Then, and Now

In an interview on November 30, 2016, Treasury Secretary-designate Steven Mnuchin said, “It makes no sense that [Fannie Mae and Freddie Mac] are owned by the government and have been controlled by the government for as long as they have,” adding, “we gotta get them 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.” More than four years later, on January 14, 2021, Mnuchin and FHFA Director Mark Calabria signed a letter agreement allowing Fannie and Freddie to continue to retain earnings in an amount up to 4 percent of their adjusted total assets (with a dollar-for-dollar increase in Treasury’s liquidation preference), but stopping far short of getting them “out of government control.” To the contrary, the letter agreement mandated that each must remain in conservatorship until all material litigation relating to the conservatorship is resolved or settled, and their common equity tier 1 capital equals at least 3 percent of their assets for two or more consecutive calendar quarters.  

What went wrong? Readers of this blog might have had a sense that something like this would happen. In a post published last January, titled “How We Got to Where We Are,” I wrote, “It is difficult to evaluate the wide range of opinion about how best to end Fannie Mae and Freddie Mac’s conservatorships, or the alternatives Treasury and FHFA now have for doing so, without an understanding of the political battles that have engulfed the companies over the past two decades, which I call ‘the mortgage wars’.” After a brief summary of that history—highlighting the deceptions and false claims from critics and opponents of the companies seeking legislation to replace them with a secondary market mechanism more advantageous to primary market lenders—I then said:    

“Today, [Mnuchin] and FHFA director Mark Calabria both understand that the only way to make good on Mnuchin’s pledge is through administrative reform. But neither, I believe, has fully come to grips with the crucial fact that in switching between these two tracks, the fictions about Fannie and Freddie that were essential elements of the attempt to replace the companies in a legislative process become impediments when the goal is to successfully recapitalize and release them in an administrative process.

If the best economic result were the overriding objective, getting Fannie and Freddie out of conservatorship would be no more difficult than it was to get them in: Treasury would settle the lawsuits by unwinding the net worth sweep and canceling its liquidation preference; FHFA would specify a true risk-based capital standard without excessive conservatism—making the companies attractive to new equity investors—and based on their updated capital requirements Fannie and Freddie each would prepare capital restoration plans for FHFA’s approval….But that’s not how process will work, because of two carryovers from the failed legislative efforts of the past. The first is that the Financial Establishment and its supporters remain committed to their twenty-plus year goal of hamstringing Fannie and Freddie’s competitive position, and are hoping to accomplish this in administrative reform by convincing FHFA to subject the companies to excessive and unnecessary required capital and burdensome regulation by using the arguments of promoting safety and soundness and a ‘level playing field’ for new competitors. The second is that Treasury as of yet has shown no signs of moving away from the false claims it’s been making about Fannie and Freddie since before the conservatorships, which it must do if it wishes them to be able to raise new capital.”

As is now evident, neither Calabria nor Mnuchin were willing or able to break free of their prior non-economic policy objectives for Fannie and Freddie, or their fictionalized versions of the companies’ business, performance during the financial crisis, and current levels of credit risk. Ultimately, this doomed the chance of Fannie and Freddie being released from conservatorship before the end of the Trump administration last Wednesday.

Director Calabria bears the brunt of the blame for this failure, in my view. The Housing and Economic Recovery Act (HERA) states that “the Director shall, by regulation, establish risk-based capital requirements for the enterprises to ensure that the enterprises operate in a safe and sound manner, maintaining sufficient capital and reserves to support the risks that arise in the operations and management of the enterprises.” Calabria dismissed this clear directive to base Fannie and Freddie’s capital on the risks of the loans they guarantee, and instead imposed on Fannie and Freddie a 4 percent minimum capital requirement taken from the Basel bank standards—in spite of the fact that the companies are not banks, have no business or activity in common with banks, and for the last three decades have had credit loss rates one-sixth those of the commercial bank credit loss rates published by the FDIC. Then, to purportedly be in compliance with HERA, Calabria produced a risk-based standard with enough cushions, elements of conservatism and buffers to push its required capital first near (in the May 20, 2020 rule) and then above (in the final standard, the December 17, 2020 “Enterprise Regulatory Capital Framework”) his bank-like minimum.  

Calabria’s arbitrary and unjustified capital rule had three negative effects on the process for releasing Fannie and Freddie from conservatorship. Most obviously, it resulted in an excessively large amount of capital (nearly $300 billion) they had to retain or raise before they could be deemed adequately capitalized. Second, having to hold far more capital than needed to cover their worst-case credit losses will force the companies to significantly increase their guaranty fees, making them less competitive and reducing their growth and value. Finally, a capital standard so evidently, egregiously and deliberately misaligned with the risks of Fannie and Freddie’s credit guaranty business signaled a degree of regulatory hostility certain to deter potential new investors from putting equity into the companies.

Treasury holds the key to the release of Fannie and Freddie from conservatorship: it must approve that release, and of course no new capital will be invested in the companies as long as the net worth sweep is in effect and Treasury retains its liquidation preference. Since the first lawsuit against the sweep in the spring of 2013, Treasury has consistently maintained that the sweep was legal, and a reasonable business judgment by it and FHFA. This posture put Mnuchin in the position of needing an extremely good reason for canceling the sweep and relinquishing the liquidation preference voluntarily, as these would be, and be seen as, significant concessions. Delivering on his promise to release Fannie and Freddie from conservatorship might have been such a reason, but the FHFA capital requirement put this out of reach. With Calabria requiring the companies to have close to $300 billion in capital to be considered “safe and sound,” Mnuchin could not credibly allow FHFA to release them from conservatorship, even under a consent decree, with only the $35 billion in capital they have currently, nor could he assure anyone that the additional capital could be acquired over any specified period of time. Thus deprived of the “win” of being able to authorize a definitive release from conservatorship, Mnuchin had no reason to give up the net worth sweep and liquidation preference, making his, and Director Calabria’s, best alternative the January 14 letter agreement, kicking the problem to the Biden administration.           

But that was then; what will happen now? Barring a dramatic shrinkage in the size of their business (which may be an objective of the Calabria capital rule), it would take Fannie or Freddie longer than the end of the new administration that just began last week to achieve 3 percent capitalization through retained earnings alone. But this should not be their fates, because neither of the factors that impeded their release from conservatorship during the Trump administration—the non-economic policy agenda imposed upon them, or the stubborn adherence to a fictionalized version of their past and present roles in the market and risks posed to taxpayers—are likely to persist in a Biden administration.

Fannie has been political since it was spun out of the government in 1968, and Freddie since its creation in 1970. Through the late 1990s, both enjoyed strong bipartisan support in Congress. Yet even during this period, Republican and Democratic administrations had different policy objectives for them. In general, Republican administrations sought to limit or roll back the benefits conveyed to the companies by their federal charters, which they believed gave Fannie and Freddie unfair advantages over their private sector competitors. (Banks were considered “fully private,” even though they benefit greatly from government guarantees on their consumer deposits.) Democrats, in contrast, supported those charter benefits, but wanted the companies to use them to do more affordable housing business, at lower returns, than company management and shareholders would have done themselves.

These same philosophical differences exist today. Mark Calabria is an extreme example of the school of “neutralizing Fannie and Freddie’s benefits through overcapitalization and overregulation,” while the majority of the members of the Biden economic team should view the companies as vehicles for helping to make housing finance affordable to as broad and diverse a group of potential homebuyers as possible. This opposite orientation is likely to result in a more favorable dynamic for a successful release from conservatorship than was in evidence during the Trump administration—particularly if, as I and many others expect, the Supreme Court rules for the plaintiffs in the Collins case this spring.   

Plaintiffs are asking the Supreme Court to uphold the decision by the Fifth Circuit en banc that the net worth sweep was a violation of the Administrative Procedures Act (APA), and also to uphold the Fifth Circuit decision that the director of FHFA is unconstitutional while reversing the remedy of prospective relief and granting relief retroactively in the form of a voiding of the net worth sweep. I am skeptical that plaintiffs will prevail in their request for retroactive relief on the constitutional claim, but I believe the Court is very likely to uphold the Fifth Circuit’s ruling on the unconstitutionality of the FHFA director, and extremely likely to uphold the Fifth Circuit’s finding that the net worth sweep is a violation of the APA. If these predictions prove correct, the APA issue would be remanded to the District Court for the Southern District of Texas for trial on the facts, while the Fifth Circuit’s decision on the FHFA director would stand, allowing President Biden to remove Director Calabria at will (although Calabria may challenge that action, adding some time to the process).

A win by plaintiffs on the APA claim would give Secretary Yellen a rationale for initiating settlement talks, together with the political cover Mnuchin wished for but never felt he had. Treasury will not want a trial on the facts in Collins, and it may not even want to get to the motion to dismiss stage. As I documented in my amicus curiae brief for the Supreme Court, the facts overwhelmingly contradict Treasury’s claims that the conservatorships were legitimate rescues of the companies, and that the net worth sweep was a reasonable judgment about the best way to help them continue to pay their dividends. Moreover, documents produced in discovery in the Court of Federal Claims show Treasury officials knew Fannie and Freddie were about to experience a surge in earnings from the reversal of estimated or artificial losses booked by FHFA, and discussed among themselves and others that the purpose of the sweep was to prevent the companies from retaining those earnings. These “bad facts” give plaintiffs a very strong hand in settlement negotiations, and should produce a result for them nearly as favorable as the granting of a motion to dismiss.

A second favorable decision from the Supreme Court, upholding the Fifth Circuit’s ruling on the unconstitutionality of the FHFA director, should lead President Biden to quickly ask for Mark Calabria’s resignation, for two reasons. First, a win by plaintiffs on the APA claim will make it clear that Fannie and Freddie cannot be kept in conservatorship indefinitely, and the Calabria capital rule is the main impediment to attracting the private capital necessary to permit their timely release. Second, as I noted earlier, I believe most of Biden’s economic team will not be nearly as ideologically hostile to the companies as Calabria is, and will understand the benefits of a Fannie-Freddie capital rule that meets a stringent standard of safety and soundness but does not go so far beyond that as to impede (or, in the case of the Calabria rule, cripple) the companies’ abilities to carry out their chartered missions.

The fact that Calabria so evidently ignored the readily available data on bank, Fannie and Freddie credit losses when he imposed the 4 percent Basel bank minimum capital standard on the companies’ credit guaranty businesses will make it easier, and less controversial, for a Biden-appointed FHFA director to set a new, more effective, and much lower risk-based capital requirement for them, in turn justifying a much lower minimum. My “Comment on FHFA Capital Re-proposal” identifies the relevant historical data the Biden team can draw on and cite as a basis for coming up with a true, data-driven risk-based standard, while the final section of the comment (“FHFA must re-do, and greatly simplify and clarify, its risk-based capital standard”) offers suggestions for structuring the standard in a way that will make it transparent, understandable, and defensible to advocates of taxpayer protection and affordable housing alike.

Director Calabria may have thought he was “hard-wiring” his final capital proposal when he got Secretary Mnuchin to agree in the January 14 letter that Fannie and Freddie could only be released from conservatorship, even under a consent decree, when their common equity tier 1 capital reached 3 percent of their adjusted total assets for two consecutive quarters. Changing that now requires Secretary Yellen’s concurrence. But that will be good, because it will ensure that she and her senior staff engage in the development of the new capital rule. Yellen not only is Treasury Secretary, she also is chair of the Financial Stability Oversight Council (FSOC), which had this to say about the Calabria rule: “Risk-based capital requirements and leverage ratio requirements that are materially less than those contemplated by the proposed rule would likely not adequately mitigate the potential stability risk posed by the Enterprises.” Yellen’s involvement in the development of a data- and fact-based version of the capital rule, to which she is committed, should be sufficient to gain the FSOC’s support for the new rule. That will be important when it comes to setting the periodic commitment fee for the continuation of the Treasury backstop. If the financial regulatory community is in agreement that the revised capital standard is indeed rigorous, this fee will be much lower.

The cancellation or unwinding of the net worth sweep—whether through a ruling by the Supreme Court granting retroactive relief on the constitutional issue, settlement of the lawsuits, or a successful motion to dismiss by plaintiffs in the Southern District of Texas—a new risk-based capital standard based on historical fact rather than ideological fiction, and a reasonably priced periodic commitment fee would make the path to recapitalizing and releasing Fannie and Freddie from conservatorship far easier for the Biden economic team than it turned out to be for the Trump team. In particular, a sensible capital requirement would enable FHFA (with Treasury approval) to greatly shorten the time at which Fannie or Freddie could be released from conservatorship under a consent decree, perhaps by tying that release to the closing of an equity issue that hits some threshold percentage of “adequately capitalized,” and it also would allow the companies to raise capital more easily, and on better terms, by making them more attractive as investments.

Nothing in Washington ever happens ideally or smoothly, but the elements now appear to be in place to finally produce an end to the twelve-year conservatorships of Fannie Mae and Freddie Mac. The keys, in my opinion, will be whether the Biden team is willing to abandon the fictions about Fannie and Freddie in favor of the facts and data, and to replace the Calabria capital rule with one that works for the companies and homebuyers rather than banks. I believe it is in the best policy interests of the Biden administration to do both, and that it will.  

74 thoughts on “Then, and Now

  1. ROLG and/or Tim

    1. Should SCOTUS or Texas Court wipe out the balance due on the Senior Preferred to Zero, could Shareholders, or Fannie and Freddie themselves, sue to be let out of conservatorship (i.e. no real debt)? It seems to me (based on the new letter agreement) the ball is still in Treasury’s court and it wouldn’t necessarily be incentivized to end the conservatorship.

    2. Do either of the other two major suits come with financial damages directly awarded to shareholders, should Plaintiffs win those?

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    1. I don’t believe shareholders would have standing to sue to have Fannie and Freddie removed from conservatorship (and the companies certainly would not). But if the net worth sweep were declared void and unwound, it would become clear that Fannie and Freddie could not be kept in conservatorship indefinitely; the question would shift to when and under what conditions they could be released. At the moment those conditions, and that general timetable, have been set by Calabria and Mnuchin in their January 14 letter agreement, although they could be changed by a new FHFA director appointed by Biden, with agreement from Treasury Secretary Yellen.

      The “other major suits” are the breach of contract claim before Judge Lamberth and the regulatory takings suits in the Court of Federal of Claims. These all are derivative suits, meaning that were damages to be awarded they would be paid to the companies, not shareholders.

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    2. @EdM

      perhaps another way to consider your question is whether remaining in conservatorship would be a bar to raising substantial capital IF SCOTUS affirms the 5th circuit en banc collins opinion regarding the statutory APA claim. if it is clear going forward that the conservator has a duty to rehabilitate the GSEs, then perhaps the GSEs will be able to raise money while still in conservatorship. of course, SCOTUS would not find that the NWS violated this rehabilitation duty, it would only remand to district court for trial/summary judgment on the question. so my own view is that no capital could be raised in conservatorship until, at the earliest, Collins Ps win on summary judgment that voids NWS.

      rolg

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  2. Tim

    I found this news blurb interesting (IMF): “Commercial banks and savings institutions beefed up their MBS holdings in the fourth quarter of 2020, showing strong appetite for pass-through securities issued by Fannie Mae and Freddie Mac.

    A new Inside MBS & ABS analysis of bank call reports shows the industry held a record $2.521 trillion of single-family MBS at the end of the year. During the fourth quarter, banks added $210.48 billion to their mortgage-securities holdings, a 9.1% increase from the prior period.

    Investment in pass-through securities issued by the two government-sponsored enterprises surged 13.9% to $1.538 trillion.

    Bank of America, the largest MBS investor in the banking industry, added $108.26 billion of GSE pass-throughs to its portfolio during the fourth quarter. The bank also shed $13.67 billion of Ginnie Mae MBS during the period and reduced its holdings of agency collateralized mortgage obligations by $1.07 billion.”

    I know you have argued that with the prospect that the GSEs will increase G fees to be able to meet excessively high GSE capital levels, banks will obtain additional profits from their whole mortgage loan and PLS portfolios. However, to be able to fund a mortgage pipeline, banks have to navigate the headaches of managing a wholesale/retail mortgage finance operation, with attendant management time, expense and regulatory compliance. While nonbank lenders are increasing their percentage of the primary mortgage business (think Rocket mortgage), it seems banks are increasing their exposure to the mortgage finance market by investing in GSE guaranteed mbs. from a bank management POV, this can be done on a six foot long trading desk without the transaction costs involved in doing the dirty work of originating/buying mortgages.

    do you see this as a real market shift, and if so, wouldn’t this be favorable for the GSEs?

    rolg

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    1. The change in bank holdings of single-family first mortgages–both whole loan and MBS–since Fannie and Freddie were placed in conservatorship is something I’ve written about frequently (most recently in my “Comment on FHFA Capital Re-proposal”). I get my data from the FDIC, which as yet has not put up figures for December 31, 2020. But between March 31 and September 30, bank holdings of single-family mortgages and MBS rose from $3.872 trillion to $4.041 trillion, an increase of $169 billion, or 8.9 percent at an annual rate. Of that increase, however, virtually all of it came in holdings of Fannie or Freddie MBS, CMOs and REMICs; those rose by $161 billion–or at an annual rate of 23.0 percent–continuing a trend that has been evident since the end of 2007. Then, 28.9 percent of banks’ holdings of single-family first mortgages consisted of Fannie or Freddie securities; as of September 30, 2020 Fannie and Freddie securities made up 40.5 percent of that total. (These dollar numbers are lower than the ones you cite from Inside Mortgage Finance, which include second mortgages, home equity loans and commercial mortgages and MBS; my analysis focuses on single-family firsts.)

      Are these increased holdings by banks good for Fannie and Freddie? In the sense that it’s demand for the only product the companies now produce, I suppose they are. But at a broader level, they also show that banks have clearly been “winners” in mortgage market share since Fannie and Freddie were put into conservatorship. And we haven’t yet seen what the effects will be once the companies either begin, or are required by FHFA, to price their business to the new capital requirements that just went into effect this week, which are more than 70 percent greater than the capital levels that led to the guaranty fees that produced the share effects I’ve documented above.

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  3. Tim: I heard Tim Pagliara call you the “Professor,” which is an apt and well deserved nickname. Thanks for your insightful contributions over the years. I’m just curious if you believe that incremental progress has been made on ending the conservatorships over the last several years, or if a lot of what has occurred is just wheel spinning. It seems to me we take 3 steps forward and 2 steps back. Do you think this will be resolved during the Biden administration? I suppose any optimism there is dependent on a SCOTUS affirmation. I’m trying to wrap my head around a realistic timeline, knowing we’re already 12 years deep, and that these political footballs keep getting punted.

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    1. I think in the last few years there have been three significant steps towards releasing Fannie and Freddie from conservatorship. The first is that what I call the Financial Establishment has effectively given up in its quest to replace the companies with a secondary market mechanism more to its liking (due, I believe, to a combination of not having been able to come up with anything that works as well as Fannie and Freddie do, and the realization that it’s highly unlikely anything they did come up with would be able to pass in Congress). That means there now is consensus around TINA (“there is no alternative”) for the companies. Second, after a string of losses in the net worth sweep cases in the lower and appellate courts on points of law, the Fifth Circuit en banc finally ruled for plaintiffs in the Collins case, and this ruling has gone before the Supreme Court, which is close to rendering its decision. And third, the Director of FHFA, Mark Calabria, is on record stating that he believes the net worth sweep is illegal (although he has not been successful in getting Treasury to eliminate it, if indeed he has tried).

      It is highly unlikely that any further moves will be made toward releasing Fannie and Freddie from conservatorship until the Supreme Court rules on Collins. At the moment I don’t think anyone on the Biden economic team is paying much attention to this issue, given everything else on its plate. A SCOTUS decision on the net worth sweep case, however, will put the Fannie-Freddie issue squarely on the table, whichever way it goes.

      It’s foolish to try to make predictions about the futures of Fannie and Freddie until we know the outcome of the Collins case at SCOTUS. What I will say, though, is that what happens to them will depend heavily on who in the Biden administration takes the lead on the issues relating to the companies, and what their policy and political objectives for them are. In the Trump administration, it seems clear that Treasury Secretary Mnuchin started out as the lead on Fannie and Freddie, but that Calabria was able to seize that role through his actions as conservator and role as regulator–for the latter, through his capital rule. The terms Calabria set for Fannie and Freddie’s required capital proved too difficult for Mnuchin to use in crafting a release proposal that would justify his giving up the net worth sweep and Treasury’s liquidation preference voluntarily, so he ended up kicking the problem to his successor, Janet Yellen.

      As I said in my current post, I believe it’s unlikely that either Yellen or a potential successor to Calabria as FHFA director (assuming president Biden is able to remove him) will share Calabria’s objective of marginalizing Fannie and Freddie through overcapitalization and overregulation, and instead will want the companies to be able to function effectively in support of the administration’s goal of providing broader and less expensive access to affordable housing. Until someone steps up and announces a policy towards the companies, however, this is only speculation. But if the Biden administration does want Fannie and Freddie to be successful, bringing them out of conservatorship will be neither difficult nor time-consuming.

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      1. Tim

        this was well put, and it puts into stark relief the curious role Calabria has played. On the one hand, the movement towards conservatorship release over the past four years is striking (first judicial opinion that recognizes conservatorship duty, the evaporation of alternatives to the GSEs being floated in think tanks and congressional halls, recognition that GSEs play a systemically important positive role in national economy and not just present a systemic risk etc) and it seems that, as you put it, Calabria’s excessive capital conservatism was the primary roadblock to the execution of a Trump administration recapitalization plan. Assuming, as I do, that Calabria will be replaced soon after the SCOTUS Collins decision, one wonders whether the execution of that plan will become feasible…and how long it will take if one assumes, also as I do, that Calabria’s replacement will want to put a personal stamp on that plan (whether substantive or cosmetic).

        rolg

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        1. Is your assertion that Calabria tied Mnuchin’s hands based solely on your own assessment or is there some information you’re privy to thats not public? I just find it incredible that mnuchin would approve the hiring of a person who would later utterly screw him.

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          1. I don’t believe Calabria “tied Mnuchin’s hands” deliberately, nor do I know that Mnuchin “approved” of the appointment of Calabria as director of FHFA—he simply may not have opposed him. And my assessment of why Mnuchin and Calabria were unable to deliver on the former’s promise to get Fannie and Freddie out of government control during the Trump administration does not draw on any nonpublic information; it’s based on my analysis of what both officials said and did.

            Over a year and a half ago, in a post titled “Assessing the FHFA Capital Rule,” I wrote: “FHFA’s revised capital proposal is due to be released shortly, so it was with considerable concern that I read the recent spate of comments by the new FHFA Director, Mark Calabria, repeating the general (and insupportable) assertion that ‘Fannie and Freddie ought to operate under essentially the same capital rules as other large financial institutions’…. Potential investors in a recapitalization of Fannie and Freddie should pay close attention to where FHFA comes out on this proposal, because it will be a window into the agency’s likely regulatory posture with respect to the companies post-conservatorship. At the one extreme, if FHFA makes only minor changes to its June 2018 capital proposal, this would strongly indicate that it intends to favor ideology and politics over economics in its future regulation, which should be a bright red light for any investor with a functioning memory.”

            As we now know, Calabria did even worse than make “only minor changes” to the June 2018 proposal; he made the final capital rule aggressively bank-like, raising the level of capital Fannie and Freddie would need to achieve to meet Calabria’s definition of “adequately capitalized” by more than 70 percent. Just as even I didn’t expect him to do that, Mnuchin had no reason to expect it either. And, as I discuss in the current post, Calabria’s insistence on using overcapitalization to redefine the companies’ roles in the mortgage market was not only a “bright red light” for potential new investors, it also was an insurmountable hurdle for Mnuchin to overcome in devising a workable plan to remove Fannie and Freddie from conservatorship in the short time he had left between the publication date of the final capital rule and the inauguration of president Biden.

            A simple way of thinking about what happened is that Calabria had two objectives: removing Fannie and Freddie from conservatorship, and using his capital-setting authority to attempt to reshape their business according to his ideological beliefs as to how they should operate. His utter inflexibility on the second objective doomed the success of his first, and there was nothing Mnuchin could do about it.

            Liked by 1 person

          2. Tim- It is my understanding that FSOC which is chaired by the Treasury Secretary blessed the Calabria capital rule. Wouldn’t that have been the opportunity to push back?

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          3. In theory, yes. But in practice that wasn’t going to happen, for two reasons. First–and probably most importantly–Treasury as an institution has been an opponent of Fannie and Freddie, and an advocate of using “bank-like capital” to reduce or eliminate the advantages of their federal charters, for decades. Calabria knew that, which leads to the second point: he took advantage of not just Treasury’s predisposition, but also that of the other banking regulators on the FSOC, to gain their support for his 2020 capital proposal on “safety and soundness” grounds. I doubt that anyone on the FSOC understood that deliberately overcapitalized, non-competitive companies would be very hard to reintroduce to the market as shareholder-owned entities. To the contrary, there still is a widely-held misperception that overcapitalization isn’t really a problem–the companies will just raise their guaranty fees by 20 basis points or so, and everyone will be happy. As I discussed in my FHFA capital comment, however, it’s not that simple: there are market constraints as to how high Fannie and Freddie can raise their guaranty fees before the business either goes somewhere else, or doesn’t get done at all.

            Getting Fannie and Freddie out of the box they’re now in–having an excessive and unjustified capital requirement, and a regulator who seems perfectly happy to leave that requirement as it is, and let the companies meet it through retained earnings, irrespective of how long that takes–will require not just a new director of FHFA appointed by Biden, but also a much better understanding of the economics of Fannie and Freddie’s business by the key members of the Biden economic team, who ultimately will determine Fannie and Freddie’s fates. “Magical thinking” about the dynamics of that business won’t cut it, just as that has failed for those who over the past twelve years have proposed ways to replace Fannie and Freddie with their preferred alternatives.

            Liked by 1 person

    1. Thanks. I’ll read your piece after I finish reading Fannie Mae’s 2020 10K. I tend to read the quarterly 10Qs selectively–focusing on certain sections in which I have the most interest–but the “K” I read completely. I’m only up to about page 80, but so far this one contains a lot of valuable information. I’ll mention a couple of “headline” revelations. The first is that Fannie has not yet begun to price its business in accordance with the November final capital rule (something I had been wondering about), but expects to do so “sometime in 2021.” That delay is interesting, to say the least. Fannie notes that FHFA had given it minimum guaranty fees based on its previous (June 2018) capital standard and a “minimum ROE target.” If FHFA does the same thing for the new capital rule, it has the power as conservator to mandate Fannie (and Freddie) to raise guaranty fees to levels that are non-economic for a good portion of their business. If I were Fannie I would want to delay that for as long as possible (while hoping that the Biden administration replaces Calabria with a director who isn’t intent on using an unjustifiably high capital requirement to make then non-competitive). Fannie also disclosed that as of December 31, 2020 its required total capital under the new standard was $185 billion. That means that even with its retained earnings of $8.8 billion in the last two quarters the company is over $5 billion further away from adequate capitalization than it was on June 30 (when its total required capital was $171 billion), because of very strong business growth since that time.

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    2. The front page court cases are usually decided in June. Do we have any reason to believe that Collins v Mnuchin will be decided before June.

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    3. ROLG,

      Nice article as always. I am curious about the possibility that SCOTUS decides the for cause removal in Ps favor including remedy. Are we done then? Doesn’t need to go back to TX?

      Also, on the APA, is there any way SCOTUS would decide the merits and remedy itself instead of remanding to TX? However unlikely, just curious if something like that has happened in reality or if it would just be a plot in a movie for dramatic effect for SCOTUS to go so far.

      Liked by 1 person

      1. @juice

        if scotus win on unconst claim, it should be a remand for fed district court to iron out details. you never know if scotus will throw in a curve ball, but it should be about all done.

        if scotus win on APA claim, no SCOTUS decision on merits/remedy, though again watch out for any editorializing on what was a very favorable 5th C en banc majority opinion.

        rolg

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        1. There is no question that the next milestone in the journey to release Fannie and Freddie from conservatorship and allow them to get their capital structures in order is a decision by SCOTUS in the Collins case, but I’m surprised how little attention commentators and observers seem to be paying to the condition Calabria and Mnuchin put on that release, even under a consent decree, in the January 14 letter agreement–that each company must have common equity tier 1 capital equal to 3 percent of its adjusted total assets. For Fannie, that requirement as of December 31, 2020 was $139 billion.

          At December 31, 2020 Fannie’s core capital (common equity tier 1 capital, plus $19.1 billion in junior preferred stock) was a negative $95.7 billion. Even were Treasury’s senior preferred to be eliminated or cancelled, Fannie’s CET1 capital would only be $6.2 billion–its total stockholders equity of $25.3 billion less its $19.1 billion in junior preferred. It could get back up to $25.3 billion in CET1 capital by converting its junior preferred to common, but that still would leave it $114 billion below its release point. I estimate Fannie’s basic earning power to be about $11 billion per year, after-tax. (As I’ve noted before, Fannie’s earnings between 2016 and 2019 were boosted by almost $3 billion per year by drawdowns from its loss reserve; that source of earnings now effectively has ceased, and soon will revert to consistently being a negative provision for loan loss). At this earnings rate, it would take Fannie more than 10 years to achieve 3 percent CET1 capital through retained earnings, absent shrinkage in its business (or a credit to federal income taxes for overpayments to Treasury in the net worth sweep, which could be as much as $15 billion). Business growth in line with likely home price appreciation would add further to that timeline.

          Something, then, will need to give in order to resolve Fannie and Freddie’s conservatorships over any reasonable time frame. That “something” is the Calabria capital requirement, and the associated condition that no release under a consent decree (permitting external capital raises) can occur before the companies achieve 3 percent CET1 capital through retained earnings or business shrinkage. It’s more than a little surprising that this issue is getting so little attention from those with investments in the companies’ shares.

          Liked by 1 person

          1. Tim

            the only way I could understand the 3%CET1 rule placed in the letter agreement was as a bargaining chip. under this theory, T decided to let scotus decide collins (Mnuchin pulled the wimp card…I rather imagine Calabria acquiesced rather than eagerly agreed), and the govt anticipated that there would be bad news for the govt at some point in the legal process, leading to the possibility of an eventual global litigation settlement. business settlement negotiations are often like poker games, as the better player is the one with the most chips at his disposal in playing each hand. with this onerous capital chip as part of the negotiation pot, govt has strengthened its hand. one hopes that with a new fhfa director, this 3%CET1 chip is willingly offered up in settlement.

            rolg

            Like

          2. Your “bargaining chip” theory assumes that the government has an identified objective for the litigation settlement, and that this objective will carry forward to the new administration. I doubt either is true. I believe Calabria has an objective–to use his position as conservator and regulator with power to set Fannie and Freddie’s capital requirements to try to re-make the companies as “emergency use only” providers of mortgage liquidity during times of stress, when private sources of capital have withdrawn from the market, but I have no reason to think Mnuchin ever bought into this objective, and I very much doubt that either Secretary Yellen or a Biden-appointed FHFA director will share it. And what Calabria wants is antithetical to the interests of all stakeholders in the companies–homebuyers, common stockholders and owners of junior preferred stock. (Some holders of junior preferred seem to either not realize or have forgotten that their shares won’t be converted to common until after Treasury either exercises or cancels its warrants: per the Senior Preferred Stock Agreement, those warrants “will be exercisable for a number of shares of Common Stock that, together with the shares of Common Stock previously issued pursuant to this Warrant, is equal to 79.9% of the total number of shares of Common Stock outstanding on a Fully Diluted basis on the date of exercise.” Calabria’s 3 precent capital release point lets Treasury sit on the warrants right up to their expiration date, in September 2028.)

            In my view Calabria and Mnuchin did not leave the Biden team with a “lockbox” containing the elements of a settlement; they left it with a prescription for two non-functioning companies at the center of the secondary mortgage market that the new Treasury Secretary and FHFA Director will have to radically change, once this issue becomes a priority for them, to not just get the companies out of conservatorship but also unlock their potential value for homebuyers, common shareholders, and holders of existing junior preferred stock alike. The notion of a “secret plan already agreed to by all parties,” that will be put in motion once SCOTUS rules in Collins, strikes me as highly unrealistic.

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          3. Tim,

            Okay, 3% is too much. What do you recommend and how would it play out in terms of meeting overall private capital raises and the timing of them? 2.75%? 2.50%, 2.25%, 2%? What should the rate be?
            Assume you would not recommend/advocate a sub-2% capital rate, would you?

            Like

          4. Zak: As I said in my first comment, the overpayment could be as much as $15 billion per company, if fully credited.

            VM: We’re talking about two different (but related) capital percentages. The 3% figure (maintained for two consecutive quarters) is the minimum amount of capital at which the January 14 letter agreement would allow FHFA to release either Fannie or Freddie from conservatorship; the requirement for full “adequate capitalization” varies by company (because of the stability buffer, based on asset size), with Fannie’s percentage at June 30, 2020 being about 4 1/2 percent under the Calabria standard.

            I don’t have a numerical recommendation for the companies’ required capital. What I have recommended is that a Biden-appointed Director of FHFA follow HERA and calculate a straightforward stress capital requirement (with no cushions or add-ons) for each company, add a reasonable cushion for model and other unquantifiable risks, then add a “going-concern” buffer of sufficient size as to ensure market confidence, but that also recognizes the income the companies will earn if they indeed are going concerns. The new FHFA director will be the one who creates the standard, however, and Secretary Yellen will need to be convinced that it in fact is robust and credible. Having done my own versions of this exercise in the past, I believe a total capital requirement of around 3 percent would be more than enough to meet the criteria I’ve set out.

            The next question is, “At what level of capitalization do you release the companies from conservatorship, under a consent decree?” That will be a subjective call made by the regulator. Again, if it were me I’d say no more than half the fully capitalized amount, which using my 3 percent figure would be 1 1/2 percent. And I would allow both companies to reach that 1 1/2 percent amount WITH an external capital raise; that is, I would say to each one, “Whenever you think you can raise enough common equity to hit the 1 1/2 percent threshold, you’ll be released from conservatorship under a consent decree (that both parties agree to) on the day that transaction settles, and you will then have a defined period of time (specified in the consent decree) to obtain the rest of your required capital, whether through retained earnings, issues of new common, or issues of new preferred (up to the maximum permitted by the capital standard).” We’ll have to see how the new FHFA director chooses to do this, but my would way would get the recap done “reasonably fast,” to use former Secretary Mnuchin’s phrase. (It also would clear the way for a rapid conversion of the outstanding junior preferred to common, to allow Fannie and Freddie to issue new non-cumulative preferred at today’s much lower dividends.)

            Liked by 1 person

  4. With all of the Forbearance programs ending soon for many people, I am wondering a couple of things. 1. How will their ending impact the GSEs in terms of balance sheets & income? 2. Do you think the planned Biden stimulus will include some sort of funding to help cover losses or will the GSEs bear them? 3. Is there anything in this that might be a catalyst for Calabria/Yellen to do something with conservatorship to protect tax payers?

    Liked by 1 person

    1. I am expecting both Freddie and Fannie to address the forbearance issue and delinquency and credit loss outlooks in their 2020 10Ks that will come out on Thursday (for Freddie) and Friday (for Fannie), so rather than speculate I’ll just wait to see what they say. I don’t expect anything in the Biden stimulus plan that would given assistance to either company in covering their credit losses, although a stimulus program of the size currently being discussed should help the overall economy and thus be beneficial to the credit picture. Nor do I envision Calabria or Yellen doing “something with [the] conservatorship to protect taxpayers;” I don’t believe any substantive policy actions with respective to the companies will be taken until after we have a ruling on the Collins case from the Supreme Court.

      Liked by 1 person

  5. Curious … if any serious amount of external funding is needed, and/or the warrants sold to 3rd parties, would questions around possible major changes in the business model (e.g., becoming utilities) require congressional approval that, in turn, will make release from cship problematic due to gridlock?

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    1. There are many different variants of the “utility model,” but two features all have in common are a single entity or a very small number of entities providing a particular service, and limits on the returns that or those entities can earn. As just two companies, Fannie and Freddie meet the first criterion for utilities now, and limits on their returns could be imposed administratively, with their concurrence. The reform proposal I wrote for the Urban Institute nearly five years ago, “Fixing What Works,” envisioned Fannie and Freddie agreeing to allow FHFA to impose limits on their returns (I suggested 10 percent after tax) in an “exchange for consideration” giving them access to government support in the unlikely event that were needed. Moving forward five years I would amend that somewhat–I would make the “consideration” a capital requirement that allows the companies to conduct their business on a sensible economic basis, with the government support paid for through a periodic commitment fee. This could be done in a consent decree between FHFA and the companies releasing them from conservatorship, without the need for legislation.

      Whether a “serious amount of external [equity] funding” is needed would be left to each company to decide, and I’m not sure what you mean by “the warrants sold to 3rd parties.” By terms of the SPSA “the Warrant is not transferrable,” although Treasury “may assign its right to receive the Exercise Shares issuable upon such exercise to any other Person.” The warrants become void if not exercised before September 8, 2028.

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      1. Tim, thank you … ok, so the business model question could be addressed administratively … but would that issue still need to be resolved before new investors would put money into the companies … and/or buy the shares (or rights to shares) that might be issued under the warrants? … and, if yes, could the resolution of the business model question be required before release from cship? … in other words, do new investors first need to know if their return is going to be set by regulators and, if yes, what that will be? … thanks

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        1. The first thing that will need to happen before either company could raise any new equity is that the net worth sweep and liquidation preference would have to be dealt with, through either a victory in or a settlement of the lawsuits. Then the companies and FHFA would have to agree on a capital plan that details how each of Fannie and Freddie will reach full capitalization. (This plan will be made much easier if a new FHFA director revises the capital standard to remove the excessive amount of cushions, buffers and conservatism built into the Calabria standard.) I personally do not believe that investors will put any significant amount of new capital into the companies as long as they are in conservatorship. That means each company would need to be released under a consent decree, either before they issue new capital or, as I suggest in my current post, pursuant to the settlement of an equity issue that enables them to reach some threshold percentage of “adequate capitalization.” This consent decree would include any language related to regulated (“utility-like”) returns or any other changes in their business model, assuming the companies agree to them.

          But note that none of this will tell investors “what their return is going to be.” A regulated return sets a maximum, but the companies could still fall short of that. And the return to an investor in the common shares also will depend on the number of shares outstanding, which until full capitalization is attained will remain unknown. Finally, your reference to “shares that might be issued under the warrants” implies that these shares could add capital. They will not. Unless canceled (which I do not expect they will be) all they will do is dilute the existing common, by adding 4.604 billion shares to the 1.158 billion shares already outstanding (for Fannie).

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    1. “unless a majority of SCOTUS can be cobbled together during
      conference and opinion writing that simply concludes that this will have to
      do, in the absence of anything better, in order to reach a preferred result.”

      We’ve seen worse administrations of justice and interpretations of law

      Liked by 1 person

    2. Many thanks for your contributions to this discussion! Hope this decision is based on common sense as well as the Constitution.

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    3. ROLG,
      Thanks for the article I always appreciate your perspective!

      One question I’ve had for some time is based upon that there seems to be some “consensus” that sufficient support exists from the various emails and other documents obtained through discovery to provide the P’s a win on the APA claim if it goes back to the lower court (and possibly even granting of summary judgment). As damning as some of the emails are (ie. that Fannie was entering the “golden years…”) is there enough? I’m assuming there is a lot we haven’t seen, but it seems that could play either way. Very curious of your and Tim’s thoughts.

      Thanks again,
      Jack

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      1. @jb

        federal civil trials are decided by a preponderance of evidence (ie >50.1%). so if the legal rule is that fhfa had a duty to do such things as may return F/F to safety and soundness (that was the rule propounded by Willett at 5th C, and I dont see SCOTUS watering it down, though I suppose that is possible), then it would be very hard for me to understand how the fed district judge can find for govt, based upon what Ps have alleged in complaint (the nasty fairholme discovery) and what government has already stated publicly (ie Treasury announcing at time of NWS that it was designed to make sure the GSEs cant rebuild capital…the exact opposite of what government counsel would have to argue at trial).

        which is why it may make tactical sense for Ps to go for summary judgment on the APA (statutory) claim.

        rolg

        Liked by 1 person

        1. Jack: To your question of “is there enough” evidence in favor of the plaintiffs in the APA case, if you haven’t already I suggest you read the amicus curiae brief I submitted to the Court (linked in the current post). I believe you will see that the net worth sweep was the culminating step of a series of actions initiated by Treasury to bring Fannie and Freddie under government control for policy (and ideological) purposes, while it was publicly claiming to be rescuing them to protect the taxpayer from the consequences of their failure. As I’ve often said elsewhere, the events and activities I detail in the amicus are inexplicable if this had been a true rescue of the companies, but make perfect sense in the context of a pre-planned takeover. The net worth sweep occurred because Treasury never thought Fannie and Freddie would survive long enough–because Congress was expected to replace them with an alternative more to the liking of the banks and their allies– for all of the estimated and artificial losses put on the companies’ books by FHFA to come sloshing back onto their income statements, as they began to do in 2012. Treasury and FHFA concocted the sweep to prevent Fannie and Freddie from retaining these earnings as capital, and calling into question whether their booked losses had been real in the first place. And if this evidence weren’t enough, we have the documents produced in discovery in the Fairholme case in the Court of Federal Claims that show Treasury officials admitting to themselves and others exactly what they were doing, which was the opposite of what they claimed publicly.

          Were SCOTUS to remand this case to the District Court for the Southern District of Texas, it will not “play either way”–the government will lose, and it knows it.

          Liked by 5 people

          1. Your amicus curiae brief is unique and helpful. It removes the defendant from moral high ground. I read many related court orders. The judges believe government “saved” GSEs, or they dislike “rich” shareholders, or “soon to be rich” shareholders.

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    4. During the SCOTUS oral arguments one judge brought up how the Fannie shares aren’t worthless and still trading ….so they weren’t wiped out. Etc. etc. which just leaves this bad taste in my mouth where that I fell like even if we win the suits, I get this feeling they (or lower court) will make sure it’s an AIG type ending. Yeah govt screwed your but no positive remedy for plaintiffs …thoughts?

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      1. It was Chief Justice Roberts who made the point about Fannie and Freddie common shares still having value (he’d even looked up their closing prices from the previous day). Listening live, I thought Roberts was just reacting to the characterization of the shares as being “worthless” after the net worth sweep was imposed, and I thought David Thompson gave the right response (the shares current value reflected the possibility of a SCOTUS decision reversing the sweep, as well as the possibility of a subsequent amendment altering the sweep’s terms). I didn’t infer from the Roberts observation and comment any reluctance to grant an appropriate remedy to plaintiffs should they prevail on the legal issues, and in any event if the justices uphold the Fifth Circuit en banc’s decision that the sweep was in violation of the APA, SCOTUS would not be granting a remedy–it would remand the case to the District Court in the Southern District of Texas, making the remedy issue its problem.

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          1. The lower court ruled against plaintiffs on the law; SCOTUS would be remanding the case saying essentially, “You were wrong on the law, now consider the case on the facts.” Those facts heavily favor the plaintiffs.

            Liked by 4 people

      2. If I may add to Tim’s remarks, CJR was arguing by disjunction in an effort to debunk the nationalization claim. If commons have value (weren’t wiped out), then no nationalization took place. Commons do have value, therefore, no nationalization…(modus ponens).

        CJR’s observation was either trivial or irrelevant.

        1. Nobody thinks the GSEs were *literally* nationalized. Accordingly, Justice Sotomayor’s (?) point was still valid. For all intents and purposes the GSEs were nationalized (figuratively), making CJR’s point trivial.

        2. However, the *figurative* nationalization of the GSEs is not mutually exclusive to shares trading with some value. Therefore, if he his point was not trivial and instead he actually wanted to be relevant to the point, then he argued by false disjunction since stock value and figurative nationalization are not incompatible concepts. Either way, he didn’t impress me.

        I’m not a lawyer nor do I pretend to know anything about the law, but I do know a thing or two about informal fallacies, logic and argumentation. I’m often dissatisfied and disappointed with those who are empowered to render cogent decisions based upon rigorous analyses.

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        1. there were a couple of questionable lines of inquiry from Justices….1) Roberts weakly positing that the trading market may somehow negate the clear terms of the NWS in sweeping all equity value away from common and JP to SP; 2) Breyer asking govt counsel what should he do, that he was in dissent before (presumably Seila), now what do I do?, as well as why didnt Ps bring takings claim, which of course Ps did and there is no rule which says you can’t bring every claim that the law entitles you to at the same time; and 3) Kagan with her fear that millions of Social Security case dispositions will be invalidated, which really is a relitigation of the Seila holding, as if Seila could be overturned in less than one year.

          hard to know what to make of this.

          rolg

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  6. Tim – do believe the thrust of this write up is accurate?

    Message From FHFA to GSE Sellers: Securitize or Get Out?
    dhollier@imfpubs.com, pmuolo@imfpubs.com

    Proposed changes made by the Federal Housing Finance Agency to the preferred stock purchase agreements are sending a chilling message to Fannie Mae and Freddie Mac users: Securitize or get out.

    At least that’s how some industry advisors are viewing the situation. For the most part, the concern centers on a clause that states beginning January 2022, the FHFA will limit the amount of mortgages any lender can deliver to the cash window of a GSE to just $1.5 billion over any four-quarter period. That’s not a misprint.

    As the Mortgage Bankers Association noted in a recent report, many lenders exceed this cap with one or both the GSEs. Those lenders may have to choose a mortgage-backed security execution instead.

    For those who don’t have the wherewithal to do that, the only option may be to sell to an aggregator.

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    1. I don’t know why Calabria added the clause to the letter agreement that Fannie or Freddie could not purchase more than $1.5 billion through its cash window over a rolling 12-month period from any one seller. (This clause almost certainly wasn’t Mnuchin’s idea). No reason was given for it, and it seems particularly odd given that just above, in the same section of the agreement, the companies are directed to “offer to purchase at all times…and on substantially the same pricing and other terms, any Single-Family Mortgage Loan that…is of a class of Single-Family Mortgage Loans that Seller then offers to acquire for Seller-guaranteed mortgage-backed securities or other non-cash consideration.” Taken together, Calabria is saying, “You MUST offer to buy these loans, but only in an amount I allow you to buy (for reasons I’m keeping to myself).” This seems to be yet another example of Calabria being a micro-regulator as conservator. If he lasts longer than the conservatorship–which I don’t think he will–Calabria will no longer have the authority to impose these sort of dictats on the companies.

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      1. Or is it more likely that the this letter agreement was rushed, without review, proper proofreading or without a comment period, before Mnuchin had to leave out the door? Maybe it’s time for the Mortgage Bankers Association or some other trade group to send a letter directly to Dr Mark Calabria asking exactly what the intention and purpose of this 1.5 billion dollar directive is. That doesn’t have to be the only question for clarification, by the way.

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  7. Tim,

    Wouldn’t the APA trial in the Southern District of Texas take a year or more to go to trial as well, or is this a damages judgement that could happen sooner.

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    1. Before the case would go to trial both parties would file motions to dismiss, and the case is so clear cut–documents produced in discovery for the Court of Federal Claims show that Treasury lied publicly about why it entered into the sweep–that plaintiffs should prevail at that stage, if indeed the government hasn’t settled the case before then. Settlement could take place within a couple of months of a SCOTUS verdict, and if the case does reach the motion to dismiss stage I think it could be concluded this year.

      Liked by 2 people

      1. Ed M

        much depends on the language of scotus’ opinion re the APA claim, but I expect that scotus will affirm the 5thC en banc majority opinion that denied the govt’s motion to dismiss the APA claim (that had been previously been granted by Judge Atlas), insofar as Ps have presented a plausible (the standard required to defeat a motion to dismiss) case that the NWS contravenes the conservator’s duty to seek to make the GSEs safe and sound. in essence, scotus would determine that the law provides that the conservator has a conserve and preserve duty to make the GSEs safe and sound, and Ps are entitled to present direct claims, that are not barred by the anti-injunction and assignment of rights provisions of HERA, that the NWS breached the conservator’s duty. then what?

        I expect Ps to file a motion for summary judgment in front of Judge Atlas (if she retains the case)…SJ is a judgment that Ps win without the need to go to trial. in essence, Ps would argue that the NWS is inimical to the conservator’s duty…that the govt can present no set of facts to prove that the NWS was calculated to make the GSEs safe and sound. in this motion for SJ, Ps would set forth all of the evidence produced in Fairholme discovery, showing that the govt’s intent and the NWS result was to prevent the GSEs from ever becoming safe and sound. the govt will try to argue to defeat P’s motion for SJ that the NWS was a step on the path to safety and soundness, but I cant see how this argument would convince the judge, and I am unaware of what evidence it could introduce, that was contemporaneous with the NWS, that would support this argument. if the govt can produce such evidence, then the judge would say she needs to have a trial to determine the facts, and whether those facts support the govt’ or Ps position.

        a motion for SJ would save a lot of time over the time required for a trial.

        rolg

        Liked by 2 people

        1. Why is it always the Ps filing the motion? Can’t the Commons file claims provided they are (almost) more hurt by Net Worth Sweep?

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  8. Thanks Tim for a wonderful summary of the current state of affairs. This is the only article across the internet that comes out without any bias of any class of shareholders and calls a spade a spade. Every other article or interview that I have seen in the last few days is twisting and turning the facts just for scaremongering purposes. Thanks again for the wonderful article and a clean summary of the state of affairs without injecting any shareholder opinions into it.

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  9. Thanks Tim for this great post. A couple of questions if I may: 1) Do you see incentives for either side to settle before SCOTUS rules? I have a hard time thinking of reasons Ps wouldn’t settle, but I am less sure of the government’s incentive to settle. 2) If scotus rules in government’s favor, what happens next? Is raising private capital even feasible in this scenario, given that there would be little political incentive to write down the seniors?

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    1. On your first question, if the Mnuchin Treasury–which had spent a great deal of time on this issue–couldn’t find a reason to settle either before oral argument at SCOTUS on December 9 or before the end of the Trump presidency on January 19, there is even less reason to think that the Yellen Treasury would try to do so before the Court announces its verdict. And if the Court rules for the government on the APA issue (which I think is highly unlikely), I believe we would be stuck for a while. There is still the breach of contract suit in Judge Lamberth’s court and the regulatory takings case before Sweeney (who has now been replaced by a new judge), but these are both more than a year away from a decision point. Having SCOTUS rule that the sweep was legal, but still having the damages cases outstanding, makes resolving the conservatorships truly a “hard problem” for the Biden administration, and hard problems generally get pushed out into the future until there is no good alternative but to figure out what to do about them. And with the net worth sweep remaining in effect, raising private capital would NOT be feasible.

      Liked by 1 person

      1. Tim,

        Another great article that presents the situation very fairly.

        Why is it a consensus that we should win based off the APA claims? From what I can tell, most people are saying because it was barely discussed, the judges have already made up their minds on their decision, however given that either argument (constitutional/APA, with APA seeming to be more important) results in a huge win for the shareholders, isn’t it just as likely that they have decided to reverse the en banc decision, and thus all hope lies on the constitutional claim, which took up a large majority of the oral arguments? I think even if they had decided that as a win, there would be more discussion as they often times play devils advocate. I suppose the argument can go both ways, but from reading and listening to the oral arguments it bothers me how little the APA claim was discussed

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        1. My interpretation of the lack of discussion of the APA claim in the SCOTUS oral argument is that there really wasn’t much to discuss. The government did not attempt to make the (ludicrous) argument that seemed to have won the day in the lower courts– that because HERA stated that FHFA “may” take certain actions as conservator (instead of “shall” take them) it meant FHFA could take any actions it wanted, including agreeing to send all of the companies’ profits to Treasury forever–probably because it didn’t think it could argue that before the justices with a straight face. So all the government had left was to claim that no matter how egregious FHFA’s conduct as conservator was, all avenues for challenging it were blocked by the wording in HERA. The government did make that claim, plaintiffs responded that would be an unconstitutional lack of due process, and not much more needed to be said.

          Liked by 1 person

  10. Tim – Do you expect any resistance from Maxine Waters to the ending of the conservatorship on reasonable terms?

    Great write up – thanks for all the time you put into this very very important issue!

    Like

    1. As I noted at the end of the piece, getting to an end point on this won’t be without some hitches. Like many members of Congress, Chair Waters, in my experience, “knows a lot of things that aren’t so,” and may require some convincing. But in principle she should concur with what I’m expecting to see happen. The alternative to ending the conservatorships is nationalizing the companies, which Waters won’t favor, and if the conservatorships ARE ended, she certainly should support ending them on reasonable terms, because that will leave Fannie and Freddie in position to do more for affordable housing, which is a priority for her. And also in practice, she won’t be in a position to block an administrative “recap and release” if a new FHFA director and Secretary Yellen agree to and support it.

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