat at the table unless you agreed with the fictional versions of Fannie and Freddie’s roles in the crisis and their “failed business model,” and agreed they had to be replaced. These people knew Corker-Warner wouldn’t work, but thought that if it made it out of committee it could be fixed before it was adopted.

            My reason for recounting this is to emphasize just how much misinformation about Fannie and Freddie was “in the water system” at and beyond the time the net worth sweep was adopted. It really wasn’t until the lawsuits against the sweep were filed that a more fact-based version of the companies began to emerge. As this happened, more informed criticisms were made of the various alternatives proposed for replacing Fannie and Freddie (including the Urban Institute’s “More Promising Road” proposal, which would have relied exclusively on a mix of credit-risk transfer securities and junior preferred stock—and no common equity at all—as capital), and the tide started to turn against the idea that the companies had to be replaced in order for the conservatorships to end. This shift in attitudes had little to do with which party was occupying the White House.

            Today, there are no strong advocates in either house of Congress for replacing Fannie and Freddie. And once the net worth sweep is invalidated—whether voluntarily by Treasury or legally by the Supreme Court—there will be no defensible argument for keeping Fannie and Freddie in conservatorship. A Fourth Amendment this year will get the companies out of conservatorship more quickly, but I think they will be coming out during a Biden administration as well, and very likely under much more favorable terms than Calabria is proposing. For holders of Fannie or Freddie preferred, therefore, root for a Fourth Amendment this year, but don’t despair if one doesn’t happen.

            Liked by 4 people

          4. Tim,

            If oral arguments are heard on 12/9 and one assumes no settlement after that so as to wait for a ruling June 2021 and Collins does not prevail, handing the Government a win would rule an exit and private capital a virtual impossibility, would it not?

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          5. No, not necessarily. In that (in my view very unlikely) case the Biden administration would have a decision to make. It could go back to pretending it was waiting for Congress to tell it what to do, and leave the companies in conservatorship indefinitely; it could request that Congress nationalize them, or it could unilaterally cancel the net worth sweep and allow the companies to build capital and put themselves on a path to exit conservatorship. Without knowing who the principals in the new administration will be, it’s not possible to handicap those three.

            Liked by 1 person

          6. @mfs

            your scenario is one reason why a release from conservatorship into consent decree by Calabria before Biden tries to remove him is so important. once conservatorship is exited, all of the extraordinary powers of conservatorship disappear, and fhfa is bound by the consent decree…which should state that it cant be amended without consent of GSEs. given GSEs current financial condition (most especially if there s a 4thA), a re-entry into C would be hard to support legally.

            rolg

            Liked by 2 people

          7. @ROLG,

            An exit beginning now is a much cleaner than a possible exit post SCOTUS ruling of any kind. December 8th is the deadline. Hoping it’s OK to disagree with Tim on this point. Single malt headed your way soon.

            Liked by 1 person

          8. MFS–It’s OK to disagree with me on anything. And the “disagreement” on the timing of the companies’ exit from conservatorship isn’t a matter of preference; it stems from reading the signals differently (and, in my case, the fact that I am not in direct contact with the principals).

            I’ve had the view for quite some time that Treasury wouldn’t give up its economic interests in Fannie and Freddie without credible legal cover. I thought it had that with the en banc ruling in Collins in September of last year, but Treasury appealed this ruling to SCOTUS and kept making the same legal arguments that the net worth sweep was a proper and valid action. So, we’re now two weeks away from SCOTUS oral argument, and the President’s posture with respect to the election results has put a heightened focus on anything the administration does. Neither the timing nor the circumstances seem to me to favor a unilateral decision by Treasury to cancel the net worth sweep and relinquish its liquidation preference. But there is a widespread expectation that it will, so I’ll be very interested to see (and shouldn’t have to wait too long).

            Liked by 2 people

    1. I read this yesterday evening. David Thompson seems quite confident that his arguments will prevail with a majority of the SCOTUS justices.

      While I was a bit surprised he filed a couple of days early, my lawyer filed my amicus one day early, and this reply brief was relatively short, with a 6000 word limit (of which it used all but 3, according to the certificate of word count). But with everyone now reading tea leaves, the early filing may raise hopes that a settlement might be imminent.

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    2. ROLG,

      Is it a fair argument to make that if there was going to be a settlement, it would have already happened? I understand many people are arguing that it just has to happen prior to Dec 9th, prior to oral arguments as it is disrespectful to the SCOTUS to waste their time, however, I would imagine they have been reading up on the case for weeks now and much of the prep work for Dec 9 has already been done.

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  24. Tim

    I am just beginning to commence the necessary brain damage to read through and try to understand the final rule, but my principal focus is on transition, and the extent to which this final capital rule binds during the capital raising period, as opposed to how the final rule affects the GSEs at some future post-cap raising date. I am trying to understand whether the capital raise is feasible. on p. 22 of final rule: ” …FHFA contemplates that the compliance dates for the PCCBA and the PLBA will be the date of the termination of the conservatorship of the Enterprise (or, if later, the effective date of the final rule), so as to provide additional authority to FHFA to restrict dividends and other capital distributions during the period in which the Enterprise raises regulatory capital to achieve compliance with the regulatory capital requirements. FHFA expects that this interim period could be governed by a capital restoration plan that would be binding on the Enterprise pursuant to a consent order or other transition order.”

    at first blush, it seems that fhfa thinks the consent decree phase is part of conservatorship. I believe this is wrongheaded, and no capital can be raised, if during the consent decree phase fhfa as conservator retains its conservatorship powers under HERA….unless the consent decree explicitly states that fhfa forfeits all conservatorship powers except those set forth in the consent decree (most prominently, limiting dividends/exec comp). my simple point is that any investor is going to ask itself whether NWS 2.0 can happen again…if so, no money on the barrelhead from me, thank you….and if there is any residual retained unlimited conservatorship authority, you can kiss the capital raise goodbye.

    rolg

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    1. Starting to wonder if we are headed toward a several year capital retention phase that moves slowly and attracts no congressional fireworks.

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    2. It’s not clear to me how FHFA envisions the transition out of conservatorship, and it’s possible that Calabria has not yet determined how he would like to attempt to do it. What IS clear to me is that he relishes the powers he has as conservator, which suggests that he will be inclined to relinquish them as incrementally and as slowly as he can.

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    3. Can someone help clarify this question I have?

      Was the FHFA structure ruled illegal?

      ( I believe it was)… and so if this is the case, and now the case is going to SCOTUS, does this make MC fireable at will, or is this decision pending at the result of SCOTUS?

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      1. @Andrew

        the 5th circuit en banc found fhfa’s structure unconstitutional. that binds the 5th circuit and the district courts within the 5th circuit only. if for example Collins is settled before a SCOTUS decision, and Biden seeks to remove Calabria at will, Calabria could resist by, for example, filing a declaratory judgment action in the DC federal district court…which would not be bound the the 5th circuit holding. unless Calabria’s card reader is turned off and he is escorted out of the building by federal marshalls, Calabria would stay in place until he loses (as I think he will) in federal district court, in an appeal that he could take as of right in a federal circuit court, and any SCOTUS cert grant. query whether any of his decisions post removal attempt could be voided (backward relief) by POTUS when Calabria’s court actions prove unavailing.

        rolg

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    1. “The final rule mandates that the GSEs maintain tier 1 capital in excess of 4% to avoid restrictions on capital distributions and discretionary bonuses.”

      Now we know why Freddie Mac CEO left ( or at least make a good educated guess).

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    2. Yes. Apparently the final FHFA capital rule is out. I haven’t seen any details yet, but according to a Dow Jones headline it will require Fannie and Freddie combined to hold $280 billion in capital. That’s considerably higher than the amount in the May proposal, but presumably most of the difference is due to growth in the companies’ business (responding to market needs) since that time.

      As I expected (and discussed in the current post), Calabria is not giving in on his insistence that Fannie and Freddie hold bank-like capital in spite of the fact that the credit risks of the loans they guarantee don’t justify anything close to that amount, even to comfortably survive another 25 percent drop in home prices.

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        1. Looking at the fact sheet, the May 20 capital proposal required Fannie and Freddie to hold $233.9 billion in capital as of September 30, 2019. Growth in the companies’ business since that time would have raised the amount of their required capital as of June 30, 2020 to $262.7 billion. Changes made by FHFA to the structure of the final capital rule pushed required Fannie and Freddie capital at June 30, 2020 UP by another $20.7 billion, to a total of $283.4 billion. The main driver of that increase was a decision made by FHFA to increase the minimum capital requirement on ANY mortgage loan from 1.2 percent to 1.6 percent. (FHFA did give some additional credit for credit risk transfers, but that only trimmed $2.7 billion off the companies’ total capital requirement–less than one-quarter of what the increase in the minimum capital requirement had added to it.)

          FHFA had received an overwhelming number of comments on its May 20 capital proposal saying that the capital requirement was too high, and determined too arbitrarily. Even the American Bankers Association and the Mortgage Bankers Association said that. So…FHFA raised it further. And it did so in probably the worst way possible–by adding to the (indefensible) minimum capital requirement on any mortgage guaranteed by the company. With this change, the companies now effectively are left with no means for cross-subsidizing higher-risk affordable housing loans, as they had been able to do in the past.

          In the write up in the fact sheet, FHFA justified this increase by referencing the Financial Stability Oversight Council report (which Director Calabria had sought, and enthusiastically endorsed), and also doubling down on the insistence that what it calls Fannie and Freddie’s “peak cumulative capital losses”–which include the $300 billion-plus in non-cash expenses FHFA required them to book after they were forced into conservatorship, designed to ramp up their draws of non-repayable senior preferred stock paying a 10 percent annual dividend in perpetuity to Treasury–is a real number, and a more valid basis for a capital requirement than actual incurred credit losses.

          It is impossible to escape the conclusion that Calabria is using the main tool he has, the power to set Fannie and Freddie’s capital requirements, to force them to price the only business they are allowed by charter to do–guaranteeing the credit of residential mortgages–in a way that makes them uncompetitive with banks, the FHA and other sources of mortgage credit, and thus shrink their role in the market. He is thumbing his nose at historical market data and comparative economics, and insisting these capital requirements are necessary to “protect the taxpayer.”

          Setting aside for the moment what happens with the net worth sweep and when–whether it is eliminated in a negotiated settlement with plaintiffs in the lawsuits or ruled invalid by the Supreme Court–three parties now face decisions about how they will react to the final capital rule. Fannie and Freddie will have to determine how they will manage their companies, and price their business, in the face of a capital requirement that is absurdly misaligned with the risks of the loans they guarantee. Investors will have to decide whether they want to invest any new money in companies whose regulator is so overtly determined to marginalize them competitively. And the incoming administration will have to decide whether it wants Fannie and Freddie–which if properly capitalized and regulated could serve as the engines of an efficient and effective system for financing affordable housing–to continue to be run by a director who so obviously does not believe in their chartered missions, or indeed even their existence.

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      2. Sixth circuit Mediation planned for DEC 2nd was also cancelled today. Is there a chance a settlement was reached? PSPA next?

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  26. In its Performance and Accountability Report for 2020, released today, FHFA said that it expects to issue a final capital rule “early in FY 2021.”

    In addition, FHFA said that it “plans to issue a notice of proposed rulemaking for the Enterprise capital planning rule to support sound capital management. The rule would require each Enterprise to develop and maintain a capital plan. The plan would assess the expected uses and sources of capital, by estimating revenue, losses, and capital levels over a defined planning horizon, under both expected and stressful conditions, including scenarios provided by FHFA and at least one scenario developed by the Enterprise.”

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    1. This report from FHFA very likely means that the final capital rule will not be released before the December 9th oral argument of the Collins case at SCOTUS. While FHFA’s fiscal year 2021 begins on October 1, 2020, the fact that the Performance and Accountability Report was issued with today’s date strongly implies that a release of the capital rule is not imminent. By most definitions, “early fiscal year (FY) 2021” will extend through the end of January (with “mid-FY 2021” being February through May, and “late FY 2021” being June through September), so my guess is that we won’t see the final capital rule until sometime in January.

      I read the paragraphs on the “notice of proposed rulemaking for Enterprise capital planning rule to support sound capital management” after I’d come across the report’s Table 2 titled “FHFA Staffing Summary,” where I saw that at year-end FY 2020 FHFA had a total staff of 635, which it is budgeting to expand to 748 at the end of FY 2021. It will be doing this during a pandemic and a struggling economy, and made this plan in an administration that prides itself on reducing regulatory burdens (apparently FHFA was given an exemption from this initiative). I have no idea why one would need to issue a notice of proposed rulemaking for the capital plans Fannie and Freddie will need to file to (eventually) exit conservatorship, but this additional element of bureaucracy–combined with the planned 18 percent increase in FHFA’s staff this fiscal year– lends credence to the notion that the resignation of Freddie Mac CEO Brickman may have been due to exasperation over the plans and processes of Director Calabria, and an unwillingness to wait for him to be replaced with a less hostile regulator by President Biden sometime after his inauguration on January 20.

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      1. Tim,

        It appears FHFA plans to finalize the capital rule by the end of the year. If you look at page 47, FHFA elaborates what “early fiscal year 2021” means. It states, “FHFA plans to finalize the rule in the first quarter of FY 2021.”

        Q1 FY 2021 being Q4 2020.

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        1. I had not gotten as far as page 47 of the report (I stopped my reading at the end of the “Management’s Discussion and Analysis” section, on page 30), but the sentence you quote–“FHFA plans to finalize the rule in the first quarter of FY 2021”–appears in a subsection titled “Enterprise Housing Goals,” and refers to “a proposed rule with calendar year 2021 housing goals for the Enterprises,” issued in August 2020. That’s different from the capital rule. Moreover, the fact that FHFA did not use this same “first quarter of FY 2021” formulation to describe the date of issuance of a final capital rule, but instead chose to say it would be issued “early in FY 2021,” reinforces my interpretation that we are unlikely to see the final rule until January of next year, at the earliest (FHFA’s deadlines have been known to slip).

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      2. Tim

        ” FHFA plans to issue a notice of proposed rulemaking for the Enterprise capital planning rule to support sound capital management. The rule would require each Enterprise to develop and maintain a capital plan. The plan would assess the expected uses and sources of capital, by estimating revenue, losses, and capital levels over a defined planning horizon, under both expected and stressful conditions, including scenarios provided by FHFA and at least one scenario developed by the Enterprise.”

        do you think this “capital planning rule” referred to by FHFA in this Report is the same as the capital restoration plans referred to in the Safety and Soundness Act as amended by HERA? my guess is that this capital planning rule is a new rule envisioned by Calabria that would tell the GSEs how to go about their financial planning activities, apart from the capital raising plans that the GSEs will have to implement to meet the final capital rule…there certainly was no statutory reference that I saw that related to this proposed rule making.

        rolg

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        1. I’ll need to go back and read FHFA’s Performance and Accountability report more carefully (it has the attribute of “once you put it down you can’t pick it up again”), but I took the Enterprise capital planning NPR as FHFA wanting more detail, including contingencies, behind the companies’ capital planning in general. It seemed to me that if FHFA wants this once Fannie and Freddie are adequately capitalized, it also would see the need for it in assessing the degree of realism of a multi-year plan for reaching their target capital levels. I thus took it as being HERA (statutory requirement), plus what Calabria, as regulator, would like the companies to do on top of that. But I suppose we’ll see when the NPR comes out.

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          1. Tim

            my only thoughts were that if the NPR was intended to encompass the GSEs’ capital restoration plans, a statutory reference to that would have been de rigueur from an agency process POV…and one would think that having hired underwriters/financial advisors with a view to conducting capital raises, something FHFA is not expert at, the GSEs would not need for FHFA to go through a rule making process for that.

            rolg

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          2. On page 23: “During the coming fiscal year, FHFA plans to publish and take public comment on a proposed regulation requiring the Enterprises to submit resolution plans (living wills) similar to those currently required of other large, regulated financial institutions.” To me this is yet another sign that Calabria is trying to shoe-horn the GSEs into Basel III come hell or high water.

            Liked by 1 person

      3. FHFA doesn’t receive Appropriations from Congress and thus can just make an assessment to obtain funds from the Enterprises (GSEs) and, if I understand correctly, the Federal Home Loan Banks as well. My point is they have no real incentive to lower costs or reduce unnecessary bureaucratic spending. FHFA, in my opinion, is just an independent branch of government with no oversight, but of course others have already made that point in front of the Judiciary.

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  27. Freddie Mac CEO David Brickman is resigning in January after about a year and a half on the job, the company has disclosed in a filing.

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    1. I saw that, and, given the timing–a November 9 resignation date–viewed it as the first tangible external sign of a possible negotiated deal to end the lawsuits being pushed though before the December 9th oral argument at SCOTUS. While I certainly could be wrong, one interpretation of the resignation is that Brickman did not agree with one or more of the key terms of the proposed settlement, and his board did not back him up, so he resigned. If that is correct, it also would imply that Fannie’s board and management DO agree with, or at least are willing to accept, the proposed terms of settlement, and that it will go forward. But there could be other reasons for the Brickman resignation as well. Perhaps we’ll learn more soon.

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        1. I have nothing specific in mind. But when I take Calabria’s statements that Fannie and Freddie have “some of the worst corporate cultures I’ve ever seen” and that they need to undergo substantial (unspecified) administrative reform before they can be released from conservatorship, and combine them with his frequent claim that what he really wants for them is major legislative reform, I can easily see him wanting to achieve changes to some aspect of Fannie and Freddie’s structure or operations that he can’t impose as a conservator or regulator, but could try to get as a price for a negotiated and early exit from conservatorship. In that case–and again, this is pure speculation–Brickman might have said, “Nope, I’ll take my chances that the net worth sweep will be invalidated by the Supreme Court, and that I can ‘get out of jail free’ without having to pay the price Calabria is demanding,” but that his board didn’t go along with him.

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          1. Tim

            this is interesting and I dont have too much additional speculation to shovel onto this…other than to say that from a GSE investors’ POV, they would like to see both a PSPA settlement AND an exit from conservatorship into consent decrees before 1/20. I would add that in my experience, people resign more often over their salary than due to principle, and I imagine Mr. Brickman might wish to see a bump up in his depressed salary somewhere soon on the horizon. IF there is any negotiation of a consent decree, I could see the subject of exec comp being discussed…exec comp could have been also a subject of further specification in the final cap rule, so it could very well be that no consent decree discussion is currently going on…salary wouldn’t likely be a topic of a PSPA amendment….so perhaps whether in the weeds of the final cap rule or in the outline of a proposed consent decree, Mr. Brickman didn’t like what he was seeing regarding the future of exec comp. or as you suggest it could be a principled disagreement with Calabria trying to leverage a change unrelated to salary.

            rolg

            Liked by 1 person

          2. Tim,

            Do you think that the two GSEs will also be at the table for settlement talks? I thought it was just between the Collins attorney and Treasury and at most FHFA. Do you think any settlement discussions would also go for the input from the GSEs?

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          3. No, Fannie and Freddie would not need to be a party to discussions to settle the lawsuits; I do, though, believe that if FHFA as conservator agrees to any significant changes to the companies’ activities or operations as part of a Fourth Amendment to the SPSA that the companies’ boards object to, those changes would not stand up under legal challenges.

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          4. Andrew Ackerman with WSJ is saying that the departure of Mr. Brickman is because the Trump admin has run out of time to reach a settlement and the odds of a release now are basically zero. Do you put any credence into this position?

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          5. I don’t know why Brickman left. The timing suggests that his decision is somehow tied to the election. But I don’t know whether it’s because he’s unhappy with some aspect of the terms of a proposed settlement and Fourth Amendment, because with Trump’s (still not conceded) loss he thinks a settlement and release from conservatorship is either less likely or less imminent, or if the timing is coincidental and there is some other reason for his departure.

            Liked by 1 person

      2. Tim, might I propose an alternative explanation that Brickman is unhappy with the final capital rule? The capital rule proposal included restrictions on executive discretionary bonuses prior to the GSEs being fully capitalized.

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        1. Sure, although I doubt that’s it. Freddie had ample opportunity to comment on these restrictions in its 69-page comment letter on FHFA’s capital proposal–which was quite detailed and highly critical in a number of areas–and it did not do so.

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          1. Freddie Mac CEO LEAVING & others retiring in PROTEST against FHFA Regulator – WSJ – Andrew Ackerman-

            “Mr. Brickman joins a group of high-level executives who are stepping down from the companies, including Fannie’s longtime head of single-family housing, Andrew Bon Salle , who is retiring at the end of the year. Some former officials said morale at the firms is low, partly because of what they describe as micromanaging by their regulator, the Federal Housing Finance Agency. For instance, the FHFA has recently restricted the companies’ ability to offer new products.”

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          2. I wouldn’t call Bon Salle and Brickman “a group of” executives; I’d call them two (I don’t know any other senior people who have announced their departures). And it seems as if Ackerman hasn’t asked either one why they’re leaving (if he had he’d tell us what they said, even if it was to decline to comment). It’s too bad there don’t seem to be any actual reporters covering the companies.

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  28. Don Layton has a new piece out:

    https://www.jchs.harvard.edu/blog/common-sense-gse-reform-recommendations-biden-administration

    In it he says, “The first possible path is to leave the companies in long-term conservatorship, which has worked, and continues to work, unexpectedly well (including during the pandemic), and then possibly revisit the question of conservatorship exit in a few years. This additional time in conservatorship, however, should not be one of stagnation; more operating reforms and improvements can be implemented, building on the many that have already occurred while the two companies have been under government control. ”

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    1. That’s correct. But Layton also adds, “The second possible path, based on the only proposal believed to be able to successfully navigate all the complexities and risks of conservatorship exit, is to additionally implement, via administrative means, the early years of a long-term transition to the utility model.”

      While I thought that in general Layton’s paper was very good (with the exception that I wish he would stop repeating his story of how bad Fannie and Freddie were before the conservatorships, and how great a job he and FHFA did in fixing them, because (a) it’s based on the FM Watch-influenced version of Fannie and Freddie he learned when he was at Chase, and erroneous in many respects, and (b) it creates the false impression that post-conservatorship they must remain very stringently regulated lest they return to their alleged “evil ways,” which isn’t helpful), I don’t agree with his “only two possible paths” conclusion.

      I think there are more than two paths, and that indefinite conservatorship isn’t one of them. Once the net worth sweep is either canceled voluntarily by Treasury or ruled invalid by SCOTUS–and I believe one of those (more likely the latter) will occur–FHFA will not be able to justify keeping Fannie and Freddie in “long-term conservatorship.” It’s de facto nationalization. As the companies continue to build capital through retained earnings and possible new equity offerings, FHFA will have no choice but to set a specific capital threshold at which they will be permitted to exit conservatorship, and return to a normal regulatory relationship with the agency.

      I do agree with Layton on the utility model (long-time readers may recall that it was a component of the mortgage reform proposal I made for the Urban Institute’s “Housing Finance Reform Incubator” project in March of 2016, which I titled “Fixing What Works.”) As Layton states, it could be implemented as part of a Fourth Amendment to the Senior Preferred Stock Agreement between Treasury, FHFA and the companies, which, among other things, would lock in the conditions and the terms of the Treasury backstop arrangement.

      Finally, I was glad to see Layton’s comments about the importance of replacing Mark Calabria as FHFA director, and his strong disagreement with the idea of making credit risk transfer transactions mandatory.

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      1. Tim

        In his latest piece, Layton posits a transition to a utility model after the GSEs have been recapped in conservatorship. HA! I strongly believe the GSEs cannot raise any money in the capital markets while in conservatorship. Layton doesn’t acknowledge this, but if the Biden Administration follows this line of thinking, you will be looking at a continued extended conservatorship of indefinite duration, where retained earnings are the sole source of funds for recapitalization.

        if I were negotiating a settlement for Collins Ps, I would want some assurance that this will not be the result before I would authorize the dismissal of the Collins case.

        rolg

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    1. Ron Klain was more than a “lobbyist” at Fannie Mae (Fannie had dozens of lobbyists); he was a close political advisor to Fannie’s Office of the Chairman, of which I was a member between late 2000 and my departure in early 2005. Unlike most lobbyists, who we never saw, Klain was frequently in the building and attended many of our key political strategy meetings. I thought very highly of him then, and still do. He is well respected by both Democrats and Republicans, and I believe he will make an excellent Chief of Staff for Joe Biden.

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  30. Under the circumstances, assuming no settlement, a great deal of the future of the Fannie and Freddie will depend on the next Secretary of Treasury. It sounds like 2 names are appearing in conversations, Lael Brainard and Janet Yellen. NY Times seems to feel Lael is the likely successor to Mnuchin.

    Anyone know their thoughts on recap & release? Capital Rule?

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    1. I’ll start out by saying that I believe the challenges likely to be made by President Trump to overturn the results in states recently declared to have voted to elect Joe Biden will not be successful, and that Biden WILL become the 46th President of the United States on January 20th.

      I’ve said earlier that I have not heard a convincing case for why Treasury Secretary Mnuchin would agree to settle the net worth sweep cases prior to the December 9 oral argument in Collins before the Supreme Court, and that still holds. Moreover, in my view the longer President Trump contests the election results the more that will freeze everyone in place, and make it even less likely that all of the components of a complex legal settlement can be put together in the next four and a half weeks.

      I know the general sentiment is that a Biden victory, and no pre-inauguration settlement, is a very bad outcome for Fannie and Freddie, as well as its existing (and potentially new) shareholders. But I’m not so sure about that. One very significant ramification of a Biden presidency is that it very likely will result in the replacement of FHFA director Calabria well before his term expires in 2024. Calabria’s words and deeds in the last year or so have made it abundantly clear (at least to me) that he is no friend of the companies, and that his price for releasing them from conservatorship is to burden them with capital requirements that will severely constrain their competitiveness, and also to smother them with intrusive regulation. This posture would have a major, and perhaps crippling, negative effect on the companies, even after they are released.

      As one who for the last dozen years has worked to have Fannie and Freddie released from conservatorship in a way that maximizes their value to both homeowners and shareholders (existing as well as new), if you were ask me to choose between a quick settlement of the lawsuits and a release of the companies under a consent decree with terms set by Calabria–and Calabria remaining FHFA director for the next four years–and the invalidation of the net worth sweep by the Supreme Court next spring and the potential for their release under a new FHFA director appointed by Biden, I would unhesitatingly pick the latter. I believe that once the net worth sweep is reversed, the rationale for keeping Fannie and Freddie in conservatorship evaporates, irrespective of who is president. But I also believe that Biden will WANT them released–and functioning effectively–as a matter of public policy (and will do my best to try to convince the Biden economic team of the wisdom of doing that.)

      We obviously need to wait to see if anything happens between now and December 9, but I’m probably more optimistic than most that the lack of any action during this time will not be a bad thing for the companies or their stakeholders.

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      1. Tim

        I believe that if there is no settlement of Collins, so that les jeux son fait (the chips are down), then the Collins plaintiffs will prevail before SCOTUS. I believed this rather strongly before Justice Ginsberg’s passing, and I believe it even more strongly after Justice Barrett’s confirmation.

        I believe the SG knows it’s a losing case in front of this SCOTUS, which leads me to believe that Treasury will finally consider itself empowered to pursue its policy objective (recap and eventual release) rather than let DOJ continue to pursue its litigation objective (win the case). Litigators litigate until they are told not to litigate. I have always been of a view that while in business, where litigation is a means to a business end, the attentive client controls the lawyer (especially since the client is paying the lawyer’s bills), DOJ stands on an equal footing with all other executive branch departments (and there is a tradition of independence from even POTUS itself). so litigating with the govt is difficult because the lawyers are good, and they are without a leash since no one is on the hook to pay their bills (indeed, the more the DOJ recovers in fines etc the larger its budget) and no one in a peer executive branch is empowered to tell the DOJ how to handle a case. I think Mnuchin was sincere when he said almost four year ago that “reforming” the GSEs was a priority for the Trump administration. at this late date for the Trump administration, reforming the GSEs can only be done by means of a business transaction…SPSA amendment and conservatorship consent decree…which Treasury can do on its own motion, and does not require the active involvement of DOJ if plaintiffs stipulate to the dismissal of their case.

        As for Treasury and political cover, I am not sure there is any political cover needed for Mnuchin to seek at this point, given that in a few months he will return to LA to finance films again (perhaps even poolside). I assume that within Treasury, Counselor Phillips spent his two years laying the paper groundwork for a settlement transaction if that was to be undertaken, so the process will have the requisite process foundation. of course, this is a big ticket negotiation and settlement cannot be said to be a forgone conclusion once negotiations begin. but I dont foresee any political fireworks before a Biden inauguration if there is a settlement….reading between the lines of Sens. Warner/Rounds recent letter, it seems that a settlement will not be a surprise on Capitol Hill.

        moving beyond the near term and venturing to consider the longer term, as you have done Tim, I would think that a Collins win before SCOTUS makes conservatorship release a foregone conclusion…eventually. on what terms and when are impossible to fathom since no one knows whether and when Calabria will be replaced or be permitted to serve out his term…and of course if and how receptive capital markets will be. but when there is a multiplicity of possible paths, sometimes the inertial path is the most likely. so the advent of the Biden administration may not even present a speed bump for conservatorship release and recapitalization. when Collins is affirmed, the principle that the conservator has a duty to return the GSEs to a safe and sound position will have been affirmed, and once this is done (yes, perhaps years from now), conservatorship must end for there is nothing left for conservatorship to do. the DOJ litigating principle, that the conservator has no particular duty so that there is no required conservatorship objective and terminus, will have been rejected. and all this irrespective of who is POTUS.

        so if this is right then a GSE investment is driven ultimately more by litigation merits than political currents. but delay due to political interest and government (mal)administration has made and could continue to make that investment result a diminishing time-adjusted return.

        rolg

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      2. Tim – I have been following your blog posts closely, and your comments even closer, and today is the first time I break my silence of being a shadow follower.

        I respect your view more so than anyone in this space because you have demonstrated time and time again an impartial and objective view of the scenario and the path to release, and as Bruce Lee once said “The most dangerous person is the one who listens, thinks and observes.” which I have done my best to do so when you post, but today marks the first time I break my silence as I wonder why you would pick the latter in this scenario, when the Obama administration has done no favors towards the GSE’s, and you could argue with complicit in the swept of their profits and consequently their shareholders. Surely, a FHFA director such as Calabria, that wants them to exist on a playing field that encourages competitors is preferable than a wildcard where the decision rests solely on a man who was involved in an admin directly responsible for the situation they are in today?

        In addition to that, a verdict by SCOTUS is likely to lead to years of more of the same in the judicial process we have witnessed, where as I think most (preferred) shareholders are ready to get this over with and finalized.

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        1. ROLG and Andrew–

          First of all, I’ll again state that while I do own common and preferred shares of Fannie Mae (a legacy of stock-based compensation received while I was at the company), the goal of my work on the blog is to promote the release and recapitalization of Fannie and Freddie on terms that maximize their value to ALL stakeholders, starting with homeowners but including shareholders and employees. For this objective to be realized, three conditions must be met: the net worth sweep must be cancelled; the companies must be released from conservatorship, and they must be structured and regulated in a manner that allows them to succeed as shareholder-owned companies.

          I agree with ROLG that the Collins plaintiffs are highly likely to prevail in their case at SCOTUS. A pre-oral argument settlement of the case would eliminate the net worth sweep sooner, and thus accelerate the timeline for release and recapitalization. I have no real issue with that (although I do worry that not definitively resolving the issue of whether the net worth sweep was legal under the anti-injunction clause of HERA may leave a cloud over the companies’ shares in some investors’ eyes); I just don’t know that Treasury will in fact give up its current rights to Fannie and Freddie’s net income and its liquidation preference in the companies without being told to by SCOTUS. If it does, great; if not we wait for the Supreme Court to rule.

          My bigger concern is what happens next–whether post-settlement or post-SCOTUS ruling. In either scenario you will have the net worth sweep canceled, Treasury’s senior preferred stock and liquidation preference gone, and Treasury owing each company at least $12.5 billion (probably in federal tax credits), and possibly more if pre-judgment interest is included on sweep payments made after the senior preferred was deemed to be paid down. What does that do for existing shareholders? The value of each company’s common stock will depend on how many new shares will have to be issued to reach their target capitalization percentages, and what the companies’ earnings power will be at that time–that is, their earnings per share after they are fully recapitalized. The value of the existing junior preferred stock will depend on whether these shares are tendered for, converted to common, or sit on the balance sheet until their dividends can finally be turned back on.

          I don’t do recapitalization scenarios or stock price projections, but I will say that the values of both companies’ common stock, and the prospects for price gains in their junior preferred, have been significantly worsened by Director Calabria’s seeming insistence that Fannie and Freddie hold 4-plus percent capital on mortgage credit guarantees that currently are experiencing losses of 2.5 basis points per year. I don’t believe he will back off that, so that makes me think that the most important determinant of Fannie and Freddie’s value going forward–whether for homebuyers or shareholders–is whether Calabria stays in place or is replaced by someone who will set their capital requirements not on ideological or pro-bank grounds, but based on economics and the credit risk of the (one) underlying business they are in. A Biden presidency would open the door to replacing Calabria, whereas the continued incumbency of President Trump most likely would not.

          For Andrew (and others), I would note that this is not a political opinion. The ill-treatment of Fannie and Freddie has occurred under both parties and spanned several administrations. But here we now are, after eight and a half years, with the net worth sweep poised to end–whether by negotiation or a ruling by the Supreme Court–irrespective of who the next president is. Given that, would you, as a stakeholder in Fannie, Freddie or both, rather have their future values determined by Mark Calabria’s vision of what their roles and functions should be, or take your chances that a new director appointed by President Biden may treat them less punitively than Calabria has shown he wishes to? For me it’s not a hard call, and it’s why I see more positives than negatives in a Biden presidency–politics aside.

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          1. Tim-

            Unless, of course, the Biden presidency names someone like Jim Parrott/Dave Stevens as director of FHFA. So for me that would be a hard call.

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          2. That IS a risk, but one that the “good guys” (including me) can and will work to prevent.

            And I do understand that some readers will view this through a political lens; I’m trying to approach the issue as pragmatically as I can.

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          4. This is probably a good time to reiterate one of my “ground rules” for this site. There are some questions that for whatever reason I choose not to answer, and delete. The person asking the question does not know why it was deleted, and may question my rationale for doing so, which is understandable. This question from MFS in one I normally would have deleted, but in this case I WILL say why: I don’t see any benefit from attempting to answer it. I could criticize Jim, and say why I don’t think he’d be successful if he put himself forward as a candidate for Director of FHFA, but I generally don’t like to be publicly critical of people involved with the mortgage reform dialogue, because I know most of them and want to be able to work collegially with them. (And readers will note that it’s only very recently that I’ve begun to be openly critical of Director Calabria.) Or, in the event I knew more about how Jim is viewed by certain key people within the Biden camp than I wished to disclose, I might not want to say that either. And I don’t like to just give meaningless, generic answers to questions–“that’s a good point”; “yes, that’s certainly possible”–because it makes it seem as if I don’t have an opinion or know what’s going on. So in these cases, hitting the delete button seems to be the best option, and it’s what I do. I hope readers understand these deletions as being done for reasons they may not know, and not take them as either implicit criticisms or evasions.

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          5. Tim

            well if Joe light says it, then everyone must know….”Officials at the FHFA and Treasury Department have been working on such an amendment for months, said a person familiar with the matter, and long have been in agreement on some of the issues that such an amendment would contain.”

            https://www.bnnbloomberg.ca/fannie-freddie-plan-could-face-race-to-finish-after-biden-s-win-1.1519619.amp.html?__twitter_impression=true

            as for the investment cloud that may hover over the GSEs in the capital markets should there be a settlement and no judicial resolution on the merits making clear the NWS was invalid, as you intimate, this is why both a 4thA NWS settlement AND an exit from conservatorship into consent decrees is so important. the specter of illegality repeating itself under the guise of conservatorship is real, which is why the conservatorship must end before the Biden inauguration. whoever Biden might install as a new FHFA director, once the GSEs are governed by consent decrees that cannot be amended without their approval, this specter of illegality is disarmed imo, because the NWS was only justified as a conservatorship power. if exited from conservatorship into consent decrees, any new FHFA director can execute on the consent decrees and maybe, rose colored glasses, ameliorate the capital rule in some fashion, but can no longer exercise unbounded conservatorship power.

            rolg

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          6. Just to close this off, I’m in no way opposed to a settlement of the lawsuits before oral argument on December 9; I’m not expecting it, but I easily could be wrong, and would be happy if one occurs. Yet as a proponent of having an efficient, effective secondary mortgage market, I also believe all stakeholders will benefit from Fannie and Freddie’s having a regulator who is not ideologically opposed to their existence, and I intend to continue to work to achieve that.

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          7. Tim
            After the bailout most companies were allowed to buy back the warrants they issued to treasury. Is there any rule/law in place that FnF can/will have first right of refusal? Do you believe they will be allowed to buy them back? Logically, who gets to keep the warrants should be a starting point to determine how many new shares will need to be issued to meet capital requirement.

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          9. [Edited for length]. I appreciate the answer which you clearly put thought into. You and I had a similar belief where prior to the elections I felt this would play out in the courts and that many people have rose colored spectacles on. I do feel like this may begin to play out differently, especially since letting the courts rule on this also puts Calabria’s job in jeopardy. Do you not feel like Calabria is considering this when deciding whether or not to let this play out?

            So just to summarize so I can understand the framework in which you are thinking. You are operating under the assumption that Biden wants a successful recap and release (please correct me if I’m mistaken).

            I feel like the sentiment towards the GSE’s has in fact been different with D or R in office. Although under Trump, watching GSE progress has been like watching paint dry (and in fact paint would have dried much quicker), we are seeing progress with the hiring of Calabria, the increase in capital reserves, and a general progression of getting the ducks lined up (although I agree that 4% seems to be a bit contradictory), but nonetheless it’s been an infinite amount more than under the Obama administration, so I’m not so sure its fair to say both parties have acted the same towards the GSEs.

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          10. Andrew–The are three direct or implied questions in your comment, which I’ll address briefly in turn.

            (1) In a Biden administration, Director Calabria’s job will be in jeopardy whether the litigation is settled or not. If it is settled, the decision by the Fifth Circuit en banc that FHFA was unconstitutionally structured would stand. Calabria could challenge it–arguing that the Supreme Court’s decision on the constitutionality of the CFPB in Seila Law did not directly apply to FHFA–but in my view he would lose that, although it would take some time for the case to be resolved.

            (2) 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.

            (3) Without getting into the four-decade history of the general approach of Republican and Democratic administrations towards Fannie and Freddie–and it HAS been different–I believe the government’s approach to the companies in both the Obama and Trump administrations has been driven by Treasury as an institution, not by the policy goals of either president. The record is quite clear that the takeover of Fannie and Freddie in September 2008 was a long-planned policy initiative of Treasury Secretary Hank Paulson, who served in the administration of Bush 43. (Bush’s involvement in this seems to have been limited to having Paulson tell him, “The first sound they’ll hear will be their heads hitting the floor.”) From Day 1 Treasury’s plan was first, to run up the companies’ non-cash expenses to bury them under an avalanche of 10 percent annual dividends on non-repayable senior preferred stock, and then to “wind them down and replace them” with an alternative more favored by Treasury and the large banks. That was the plan throughout the eight years of the Obama administration. The problem was, Treasury and what I call the Financial Establishment never could get their “reform” legislation through Congress. The failure to do so during the first three Obama years was what caused Treasury to propose the net worth sweep to FHFA in August 2012–absent that the companies would have built up so much capital it would have been difficult if not impossible to keep them in conservatorship. But even with the sweep, legislation remained stalled. By the time President Trump was elected in November 2016, and Mnuchin was named Treasury Secretary-designate, it was clear to almost everyone that secondary market “reform” would have to be done WITH Fannie and Freddie, not by replacing them. It was at that point that Mnuchin made his “we gotta get them out of government control…reasonably fast” statement. Yet coming up on four years later, they’re still in government control. There is a reason why I keep focusing on Mnuchin as the key to a legal settlement before the December 9 oral argument at SCOTUS. The Fannie and Freddie conservatorships have been a Treasury-driven operation for over a dozen years, and it has been unsuccessful at any strategy it’s come up with for ending them during the entire time. Maybe things will be different in the next four weeks. That would be great, but it’s hard for me to bet against inertia, which is why I think we’ll see the net worth sweep decided by SCOTUS, not conceded by Treasury.

            Liked by 1 person

          11. Tim – I looked in the Index of your book and don’t see Financial Establishment as a defined term used. Is there a place where you define what that means to you?

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          12. It’s a term I coined in one of the early blog essays I wrote, titled “Treasury and the Financial Establishment,” in April of 2016. There, I defined the Financial Establishment as “large banks and Wall Street firms, and their advocates and alumni at Treasury and elsewhere.”

            Liked by 1 person

      3. Mr Howard

        In your amicus presented to the court you stated FnF had about 700 billion in unencumbered assets that could be used as collateral for loans from Federal Reserve.

        Do these assets still exist today unencumbered at or above same value?

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        1. No. The companies’ unencumbered assets in June of 2008 were Fannie and Freddie (and a few Ginnie Mae) mortgage-backed securities (MBS) held in portfolio. Because these investment portfolios are dramatically smaller today, so too is the dollar amount of the companies’ unencumbered assets. Looking only at Fannie, at September 30, 2020 it held $42 billion in Fannie and Freddie MBS, compared with over $250 billion in mid-2008.

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          1. @mickey/Tim

            timely question regarding lien-free collateral, as if there is to be a 4thA, in addition to dealing with senior pref, the amendment would have to address the T line of credit…set a commitment fee, determine if it decreases as the GSEs’ capital increases, repayment terms etc

            rolg

            Liked by 1 person

      4. Do you know what Biden means in his housing plan when it states that it will be paid by an increase in an assessment of Fannie and Freddie?

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        1. You’re referring to a component of the housing plan posted on the campaign website, which proposes an increase in Fannie and Freddie’s annual contribution to the Housing Trust Fund. This amount was set at 4.2 basis points of outstanding credit guarantees in the Housing and Economic Recovery Act, passed in the last year of the George W. Bush administration. The proposal to increase it is one of several dozen elements of the Biden housing plan, and has been made before on a bipartisan basis. It would have to be legislated, however, which greatly reduces its chances of happening.

          I’ve written about this proposal before. My main objection to it is that the requirement to contribute to the Housing Trust Fund would apply only to Fannie and Freddie, rather than to all originators of mortgages. Whatever the dollar amount of the Housing Trust Fund contribution is, the companies would attempt to cover it by charging higher guaranty fees. Since the yield on Fannie and Freddie’s mortgage-backed securities serves as the basis for the pricing of all mortgages, if the companies charge, say, 10 basis points for an affordable housing fee, mortgage rates in general will be 10 basis points higher. That, however, will produce a windfall for bank originators who do not sell to Fannie and Freddie. They still will charge all borrowers the extra 10 basis points, but for the loans they retain in portfolio they will not have to remit the 10 basis points to the Trust Fund; instead it will be added to their profits. I think that’s a big reason why the affordable housing fee on Fannie and Freddie (only) has been so popular. But it’s terrible public policy. It requires all low-and moderate income borrowers to pay more for their mortgages, but only about half of what they pay in the aggregate will go for affordable housing; the other half will go to banks and other primary market mortgage holders.

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  32. Hi Tim or ROLG,

    Can you help me out with this scenario- say the Supreme Court agrees with the en banc decision on the validity of the NWS but also agrees that relief should only be prospective. Does that mean that the NWS payments made to date are left alone and moving forward the dividend payment would be based on the original agreement. Treasury would maintain warrants AND the original Sr. Prefs ($137B) and would get approx. $13.7B in dividends a year from Fannie?

    Thanks,

    Ryan

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    1. @Ryan

      this is a good question, and it points to the absurdity of a prospective only relief decision. I would say that if scotus grants only prospective relief, then while the fhfa director would be removable at will, all prior NWS dividends would be validated, and any future NWS dividends as well. so while the current NWS dividends are not distributed and are currently adding to the senior preferred preference amount, those dividends could be “turned on” in the future and distributed to govt if relief is only prospective. there are two reasons to believe this won’t happen…Lucia and Seila…two scotus cases that make clear that a P is entitled to backward relief if there is a separation of powers violation.

      rolg

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    2. so this is just more tea leaf reading, but I actually think this shows some movement on pre-release planning for the GSEs. putting aside for a moment whether ms. bair is a wise choice, this has the appearance to me of Calabria doing one of what I would guess are the many things he feels he needs to do to get the GSEs prepped for release.

      rolg

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      1. Let me first address the position of Chair of Fannie Mae’s board of directors, then I’ll comment on Ms. Bair’s appointment.

        Prior to 2005, the Chief Executive Officer (CEO) of Fannie Mae also served as its Chairman, and held the formal title Chairman and CEO. I worked for three of them: David Maxwell, Jim Johnson (who just recently passed away, on October 18, at age 76), and Frank Raines. Near the end of Frank’s tenure, Fannie’s regulator, OFHEO, took up a cause that was circulating among corporate governance types at the time of splitting the duties of Chairman and CEO, to make the former something of an overseer of the activities of the latter. Frank and other members of Fannie’s executive leadership (including me) did not see the merit of doing this, but as soon as Frank and I and were forced out by OFHEO in late December 2004, OFHEO achieved it–supporting the appointment of the other vice chairman of Fannie, Dan Mudd, as CEO and the making of board member Steve Ashley Fannie’s Chairman. I don’t know how the two formally split their duties, but Dan remained firmly in charge of the company’s day to day operations and business strategy.

        When OFHEO’s successor, FHFA, put Fannie into conservatorship in September of 2008 (at Treasury’s request), Fannie noted in that year’s 10K that “FHFA succeeded to all rights, titles, powers and privileges of any director of Fannie Mae…[and] our directors had no power or duty to manage, direct or oversee the business or affairs of Fannie Mae.” Fannie had no board member with the title of Chairman until March of 2014, when one of its directors, Egbert Perry, was named “Chairman of Fannie Mae’s Board.” The 2014 10K did not describe any duties that came with this position. Perry was succeeded by Jonathan Plutzik in December 2018, and Ms. Bair is now succeeding Plutzik.

        While Fannie remains in conservatorship, Bair will have no formal duties. Post-conservatorship, whenever that is, I assume that Bair will have duties similar to those of Steve Ashley, although that should (at some point) be up to Fannie’s board to determine. Whatever those are, Fannie’s CEO–currently Hugh Frater–still should be in charge of both strategy and operations.

        I know that even in conservatorship, Fannie’s board members are not appointed by the Director of FHFA, but are nominated and elected by the board. (Fannie’s CEO told me that Ms. Bair herself was selected, and elected, by the board.) I believe, but am not certain, that the Chairman of the Board is chosen in the same manner. Thus, while Calabria may have suggested Bair’s appointment (although I do not know this), the board would not have opposed it. And I agree that this is a move that appears designed to appeal to potential new investors–given Bair’s high profile and reputation in the financial services industry–and in that sense is a positive signal of movement along the path of the company being released from conservatorship.

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          1. @Ryan/Tim

            I would rather see 11/20 as a start date than say 12/20.

            it should not go without saying that ms. bair is very much attuned to Calabria’s wavelength, regarding capital requirements and the likely business imprint of Fannie going forward. so one might guess that Calabria is pleased. as a former fdic chair, she will be well disposed to interfacing with congress and will be a comforting presence to institutional investors. and since she was on Fannie’s board previously, she understands the business (one hopes). I am reminded of Calabria’s gratuitous and unexplained remark before the HFSC regarding Fannie’s deficient corporate culture. whatever he meant, at least he should be comforted at turning over primary board oversight of Fannie management to someone with ms. bair’s gravitas to deal with this deficiency.

            I have learned in life not to over expect performance from people, but also not to underestimate people. be open to pleasant surprise and not be shocked by disappointment. I am currently and I believe deservedly in the underestimate zone with respect to Calabria and Mncuhin, and I suppose now with the trump administration tenure at a close, I am looking to witness something of a swan song. it is past due.

            also, it has come to my attention that Sen. Toomey will chair the senate banking committee for the next two years, given his receptiveness to the recap of the GSEs, I think this is most helpful.

            rolg

            Liked by 2 people

  34. Anyone care to comment about this proposed mediation in the Rop case on December 2nd?

    “There are several purposes for mediation conferences. One is to prevent unnecessary motions or delay by addressing any procedural issues relating to the appeal. A second is to identify and clarify the main substantive issues presented on appeal. The third and primary purpose is to explore possibilities for settlement. We will discuss in considerable detail the parties’ interests and possible bases for resolving the case. You should be prepared to address all of these matters. Your attention is also directed to the document entitled About Mediation Conferences, which is available on the Court’s website at http://www.ca6.uscourts.gov under the heading Mediation Office. It provides more detailed information about mediation conferences in the Sixth Circuit.”

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    1. This is the first concrete public sign I’ve seen of movement toward settlement of any of the lawsuits. The Rop case in Western Michigan, on appeal at the Sixth Circuit Court of Appeals, is similar to the Fifth Circuit case in that it includes a challenge to the constitutionality of the FHFA director.

      The mediation was initiated by Director Calabria, as FHFA is the named defendant in the suit. It is not surprising that Calabria would like to settle Rop, because a loss in this case would limit his tenure as director. The question–as is also the question around settlement of the Fifth Circuit case scheduled for oral argument at SCOTUS on December 9–is whether Treasury is willing settle at this point. Treasury is not a named participant in the Rop mediation, but its consent would required in any agreement to cancel or unwind the sweep and eliminate Treasury’s liquidation preference in the companies. So, in my view this is an intriguing development, but not a dispositive one.

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      1. Tim, where are you getting the info that the mediation was initiated by Calabria? Unless im missing something, that info is not in the filings.

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        1. @anon/Tim

          I see a rep letter from Arnold @ Porter re FHFA, but no indication as to who initiated the mediation. as someone who has participated in mediations, both as counsel and mediator, there are very few mediations regarding already commenced litigation that are resolved…pre-litigation, they are often successful. so this may just be the 6thC initiating the mediation on its own motion, to try to cut down on its case backlog, and it is unexceptional…but if there is any positive movement to settling collins, then this would be a forum on 12/2 to also try to move Rop to settlement. I would note that counsel for Collins=counsel for Rop, so I am not sure why anyone would need a mediation to settle Rop if there is to be a settlement of Collins.

          rolg

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          3. Wondering if only Rop and Collins are challenging Fhfa’s constitutionality. If so, it’s quite convenient to have mediation involving the representatives just before the Supreme Court hearing.

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          4. @J/stuart

            collins is seeking as a remedy for its direct claim, as a shareholder, damages payable to the GSEs themselves. so shareholders all stand shoulder to shoulder benefitting from any recovery that accrues to the GSEs.

            I dont think the Rop mediation is anything other than that the 6thC has adopted a mediation referral program, which can work to jumpstart settlements in commercial disputes. but this is all besides the point because Collins is the case that will drive any litigation settlement, and if collins is settled (outside of mediation), I expect Rop to be settled irrespective of any mediation referral. both cases have a unconstitutional structuring claim.

            the interesting dynamic that has emerged now is whether the prospect of leaving his Treasury Secretary position a few months from now from will prompt Mnuchin to settle Collins before scotus oral argument on 12/9. if he truly believed as he said when he began as Treasury Secretary almost four years ago that it was crazy for the GSEs to be still in conservatorship, it would be a mark of failure if he leaves soon with no material accomplishment in this regard.

            rolg

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    1. Gary has been doing good commentary on Fannie and Freddie issues for several years now. His latest is a reminder of how lucky we were that the Fifth Circuit en banc stepped up to reverse a series of decisions based on an argument (“may” versus “shall”) that one would have to stretch to even call “colorable”: since a conservator cannot be assured that its efforts will be successful–in which case the company in question will be put into receivership–HERA literally could not have said that FHFA “shall” conserve the companies. And as Gary said, now that the case is before SCOTUS, the government isn’t even going to try to make this argument. Instead, on the APA case it’s going to try to insist that HERA must be read as permitting a conservator to loot the assets of the companies it’s supposed to be conserving, while barring any judicial challenge to that looting, whether directly or derivatively. I’d be astounded if that contention is accepted by SCOTUS.

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      1. Tim/MFS

        hindes is alluding to the role that the SG is playing in front of scotus, which I have also tried to assess, in short, while the DOJ wants to just win baby (and it is the DOJ that has been repping treasury in federal district and circuit courts) , the SG takes the baton before scotus, and it has a reputation and good will to preserve in front of scotus…and hindes (probably rightly) thinks that it was the SG that didn’t want to make the may/shall argument in front of scotus, notwithstanding that it was successful at all circuit courts but one.

        so likewise, I see the 12/9 scotus oral arg date as the date of no return, as the SG will likely not disrespect scotus by arguing the case and then later saying that it has been settled, never mind. DOJ marches to a different drummer, but it is no longer in charge. SG is left with the “not direct claim” and anti-injunction APA arguments, and I just think they are weak, and the SG knows it.

        interestingly, even if SG wins the APA claim on the anti-injunction argument (and I dont think it will), that just provides additional fodder for Ps unconstitutionally structured claim, as this would be another insulation of fhfa from control (make fhfa “more independent” than CFPB), in addition to the restriction on potus removal and insulation from congressional appropriation.

        rolg

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        1. ROLG, if fhfa finalizes cap rule and treasury+fhfa execute a 4th amendment before dec 9, wouldnt a settlement be trivial? because then the case becomes a risk for both parties for obvious reasons. so really the important thing here is to execute a 4th amendment in nov, which im guessing has already been drafted up and is pending on election

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          1. @anon

            fhfa/T shouldn’t make moves on 4thA unless they get Ps sign off…at least that collins will be settled, if not also the other cases. I see two avenues: fhfa can continue to dilly dally with its capital rule and finalize it whenever…there is no suspense there regarding what its terms will be, and its contribution to the 4thA will really just be to find a pen and ask where its sig page is; T will need to come up with an acceptable 4thA, and I dont see this happening until Thanksgiving time, which will let the election hysteria/litigation settle down…anything announced around Thanksgiving gets less attention. if trump wins then T might be more willing to hold off on the 4thA, but if there is momentum towards it now (essentially hedging a Biden win), I suspect T will just carry that momentum on, as inertia is the strongest force in the universe. I have been wrong before.

            rolg

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    2. One should note that Mr. Hindes is a good personal friend of Joe Biden. He is also a leading backer of Biden’s presidential candidacy. Finally, he was the former chair of the Democratic party in Delaware.

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  36. Tim & ROLG

    I noticed on the SCOTUS website for the Collins case that SG requested an enlargement of time in oral arguments to 100 min given the complexities of the case and the number of amicus curiae. Speaking of amicus there were two more submitted today. It sure doesn’t seem like they have made much progress towards any kind of settlement.

    https://www.supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/19-422.html

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    1. Today was the deadline for amicus briefs supporting the government, and three such briefs were submitted: two in support of the court-appointed amicus arguing that a single director removable only for cause is constitutional, and one making a (to me) more arcane argument that plaintiffs are not entitled to relief even if the FHFA director was unconstitutionally appointed (although I admit I read only the summary of the argument and not the full brief).

      In addition, the acting Solicitor General did request an extension of oral argument from 60 minutes to 100, to “enable [the parties] more fully to address the multiple distinct, complex and important issues presented by these cases.” The SG requested the following time allocation–“40 minutes for the federal parties, 15 minutes for the Court-appointed amicus, and 45 minutes for the Plaintiffs, with the federal parties opening the argument (as they did in the briefing) and presenting rebuttal.” The SG stated that the Plaintiffs consented to this proposed structure, and the Court-appointed amicus did not object to it.

      We don’t yet know whether SCOTUS will grant this extension.

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      1. Tim

        calling professor Harrison’s brief arcane is charitable. imo, it is sophistry. he argued along similar lines in Seila, and only Justice Sotomayor referred to it, at oral argument, before it was ignored. because Seila is binding precedent for Collins, absent some intelligible way to distinguish the two cases, the court appointed amicus and these amicus filed today seek to provide the basis for such distinguishment. even as SCOTUS precedent holds that an action by an unconstitutionally structured agency is void (Bowsher), Harrison argues that the statutory provision that created the constitutional issue never was enforceable, since the provision was unconstitutional, so that the agency never really and truly was unconstitutionally structured (we were all just under a misapprehension), such that the action never was taken by an unconstitutionally structured agency. Not going to fly before SCOTUS.

        rolg

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        1. @Tim/MFS

          as for request for enlargement of time, this seems to me to be a nothing burger. while every good appellate lawyer thinks he/she can convince justices during orals, they know deep down that really orals is mostly for the justices to talk to each other primarily. having said that, it is true that for SG (and collins counsel) to hit all of the points then would like to hit, extended time would be necessary. so more time would be chicken soup. I will already owe Tim a beer if collins is argued 12/9, but I am thinking of upping the bet to make it a chaser to some teenage single malt.

          rolg

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          3. @Tim/MFS

            another way of looking at the SG time allotment request for oral argument is to compare the quality and scope of the amici briefs filed on behalf of Ps vs. govt. the govt supported amici include two arcane briefs by overly academic professors (the Harrison brief discussed above, and one by a prof Sugarman which is really out of left field…arguing that based upon his groundbreaking historical work, soon to be published in book form as he points out in the brief!, the framers never intended all executive power to reside in him, and therefore director removal power is not available if congress decides otherwise…this is s dog that not only won’t hunt, it won’t go outside for a sniff), and a third brief that merely asserts the alleged scope difference between CFPB and fhfa regulation in seeing to distinguish Seila (which will be rebutted by Ps reply brief, pointing out that the aggregate dollar sum of all matters regulated by fhfa likely exceeds that regulated by CFPB). compare this to the P supported briefs of far better quality which go to the merits of the legal arguments in the case (especially the Institutional Plaintiffs and Vartanian briefs), as well as Tim’s own fact-based brief.

            while there is a written word limit imposed on each party for its briefing, when you accumulate the quality and word length of the parties with their respective supporting amici, Ps briefing far exceeds the govt in both quality and length. it’s as if there is a written word limit for the govt, and a much larger word limit for Ps. the SG appreciates this, and its attempt to expand oral argument is the only response available to it based upon the way the briefing has played out.

            rolg

            Liked by 1 person

          4. Agreed, but the fact that plaintiffs’ counsel supported the request for expanded time indicates that David Thompson also would appreciate the extra time; at 60 minutes he would be squeezed a bit with the time allotted to the court-appointed amicus.

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          5. Tim

            no lawyer doesn’t want more time. I am just noting that imo the genesis of SG’s request can be traced to the glaring differences in the aggregate briefing.

            rolg

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          6. The SG request for an enlargement of time suggests that perhaps they are not close to any kind of settlement agreement, unless its all part of the negotiation tactics, but seems late in the game for that, don’t you think? Surely SG and Sec Mnuchin are in communication.

            Liked by 2 people

          7. As I’ve said before, I don’t believe Treasury intends to attempt to settle the outstanding lawsuits before the December 9 oral argument at SCOTUS (irrespective of the outcome of the election). But we’ll know in five and a half weeks.

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          8. @MFS

            the SG is a very professional office and it will be full steam ahead until it is not. this is all tea leaf reading, and I have been wrong before.

            as an example why this is a case SG doesn’t want to argue, SG makes a big point in briefing how Ps interpretation of the APA could lead to an expansion of federal lawsuits. Ps’ and the Institutional Investors’ briefs dispute the notion that there will be a flood of federal cases, since the facts of the case are specific to the NWS and scotus knows how to limit application of a case ruling to the facts presented. usually, private parties dont have to rely on the APA since there are other statutory avenues for relief, but given the HERA succession clause, the APA is a particularly apt avenue for relief in this case. SG doesn’t want to lose this case and have to worry about an expanded APA in future cases.

            rolg

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          9. @Tim/ROLG-

            “Never was so much owed by so many to so few” – Winston Churchill

            Thank you Tim for all your hard work on behalf of so many and thank you ROLG for sharing your sharp legal mind!

            Queue the Lagavulin.

            Liked by 1 person

  37. Tim

    GSEs’ Q3 20 financial results were released today and were excellent as expected. I would look forward to any insights you have. My reaction was that the “tone” of the whole GSE conversation has changed.

    There are still some references to protecting taxpayers from greedy hedge funds, such as the Sen. Warner/Rounds letter from a few weeks ago, but this was an isolated and weak missive, in my view. What seems to have more consequence now is to focus on the positive role that the GSEs played as a solution to the covid economic stress, and their important role going forward as well capitalized institutions…that being part of the solution going forward is a 180 degree turnaround from being (improperly) blamed for the GFC problems. we can all focus on the details of SCOTUS arguments, capital rules and capital raising plans, but I would also pause for a moment and notice that the lay of the GSE landscape has shifted favorably.

    you would never see a quote like this just a few quarters ago, from FNMA CEO in today’s earnings release: ““Fannie Mae has helped more than 1.2 million homeowners with forbearance plans so far in 2020, while providing record levels of critical liquidity to the mortgage market through one of the most severe and sudden economic shocks in a century. Our performance this year demonstrates our ability to support the mortgage market in a safe and sound manner even during these uniquely challenging times. To continue meeting these challenges, we believe our company and the broader housing finance system would be best served by a responsible end to Fannie Mae’s conservatorship, consistent with FHFA’s goals.”

    for long time observers of things GSE, this is a welcome reversal.

    rolg

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    1. I’ll focus on Fannie’s earnings. The “headline” 3rd quarter numbers–$5.4 billion in pre-tax net income and $4.2 billion in after-tax net income–were well above what I would peg as Fannie’s current baseline earning power of about $3.5 billion pre-tax and $2.8 billion after-tax per quarter. But when you look at the details, the above-trend result is readily explainable by two factors: (1) Fannie had a huge jump in amortized guaranty fees–from $1.49 billion in the second quarter to $2.71 billion in the third quarter–due to the impact of lower interest rates and accelerated refinances on its outstanding book of business, and (2) Fannie continued to draw down on its allowance for losses, by $1.26 billion in the third quarter. While welcome and a boost to retained earnings, both of these factors are temporary. And there is another, less positive, aspect of the refi wave that also showed up in the third quarter numbers. In the third quarter of 2019 (pre-refi wave), Fannie’s average charged fee (net of TCCA) on new business was 45.9 basis points, 2.4 basis points higher than its average charged fee on outstanding business (also net of TCCA) of 43.5 basis points. But in the third quarter of this year, the average new business charged fee of 44.9 basis points was only half a basis point above the average 44.4 basis point fee on outstanding business. So we’re now seeing a leveling off in Fannie’s guaranty fee rate, with the faster amortization of upfront fees pushing the average fee up, and the higher quality of the refi business pushing the new business charged guaranty fee rate down. Fannie and Freddie were hoping to avoid this leveling off by charging a half-basis point upfront fee on refi business last quarter, but this fee has been deferred until December 1. By that time, though, a considerable amount of business already will have repriced, and that will make Fannie’s average outstanding guaranty fee rate “sticky” at around 45 basis points–which is not where the company will want it to be if it has to hold 4.0-plus percent capital against that business.

      So I view the third quarter results somewhat less optimistically than you do. Yes, the “tone” of the earnings release is clearly positive, but the accelerated turnover of the existing book at a 45 basis point guaranty fee rate is going to be a handicap if Fannie (and Freddie) has to significantly increase its average fee rate because of much higher required capital. Potential investors will note that as well.

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      1. Tim

        picking up on your observation that the average new business G fee has trended downward, and accepting that it will have to trend upward in view of future capital raising, typically the principal impediment to raising a fee is competition. since both Fannie and Freddie will have to raise G fees, I dont see the one posing a particular competitive constraint on the other. so competition would have to come from outside the GSE space, I suppose principally PLS issuances and large banks and perhaps REITS etc holding more mortgage loans in portfolio. isn’t this non-GSE space a somewhat weak competitive threat to the GSEs (considered as a unity since they will both be raising G fees), in terms of its capacity to significantly increase mortgage loan volume away from the GSEs?

        rolg

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        1. There are three elements that will affect by how much, and how quickly, Fannie and Freddie can raise their average guaranty fee rates. For me the most important will be whether the Temporary Payroll Tax Cut Continuation Act (TCCA) expires next October. If it does, the companies should be able to begin picking up for themselves the 10 basis they’ve been charging on behalf of Treasury for the past nine-plus years, with no adverse market impact. Next there are competitive constraints. In my FHFA capital comment, I noted that there appeared to be market resistance in the past when Fannie and Freddie’s fees hit an average of 60 basis points (which currently is 50 basis points for the companies and 10 for Treasury, through the TCCA), because at 50 basis points on low-risk business they would lose significant share to bank portfolios, and at 75 basis points on high-risk business they would lose significant share to the FHA and Ginnie Mae. I have no reason to think those competitive “resistance points” have changed. The third constraint on fee raising is how quickly the companies can (a) grow, and (b) turn over their existing book. For Fannie, this book turnover is occurring rapidly now (29 percent of its $3.25 billion in single-family credit guarantees as of September 30, 2020 will have been put on and priced this year), as is strong growth (9.8 percent annualized in the first three quarters)–but without higher fee rates. If Fannie and Freddie’s fee increases begin after turnover and growth slow down, as now appears likely, it will take longer for those higher fees on new business to pull up the average.

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    1. Thanks ruleoflawguy – excellent point! If I was the Government I would call it a day and pack my briefcase and go home. How do you see a possible settlement along the lines you have suggested affecting the other major ongoing related cases (either the outcomes or the timelines)? Thanks – always look forward to your and Tim’s insightful comments!

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      1. @jim

        the principal case other than Collins is Fairholme, scheduled for trial before Judge Lamberth in spring 2022 (individual and class action plaintiffs). govt will argue that this case has been mooted by a Collins settlement that involves an economic recovery along the lines discussed in the article, though there may be some hold up value if plaintiffs can present a credible claim for additional damages since any such additional damages would be paid by the GSEs themselves, which would represent a contingent liability for the GSEs as they try to raise capital.

        rolg

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        2. @ROLG

          Washington Federal is still on in Sweeneys Court, so not clear if a Collins settlement would moot that case and conversely what is the significance of that case still outstanding as potential future damages?

          Also, back to Collins, isn’t it abundantly clear that if this admin is serious about raising private capital to protect the taxpayer and Mnuchin pushes this to be heard on 12/9, they are not serious about exiting conservatorship even if Trump wins the election? I say this cause if they hear the case and the Government prevails next spring, then zero private capital comes in. If they lose the case they risk huge damages and other cases are emboldened. What am I missing here?

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    2. This article by ROLG postulates that the existence of a substantial amount of prejudgment interest that would be awarded following the invalidation of the net worth sweep by SCOTUS (whether for reasons of constitutionality or a violation of the APA) gives plaintiffs substantial leverage in negotiating a settlement of the Collins and other cases before oral argument is heard on December 9. I believe, however, that in the event the Court finds that the net worth sweep IS invalid and the remedy should be to unwind it retroactively (as plaintiffs have requested), then no additional prejudgment interest will be owed.

      There are two ways plaintiffs could receive relief on a ruling invalidating the net worth sweep. The first is that the excess sweep amounts Fannie and Freddie have paid over the 10 percent (at a quarterly rate) on the balance of their outstanding senior preferred stock, owed under the original PSPA, would be refunded to the companies in cash. In calculating the amount of this refund, both companies would be credited with prejudgment interest on the excess payments made to Treasury each quarter. The interest rate used to calculate this credit would be no less than the companies’ cost of borrowing (since in practice they were required to replace their “swept” retained earnings with a mix of short- and long-term debt), and at the Court’s discretion it could be higher. In this alternative, Fannie and Freddie would receive a cash award composed of the cumulative overage of their excess net worth sweep payments—relative to the $19 billion or so they would have owed each year under their original 10 percent dividend arrangements—since the beginning of the sweep, plus the pre-judgment interest. But their now $193.5 billion in Treasury senior preferred stock would remain outstanding, and they would continue to be required to pay 10 percent per year on it.

      The second way of invalidating the sweep is to retroactively recharacterize each quarter’s sweep payment in excess of that quarter’s owed 10 percent dividend as a paydown of the outstanding senior preferred. Plaintiffs have done this calculation, and the result is that up to the point at which Fannie and Freddie were permitted to retain a limited amount of earnings (up to $25 billion for Fannie and $20 billion for Freddie), this method results in the senior preferred for each company being paid off entirely, and Treasury owing each about $12.5 billion, which could be paid either in cash or (more likely) as credits against future federal income taxes payable. In this second method, however, Fannie and Freddie’s sweep payments in excess of the 10 percent dividend effectively get credited with “earning” that percentage as the senior preferred is paid down, and no additional prejudgment interest is owed.

      It’s possible to make an argument for using the implicit 10 percent crediting rate of the second alternative as the interest rate for calculating prejudgment interest under the first method (although I doubt the Court would be persuaded by it). But even if so, under the first method the senior preferred would remain outstanding, and neither the government nor the plaintiffs will want that. The government won’t want to write combined checks for more than $200 billion to Fannie and Freddie, and the companies would much rather have the senior preferred—and its required (punitive) 10 percent dividend—gone, so they can quickly rebuild their capital base.

      If this analysis is correct, as I think it is, then plaintiffs do not have the “additional leverage” of prejudgment interest to use in negotiating a settlement. And we’re back to asking whether plaintiffs are better off trying to settle before SCOTUS hears the case, and whether Treasury can come up with a defensible rationale for giving up its current claim to the companies’ annual income, and a $200 billion-plus liquidation preference, without having been told to do so by SCOTUS. I’m still waiting to hear an argument I find convincing for such a settlement scenario.

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      1. Tim

        I agree with almost all of this. at the end of the day, prejudgment interest (imo plaintiffs have a good case for 10% compounded under the forced investment theory) on the excess over 10% dividends paid pursuant to the NWS (your first method), plus the cumulative excess dividend amount, is not less than, and unless my hobbled math talents mislead me, somewhat more than what would be called for under the “IRR 10% moment” calculation (your second method) that Pollock first published, and which has been picked up by Craig Phillips and others. I think the portion of the thrust of my argument, that there should be a satisfactory economic settlement, is bolstered by the availability of prejudgment interest, and I agree that I was wrong to believe that prejudgment interest provides such additional leverage as to result in a contemporaneous release from conservatorship (and one may credibly wonder whether FHFA could even move this fast before 12/9).

        as for your skepticism that Treasury will not settle Collins before SCOTUS decides it for Treasury, that would simply be a continuation of the overall govt strategy incoherence that I refer to in the article, and so your skepticism is warranted. I do think that Collins en banc decision was a wakeup call for the govt (not having lost in litigation before then), and the prospects for a SCOTUS govt win are not worth the risk of an embarrassing economic loss, whose genesis can be traced to the Obama administration, but whose blame will be left at the feet of the Trump administration. Clearly, I have been wrong before.

        rolg

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        1. ROLG: One clarification on your response: My second method (which really is the plaintiffs’ proposed method) is not the same as Alex Pollock’s “10 percent moment” calculation. That IRR-based calculation is one that sometimes is used to justify a lower repayment to Fannie and Freddie (in the event that the net worth sweep is reversed) than would be the case using the plaintiffs’ method.

          I have not tried to replicate the Pollard calculation, and don’t intend to now because it’s not currently on the table as an alternative way to award damages. The plaintiffs’ method also has the advantage of simplicity: take the net worth sweep payment in Quarter X, subtract the 10 precent dividend (at a quarterly rate) owed on balance of senior preferred outstanding at end of Quarter X-1, then deduct this amount from the amount of outstanding senior preferred at Quarter X-1 to produce the amount of outstanding senior preferred amount at the end of Quarter X; repeat this process for each subsequent quarter until the senior preferred is paid off, after which all further sweep payments are deemed owed to the companies. That’s now a known number, and requires no assumptions to produce it.

          I also see the political calculus differently. This administration has been making the argument that the net worth sweep was legal and justified for over three and a half years. It’s had multiple opportunities to repudiate the “Obama-era” sweep–publicly opposed by the current FHFA Director (albeit in a prior position)–and not taken any of them. If it sticks with its current argument and loses the sweep case at SCOTUS, it can say, “well, we played the hand we were dealt, and it didn’t work out.” If it settles now, it has to both address its defense of the sweep for the past three and a half years (it can’t just say, “oh, never mind all that,”) and defend itself against the “giveaway to the hedge funds for not much in return” argument.

          Liked by 1 person

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          1. 3.5 year defense of sweep would be it benefited taxpayers. Settling would be due to the risk of severe loss to taxpayers in light of 5th Circuit. Appeal to SCOTUS is just what lawyers do even when looking to settle (in this case, on behalf of taxpayers).

            The spin is easy and, relatively speaking, nobody is even watching let alone able to show GOP inconsistency within the strictures of political soundbites.

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          2. The decision of the Fifth Circuit en banc occurred over a year ago. In lieu of settling then, Treasury filed an interlocutory petition for certiorari with SCOTUS because it said it sought to remove the “legal uncertainty” about the outcome the net worth sweep cases so it could proceed with ending Fannie and Freddie’s conservatorship; so, why not wait to see what SCOTUS does–particularly since settling won’t resolve all the legal uncertainties, whereas a ruling from SCOTUS will. And finally, the one significant change that’s happened since the Fifth Circuit en banc decision is that Calabria’s draconian capital rule has greatly reduced the value of the warrants Treasury holds for 79.9 percent for Fannie and Freddie’s common stock, which weakens Treasury’s settlement incentive (and its potential for claiming future financial benefits for taxpayers).

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          6. @frances

            warrants, warrants, warrants. Warrants have obvious economic value, but they also have strategic value if Treasury wants to entice some whale to invest. because they have no real exercise price, they do not contribute to raising capital through exercise. but if some whale wants to buy alot of common stock in the offerings (creating capital) but wants a sweetener, Treasury might wish to sell the whale a slug of its warrants in connection with the offering at an attractive price. If this were to occur, it would most likely occur in connection with a pre-public offering private placement.

            Rolg

            Liked by 1 person

          7. Just wanted to put my two cents in on the argument whether anything happens prior to SCOTUS argument 12/9. In my opinion, if Trump wins, he will want to see what SCOTUS does with the case to have a definitive answer on a net worth sweep type of charade in the future, to remove the temptation from the likes of Parrott to repeat the action if/when Dems win the Presidency. This also gives the Administration cover to proceed with a recap and IPO once one of the decision tree iterations have been narrowed. Gov’t was told to settle by SCOTUS and the hedge funds argument is moot. I don’t see a settlement if Trump wins. It will likely be decided by SCOTUS.

            Just like Trump wants SCOTUS to eliminate Obamacare so he can negotiate what he perceives to be a better solution for healthcare. He is not tipping his hand on keeping ACA intact even if he wins at SCOTUS because if he did so, he’d lose negotiating leverage with the Dems. Same logic applies to the GSEs, he won’t settle until forced to do so, keeping optimal leverage in the process.

            On the other hand, if Biden is elected, decision tree opens up and we have more uncertainty as a result. Ultimately, the case shouldn’t go to SCOTUS by 12/9 because Calabria will want to protect his job, but FHFA isn’t the lead on the settlement and Mnuchin may or may not do anything.

            I hope I’m wrong on this and there is a settlement by 12/9, but overall, I think there is a 75/25 chance of SCOTUS deciding this. (100% if Trump wins, 50/50 if Biden wins)

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          8. Tim

            Wasn’t the decision to file for cert post 5th circuit ruling really the DOJ and the SG more so than Sec Mnuchin, despite him being the named defendant? Also, wouldn’t it have been premature to settle before all advisors were in place and a formal exit strategy solidified and able to be announced? In the meantime, this allows more time for negotiations up to the last minute and in this case ROLG suggests 12/9.

            Speaking of the advisors I imagine they may be opining on settlement v SCOTUS decision based on institutional investor feedback. A government win would really scuttle any exit plan.

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          9. Favorable resolution or settlement of the lawsuits is an absolute prerequisite for Fannie and Freddie’s release from conservatorship under a consent decree and subsequent recapitalization, but I don’t know why the parties would feel they have to have a capital plan in place before settlement could occur. Settlement of the suits is a matter between Treasury–which is both the instigator and the beneficiary of the net worth sweep–and the plaintiffs, while the recapitalization plan is a matter between the companies and FHFA. I would be surprised if Treasury has been holding up settlement negotiations pending promulgation of a final capital rule and the development (with advisor input) and approval (by FHFA) of the companies’ recapitalization plans.

            Liked by 1 person

        2. Response to Alecmazo, if the gov’t waits on SCOTUS to decide and the ruling favors Plaintiffs, then the Gov’t leverage to negotiate diminishes dramatically…that seems like a bad idea for them

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  39. “And neither Mnuchin nor Treasury have given any indication that they’re about to throw in the towel on the claims the government has been making since 2012 that the net worth sweep was valid and necessary.”

    Tim,

    Could it be as simple as this?

    Mnuchin realizes there will be a day of reckoning. (He even acknowledged on Maria’s show the illicit nature of the NWS and he can’t ignore the likelihood of SCOTUS upholding the Fifth Circuit.) It seems reasonable to me that his mindset simply is if Trump loses in November, then let NWS overage (and any punitive damage for 10% usury or whatever) be paid back by Biden’s Treasury, especially since Obama’s Treasury began the NWS. In other words, there is zero political motive to settle before the election given (a) the bad press for doing so – e.g. favoring Hedge Funds etc., and (b) the possibility that Biden’s Treasury might have to foot the bill, which surely doesn’t bother Mnuchin. (Might even delight him as a consolation prize for a Biden win.)

    But there could be some pragmatic reasons why they might settle if they are holding the purse strings in spring or 2021. They could reduce the amount of payback that they might otherwise pay under a severe SCOTUS ruling. They also wouldn’t have to carry the baggage of a SCOTUS rebuke for theft.

    It would be nice to see Trump’s Treasury throw in the towel based upon pure integrity, but we know that hasn’t happened and, therefore, won’t happen. Notwithstanding, although I see no political incentive and plenty of political disincentive to settle given the possibility of a Biden victory, I do see advantages (with zero downside) to settling if Trump wins in two weeks. Aside from saving money, they can settle with no serious consequence to the GOP in 2024, if that were a concern for the party or the president. They could even possibly still distance themselves from the illicit nature of the NWS with a bit of spin and use of Sweeney’s documents.

    Ron

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  40. Is the Fifth Circuit En Banc Opinion a Bad Call or Have the Treasury and FHFA

    Perpetrated a Fraud on the Court in Collins v. Mnuchin ?

    https://www.jurist.org/commentary/2020/10/joseph-marren-collins-v-mnunchin/#

    The purpose of this article is to slow down the action so that everyone understands
    what the real facts and issues are in the case.

    Hopefully, the United States Supreme Court may conclude in its upcoming review of the case that:

    1. The Agencies pleadings were in bad faith and that Federal Rule of Civil Procedure 11 has been violated; and

    2. The Agencies have committed a fraud on the court under FRCP 60.

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    1. This is a speculative article that presents its author’s opinions and theories as accepted fact, then goes on to argue that in light of these alleged “facts,” which FHFA and Treasury did not acknowledge in their pleadings, the Supreme Court should find these pleadings to be fraudulent. It is not clear, at least to me, what the author thinks should happen after that. But it doesn’t matter, because this argument is not before the Court, will not be put before the court, and even were it to be, would be dismissed out of hand.

      I won’t recap the article, except to say that the author (Joseph H. Marren, President, Chief Executive Officer and Chief Compliance Officer of KStone Partners, LLC) believes that (a) the Office of Management and Budget improperly modified the government’s “Combined Statement of Receipts and Balances” in 1953, and (b) this act somehow invalidated the government’s decision to remove Fannie Mae’s liabilities from the federal budget when it was privatized in 1968 (and to keep Freddie’s liabilities out of the federal budget after it was created in 1970). From that point, though, I literally cannot follow the author’s argument as to why these two developments make Treasury and FHFA’s pleadings in the Collins case false. I would counsel readers not to waste as much time on this article as I did.

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        1. Thanks; I hadn’t known that Mr. Marren had tried to get his argument in front of the Fifth Circuit Court of Appeals, and been roundly rejected. This makes it all the more puzzling why he thinks he might have more success with SCOTUS. (It could be a case of “nothing else to do during a pandemic….”)

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  41. Tim,

    Director Calabria continues to point to the FSOC’s position that “the re-proposed capital rule may not provide enough capital to withstand a serious downturn in the housing market.” Do you think he’s trying to prepare the market for an even more onerous capital rule than the re-proposed one or do you think this is just cover for him pushing through the reproposed rule in its current form?

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    1. I believe Calabria is just laying the groundwork for publishing the rule in close to its current form (with a probable increase in the credit given to securitized credit risk transfers, and possibly also some relaxation in the restrictions on dividends paid on new issues of preferred stock–and potentially also common–during the recapitalization period).

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      1. What do you think the timeline looks like at this point? FHFA has had almost two months to review comments. What’s the reason for the delay in publishing the final rule?

        Do you think there is still time to get everything done (settlement and Fannie/Freddie coming up with plans for capital raise(s)) if President Trump is not re-elected?

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        1. I don’t have any insight into the timing for the publication of a final FHFA capital rule, although I would be surprised if the rule is made final before the election (which now is only two weeks away). After that, the handicapping will depend heavily on who won, or appears to be in the best position to win (should mail-in ballots be required to declare a winner). But as I say below, should Trump lose I think Calabria will want to move quickly to finalize the capital rule and settle the lawsuits prior to the December 9 oral argument before SCOTUS in Collins v. Mnuchin (and Mnuchin v. Collins), in order to avoid the possibility of having his directorship of FHFA be ruled unconstitutional in a decision in these cases. But that process is not his to run; it’s Mnuchin’s. And neither Mnuchin nor Treasury have given any indication that they’re about to throw in the towel on the claims the government has been making since 2012 that the net worth sweep was valid and necessary. A settlement of the lawsuits before December 9 would require Treasury to effectively say, “We still think we’re right on the net worth sweep; we know the issue is being argued at the Supreme Court in early December for a definitive decision next spring, but we’ve nonetheless decided that this is the right time to give the plaintiffs what they’ve been demanding to settle these cases, so Fannie and Freddie can be returned to shareholder-owned status.” I personally have a hard time seeing how Mnuchin as an individual, and Treasury as an institution, could get to the point where that looks to be their best option.

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          1. Is it fair to say that you do not see a consent decree being put in place prior to a transition of power if Biden wins in November? If that’s the case, will we just continue in this state of purgatory for the next 4-8 years unless the Supreme Court strikes down the NWS?

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          2. All I’m saying at this point is that I do not see a good argument for a consent decree being issued before the December 9 oral argument, given the current state of play, which includes (a) Treasury’s continuing to defend the rationale for and legality of the sweep; (b) the case coming before the court in December, and (c) FHFA Director Calabria’s capital rule removing a very large amount of value from the warrants Treasury holds for 79.9 percent of Fannie and Freddie’s common stock, which would be Treasury’s financial rationale for giving up the sweep and the liquidation preference voluntarily. Perhaps someone has made a good argument for this, and I just haven’t heard or seen it.

            We may get a sense of how SCOTUS will rule on both the constitutionality and the APA issues after oral argument on the 9th. If so, that could shed some light on what, if anything, the administration may do between then and January 20, 2021 (assuming Trump loses).

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    1. The Layton piece is largely speculative, and I didn’t find it to be particularly informative (of course, I’m up to date on all these issues) or insightful. I also found it odd that he largely avoided any discussion of the lawsuits, and the role either a favorable or an unfavorable ruling for the plaintiffs by SCOTUS–or a pre-emptive settlement of the cases between the election and the December 9 date of oral argument–would play in any of the outcome scenarios he’s postulating. This, in my view, was not one of Layton’s better pieces.

      The brief for the court-appointed amicus was about what I expected. Amicus Nielson claims that the Seila Law precedent on the constitutionality of the CFPB director is not applicable to the director of FHFA, for three reasons: (1) the head of FHFA who agreed to the net worth sweep, Ed DeMarco, was an acting director, who COULD (according to the argument of the amicus) be removed at will; (2) FHFA does not deal directly with the public and thus does not pose the threat to individual liberty that the CFPB does (so that having a director removable only for cause does not raise the same constitutional issues as in Seila Law), and (3) the “for cause” restriction on the removal of the FHFA director is not as limiting as the “inefficiency, neglect or malfeasance” standard that constrains the ability of the president to remove the director of the CFPB. None of these are new arguments, and plaintiffs counsel (Cooper & Kirk) will have the opportunity to respond to them in the consolidated reply and response brief they will file on November 23. At that point we’ll be able to evaluate the arguments made by both sides, and assess which appear likely to carry more weight with SCOTUS.

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      1. Tim

        I would only add that amicus really had two paths: i) to distinguish FHFA from CFPB (former regulates 13 entities, latter regulates millions of people and entities), so that Seila does not apply to Collins (remembering that even though Seila was a 5-4 majority, if FHFA=CFPB, then Collins will be 9-0…this is precisely the effect of precedent), and ii) distinguish the NWS in Collins from the CID in Seila, insofar as the former was decided by an acting director, and the latter by the director, of the respective agencies. as for the removal standard, Roberts has already said in oral argument to the amicus in Seila that removal for cause is tantamount to removal for inefficiency, neglect or malfeasance…that dog not only won’t hunt, it won’t bark.

        These arguments are very weak, though presented in the brief as best as they could have been. Which circles back to your point re the Layton piece. Collins is a case the government does not want to argue, and it makes no sense to handicap the parties’ actions going forward without considering the long shadow Collins casts back from the 12/9/20 oral argument.

        rolg

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        1. Rolg,
          When you say the Collins case is a case the government doesn’t want to argue, a part of me hopes you’re right but I’ve struggled with wanting to believe that but questioning, particularly if Trump were not be re-elected, why Mnuchin/Treasury and Calabria/FHFA will ultimately care seeing they would both likely be replaced. I just don’t see either truly ever owning or taking ultimate responsibility for the current situation and or adverse ruling against the government. What are the main reasons you see it that way, I’m very interested in your perspective. Thank you!

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          1. @jack

            well, when I refer to the govt not wanting to argue Collins in front of SCOTUS, I refer principally to the Solicitor General (who is now an acting SG) rather than Calabria/Mnuchin. assuming there is a Justice Barrett installed before 12/9, the SG is left with 6 “conservative” justices, who are not overly inclined to give the govt the benefit of the doubt regarding matters of separation of powers and administrative agency overreach, to hear a very weak argument (remembering that the SG is not even arguing that FHFA=/=CFPB). in front of SCOTUS, it is the DOJ and specifically the SG who calls the shots, not Calabria or Mnuchin. and the last thing the SG wants to do is argue the case on 12/9 and then be told by Calabria and Mnuchin that they have a settlement. the SG, as a repeat player in front of SCOTUS, would find that to be disrespectful of SCOTUS. So what I think you have is a weak case on the merits, where the govt’s position is not even conducive to an administrative recap and release, and which if it is to be settled, really has to be settled before 12/9. I have been wrong before.

            Remember, the govt “won” the Collins constitutional claim at the 5th C en banc, insofar as it held FHFA was unconstitutionally structured but there was only prospective relief available (these two points were what the DOJ argued for). Now comes Seila, and CFPB is both found to be unconstitutionally structured AND there was backward relief granted (subject to a determination whether the CID had been subsequently ratified by a” removable at will” CFPB director…there is no ratification question to be answered in Collins). Now comes SCOTUS granting Ps cert petition in Collins on the question of backward relief ( and whether FHFA=CFPB). and I haven’t even gotten to the APA claim, which Collins Ps won at the 5th C en banc. so I have to believe the SG thinks this is an ugly case to argue, and he certainly doesn’t want to argue it if FHFA/T have any intention of settling it.

            rolg

            Liked by 2 people

          2. I think it’s very likely that if President Trump loses the election, Director Calabria will be strongly in favor of settling the lawsuits. He would like to be able to publish a final capital rule, and– with the net worth sweep unwound and the liquidation preference eliminated–negotiate a consent decree that would lock in some of the changes he would like to see Fannie and Freddie adopt as concessions for being allowed to exit conservatorship. And I have no doubt he would like to remove the issue of the constitutionality of his directorship from the SCOTUS calendar, and thereby maintain his position in a Biden administration until his tenure is challenged in the courts (which will take a while to resolve). I also accept the judgment of ROLG that the Solicitor General would rather not argue the Collins case before SCOTUS if he doesn’t have to. My question, though, is: where is Secretary Mnuchin on this? While Calabria has been making his preferences on the recapitalization process known to anyone who is willing to interview him, there has been absolute radio silence from Mnuchin, and Treasury, on THEIR preferences. And they are the ones who will have to give up the rights to $15 to $20 billion in annual net income from Fannie and Freddie–and a $200 billion-plus liquidation preference–for “nothing.” It’s easy for Calabria to say, “go for it”; it’s a much trickier matter for Mnuchin to come up with a defensible rationale for taking that step.

            I’ve been saying for some time that I believe Treasury is looking for political cover to insulate it from the criticism it will receive for “giving away billions of dollars of taxpayer money to hedge funds.” It doesn’t have any more cover today than it had nine months ago, and it won’t have any more in the period between the election and the December oral argument at SCOTUS. I’ve heard the theory that if the president loses, that will free up FHFA and Treasury to push through a settlement and consent decree. But I’ve yet to hear a convincing argument as to why that should be. Indeed, I just as easily can see it running the other way. Mnuchin’s choice essentially will be: (a) “I gave it my best, but we just ran out of time; let’s see what the Ds can do with this,” or (b) “Before I go, here’s $100 billion-plus for my buddies in the private sector.” I’m glad I’m not in the prediction business. Again, this would be more straightforward if it were Calabria’s call, but it’s not.

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          3. Tim, just my two cents. The letter from Senator Warner gives a hint what the Treasury is cooking up. Not wanting to advertise it is understandable knowing how everything this administration does is spun negatively by MSM.

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          4. Tim

            Regarding Mnuchin, and where he has been, I would say that he has been busy. But it seems to me that the math is compelling to Mnuchin…as a price to get the GSEs recapitalized, every dollar the GSE shareholders “get”, Treasury “pays” 20 cents, by virtue of Treasury’s warrant position. As for political cover, I suppose that FSOC putting its imprimatur behind the GSE recap goes a long way, and the political pushback represented by the letter from Sens Warner/Rounds seemed pretty weak to me. The letter’s political pushback was whether a GSE recap was a good financial deal for taxpayers (not whether it was good housing policy), and the answer will be that this is the best financial deal for taxpayers since the Louisiana Purchase. I never quite understood the disconnect over the past 18 months between Treasury’s litigating position (inherited from the Obama administration) and Treasury’s recap the GSEs policy position (a break from the Obama administration). I just think it will be time soon for Treasury’s policy position to win out over its litigating position, most likely more with a whimper than fanfare, as incoherencies usually do. given the tumult over the next few months, no one will notice.

            rolg

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          5. In addition to the disconnect between Treasury’s litigating position on Fannie and Freddie and its (rumored but nowhere explicitly stated) economic position on the companies’ recapitalization, there also is a major disconnect between Calabria’s insistence on greatly overcapitalizing Fannie and Freddie as a condition of their release from conservatorship and Treasury’s position as holder of warrants for 79.9 percent of their common stock, whose value for the foreseeable future would be greatly diminished if Calabria sticks with his May 20 capital rule (as he’s giving every indication of doing). Treasury’s payoff for voluntarily relinquishing its right to Fannie and Freddie’s earnings and asset value thus seems much lower today than it did at the beginning of the year.

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  43. I’m sorry something just doesn’t jibe. Why hire a JP Morgan/Morgan Stanley to recap with a capital plan that is unrealistic?…nope not jibing

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    1. @BIGe

      Pricing.

      if fhfa came out with a realistic capital rule, then the capital raise would be easier, and the common stock price at which the offerings would be executed would be higher. Calabria’s capital rule will be more onerous, making the capital raise harder, making the offering price of the common stock lower. of course, this adversely affects Treasury the most as a 79.9% holder of the common stock, but Treasury would appear to be price insensitive (on the low end).

      the mantra on Wall Street is “we can do this deal for you, but you may not like the price”…but the GSEs are a compliant issuer, because they have no options other than to let the underwriters play the “how low can you go” pricing game, because fhfa and Treasury are sacrificing the GSEs’ common stock price at the altar of “bank like capital” levels.

      rolg

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      1. Did anyone ever answer Vartanian’s question about why new equity would come in since they could be sacrificed on any number of alters at anytime and the courts won’t say boo about it for …oh a decade or so?

        To me, that makes it nearly impossible before getting out of the gate. People forget, sure, but not the kind with the capital required here.

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        1. @anon

          as I read vartanian, he was simply pointing out that the GSEs could not raise any money while in conservatorship, given the unsettled legal status of fhfa’s power as conservator…a point I entirely agree with. of course if scotus were to affirm the APA decision of 5th C en banc, then there would be legal clarity…but in the event there is a settlement before a collins scotus decision, the capital markets should be receptive to offerings from the GSEs once they have been released from conservatorship, likely into a consent decree where the obligations of the GSEs are specified and the fhfa director can no longer exercise conservator powers under HERA….and can not put the GSEs back into conservatorship given their current and prospective earnings.

          rolg

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        2. To me, both the attitude of the regulator and the huge total volume of capital he is requiring are going to pose not just pricing, but potentially feasibility issues for the first public offering the companies make.

          The potential buyer of a new issue of Fannie or Freddie stock has to “back in” to an offering price, by estimating both the future earnings of the companies and the number of new common shares they ultimately will issue to reach full recapitalization (which implies an estimate of the mix of retained earnings to new publicly obtained capital, and also an estimate of the preferred to common ratio of that new capital–and obviously an assumption that the Treasury warrants convert to common). Next, once they have their estimate of common shares outstanding at the time of full recapitalization (call that “Year X”), they’ll need both an estimate of company earnings in that year and a guess at an earnings multiple to arrive at a projected Year X share price. Finally, they will discount that Year X estimated share price back by the return they, as an investor, would require to buy those shares today. The “unfriendly regulator,” past history of political risk, and estimation uncertainties for the various variables in question all would be factors that increase this discount rate.

          I’ve done some rough work along these lines, and given a 4 percent-plus capital requirement and the investor-unfriendly regulatory and political environment at the moment, the first public offering looks like a very heavy lift.

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          2. Tim

            heavy lift indeed!

            as you intimate, one variable that I am sure JPM/MS are looking at is the mix of preferred to common to be offered, which is complicated by Calabria’s preference for common equity capital. given the current rate environment, I expect there to be a receptive market (as always, at a price!) for preferred, but Calabria would either have to loosen his focus on common equity capital (which as I recall was a focus of the Muirfield Capital Global Advisors LLC comment letter), or give common equity capital credit for convertible preferred prior to conversion.

            also, Calabria will have to phase in the binding effects of the final capital rule’s restrictions over time to provide the offerings what I call regulatory runway…about this, I have some trepidation simply because I do not value Calabria’s understanding of the capital markets…JPM/MS will just have to be insistent.

            I have been harping on price because I do not see any player in this offering that is a proponent for maximizing the price of the common stock…which of course is very strange for a common stock offering (in my experience, unprecedented)! Calabria could care less, and it seems that Treasury is price indifferent (a luxury it can afford to have, as it owns more warrants than the day is long). GSEs’ management are indifferent (putting aside the thought that they may actually prefer a low price if they ever are able to get stock options). the junior preferred holders are indifferent (and arguably happy to see a lower common price as well). who at the table is banging for as high a common stock price as possible? the simple answer is no-one.

            I have no idea how low the common stock price will have to go, but I would point out that the common stock will have to be listed on a national exchange in connection with any offering, and so the liquidity haircut now present due to pink sheet trading will disappear. moreover, there will be some price lift resulting from the actual commencement of the capital raise process. all this to say that there is plenty of room for the common stock price to be punished and, given the expected capital rule and the absence of anyone with an economic interest to maximize the common stock price, punished the common stock price will be.

            rolg

            Liked by 1 person

          3. Holding earnings and P/E estimates fixed, the offering common price strictly decreases as the capital required to raise increases. At some point the price crosses the axis, making the raise impossible. This is the point where investors wouldn’t even accept 100% of the common equity (which entails a full wipeout of the existing commons and warrants) for the capital they are being asked for.

            Theoretically the GSEs can raise the needed capital right up to that point assuming that Treasury really is insensitive to price. They have other ways of making money anyway, like partial monetization of the seniors (unlikely) and commitment fees (a virtual certainty). So if Treasury really doesn’t care about the warrants, the GSEs can price the offering all the way down to $0.01 if it can bring in enough capital. A heavy lift is fine, an impossible one isn’t.

            Given that the gap between Calabria’s CET1 and Tier 1 capital standards is only $25B, less than the $33B of outstanding junior prefs, I don’t think he would sign off on any new pref issuance unless the juniors are exchanged for commons. That puts a limit on how much of the common equity the GSEs can offer overall, though. The juniors won’t accept any offer that gives them less than $33B of value, and would likely require more due to the greater uncertainty involved. If the offering price is low enough (meaning the new investors get a bigger chunk of the common equity), the juniors won’t accept an exchange at any price, essentially preventing any new prefs from being issued.

            Also, the more the GSEs’ asset base expands, and it is exploding this year, the higher the dollar amount of 4% becomes. The heavy lift is getting heavier.

            Liked by 2 people

          4. @midas

            I appreciate the comment, but may I suggest that you have set up a straw man by saying “Holding earnings and P/E estimates fixed…” I can’t predict earnings (though I imagine that at end of month, we will see very good GSE Q3 earnings), but I can predict that P/E estimates will fluctuate. this is the whole dynamic created by pricing. every day in the equity capital markets, stock prices fluctuate (and do estimates of earnings, but let’s put that aside) which necessarily affects the P/E ratios for all trading companies. usually these P/E ratio fluctuations are range bound for public companies unless there is unexpected news, but one can expect that for the GSEs, needing to raise the capital required to satisfy Calabria’s capital rule, the P/E ratio will start out substantially less than one may expect, and certainly less than a fully-capitalized GSE would merit…hence common stock pricing will have to suffer, at least at the outset of the capital raising program.

            rolg

            Liked by 1 person

          5. At the risk of being overly simplistic, the price of a share of common stock is some multiple of its earnings (whether trailing, current or future) per share. For Fannie and Freddie today, the earnings component of this equality is the most predictable; the number of shares that will be outstanding when they reach full capitalization is the least predictable, and the multiple the market will assign to their earnings per share is the middle of this “range of predictability,” although probably closer to the high end.

            For the companies’ future earnings, several adjustments need to be made to the figures they’ve recently reported. The most important is to recognize that the significant (positive) benefits for credit losses they’ve been reporting for the last several years–the result of continuing to draw down on the mammoth over-reserving that was done prior to 2012–will turn to a modest (negative) provision for credit losses. Fannie reported an average of more than $3.0 billion in benefits for credit losses in the 2017-2019 period, and at some point fairly soon this should swing to a negative expense (provision for loan loss) of between $500 million and $1 billion (I have not done the numbers for Freddie). And once released from conservatorship under a consent decree, both companies also will need to pay their “periodic commitment fee” for the continuation of the Treasury backstop. Estimates of this vary widely, because it will depend on how Treasury chooses to price it. When I’m doing projections I use $500 million per year for Fannie, but I don’t have much confidence in that number. On the positive side, both companies will attempt to raise their average guaranty fee rates to increase the return on the (excessive) amount of capital they likely will be required to hold. But raising guaranty fees also will cut down on, and perhaps even reverse, their business growth, so holding the size of their business constant is probably the most reasonable assumption.

            But as I say, the earnings are the easy part. There are many unknowns and interactive variables in doing an estimate of the amount of new shares that will be need to be issued to reach full recapitalization. If I were looking at an investment in the companies (and to be clear, I am not), I would do a large number of projected scenarios with varying assumptions of variables including the mix of retained earnings to new equity issues, the proportion of preferred to common raised, and what (if anything) is done with the existing junior preferred, and see if there is a “central tendency” for the number of new shares likely to be issued before the companies fully meet their capital requirements (with some excess reserving also assumed, since it will be prudent for the companies to have those). That median estimate of shares outstanding (which would include the warrants converted to common) would give me the shares (“s”) to divide into my projected earnings (“e”) and thus a future eps estimate at time of full recap.

            Then I’d need an earnings multiple to get a share price. What should that be? Unfortunately, the further one goes out into the future the more difficult it is to estimate. Fannie and Freddie’s p/e ratios can be thought of in terms of two components: the market multiple (say of the S&P 500), and their relative multiple. The companies always have sold at a significant discount to the market multiple, for two reasons: one, they’re financials (which sell at discounts) and two, on top of that they have political risk (which has increased in recent years). Today the earnings multiple of the S&P 500 is close to 30:1, far above its historical average. This is mainly because interest rates are so low. The farther one goes out into the future, the more likely it would seem that market P/Es will “regress to the mean,” which for the S&P 500 is a LOT lower than it is today. And the Fannie and Freddie relative multiple is no easier to estimate.

            I’m sure Fannie and Freddie’s investment bankers are doing all of the analyses I’ve outlined above, but I don’t know what sorts of results they’re seeing. Whatever they are, however, the bankers will either use these analyses to try to convince new investors of the value of the stock at the offering price they recommend, or they will say to the companies, and FHFA, something along the lines of “at the level of capital that’s being required, and with the transition rules as currently posed, there is not a feasible way to begin recapitalizing with new equity at this time.”

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          6. Tim

            while I agree with what you say, I just believe that the standard question, what is Fannie/Freddie’s P/E, is not going to be a given fixed multiple of steady state earnings, determined based upon baseline characteristics of the business/political risks, it will be depressed at the beginning of these capital raises, and increase over time as the capital raises are successfully executed to a steady multiple. No company that is going to raise this amount of capital will have a single multiple throughout the program. and I believe that you will never see JPM/MS say at the outset, this is a bridge too far. they will say, for this first capital raise, here is the price that clears out our book. GSEs’ management will likely be displeased with this price, but will be “assured” that the next capital raise will be at a price (multiple) more to their liking.

            rolg

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          7. I’m not suggesting that either company will have a “single [p/e] multiple throughout the [capital raising] program.” I believe that because of all of the uncertainties associated with the recapitalization, the p/e multiple used to price the initial capital raise will be extremely low, and that–assuming the first issuance is successful–the p/e will rise over time with future issues. But I disagree with your statement that there is no such thing as a “bridge too far” for the investment bankers to cross. There is some share price at which the dilution caused by the large number of shares that have to be issued (because of that low price) LOWERS the p/e that will apply to the subsequent capital raise, and thus makes the ultimate capitalization objective unachievable. I have not attempted to estimate what that “death spiral” share price is, but I wouldn’t be surprised if a 4-plus percent capital requirement puts us close to, if not below, it (the bankers will know, at some point). And I’ll say one other thing. The excessive capital requirement has two effects. The first is obvious: you have to raise that much more equity. The second effect is not as obvious, but equally important: the more capital you require, the further into the future you push the point at which the exercise is completed. And the longer the process takes, the more the uncertainties associated with it compound and feed back on themselves, raising the discount rate investors apply to the process as a whole. At some point they simply say, “that’s too much uncertainty for me; I’m not going to play, at any price.”

            Liked by 1 person

      2. Tim,

        An excellent writeup as always. It amazes me that Calabria talks about obeying the Rule of Law, and then talks out of the side of his mouth. Your writeup is well thought out and answers some of the ‘end game’ questions I had in earlier posts. Assuming the 4% is sacrosanct, rationality will return when Calabria is gone — either forcibly or at the end of his term.

        ROLG,

        This is extremely well stated on your part. It is very possible the highly-paid underwriters will simply do a deal at any (presumably low) price. This of course will be taken out of the hides of the current Common Shareholders.

        Calabria appears to be a stubborn mule on his 4% capital threshold. His Libertarian underpinning(s) are strong and to a fault IMO. Keep up the great comments!

        VM

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        1. I guess when Calabria mentioned there will be no ‘’windfall’ for shareholders in the past, he had the 4% capital rule on his mind.

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  44. ” their market risk is low because their guaranty fees are locked in up front and tend to be recaptured (and can be increased) when mortgages refinance”

    This is true today, but it wouldn’t necessarily be true always. If there were additional guarantors (private or government), mortgage holders could refinance away from a GSE and take those contractual G-fees with them to the new guarantor. This would decreases the reliability of those future G-fees and increase the volatility of the capital levels.

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    1. @ Patrick

      yes, but this gets at Calabria’s oft-mentioned remark about the supposed benefits of competition to the GSEs….how many alternative MBS guarantors do you expect to arise to compete against two trillion dollar entrenched guarantors? if someone at a tbtf bank submitted a business plan to enter this market (even if there is legislation expanding the federal charter), this would be career suicide. this gets at what galls me about Calabria…he has no market sense or savvy. anyone with common sense would realize that if you wanted to expand the universe of MBS guarantors, you would first have to break up the GSEs, as no-one is going into the business as the market landscape exists…and talk about winding down the GSEs seems to have thankfully dissipated.

      so net net, GSE guarantee fees as a counterbalance to losses are money good.

      rolg

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      1. Can’t the big banks enter the MBS guarantor market? How about AMBAC? What companies guarantee the jumbo market? Can’t they enter?

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        1. @zak

          this is a putrid area of the investment landscape that I know something about, as I studied the monoline insurers extensively at time of GFC (in connection with handicapping the putback litigation they all brought against the tbtf mortgage originators). the muni monoline guarantors such as MBIA, AMBAC, Assured Guaranty etc all thought in mid 2000’s that if insuring muni debt was so easy they would insure PLS MBS and CMBS. they all got their heads brutally handed to them (though Assured Guaranty less so than all of the others). None of these players would go near insuring MBS and CMBS today (indeed, only Assured Guaranty would have the wherewithal to even consider it), and their miserable experience guarantying MBS and CMBS stands as a cautionary tale for any other institution that might consider it. turns out the GSEs’ business execution is not that easy to replicate.

          rolg

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    2. Patrick: Fannie and Freddie’s guaranty fees ARE locked in up front, and remain fixed for the life of the loan. And I said they “tend” to be recaptured– allowing for some refinance leakage. In fact, for the past 30 years Fannie and Freddie have had close to a 100 percent recapture rate, and indeed during refinance waves their volumes of outstanding credit guarantees almost always have grown, sometimes sharply. The assumption about the creation of new credit guarantors is not one that is sensible to be making today. Should Congress pass legislation permitting them, and should anyone start them and some be successful, then, as their market share increases the credit guarantor regulator could apply an appropriate “haircut” to Fannie and Freddie’s future guaranty fee streams to account for this effect. In its proposed capital rule, FHFA effectively applies a 100 percent haircut to Fannie and Freddie’s ongoing guaranty fees–the polar opposite of the zero percent leakage that has typified the companies for the last three decades. That is not defensible.

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      1. Fair points, thank you for the comment.

        “…indeed during refinance waves their volumes of outstanding credit guarantees almost always have grown, sometimes sharply.”

        I am curious if you are inclined to indulge — why have GSE outstanding credit guarantees usually grown during refi waves? That’s an interesting trend with no obvious reason jumping to my mind.

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        1. I’m not sure what the main reasons are behind the correlation between high mortgage liquidation rates and a faster growth in Fannie and Freddie’s credit guaranty business–it’s likely some combination of the fact that housing starts, sales, and prices all tend to grow faster when interest rates are low, and a shift in investor mortgage preferences–away from whole loans towards MBS–when refinancing is strong. Whatever the reasons, though, the correlation is well documented, and we’re seeing it again this year. During the previous three years–2017 through 2019–Fannie’s annual MBS liquidation rates stayed within a relatively narrow range of 14 to 17 percent, and its annual business growth was both fairly low (an average of 3.5%) and consistent, ranging from a high of 4.2% in 2017 to 3.0% last year.
          But so far in 2020 (through August), Fannie’s MBS liquidation rate is running at an annual rate of 29%, and the growth in its guaranty book of business has accelerated to an annual rate of 10.4%.

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  48. Tim,

    1. Why do you suppose FHFA even bothered to invite comments on the proposed capital rule, especially given the fact that Dr. Calabria made no attempt to respond to formidable criticism?

    2. Do you suppose the thoughtful and overwhelmingly negative comments came as a complete surprise?

    Bewildered,

    Ron

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    1. Ron: On (1), proposed rules have a comment period as a matter of process. On (2), I don’t know that Calabria was surprised by the number and the intensity of the negative comments FHFA received on the rule, but he very likely was unhappy with them. In fact, I suspect the negative comments from Fannie and Freddie were what triggered his “worst corporate culture” remark about them.

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      1. Tim

        I have been trying to understand Calabria’s unexplained/unsubstantiated “worst corporate culture” accusation. One may wonder, given the absence of any corporate business experience on Calabria’s resume, how he might have come to this conclusion objectively…which leads me to suspect that Calabria’s accusation was motivated more by ego and pride than developed business judgment.

        I recall Calabria’s HFSC testimony recently where he stated emphatically (and somewhat dismissively) that no one will have to pay more for their mortgages because of the proposed capital rule because it will be phased in over time. His body language and intonation showed real disdain when he said this. Now, this assertion may or may not prove to be true, but whether it will be true depends upon many variables relating to the GSEs business models and the state of the capital markets, about which no one can predict with assurance…but whose prediction would seem more reliable, the GSEs themselves who run these businesses, or their academic/think tank regulator? so when both GSEs predicted a substantial G fee raise caused by the proposed capital rule in their formal comments, it does seem to me that Calabria’s reaction was to ‘take it personally”, and reveal an egocentric bias to the whole capital setting process.

        If this is the wrong take, then the onus is on Calabria to explain himself.

        rolg

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        1. I did not sit through (or read the transcript of) the entire HFSC hearing, but when I heard Calabria make the “no one will have to pay more for their mortgage” comment he was referring to the proposed 0.5 percent upfront fee Fannie and Freddie had proposed for refinances. And that very likely was true. People refinancing their mortgages do so in response to a drop in mortgage rates and to get a lower monthly payment, and even with the refi fee (which for loans at the low rates prevailing at the time would probably amount to only an extra 5 or 6 basis points per year) borrowers still would be saving money, compared with their previous monthly payment. If Calabria also DID say that moving from around 3 percent capital (which is what Fannie and Freddie are pricing to now) to over 4 percent capital would result in neither higher guaranty fees nor higher mortgage rates–whether the higher capital is phased in or not– then, yes, as Ricky Ricardo would say, “he’s got some ‘splainin to do.”

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