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 by plaintiffs for summary judgment 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.  

176 thoughts on “Then, and Now

  1. Tim,

    In case you haven’t seen this yet, I thought you might find this interesting. FHFA released a paper today titled “A Quarter Century of Mortgage Risk”.
    https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Publishes-First-of-its-Kind-Comprehensive-Dataset-on-Mortgage-Risk-from-1990-2019.aspx

    I imagine that whatever holes there are in the paper, you would be able to find them and explain. I haven’t read the paper yet myself (just the first couple of pages so far), but it certainly looks to be in your wheelhouse.

    Liked by 1 person

    1. Just reading the abstract they’re trying very hard to shift blame for the crisis away from the origination practices of the PLS market and instead focus on providing credit to low income borrowers. That it came out of the Calabria FHFA and has an AEI contributor is really all you need to know about whether they are making a good faith attempt to measure risk or are just trying to torture the data to fit the conclusion they started with. Still it would be a worthwhile exercise to debunk since this is probably meant to further cripple the GSEs with overly conservative capital instead of the risk-based standard that Tim created with Volcker and I am quite curious what he will make of this.

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    2. from the paper:

      “We find that roughly half of the overall rise in the stressed default rate owed to these risky product features; the other half of the rise stemmed from more “plain vanilla” forms of borrower leverage, such as an increase in DTIs. Thus, a narrative that focuses primarily on risky product features overstates their role during the boom and underplays the risk-increasing effect of more prosaic forms of leverage.”

      excuse me? this is a predetermined inquiry. if you find half of the increase to “stressed default rate” is owing to risky mortgage features that are no longer permitted in mortgages bought by GSEs, then end of story…you have found your biggest culprit! to ignore this and say that the non-plain vanilla mortgages effect is overstated is to write the story in advance.

      rolg

      Liked by 1 person

      1. Wow! The (greatly expanded) FHFA staff has been busy. On Monday they released a report titled “Performance of Fannie Mae’s and Freddie Mac’s Single-Family Credit Risk Transfer,” and today they’ve put out a working paper on “A Quarter Century of Mortgage Risk.”

        I downloaded the working paper, noted that it was 99 pages long and co-authored by two academics and a staff person from the American Enterprise Institute, and mentally shifted it to my “when I can get around to reading this” pile. I obviously can’t comment on something I haven’t yet read, but I’m not surprised to see the comments above by dismaltoast and ROLG, who seem to have read at least some of it.

        FHFA’s Credit Risk Transfer report is a different matter. I found a lot that was of interest in it, in terms of both the things FHFA said and didn’t say. There may be a blog post in there, and if there turns out to be I’ll go to work on one for publication next week. After that I’ll try to get to the risk paper.

        Liked by 2 people

  2. Tim

    Calabria is going to address “living wills” for the GSEs at this Brookings sponsored virtual confab: Living wills for housing government-sponsored enterprises: Implementation and impact

    “Tuesday, May 11, 2021, 3:00 – 4:00 p.m. EDT
    Online: https://www.brookings.edu/events/living-wills-for-government-sponsored-enterprises-implementation-and-impact/

    One of the best tools to resolve large complex financial institutions are resolutions plans, also known as living wills, that outline liquidating, reorganizing, or otherwise resolving failure. New regulations from the Federal Housing Finance Agency (FHFA) will require the housing government-sponsored enterprises (GSEs)—Fannie Mae and Freddie Mac—to prepare living wills, just as large banks have been required to do since passage of the Dodd-Frank Act. How we prepare for death can reveal a lot about how we plan to live. What will Fannie and Freddie’s resolution plans mean for the nation’s housing market, which depends on the GSEs?

    On Tuesday, May 11, the Center on Regulations and Markets at Brookings will host Mark Calabria, director of the FHFA, to give keynote remarks on the agency’s progress in creating this rule. Following the keynote remarks, a panel of experts will respond to the resolution plans.

    Viewers can submit questions via email to events@brookings.edu or via Twitter using #LivingWills.”

    My question is where does the FHFA director derive statutory authority to promulgate the requirement for GSE living wills? I dont see it in HERA…

    rolg

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    1. The “living will” requirement comes from Section 165(d) of the Dodd-Frank Act, requiring that “bank holding companies with total consolidated assets of $50 billion or more and nonbank financial companies designated by the Financial Stability Oversight Council (FSOC) for supervision by the Federal Reserve periodically submit resolution plans to the Federal Reserve and the Federal Deposit Insurance Corporation.” HERA does not make any reference to living wills, let alone authorize FHFA to require them of Fannie and Freddie.

      The living wills are another clear example of FHFA Director Calabria imposing rules and regulations designed for large multinational banks on Fannie and Freddie. The former CEO of Freddie Mac, Don Layton, wrote a scathing critique of the FHFA living will proposal this past February, titled “The FHFA’s Proposed GSE ‘Living Will’ Rule,” with the subheading of “Fatally Flawed and Unusually Vague.” In this piece, Layton correctly pointed out that (a) the structures of Fannie and Freddie are “ultra simple” compared with large multinational banks, (b) over 90 percent of companies’ assets are financed as MBS, which are not subject to illiquidity risks, and (c) receivership would not be the policy choice in the highly unlikely event that either Fannie or Freddie were to experience financial difficulty, given the existence of the Treasury senior preferred stock agreements. Indeed, this last point is one of the two “fatal flaws” Layton identifies in the FHFA exercise: “The denial that the government support agreement for the GSEs exists and can be relied upon.” (The second fatal flaw is “the requirement that the GSEs plan to continue operations in receivership without that support, despite its being necessary and integral to their business model.”) Layton concludes from his analysis that the FHFA living will proposal “seems to be more a policy document than a technical one, reflecting FHFA Director Mark Calabria’s well-known policy objective of shrinking the GSEs’ footprint.”

      I agree with that conclusion. Calabria has made no secret of his intent to use bank-like capital and regulation to effectively eliminate the advantages of Fannie and Freddie’s federal charters, and thus their abilities to continue to provide the type of secondary mortgage market support for low- moderate- and middle-income homebuyers they had been so successful at doing prior to their conservatorships. (This also is the reason for the caps placed on various types of higher-risk business in the January letter agreement with Treasury: Calabria wishes to convey the sense that until Fannie and Freddie can attain the capital levels he is requiring of them, allowing them to do more than the capped amounts of these business types presents too much risk risk to the taxpayer, which is preposterous.) Calabria is not going to change his approach to regulation or capitalization, so the only way to meet the objectives of all of the companies’ stakeholders–homebuyers, mortgage lenders, investors and employees–is for the Biden administration to change its FHFA director, which it should do at its earliest opportunity.

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    1. This is very clear and logical, and I agree with almost all of it. I still don’t think the Justices will grant retroactive relief on the constitutional claim, for the reasons you identify. The horse I’d put my money on is the APA claim.

      My “nightmare scenario” for the SCOTUS ruling, however, is a variant of what I believe occurred with the Perry Capital appeal. There, Justice Ginsburg went from asking informed and logical questions—and making appropriate responses to what he was hearing—at oral argument, to then swinging around and joining Justice Millett in a tortured (and in my view deceptive) opinion declaring the net worth sweep to be unchallengeable either directly or derivatively. I believe that what happened in this case is that Ginsburg’s good friend Peter Wallison (who when he was counselor to the President under Reagan was responsible for getting Ginsburg his seat on the DC Court of Appeals) persuaded him that he had to side with Millett in order to prevent the “evil” Fannie and Freddie from being able to free themselves of the shackles Treasury and FHFA finally had been able to place on them.

      A redo of this episode at SCOTUS would have the many high-profile opponents of Fannie and Freddie with ties to the Federalist Society making a similar pitch to some or all of the six conservative justices on the court, all of whom have Federalist Society credentials. In this case the pitch would be: “You are the last line of defense against having our two decades of work to remove these horrible children of the New Deal from what should be a fully private mortgage market all be for naught.”

      It wouldn’t surprise me at all if such conversations have taken place. But even if they wished to, I can’t see how five conservative justices could agree on an argument for overturning the APA decision by the Fifth Circuit en banc, and overcoming the compelling and piercing arguments made by Judge Willett. The government has abandoned its weak-reed “may versus shall” argument, and after that there really isn’t much left on the legal side. The best remaining argument for upholding the legality of the net worth sweep seems to be the assertion that Congress intended FHFA to be a “super-regulator,” different from and more powerful than the FDIC, even though there is no evidence of this in statute or the legislative history, and the conservatorship language in HERA is virtually identical to the language in the FDIC Act.

      I think there’s less than a ten percent chance that SCOTUS makes a blatantly political decision on the APA claim in Collins—and if it does then it obviously wouldn’t rule for plaintiffs on the remedy for the constitutional claim, and might not even agree that the FHFA Directorship is unconstitutionally structured. But if you ask what makes me a little bit nervous about the upcoming SCOTUS decision in Collins, that’s it.

      Liked by 1 person

      1. Tim

        couple thoughts about your nightmare scenario:

        1. conservative judges and justices can fall all over the map when it comes to agency power. the great Scalia after all penned the Chevron doctrine that endowed agencies with vast discretion, albeit as a way to limit the “legislation from the bench” that was one of his principal missions. Gorsuch, Kavanaugh and Barrett have evidenced a particular distaste for the Chevron doctrine and the expansion of federal agency power. Same can be said for Thomas and Alito. they are far closer to the Judge Willett view of agency power than Judge Ginsberg.

        2. yes justices read the papers and talk to DC movers and shakers, but DC has become a hotbed for politicalization of SCOTUS, led principally by Sen. Whitehouse. I dont think any Justice will allow him/herself to feel the tap on the shoulder as Judge Ginsburg did. “Influencing” a Justice in this political climate is hard for me to imagine.

        rolg

        Liked by 2 people

        1. I don’t expect a political ruling from SCOTUS either. But then again, back in 2004 I did not expect the chief accountant of the SEC to make a blatantly political ruling against Fannie Mae on the “accounting fraud” charges made by FHFA’s predecessor agency, OFHEO–stating that we had implemented the standard for accounting for derivatives, FAS 133, incorrectly, yet declining to specify to either us or our outside auditor, KPMG, where or how. That’s why I’m giving my “nightmare scenario” for the SCOTUS ruling in Collins a probability of under ten percent, but not zero.

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          1. Tim / ROLG,

            Nor did we expect Justice Ginsburg to capitulate to Justice Millett’s convoluted reasoning, which was alluded to already. I find that the only two options in these sorts of scenarios (e.g. OFHEO and D.C. Court of Appeals) is, of course, incompetence and corruption.

            If we’ve learned anything, isn’t it that legal logic has not always been preeminent? (Even 5th Circuit was divided.) The question is whether we have good reason to believe SCOTUS is any less vulnerable to what is safe to say was unethical behavior (and not just faulty reasoning) of government agencies and a significant appeals court. Personally, I think not.

            I think we all stand hopeful with some degree of confidence, but the pressure to salt the earth with the GSEs has shown itself to be relentless, which I believe makes SCOTUS pervious to the same pressure.

            Liked by 1 person

          2. Unfortunately in this saga naming a “nightmare scenario” is equivalent to a gun appearing in a Chekov scene.

            Liked by 1 person

        1. Yes, I am. But not all members of the Federalist Society have the same attitudes towards Fannie and Freddie, particularly when it comes to the net worth sweep. I believe the large majority of Federalist Society members, if they knew the facts of the matter, would see the net worth sweep as an egregious misuse of government power, and favor it being voided. Some, however, would (and do) make an exception for this misuse of agency power if it results in restricting or eliminating two companies they strongly oppose, under the banner of “the ends justify the means.” These are the ones I’m concerned about (David, obviously, not being among them).

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    1. The “headline” comments on these numbers are that (a) the quarterly net income figure ($5.0 billion) is elevated by temporary factors and not sustainable, and (b) while Fannie’s net worth of $30.2 billion at March 31, 2021 is up by $13.7 billion from $16.5 billion at June 30, 2020, its new “Enterprise capital requirement” from FHFA has risen by even more than that–$19 billion–over the same time period, leaving Fannie further away from being adequately capitalized than it was nine months ago.

      Taking the second point first, Fannie’s required capital has risen so much because of rapid business growth–9.2 percent in its single-family book of guaranty business between the first quarter of 2020 and the first quarter of 2021–as sharp declines in interest rates during the early months of the pandemic triggered a heavy volume of refinance business. But this is another indication that the new FHFA capital standard is badly mis-calibrated, and far too high. A company should be able to easily finance its growth through internally generated capital. The growth in Fannie’s business should slow down in the coming quarters, but its growth in net income will as well. And even with only moderate business growth, the new capital required by that growth will consume a significant amount of Fannie’s quarterly retained earnings, making progress in reaching “adequate capitalization” status agonizingly slow. A new FHFA director has to fix this problem for Fannie (and Freddie) to escape the conservatorship trap director Calabria has them in. It’s revealing that Fannie’s first quarter financials showed that other than the “adverse market fee” of 50 basis points it had announced earlier, the company did not appear to make any significant change to its base guaranty fees. To me, this indicates that Fannie management intends to try to keep its pricing at levels consistent with its old “conservatorship capital requirements” for as long as it can, in the hopes that before too long it gets both a new FHFA director and a capital requirement that makes economic sense.

      As noted in its press release and 10Q, Fannie’s first quarter net income was elevated by a high level of income from the amortization of upfront guaranty fees, caused by the rapid level of prepayments during the quarter. As prepayments slow in the future, so will amortization income. Fannie also got a boost in net income from having a positive benefit from credit losses in the first quarter ($765 million), as it continued to draw down the loss reserves it had booked (at FHFA’s direction) during the early years of the conservatorship. With interest rates now more likely to rise than to begin falling again, we soon should see Fannie booking a more normal (negative) provision for credit losses. One offsetting positive to this is that Fannie has effectively ceased doing credit-risk transfer transactions, so its quarterly cost of doing these, which was $444 million in the first quarter of 2020, was much lower in the first quarter of 2021, at $351 million, and should continue to fall going forward.

      Liked by 2 people

      1. Tim

        Looking at these results from altitude, if you told me one year ago that these results would roll in during a pandemic where extraordinary nationwide lockdown measures were taken, I would have taken them in a Manhattan minute. the GSEs were part of the solution to getting through this pandemic, and I would expect that the historical antagonism to the GSEs will sound shrill, should it resurface (though I expect the richest congressperson in DC, Sen. Warner, to continue to rail against hedge funds). what I hope also doesnt resurface is the misguided search for govt revenue by any means necessary. A favorable SCOTUS opinion in Collins will put an end to that, I expect.

        rolg

        Liked by 1 person

  3. Tim: The sentiment expressed in the second to last sentence in the article referenced below, i.e. “Given that the director (whether acting or permanent) has the legal authority to act as a super-CEO over both Freddie Mac and Fannie Mae while they are in conservatorship, given that this in turn means she or he has tremendous power over housing finance, and given that mortgage markets and the operations of the GSEs are universally understood to be exceedingly complex, the choices should be people with very significant financial regulatory or mortgage industry experience, and ideally both,” is likely shared by many parties interested in the future of housing finance. While you may not want to “name names” for good reasons, I was wondering if you have any suggestions or thoughts on potential future permanent directors? Is this an issue being explored in depth by interested parties? TIA!

    https://www.jchs.harvard.edu/blog/three-decisions-biden-administration-will-need-make-if-supreme-court-eliminates-fhfas

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    1. First of all, after agreeing with Layton that the ideal candidate for the next Director of FHFA would have very significant experience in both the mortgage industry and the regulatory world, I would add that (a) very few people will have both, and (b) if you have to pick between the two, I would emphasize the mortgage industry experience over regulatory experience, since the former is a sine qua non for such a specialized regulatory agency, and the lack of the latter can more easily be compensated for in an institution full of people with such experience.

      And you’re correct, I am not intending to put forth any names for the Director of FHFA in the Biden administration, if for no other reason than that it’s now been more than sixteen years since I’ve been in the mortgage business on a day-to-day basis, and during that time many people may well have gained knowledge and experience, and established a track record, that would make them good candidates for the FHFA directorship without my ever having become aware of them. If and as names for the job are floated, however, I will offer my views on their suitability for the job–to the extent that I have such views–since I believe it is critical for the future of the mortgage finance industry that the right person be appointed to lead FHFA as it engineers Fannie and Freddie’s release from conservatorship, then serves in a constructive regulatory capacity as they rebuild their capital, regain their financial strength, and return to shareholder and management control.

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      1. Mark Zandi and Susan Wachter were named in a Bloomberg article in January as potential candidates the Biden administration was considering. Do you have any views on their suitability?

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        1. I know Mark Zandi, but not Susan Wachter. Based on what I’ve read about Wachter and know about Zandi, I think either would be far preferable to the current director, because both seem to understand, appreciate and support the roles that Fannie and Freddie, if properly capitalized and regulated, could play in support of affordable housing. But the “who” question for the next head of FHFA is premature. First we need to get clarity from the Supreme Court that Calabria is indeed removable by President Biden other than for cause (which I think we will get), then we need to have a better understanding of what the Biden administration’s objectives for the next director of FHFA will be. On the latter, I doubt we’ll learn much until after the Supreme Court decides the Collins case. If the net worth sweep is ruled to be ultra vires, and the FHFA director is deemed unconstitutional, the Fannie and Freddie issue will move up on the President’s priority list. The first thing I would look for is which senior administration official takes the lead on it. Of the three people I would view as most likely–Biden chief of staff Ron Klain, head of the National Economic Council Brian Deese, and counselor to the President Steve Ricchetti–two (Klain and Ricchetti) have considerable familiarity with the companies, having worked with Fannie as either consultants or lobbyists. That bodes well for there being an informed policy perspective taken with respect to Fannie and Freddie’s future, and in turn for a constructive set of objectives for the next FHFA director, who will be charged with putting the companies is a position to perform the tasks the administration wishes them to do (which I believe will not be very different from what they were asked to do in previous Democratic administrations).

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  4. Tim, a question about a new FHFA director and his/her desired capital rule. Apologies for not recalling your stances on the various parts of Calabria’s capital rule; you have probably provided the answer to this elsewhere.

    The question: how workable do you think Calabria’s capital rule would be if the buffers were eliminated but everything else stayed the same? The base requirement right now is core capital equal to 2.5% of adjusted total assets, so the new headline number seems palatable and achievable without raising g-fees (the GSEs might even be able to lower those); the question is if the plumbing (the rest of Calabria’s rule) is shoddy enough to require an overhaul anyway.

    That seems like the kind of change that wouldn’t require a new comment period and finalization, as it only affects the GSEs’ ability to make capital distributions, while the much-needed capital raise could get delayed well past a potential downturn in the housing market if the new director issues his/her own full rule, which could take well over a year from conception to finalization.

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    1. There is no simple fix to the Calabria capital rule. The problem is that he started in the wrong place, with an arbitrary and unjustified bank-like 4.0 percent minimum requirement–broken into, as you note, a 2.5 percent base leverage requirement and a 1.5 percent leverage buffer–but then he added many many cushions and elements of conservatism to the risk-based standard to push its required capital, in the final rule, to well above the 4.0 percent minimum. A new director could fix the minimum requirement by just dropping the 1.5 percent buffer, but you have to re-do the risk-based standard. It won’t be that hard to do, however; I outlined how in my comment on the FHFA capital re-proposal. You start by running an honest risk-based capital stress test, without cushions or excessive conservatism, to get the base amount of capital required for the companies to survive a defined worst-case credit loss scenario. Once you have that you add your cushions and conservatism to get a margin of safety–although not so much of either that the cushions and conservatism dominate or distort the basic risk-based numbers. Only after you have the risk-based standard do you set a minimum (not, as Calabria did, before), whose purpose is to set a floor on Fannie and Freddie’s required capital, that must be met no matter how little risk the companies choose to take. The FHFA staff has done almost all of this work already; it just has to strip out all the unreasonable assumptions incorporated in or added to the stress test to push the final risk-based capital number up. That shouldn’t take very long.

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    1. It’s good that people like Dave Stevens and Don Layton are writing articles pointing out and analyzing the impacts on the mortgage market of recent pronouncements, regulations and policy actions of FHFA Director Calabria. Calabria has made no secret of his intention to use his regulatory and capital- setting powers to reduce Fannie and Freddie’s roles in the secondary market, with the views that the “private market” will adjust to make up for any business lost to the companies from these policies, and that any resulting increases in mortgage rates or reductions in credit availability are acceptable prices to pay for the “reforms” he champions. The audience for these articles isn’t Dr. Calabria himself, who seems impervious to criticism of his ideology or goals; it’s thought leaders in the industry and senior members of the Biden administration, who need to understand how Calabria is trying to reshape these two companies that are the foundations of U.S. residential mortgage finance, and determine whether Calabria’s objectives for Fannie and Freddie align with their own. In my view they certainly do not.

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      1. Mr Howard

        Trying not to pin you down, how would you regulate the GSEs if you were the present director?

        With your 15 yrs experience as CFO would you have done anything differently then looking back now (from a shareholder perspective I think you did an excellent job even before I read your book-twice)?

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        1. One’s approach to the regulation of Fannie and Freddie will be linked to one’s objectives for them. I have always thought that the companies should be regulated in such a way that the benefits conveyed upon them by their federal charters flow as directly and efficiently as possible to the people they were chartered to serve–low- moderate and middle-income homebuyers. For capital, that means tying capital to credit risk, then adding a cushion that adds a margin of safety but does not go so far as to require significant additional hikes in guaranty fees that make it harder for the companies to use cross-subsidization to extend credit to riskier borrowers. And for regulation, it means using the oversight role, rather than hard-wired micro-regulation, to keep the companies’ business and management practices closely tied to their missions and risk tolerances.

          I would contrast my objectives for Fannie and Freddie with what I perceive to be Director Calabria’s. He does not believe that the government should have created specially chartered companies to make mortgages more available and affordable, so his objectives as regulator have been to use his capital-setting and regulatory powers to effectively negate the benefits of those charters, in the name of “leveling the playing field” with what he views as fully private companies. (He sees commercial banks as fully private, which they are not; they would be unable to function in their current form without federal insurance on their consumer deposits.)

          It’s hard to answer the “would you have done anything differently as CFO” question, because of the abrupt way in which my tenure at Fannie Mae ended. As I noted in my book, in 2003 we had developed, published and committed ourselves to a set of what we called our “corporate financial disciplines,” whose purpose was to ensure not only that we never would become insolvent but also that we never would lose money in any calendar year. Yes, our capital requirements were very low, but our strategy was to limit our risk-taking and manage our risks so that this low amount of capital was sufficient to protect both our shareholders’ investment and the taxpayer. We viewed our low capital requirements a key part of the equation by which we channeled large amounts of funds inexpensively to mortgage borrowers, through very low average guaranty fees (averaging around 20 basis points).

          Rather than chase the high-risk business being originated and packaged into private-label securities in 2004, we let our share of total mortgages outstanding fall by two percentage points that year. Would Fannie have continued to do that had Frank Raines and I not been forced out by our regulator? I like to think that the corporate financial disciplines (which were abandoned, with the regulator’s approval, shortly after we were gone) would have kept us from falling prey to the lure of chasing bad business, but there is no way to know that for certainty.

          Liked by 3 people

          1. Tim/Mickey

            As a lawyer, I think it is important for a regulator to implement the statute, not pursue a personal agenda, no matter how meritorious the regulator may think it is. it is ironic that Calabria criticized FHFA in his white paper with Krimminger, arguing that the NWS does not implement the statute’s purpose to rehabilitate the GSEs (while they are in conservancy). Now that Calabria is the regulator, he seems to be pursuing a limitation of size/market impact agenda that, as far as I can tell, is not mandated by statute.

            rolg

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          2. ROLG – great post. I have been wondering all along – lawsuits not withstanding – at what point does Calabria cross the line and can be removed for cause – is he close? Seems to me he is so far over it that you would need the Hubble Telescope to find the line. Thanks!

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    1. While it is possible that the Supreme Court will rule that the net worth sweep is void ab initio and require it to be reversed, it is more probable that it will remand the Collins case to the Southern District of Texas for trial on the facts (or a motion to dismiss). A successful outcome for plaintiffs in either event likely will lead to a retroactive unwinding of the sweep, which for both Fannie and Freddie would result in the complete retirement of Treasury’s senior preferred stock (and the elimination of its liquidation preference), and leave Treasury owing somewhere between $12.5 and $15.0 billion to each company, which it most likely would pay as credits against future federal income taxes. This overpayment range has the estimate I calculated at the time the net worth was suspended (and the “overpayment clock” was stopped) of $12.5 billion at the low end, and the $15 billion number I’ve heard David Thompson cite at the high end. If you had to pick one number, I’d go with David’s.

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      1. this overpayment amount should bear prejudgment interest from date the NWS distributions exceeded the amount needed to pay off senior stock through the date of payment, so even David’s number might grow over time.

        rolg

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        1. My experience with prejudgment interest is that it’s something plaintiffs ask for but the court doesn’t always grant. It’s also possible that the difference between my $12.5 billion and David’s $15 billion IS prejudgment interest, which I didn’t include in my calculation. If so, that means David’s number WOULD grow over time.

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        2. For some color here, I made a spreadsheet that calculates what the senior pref balance would have been for each company had they paid down the seniors (and had the ability to do so) with every penny available past the 2.5% quarterly dividend.

          I got a total overpayment of $14.2B for Fannie, with the 10% moment hit in Q3 2018, and a total overpayment of $14.7B for Freddie, with the 10% moment hit in Q2 2017. My numbers don’t quite agree with FHFA’s published tables so they aren’t exact, but they do evidently agree with David Thompson by what Tim said.

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      2. Thanks for the answer Tim.
        You say ” it is more probable that it will remand the Collins case to the Southern District of Texas for trial on the facts (or a motion to dismiss). ”
        Can you or ROLG elaborate a little bit and explain what happen in a trial on the facts and why it can be a motion to dismiss?

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        1. It’s a procedural matter. If the case is remanded to the lower court, before a trial would occur both parties will be given (and take) the opportunity to file a motion to dismiss. Since the facts in this case are so clear–Treasury lied about what it did in the net worth sweep and why, as documents produced in discovery permitted by the Court of Federal Claims demonstrate–it is highly probable that plaintiffs’ motion to dismiss the case will be granted, and they will receive the relief they request.

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          1. Tim,

            Could you explain or point to a document or set of documents that detail, “… and they will receive the relief they request?” Assume of course Plaintiffs, Jr. Preferred & Commons.

            What is the relief at this stage in the game that is being or has been requested?
            Does it include an expected, or mandatory, exchange of Jr. Preferreds into Commons as some have speculated?
            Does this include Gary Hindes 6% non-cumulative expected damages as he outlined in his most recent Delaware Bay Company report?
            Given the handful of cases detailed somewhat by Hindes, are there multiple damage claims? If granted through a motion to dismiss, would the Courts allow multiple damage claims &/or pick a specific claim? Is this applicable only to Jr. Preferreds? Jr. Preferreds and Commons? Commons alone?

            TIA

            VM

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          2. so, federal civil procedure provides two alternatives to going to trial. the defendant (govt) can move for a motion to dismiss (which the govt successfully did to terminate the Collins case at federal district court until the judge’s order was overturned by the 5th circuit court of appeals, sitting en banc). a motion to dismiss is granted when the trial judge is convinced that there is no legal basis for the plaintiff to win, even assuming the plaintiff’s facts as alleged are true. In Collins, the federal district judge applied an incorrect legal standard, in the view of the 5th circuit court of appeals, that the conservator had the power to agree to the net worth sweep…and it is this question, whether the conservator had the power to agree to the NWS, that is to be conclusively determined by SCOTUS.

            the second alternative to a full trial is for the plaintiffs to show that there is no legal basis for the plaintiff to lose at trial, by filing a motion for summary judgment. this is the way for the plaintiffs to win without the need for the case to go to trial. assuming SCOTUS affirms the 5th circuit, plaintiff will have the opportunity to go back to the district court and show that, based upon the correct legal standard (that the conservator had a duty to preserve and conserve assets, and do such things as may restore the GSEs to safety and soundness), and based upon the facts that are not in dispute, there is no way for the defendant govt to show that the NWS complied with this conservator standard.

            I discuss this at greater length at https://ruleoflawguy.substack.com/p/how-will-collins-plaintiffs-proceed.

            the devil is in the details, but stepping back to understand the lay of the land, if as I expect that SCOTUS affirms the 5th circuit and holds that the conservator had an affirmative duty to rehabilitate the GSEs, then it is likely that the NWS will be found to have violated this duty. the question is how quickly: i) not quickly if a full trial is required (say, more than a year), or ii) more quickly if plaintiffs can successfully move for summary judgment after the SCOTUS Collins decision (say, less than a year).

            rolg

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          3. I’m now back in Virginia following my first airplane trip in over a year. (Thank you, Pfizer.)

            ROLG is of course correct that plaintiffs in Collins, if successful on their APA claim at SCOTUS, would file a motion for summary judgment, rather than a motion to dismiss. And when they do my expectation is that they will be successful.

            In response to VM’s question, the remedy would be to unwind the sweep, and that’s it. Holders of Fannie or Freddie junior preferred would need to wait to see what the companies’ managements would do about their shares. I believe both would either redeem or offer to convert them to common, so they could re-do their capital structures with a mix of retained earnings, newly issued common, and new issues of lower-yielding noncumulative junior preferred, although I don’t have a good guess as to when this might occur. The remedies Gary Hindes has been talking about would come from victories in either Perry Capital in the DC Circuit or Fairholme and the other regulatory takings suits before the Court of Federal Claims. A trial in Perry Capital is at least a year away, and a potential trial in the Court of Federal Claims is further off than that.

            Liked by 1 person

  5. Tim,

    You had a very good and succinct summary/explanation on direct vs. indirect claims (that I cannot seem to find) and how they relate to Fannie & Freddie. Could you repeat the difference between these claims and which claims are now relevant/valid/invalid?
    Really enjoyed your 1 hour presentation on YouTube “The Mortage Wars.”

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    1. First of all, apologies to readers for having abandoned the blog for the past few days. After receiving our second vaccine, my wife and I have taken our first airline trip in over a year, and I have been fully occupied with activities at our destination.

      I do not claim to be an expert on the differences between direct and indirect lawsuits; at best, I have what I would term an “informed lay person’s” understanding of the issue. A direct lawsuit is one filed by the affected parties themselves (in Fannie or Freddie’s case, holders of common or preferred shares, or both) and on their own behalf, whereas a derivative lawsuit is filed by these shareholders on behalf on the companies, which for whatever reason (as will be stated in the suit) cannot or will not file suit on their own. Monetary relief granted in a direct lawsuit goes to the plaintiffs that filed the suit, whereas in a derivative suit the relief generally, but not always, goes to the companies.

      For me, it’s easiest to think of the implications of direct and indirect suits by type of claim– (a) APA violation (i.e., FHFA violated HERA in implementing the net worth sweep, making it void ab initio), (b) constitutional (the FHFA director removable by the president only for cause was not constitutionally appointed when he entered into the sweep, so, according to plaintiffs, the sweep must be voided) and (c) the collection of claims for regulatory takings (the Court of Federal Claims), breach of contract, fiduciary duty and or implied covenant of good faith and fair dealing (Perry Capital, and potentially other suits as they work their way through the legal process). Plaintiffs generally have made direct and indirect claims in each of the three types of suits–hoping that the courts in question will agree that one form of claim is justiciable–but to my recollection they also make the same “prayer for relief,” whether the suits are direct or derivative.

      On the APA claims (which include Collins, now before SCOTUS) plaintiffs are asking for the sweep to be unwound; this will benefit the companies directly and the shareholders (common and preferred) only indirectly–for common shareholders through a higher share price, and for preferred shareholders through an increased incentive for the companies to offer a conversion to common or, less likely, redemption at par. The same is true on the constitutional claims. In the regulatory takings and the various “breach” suits–whether direct or indirect–the prayers for relief include “just compensation” for both the companies (Fannie and Freddie) and the plaintiffs (common and/or preferred shareholders, depending on who filed the suit).

      Again, this is my understanding of how these suits work, but I am not a lawyer and do not pretend to be offering either legal or investment advice.

      Liked by 1 person

      1. Tim/V

        the easiest way to differentiate direct and indirect corporate claims is to go to the extremes and work inward. for example, a shareholder direct claim would flow from a corporate action that eliminates a shareholder right/value in a manner not permitted by the corporate docs/corporate law. the shareholder’s bundle of rights/value in the stock have been improperly reduced.

        a shareholder claim is derivative (or indirect) where the shareholder is espousing the corporation’s rights in a situation where the corporation has not done so itself. in effect, it is the corporation’s bundle of rights/value in the corporate enterprise that has been improperly reduced (and if so, then the shareholders rights/value also suffer). in each case, shareholder value would increase through the prosecution of the claim. But what to do with respect to a claim that the corporation has dissipated assets in a way that illegally prefers one shareholder over another. This has a smattering of direct and indirect claim attributes, and this is the NWS.

        all of this is a matter of delaware corporate law. Delaware corporate law has made a mess of the distinction between direct and indirect claims, but not to fret in Collins. the the Administrative Procedure Act grants a federal statutory right for a shareholder to sue a regulatory agency (FHFA) where that shareholder has been aggrieved by agency action (ostensibly that agency action has been directed to the corporation as a regulated entity, as opposed to the shareholder), and the shareholder is within the zone of interests that are protected by the federal act under which the agency operates (meaning, for example, that a shareholder cant sue an agency to seek enforcement of an OSHA claim, since it is the corporation’s workers and not shareholders who are in the zone of interests of OSHA). this cuts through the miasma of Delaware corporate law.

        I expect SCOTUS to find Collins claims to be direct under the APA, as did even the minority opinion in the 5th Circuit en banc.

        rolg

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        1. My.understanding of the Collins case is that if SCOTUS finds for plaintiffs on the APA claim, the ultimate award to plaintiffs will be the same whether it deems the claim to be direct or derivative: the net worth sweep will either be unwound retroactively (plaintiffs’ preference, and in my view by far the most likely) or Treasury will write hundred-billion-plus checks to the companies for all payments made in excess of what was owed as a 10 percent annual dividend on the outstanding senior preferred (plus interest), while leaving that senior preferred on the companies’ books. Both forms of award would benefit Fannie and Freddie directly, and their shareholder-plaintiffs only indirectly.

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          1. Tim

            just to be precise, the APA provides a direct claim to collins Ps. if as I expect scotus finds that collins Ps have been aggrieved by the NWS and they are within the zone of interests of HERA (as they are), then collins Ps have a direct claim and the succession clause does not prelude the assertion of the claim (since the succession clause only precludes a derivative claim).

            now separate question, what is the remedy? now you turn to the question as to whether the NWS was ultra vires, or whether the FHFA violated its duty to conserve and preserve by adopting the NWS. if so, then voiding the NWS would be a proper remedy if the NWS is found to be ultra vires.

            so the remedy doesnt flow from the status of the claim, direct or derivative, as much as it flows from the nature of the violation…whether the NWS is a valid act of the conservator under HERA.

            rolg

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          2. ROLG–All true, and useful context. For readers, though, I wanted to point out that the main remedies requested by plaintiffs in Collins are (a) “Declaring that the Net Worth Sweep, and its adoption, are not in accordance with and violate HERA…’ and (b) “Vacating and setting aside the Net Worth Sweep, including its provision sweeping all of the companies’ net worth every quarter.” The final prayer for relief in Collins is the standard “Granting such other and further relief as this Court deems just and proper,” which will not lead to any significant further awards. For this reason, an APA win for Collins plaintiffs at SCOTUS–as deserved and desirable as it may be–will not have predictable monetary consequences for either common or junior preferred shareholders in the companies. There are too many other important variables–including the binding capital rule and the degree of support or hostility of the next director of FHFA–that will influence the ultimate value of Fannie and Freddie’s common shares, and the timing and terms of any conversion to common (or redemption) of their junior preferred shares.

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          3. TH– Thank you (& ROLG) for the response(s).

            Assuming SCOTUS finds that the President can dismiss/fire the FHFA Director withOUT cause, how long can Mark Calabria remain as head of FHFA? Would/could he be dismissed the next day. Is there a statute allowing for Calabria to remain until the next FHFA Director is appointed? Could there be an immediately appointed Acting Director? Could Calabria, as others have pointed out, file suit thereby remaining in his current position for 6 months or even longer?

            What could an immediate effect be?

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          4. If the Supreme Court finds the structure of the FHFA directorship to be unconstitutional, Director Calabria would be removable immediately. Whether he is or not will be up to President Biden. I doubt the president has given much, if any, thought to FHFA (or Fannie and Freddie) at this point, given all the other priority items on the agenda. A SCOTUS decision overturning the net worth sweep (whether as a retroactive remedy for the unconstitutionality of the FHFA director or as the result of a ruling that the net worth sweep was an APA violation of HERA) would put Fannie, Freddie and FHFA on the administration’s radar scope, but it’s still not clear how quickly Biden would take up the issue.

            Calabria would not challenge a ruling by SCOTUS that his position was unconstitutionally structured (there is no basis for his doing so), but in the event SCOTUS does not rule at all on the FHFA director’s constitutionality (which I think is possible but unlikely), then the ruling by the Fifth Circuit en banc–that the FHFA directorship IS unconstitutionally structured–would stand. Biden could ask Calabria to step down based on that ruling, but Calabria could challenge this action in court (saying that SCOTUS still has not ruled definitively on this point).

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  6. Tim

    Collins plaintiffs reply to the acting SG’s letter to scotus regarding the 1/14/21 letter agreement: https://www.supremecourt.gov/DocketPDF/19/19-422/173521/20210331141013635_3.31.21%20Response%20to%20Letter%20on%20January%2014%20PSPA%20Amendment%20vf.a.pdf

    in essence, Collins plaintiffs agree that the case is not moot, but rebut the acting SG’s claim that substantial capital reserves are being built insofar as this increase in retained capital is offset by a corresponding increase in the Treasury senior preferred stock preference amount.

    rolg

    Liked by 1 person

    1. In its March 31, 2021 reply to the Solicitor General’s letter, Cooper & Kirk also make the important point that the capital the companies ARE permitted to build by the January 14 letter–with an equal and offsetting amount added to Treasury’s liquidation preference–is on the foundation of an enormous core capital deficit (for Fannie Mae, a negative $95.7 billion at December 31, 2021) created by the net worth sweep, that will remain unless and until the net worth sweep is voided and reversed.

      There is some recent evidence that suggests that FHFA (and the government) may be attempting to create some confusion or ambiguity around this point. Going back to before the financial crisis, Fannie has always included a table in its quarterly earnings press release titled “Consolidated Statements of Changes in Equity (Deficit)” at the end of the release. This table contains the components that comprise Fannie’s core capital, and enables anyone to calculate it each quarter. (Fannie publishes its core capital in one of the notes to the financial statements in its annual 10K, but core capital is not published quarterly.) Curiously, Fannie’s earnings press release for the fourth quarter of 2020 did NOT include the Consolidated Statements of Changes in Equity (Deficit) table. That table was there in the third quarter release, and its omission in the fourth quarter release was not inadvertent. I suspect that FHFA (and Treasury) want people to conflate Fannie’s (and Freddie’s) total equity–which is reported in many places in the financial statements–and its core capital, which is over $100 billion lower and now is very hard for anyone to find, or calculate.

      Liked by 6 people

      1. As hard as it is to prove intent, I hope this deliberate omission is highlighted for the courts. Knowingly and willfully deceiving *should* weigh heavily with any judge.

        Thanks for pointing this out, Tim

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          1. Plaintiffs’ counsel (Cooper & Kirk) are are aware of the omission of the “Consolidated Statements of Changes in Equity (Deficit)” in the latest quarterly earnings press release. As noted in my earlier comment, Fannie still does publish both its accumulated deficit and core capital in its annual 10K, so these data are not being withheld; they’re just not as easy to find (or calculate) as they were in the quarterly press releases.

            Liked by 2 people

  7. I finished Tim Pagliara’s book, Another Big Lie. I got it on Amazon Kindle for 99 cents. Don’t see how he’s going to make any money at that price.

    I thought it was very well written. He has a comfortable, readable style. He also likes a cute turn of phrase, as in “Freddie … kept its belt of credit discipline cinched tight, even when it lost market share to the banks who had been churning out manure like a herd of elephants.” Lots of remarks like that.

    It was an excellent history of the Fannie and Freddie wars, picking up where Tim Howard’s The Mortgage Wars left off, though he gives some of that pre-2008 history as well. It goes a lot into why the GSEs were taken over. I learned quite a bit that I didn’t know.

    The book ends on a hopeful note circa mid 2019, believing that Trump and Mnuchin will finally end the conservatorship. Of course, that wasn’t going to happen. Nothing on what may take place in the Biden era.

    He’s really good at picking out the villains in the story. I think he’s too nice to Hank Paulson, ascribing motives that are IMO nowhere in the guy’s wheelhouse, but he knows Paulson better than I. Still, in general he tells it like he sees it, and it’s a story most of us know. He crucifies the big banks and their cohorts. You know all the names. He gives a lot of background on those a**holes.

    Well worth your time. An excellent defense of the GSEs and a great explanation of why they should be released from jail.

    Liked by 2 people

    1. Jeff– Thank you for that “mini-review” of Tim’s book. I haven’t read the final version yet–I’ll do so soon–but I thought the earlier draft I read in June of 2019 was quite well done. In fact, I gave Tim and his co-author this blurb to use with potential publishers: “[Previous title] takes readers on a riveting and fast-paced journey through the drama and deceptions of a little-known, decade-long fight whose outcome will affect everyone in America who owns, or aspires to own, their own home. A must-read.” I have no reason to think that the published version wouldn’t merit a similar review.

      Liked by 2 people

  8. Apparently Biden is putting $200b for “housing” in the infrastructure bill per Maxine Waters who said she was reintroducing a house bill that had $100b. Anyone know where that money is going? Tweet about it below.

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      1. If Collins plaintiffs get the remedy they’re seeking on the APA claim–a retroactive re-characterization of sweep payments in excess of a ten percent dividend (at a quarterly rate) on the prior quarter’s amount of outstanding senior preferred stock as pay-downs of the balance of that preferred, and any remaining excess sweep payments returned over time as credits against federal income taxes owed by the companies–this would have no impact on the federal budget at all. That’s an important reason in support of a favorable ruling by SCOTUS on the APA issue–it can be made without headline-generating consequences.

        Liked by 1 person

        1. Mark Calabria in an exchange with Tim Rood.

          Has the Director just exposed his narrow and biased reading of history in his communication with Rood?

          Calabria discusses how coming of age in the aftermath of the savings and loan crisis and spending seven years on the Senate Banking Committee shaped his approach to regulating Fannie and Freddie.

          “My philosophy as a regulator is to hope for the best but plan for the worst,” he said. “What’s the worst 5 percent scenario? Even if only 5 percent likely to happen, there’s too much at stake to cut corners. It’s the decisions of these companies that landed them in the conservatorship. How do you get them to take ownership of their own decisions? How do you create a culture in these companies where they stand up and say we’re not going to enable bad behavior?”

          Liked by 1 person

          1. I have not listened to Tim Rood’s interview of director Calabria (and am in no great hurry to), but I am extremely surprised and disappointed by the last three sentences of this quote from him. This is someone who now has been the head of FHFA for almost two years. Does he truly not know what the real causes of the mortgage crisis were, or the relative credit loss rates during and after the crisis of the (only) two companies he regulates versus the commercial banks he seems to lionize, or the issuers of private-label securities he would like to see return to prominence in the name of “increased competition?” The unfortunate thing is that he probably does, and is deliberately saying things he knows not to be true in the service of his ideology. Even more unfortunate is the evident dislike or disdain he expresses here. “How do you get them to take ownership of their own decisions?” “How do you create a culture in these companies where they stand up and say we’re not going to enable bad behavior?” Really? As if it falls to Director Calabria to show Fannie and Freddie management the path to leadership, wisdom and virtue. The Biden administration cannot get rid of this pompous ideologue fast enough.

            Liked by 3 people

          2. Remember that Calabria came straight from Vice President Mike Pence’s staff where he served as Chief Economist.

            It is evident that Pence has been a huge disappointment to so many people of different political stripes that he is no longer being mentioned as a serious contender in the ’24 race.

            No one should be surprised at this, nor his affiliation with and backing of Mark Calabria.

            Too bad this ideologue wasted so many peoples’ time — most especially Trump’s and Mnuchin’s.

            VM

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          3. Rood/Calabria podcast link: https://www.situsamc.com/insights/hill-episode-6-mark-calabria-director-federal-housing-finance-agency

            it is remarkable that this conversation doesnt acknowledge that if the HERA conservatorship had been conducted in good faith, the GSEs would have paid off the senior preferred stock and would have already been able to raise the capital to act as the mortgage finance counter-cyclical backstop of last resort, as intended. Calabria laments that the GSEs cant play this role now, and implies that the moral hazard leading to the current state of affairs can be laid at the feet of the GSEs, for not standing up against the massive degradation in mortgage quality before the FC. Instead, the moral hazard that has led unto where we are can be laid precisely at the feet of the FHFA, for agreeing to the NWS at the insistence of Treasury rather than implementing HERA.

            rolg

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          4. FHFA’s role in the crisis is even more involved and complicit than that. I discuss this in briefly in my book, although I don’t really emphasize it. In 2004 Fannie Mae was fully aware of what was happening in the subprime market and with private-label securities (PLS). We found more and more high-risk product being originated, and it was being priced far too high by PLS issuers. In 2003 we had adopted and publicly announced a set of what we called “corporate financial disciplines,” that effectively put most of this business off-limits to us. After increasing our market share of total single-family mortgages financed by an average of 1 percent per year between 1990 and 2003, our share of outstanding mortgages fell by a full 2 percentage points in 2004. We were adhering to our disciplines. But then FHFA’s predecessor, OFHEO, made charges of accounting fraud against Fannie in September 2004. By the end of the year Fannie’s chairman, Frank Raines, and I were forced out, and OFHEO insisted that the risk management structure Frank and I had put in place at Fannie be re-structured, and that Fannie hire a chief risk officer. In the process of changing to the new OFHEO-mandated risk-management organization the corporate financial disciplines were dropped, and responsibility for deciding what business to accept from customers was moved from the finance division to the single-family business division. This was a huge mistake, done at the worst possible time, and it soon led to Fannie “chasing” high-risk business to remain relevant in the eyes of its customers. In my view FHFA’s predecessor, OFHEO, was 100 percent responsible for this having happened. Yet in FHFA lore, that agency was a hero for standing up to Fannie’s “arrogant and undisciplined” management. What was happening with PLS and Fannie in 2004 is documented and incontrovertible, yet OFHEO/FHFA simply choose to tell a different story. This is why, for me, it is particularly distressing to see Director Calabria returning to this same fact-free FHFA playbook today.

            Liked by 3 people

  9. Through the lens of a little “mirror reading,” this Letter from the acting Solicitor General seems to suggest that the justices sent a letter to the SG (and maybe also to the plaintiffs) asking for clarification on whether January’s amended PSPA mooted the issue of relief for the plaintiffs. Should we interpret this to mean that enough justices have decided in favor of the plaintiffs but now they are deliberating over the remedy?

    Click to access 20210318171031627_letter%2019-422%2019-563.pdf

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    1. I do read this letter to the Clerk of the Supreme Court from the Solicitor General as a response to an inquiry from the court about the significance to the Collins case of the January 14 letter agreement between Treasury and the FHFA. But I would not go further and call it an indication that the justices have decided, or even were leaning, in favor of the Collins plaintiffs.

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      1. Tim,

        Would you agree though that it’s hard to drop such a court-solicited letter into a scenario that is not favorable to plaintiff? In other words, this doesn’t look bad, does it?

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    2. @Shane

      so, a couple of things.

      it could well be that this letter is a response to an inquiry SCOTUS made, logically though the Court’s clerk, regarding the import of the recent SPSA letter agreement. Typically in a reply letter from the SG such as you have posted, it would have been proper form for the reply letter to refer to the inbound inquiry and respond that this reply is in response to the Court’s inquiry. This is standard first year law firm associate level stuff.

      also, it would have been highly improper for the Court to inquire of the SG without CCing Collins Ps counsel, so Cooper & Kirk should have a copy of this inquiry and will have an opportunity to respond as well, if such an inbound inquiry was made.

      All of which is to say that such a SCOTUS inquiry may well have not been made. Generally, new POTUS administrations will look at the prior POTUS’s SG arguments in cases not yet decided and, if they disagree with the prior SG argument, make such disagreement known. This letter is not such a “flip” in administration policy…of which the Biden administration has had many recently, as did the Trump administration prior to it. I am not clear what the Biden administration’s stance on Collins is, per this letter, other than to correctly assert that the SPSA letter agreement did not moot the case.

      I will speculate, however, that SCOTUS will recognize that this letter points out that the letter agreement does espouse a capital-building and rehabilitative purpose for the GSEs that is antithetical to the NWS…which is the Collins Ps argument for why the NWS is invalid! No impartial Justice can look at the NWS, the Collins Ps objections to the NWS, and then this letter agreement and not conclude that the Treasury has backed off on the objectives and purposes of the NWS….and I would think the Justices would not think the PSPA letter agreement furthers the government’s arguments in defense of the NWS. of course, the current SG could have lent support to the government’s position by saying times have changed, the GSEs are in a position to build up capital now but not at the time of the NWS, etc. which of course would have been a weak argument, and apparently understood to be so by the current SG.

      rolg

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      1. I completely agree. I was surprised by the letter and it did not mention why it was submitted. Very odd for all the reasons you describe. I don’t see any reason this is bad for shareholders. I don’t really see it as indicating anything imminent in shareholders favor either. Just odd. I’m going to be optimistic and favor that it means good things are coming. If I had to guess, Biden admin wants the ruling from SCOTUS that for cause removal was unconstitutional and so wanted to make it crystal clear that the case was not moot as a result of the amendment, even though no one at SCOTUS thought it was or even asked if it might have been moot. Although a real stretch, the admin might even want the retrospective relief to be directed by SCOTUS instead of the administration having to take a political stance either way and this may have been their way of cluing SCOTUS in to that idea.

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        1. @juice

          I agree with your point that the Biden administration wants to see the FHFA single director removable for cause provision struck, and a determination that the case is not moot furthers this objective. and it is interesting that the remedy that most argues for the determination that the case is not moot, the backward relief asked for by Collins Ps, is not provided by the letter agreement.

          rolg

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        2. Thanks very much ROLG and Fisherman for your thoughts on the “odd” Solicitor General letter. It was for me impossible to read without thinking the Solicitor General author(s) were saying “never mind” to both the Willett opinion and the Mnuchin/Calabria agreement. And the suggestion that it was in response to a SCOTUS request added to the oddness.

          I hope Mr. Howard might at some point reflect on ROLG’s comments.

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          1. I think the point ROLG makes that had the SG letter been in response to an inquiry by SCOTUS it would have said so is a good one, and I therefore would tend to agree that it was not. That makes me more inclined to view the letter as a positive for plaintiffs. It is purely factual, is not helpful to the defense, and concedes that the January 14 agreement does not moot Collins. Why, then, might the solicitor general have written it? It’s very tempting to say that it may have been written as a subtle signal that the Biden administration would not be averse to a ruling on Collins that goes the plaintiffs’ way.

            Liked by 1 person

    1. Don Layton clearly understands what Director Calabria is up to, and is not shy about calling him on it. Each of Layton’s last three pieces on FHFA–on its final capital rule (November 2020), its requirement for Fannie and Freddie to produce “living wills” (February 2021), and now this piece on the conservatorship scorecard–were relentlessly (and justifiably) critical, and had in common the theme that Calabria is using his position as regulator and conservator of FHFA to promulgate rules and regulations designed to achieve his ideological vision of using overcapitalization and overregulation to attempt to greatly “shrink the footprints” of the companies in the secondary mortgage market. Good for Layton. I obviously share his viewpoint on this subject. The sooner the Biden administration replaces Calabria with someone not ideologically opposed to the companies’ existence and mission, the better for all of their stakeholders.

      Liked by 2 people

    1. First and foremost, thank you Tim for the Gary Hindes letter. Very informative, and great top-level succinct summary of the legal cases in terms of damages and timing. We believe Summary Judgements (SJ) may play a bigger role than Hindes mentioned, and something to watch closely.

      Toomey will be OUT of the Senate very shortly. He is trying to do something in terms of legacy on the GSEs. Sometimes this can have an impact, most of the time being a ‘lame duck’ it does not have the impact one wishes.

      VM

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    2. The Toomey press release has a “going through the motions” feel to it. I note that it says, “Ranking Member Toomey’s principles are consistent with many previous housing finance reform proposals, including the U.S. Department of the Treasury’s Housing Reform Plan released in September 2019 and former Senate Banking Committee Chairman Mike Crapo’s (R-Idaho) outline released in February 2019,” without mentioning that fact that neither of those proposals–nor any of the many others that preceded them–ever went anywhere.

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      1. Referring to the Gary Hindes recent letter on March 9, 2021 – “ Indeed, I was told “all the work was done for Q1/Q2 (stock) offerings” and that they had already held “off-the-record roadshows.” – how is this possible with the senior prefs still in place and massive litigation over the next three years?

        Thank you!

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        1. I haven’t spoken with Gary about this, but the “off-the-record-roadshows” would have been done with the expectation among all parties involved that prior to the Biden inauguration the lawsuits would be settled and the senior preferred repaid or canceled; those obviously did not happen.

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

    “In reviewing the material misrepresentations and omissions it is important to incorporate them into a summary as to what was really going on during the initial transactions putting two Government Sponsored Enterprises into conservatorship. In September 2008 why did Treasury elect to put the GSEs into conservatorship and structure the initial Preferred Stock Purchase Agreements as they did? The answer to this question completely undermines the Treasury’s “high ground” position that they were the “good guys” saving the nation from financial ruin. It appears that the Treasury was executing transactions in a structure that was politically motivated. “

    Liked by 3 people

    1. Perfectly said. I dont believe that the original intent and lack of forensic accounting has been aptly communicated in any of the lawsuits.

      Liked by 3 people

    1. This article published by the Brookings Institution and co-authored by Mike Calhoun of the Center for Responsible Lending (CRL) and Lew Ranieri (best known for his leadership of the mortgage-backed securities desk at Salomon Brothers in the 1980s), is a curious mix of two very different proposals: (1) that Treasury waive its right to warrants for 79.9 percent of Fannie and Freddie’s common stock in exchange for a commitment by the companies to establish an “independent joint affordable housing entity” in an amount equivalent to the value of the waived warrants, and (2) that the Senior Preferred Stock Agreement be amended to allow FHFA to regulate the companies as public utilities, limiting their returns and thus lowering the guaranty fees they have to charge to produce those returns.

      Implementing the first proposal obviously would require Treasury’s approval, and I don’t know how likely it is that Treasury will want to waive its right to the warrants, even to create an affordable housing fund. (The simplest way to do this would be for Treasury to exercise its warrants, then transfer the stock to each company, with the stipulation that it be sold over time to raise cash for the fund.) There seems to be a much clearer path to gaining the consent of Fannie and Freddie (which they would need to provide) for utility-like regulation—and that is to have it be a component of a consent decree that would release them from conservatorship under a revised capital standard that would permit them to do business on an economic basis.

      The Center for Responsible Lending has been publicly advocating for utility regulation for Fannie and Freddie for over a year, following its publication of an article titled “Treat Fannie and Freddie as Utilities” in March of last year. CRL also has made some of the best arguments for reducing the conservatism, cushions and buffers in FHFA’s capital requirements for the companies, in its comments on both the June 2018 and the May 2020 capital proposals. What it has yet to do, but I believe soon will, is explicitly link these two issues, as it is uniquely well positioned to do effectively.

      A less obvious but critically important effect of utility regulation is that it enables affordable housing advocates to reframe the discussion about capital adequacy. I suspect a key reason so many in government accept the argument that “more capital is better” for Fannie and Freddie is that they believe lower capital primarily benefits shareholders, and allows management to take more risk. Utility regulation removes that argument, and shifts the focus instead to a cost-benefit between taxpayers and homebuyers (who more often than not are the same person). If Fannie and Freddie’s returns are capped, one can credibly say, “Pushing Fannie and Freddie’s capital from 3.0% in the 2018 FHFA rule to 4.5% (or higher) in the final 2020 rule results in immeasurable incremental protection for taxpayers, but will reduce access to the mortgage market for X million homebuyers, and raise the cost for those who can obtain a mortgage by an additional $Y billion per year; is this the result we want?”

      I think that is a winning argument politically, particularly in a Biden administration. I also think the investment community, as well as Fannie and Freddie management, would willingly accept capped returns in exchange for a capital requirement that allows the companies to do business on a sensible economic basis, thus raising their price-earnings multiple and market capitalization as publicly traded companies.

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      1. Tim

        while I thought this Brookings piece was very interesting and directionally sound, I also found it maddeningly unclear. while positing a program in general terms makes sense when it is somewhat novel, I thought there could have been much less ambiguity.

        As to the “waiving rights” to the Treasury stockholdings notion you referred to, I couldn’t help but to read that as giving up on the senior preference and using the warrants for their value…though I was reading into the text in order to find sense. perhaps the notion of voiding the senior preferred, or having that done by the judicial system, to create value for the warrants was a Voldemort concept, about which one must speak in hushed tones.

        but wouldn’t you think that the low income housing mandate of the GSEs would greatly benefit from targeted investment of the Treasury’s warrant value as, in effect, some kind of side car funding mechanism?

        rolg

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        1. There are two fundamental ways Fannie and Freddie can support affordable housing: by guaranteeing the credit of higher-risk loans for fees that the borrowers of these can afford to pay, and through direct subsidy programs they finance.

          They have done the first of these from the time Fannie was spun out of the government in 1968 and Freddie was created in 1970, with the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 adding targets set by their regulator for the percentages of total business they are required to do in certain defined affordable housing categories. Outright subsidies were introduced in the Housing and Economic Recovery Act of 2008, which mandated that Fannie and Freddie set aside 4.2 basis points of the unpaid principal balance of each new loan they purchase or guarantee—with 65 percent going to the Housing Trust Fund and 35 percent to the Capital Magnet Fund—and stipulating that this cost cannot be passed on to the homebuyer.

          Since the companies were placed in conservatorship, discussions about their role in promoting affordable housing have focused almost exclusively on potential subsidy programs, as if these were a substitute for supporting affordable housing through their credit guaranty business. They are not; they are a complement to it. And in any event, requiring Fannie and Freddie to increase the amount of direct subsidies they provide would require legislation, which is not likely anytime soon. That is why we’re seeing the proposal in the Brookings piece that Treasury use the proceeds of the exercise of its warrants for 79.9 percent of the companies’ common stock to fund a new subsidy program run by Fannie and Freddie; this could be done administratively.

          If Treasury is willing to do it (which I have my doubts about), that would be terrific. But it’s not an excuse to leave Fannie and Freddie’s basic credit guaranty business overcapitalized to the point where they cannot support affordable housing by cross-subsidizing higher-risk loans with fees they charge on lower-risk ones. A new FHFA director, working with Treasury Secretary Yellen, needs to be committed to revising Fannie and Freddie’s capital standard and regulatory scheme to allow the companies to return to the roles they’ve played successfully since their inceptions: financing large amounts of affordable housing loans in the course of their everyday business.

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          1. FHFA Authorizes More than $1 Billion for Affordable Housing Funds
            Largest amount ever disbursed to Housing Trust Fund and Capital Magnet Fund, more than double 2019 amounts
            FOR IMMEDIATE RELEASE
            3/1/2021
            Washington, D.C. – FHFA Director Mark Calabria announced today that he has authorized the disbursement of $1.09 billion for Fannie Mae and Freddie Mac’s (the Enterprises) affordable housing allocations for 2020. This is the largest amount ever disbursed and more than double what was provided last year….

            https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Authorizes-More-than-$1-Billion-for-Affordable-Housing-Funds.aspx

            rolg

            Like

          2. This is the direct result of the provision in HERA I discussed above. Last year, because of very low interest rates and very high mortgage liquidation rates (about 33 percent at each company) and refinances, Fannie did $1.412 trillion in new business, and Freddie did $1.190 trillion. That’s a total of $2.521 trillion, which, at 4.2 basis points of the unpaid principal balance of these loans, works out to a required payment of $1.09 billion into the two affordable housing funds, which is what Fannie and Freddie made. It’s interesting that Calabria was the one to issue the press release about this “largest amount ever disbursed” to these funds.

            Liked by 1 person

          3. I did not see it as a separate expense item in Fannie’s Income Statement. Is it considered a tax?

            Like

          4. Fannie’s payments to both the Housing Trust Fund and the Capital Magnet Fund are booked in the category of “Other expenses, net.” In its 2020 10K Fannie reported in its “Summary of Consolidated Results of Operations” that “Other expenses, net” were $1.131 billion for the year, and it said in a footnote that this figure “Consists of debt extinguishment gains and losses, housing trust fund expenses, loan subservicing costs, servicer fees paid in connection with certain loss mitigation activities and gains and losses from partnership investments.” Elsewhere in the 10K Fannie said, “The GSE Act requires us to set aside in each fiscal year an amount equal to 4.2 basis points for each dollar of the unpaid principal balance of our total new business purchases and to pay this amount to specified HUD and Treasury funds…Our new business purchases were $1.4 trillion for the year ended December 31, 2020. Accordingly, we recognized an expense of $603 million related to this obligation for the year ended December 31, 2020. Of this amount, $211 million is payable to Treasury’s Capital Magnet Fund and $392 million is payable to HUD’s Housing Trust Fund.”

            Liked by 1 person

  11. 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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      1. Tim,

        In light of damages only going to the companies, what is your take on the 6% per annum increase to par going back to 2012, which Gary references in his most recent piece? That value is cited for both Fairholme cases (vs. FHFA and US).

        Like

        1. In both the breach of contract suit before the DC Circuit and the regulatory takings suit before the Court of Federal Claims, plaintiffs are asking for damages as well as pre- and post-judgment interest on those damages; the interest payments accrue (according to Gary) at 6 percent per annum from the date the breach of contract or taking occurred–in both cases, August 2012. Because these are derivative suits, the interest (if granted by the court) and damages would be paid to the companies.

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          1. Tim,

            Thanks for that. Unless I’ve misunderstood, it seems Gary believes the 6% has a direct effect on par:

            “If successful – again, the evidence of the government’s misconduct is overwhelming – shareholders would be entitled to par value plus interest (at approximately six percent) dating back to the imposition of the Net Worth Sweep in 2012.”

            In his piece he applies that premise to both non-SCOTUS cases.

            Like

          2. Any payments to shareholders from the proceeds of a judgment in favor of the plaintiffs in a derivate suit would be at the discretion of the companies; it is not mandated (and I doubt that it would be suggested) legally. I have no information on how either Fannie or Freddie may be thinking about this issue.

            [4:30 pm correction] A holder of the companies’ junior preferred stock called my attention to a fall 2018 conference call with David Thompson, counsel to plaintiffs in the Perry Capital case (and other cases), in which David made clear that damages in the claim of breach of implied covenant of good faith and fair dealing now before judge Lamberth would, if granted, be payable by the government to the current holders of Fannie and Freddie’s junior preferred securities. I do not know if the same would be the case in the event of a favorable ruling for plaintiffs in the Court of Federal Claims. I withdraw the statement I made about damages here and in the comment above (and apologize for the error).

            Liked by 1 person

    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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  12. 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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  13. 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.

    Like

    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.

      Like

      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. I’ve now listened to the audio of the interview. The transcript only covers the second of four segments of the interview (so it’s not really inaccurate, just incomplete). In the interview, Pagliara gives some background on the Fannie and Freddie conservatorships, then focuses on the Collins case, and a little on the Lamberth case. If you’ve heard Tim talk about these before, he doesn’t say anything different–he thinks plaintiffs will win at SCOTUS on the constitutional issue but not get retroactive relief (a voiding of the net worth sweep) because that’s “too big a lift” for the justices, and it raises issues they would prefer not to deal with if they don’t have to. He also thinks plaintiffs will win on the APA issue, and that if the breach of covenant of fair dealings case before judge Lamberth gets close to the trial stage the government is likely to settle. (I agree with all of these conclusions.)

          The interview isn’t about Tim’s book. I haven’t read that yet, although I read and made comments on an earlier version he did with a co-author, Corban Addison, in which Tim was one of the people in the story (but not the narrator). Tim decided to rewrite the book as a sole author, and it may have changed from what I’d reviewed earlier. I’ll get and read the published version soon, and see how it ended up.

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    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

        Like

        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

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          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?

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          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

          5. Tim

            Based on Freddie Mac’s total assets, under the current letter agreement, (if lawsuits were settled and Treasury exercised the warranties), wouldn’t they be able to come out of out of conservatorship almost immediately? Their ability to raise up to 70b in stock offering would put them over the 3% capital threshold, were as Fannie would take 3 to 4 more years of retained earnings.

            EdM

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          6. Let’s start with the factual premise. The threshold for Freddie (and Fannie) to be released from conservatorship is to have capital equal to 3% of adjusted total assets–not total assets–for two consecutive quarters or more. FHFA has never been clear as to what other obligations are included in coming up with its “adjusted total asset” figures for the companies, but I note that for the two periods in which we have total asset and adjusted total asset figures for Freddie–September 30, 2019 and June 30, 2020–its adjusted total assets were 1.16 and 1.18 times its total assets, respectively. Taking the average of those two figures (1.17) and applying that to Freddie’s total assets as of December 31, 2020 ($2.627 trillion), Freddie’s 3% capital threshold would be $92.2 billion, or $75.8 billion more than the $16.4 billion in equity capital it had on that date. And with growth, Freddie probably is still a year or more away from where it could meet the 3% capital threshold required for its release from conservatorship with a $70 billion equity issue, even were the lawsuits settled and Treasury to exercise its warrants.

            And of course this raises the question: could Freddie management in fact raise $70 billion in capital for a company still in conservatorship, and regulated by a director who is openly hostile to it? I seriously doubt that. But in any case, by the time Freddie is in a position to potentially do such an issue, we should know (a) how SCOTUS has ruled in the Collins case, and (b) whether President Biden has taken any steps towards replacing Mark Calabria with a director whose objectives for Fannie and Freddie are more in line with the president’s.

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  14. 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

        1. I generally don’t comment on the investment aspects of the potential resolution of Fannie and Freddie’s 12-year conservatorships–the focus of this blog instead has been on making the case for using facts as the basis for releasing the companies in a form that maximizes their value to ALL stakeholders, not just investors–but in this piece I thought Gary made a compelling case for Fannie and Freddie junior preferred stock as an investment.

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  15. 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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  16. A working group including staff of the FHFA, the Federal Reserve, and Treasury had conducted a review of activities associated with the provision of secondary mortgage market liquidity.

    Stephen Ledbetter, Director of Policy, Office of the Financial Stability Oversight Council, Treasury
    Adolfo Marzol, Principal Deputy Director, FHFA
    Gillian Burgess, Senior Counsel, Federal Reserve

    Mr. Ledbetter summarized the key risk mitigants that the working group had considered. He noted that a significant amount of the working group’s review was devoted to analysis of the capital rule for the Enterprises that the FHFA had recently reproposed. He described the various components of the FHFA’s proposed risk-based capital requirements, and he noted changes in the reproposal that made the requirements more closely resemble the structure of the banking capital framework. He stated that the working group’s assessment of the FHFA’s proposed capital rule focused on whether the rule was appropriately sized and structured for the risks and for the key role played by the Enterprises, and whether the rule would promote stability in the housing finance system.

    Ms. Burgess then presented to the Council on the working group’s capital resiliency analysis. She described benchmarks for the level of capital that the Enterprises require, including an analysis of losses the Enterprises experienced during the financial crisis in 2008. She then compared the proposed capital rule to the bank capital framework. She noted that there are differences in the business models of the Enterprises and banking organizations that are relevant to capital requirements, but that the credit risks these entities take are SIMILAR. She explained certain similarities and differences between the proposed capital rule and bank capital requirements, including with respect to credit risk transfers (CRT) and risk weights applied to mortgage loans. She also described the components of the proposed capital requirements as they would apply to the Enterprises over time. Finally, she noted that the proposed capital rule would require high-quality capital.

    Mr. Marzol then presented on the proposed capital rule and the FHFA’s regulatory framework. He began by addressing key elements of the structure and design of the proposed rule. He noted that model and measurement risks were inherent in any mortgage risk-sensitive framework, and that the proposed rule contained several elements intended to protect against model risk, including a 15 percent risk-weight floor for mortgage exposures and a 10 percent floor for retained credit-risk tranches, in addition to a risk-insensitive leverage requirement. He stated that in order to help address procyclicality, the risk-based capital component of the proposed rule would adjust home prices downward when they are more than 5 percent above the long-term trend or upward when they are more than 5 percent below the long-term trend. He then addressed market discipline, stating that capital requirements that are too low could undermine market discipline and give the Enterprises a competitive advantage over banks and other market participants. He stated that the proposed capital rule contained elements intended to promote market discipline, including that it built off of the bank capital framework, which could facilitate market understanding about the quality and quantity of capital, and that it included a stability capital buffer, which he stated mitigated stability risk and could offset funding advantages. He also noted that the proposed rule included explicit capital charges for market risk and operational risk.

    Mr. Marzol then addressed the extent to which the proposed rule would promote stability in the broader housing finance system. He stated that the proposed stability capital buffer was intended to address the risks that each Enterprise’s default or financial distress could pose to housing finance markets and to offset potential funding advantages. He described the differences between the proposed buffer and the capital surcharge applicable to global systemically important banks, noting that the proposed buffer was based on the Enterprises’ share of mortgage debt outstanding and was calculated based on adjusted total assets. He stated that the inclusion of the buffer was an important step for mitigating the risks the Enterprises pose to the broader system. He also noted that the proposed rule would not result in market participants having the same credit risk capital requirements for the same risk exposures, and that these differences could maintain concentration of risk with the Enterprises. In addition, he described the proposed rule’s treatment of CRT. He stated that the proposed rule would continue to award capital relief for CRT but that it sought to ensure that each Enterprise maintains appropriate regulatory capital for the retained CRT exposure. He noted that the proposed rule would generally reduce the amount of capital relief for CRT compared to the current Enterprise conservatorship capital framework.

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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

          Like

  17. 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.

    Like

    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.

      Like

      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.

        Like

  18. 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?

          Like

  19. 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.

    Like

  20. 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?

    Like

    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

        Like

        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

  21. 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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