On May 17 the Federal Housing Finance Agency (FHFA) published a report titled “Performance of Fannie Mae’s and Freddie Mac’s Credit Risk Transfer,” focusing on “the performance of the two key single-family CRT vehicles—securities issuances (also called capital markets CRTs) and insurance/reinsurance transactions—which together account for about 90 percent of all CRT issuance.” The report was remarkable in many respects, both for what it said and for what it did not say.
FHFA reminds us in this report that Fannie and Freddie’s CRT programs had their origins in the agency’s strategic plans for the companies in conservatorship: “In February 2012, FHFA released a Strategic Plan for Enterprise Conservatorships that identified several steps that FHFA and the Enterprises would pursue to ‘[shift] mortgage credit risk from the Enterprises (and, thereby, taxpayers) to private investors’….Pursuant to FHFA guidelines, Freddie Mac brought to market the first securities issuance CRT in July 2012, which FHFA’s then Acting Director described as ‘a key step in the process of attracting private capital back to the U.S. housing finance market.’ This was followed by Fannie Mae’s first securities issuance CRT offering in October 2013. Freddie Mac and Fannie Mae issued their first insurance/reinsurance CRTs in November 2013 and December 2014, respectively.”
FHFA set annual targets for Fannie and Freddie’s credit risk transfers starting shortly after the beginning of the programs, and as a consequence CRTs have been used heavily by both companies for the past eight years (although Fannie has done no CRT transactions since the first quarter of 2020). In the report FHFA says, “Between July 2013 and February 2021, about $126 billion of risk in force (RIF), or the Enterprises’ maximum credit risk coverage, had been placed through securities issuance and insurance/reinsurance CRTs.”
I consistently have been critical of Fannie and Freddie’s credit risk transfer programs, arguing that they cause the companies to pay far too much for insurance against losses that have only a remote chance of occurring, and that investors will not buy new CRT issues during periods of financial stress, when they are most likely to be of value to the issuer. FHFA addresses both of these points in the May 17 report. On the second it says, “Concerns have been raised that CRT markets may be easily disrupted during periods of market stress, requiring the Enterprises to retain credit risk they had planned to transfer. The experience during and after the COVID-19 stress offers some support to these concerns.” The pandemic, of course, merely raised the threat of adverse credit performance—home prices in fact have jumped sharply since March 2020—which FHFA recognizes by noting, “CRTs remain untested by a serious credit event.”
But it’s the data on and the projections of the economics of Fannie and Freddie’s CRTs that are—or should be—the headlines from the FHFA report. First comes a straightforward accounting of the costs and benefits of the companies’ CRT programs to date: “As of February 2021, the Enterprises had paid approximately $15.0 billion in interest and premiums to CRT investors and counterparties and the Enterprises had received approximately $0.05 billion via investor write-downs and counterparty reimbursements,” with the added clarification that “To date, the only CRT tranches or layers that have incurred write downs or counterparty reimbursements (i.e., benefits to the Enterprises) have been in a few transactions issued in 2015, 2017 and 2018 in which the Enterprises sold first-loss tranches or layers.” FHFA next reveals the results of two performance simulations it asked a consulting firm, Milliman, to run, using what it called a “Baseline scenario” and a “2007 Replay.” In the baseline scenario, Fannie and Freddie’s lifetime CRT costs were $33.60 billion and their “ultimate benefits” (credit loss reimbursements) were $1.06 billion, for a net CRT cost of $32.55 billion, while in the 2007 Replay, lifetime CRT costs were $30.72 billion, ultimate benefits were $10.10 billion, and the net cost was $20.63 billion.
I’ll repeat those numbers, and emphasize that they come from FHFA, which has been directing Fannie and Freddie to do great volumes of CRTs for the past eight years: (a) the companies’ CRT programs to date have cost them $15.0 billion and returned $50 million in benefits (all on first-loss tranches); (b) the expected lifetime result of the companies’ CRTs on $126 billion of risk in force is a cost of nearly $34 billion and credit loss reimbursements of $1 billion, and (c) even in a worst-case scenario, Fannie and Freddie will pay $31 billion and only get $10 billion back in benefits, for a net loss of $21 billion.
I have long been saying that Fannie and Freddie’s CRT programs are noneconomic, but these actual and projected figures in the FHFA report are staggeringly noneconomic. I kept waiting for the authors to admit this, but they never did. Instead, they simply say, “FHFA continues to assess the CRT programs, including their costs and benefits as well as the benefits and risks to the safety and soundness of the Enterprises, the Enterprises’ ability to perform their statutory mission, and the liquidity, efficiency, competitiveness and resiliency of the national housing finance markets.”
What of any significance about Fannie and Freddie’s CRT programs could possibly be left to assess? We’ve known the common-sense objection to programmatic CRT issuance for some time. CRTs are priced by investors who seek a comfortable risk-adjusted return on their investment; if they sense that the mortgage market is becoming a little more risky they increase the returns they require on their CRTs, and if they sense the market may become a lot more risky they can withdraw from it altogether (as they did during the initial months of the pandemic). For these reasons, it would take systematic and persistent investor mispricing, and prolonged inattention to the leading indicators of mortgage credit loss, for the issuers of CRTs to ever get more out of them in credit loss transfers than they make in interest payments. And now we have eight years of historical data, along with prospective simulations overseen by FHFA, that lay out the terrible economics of CRTs with blistering clarity (while emphasizing this by noting, “CRT investors and counterparties are projected to receive a simple return of about 26 percent on the original reference pool UPB in the baseline scenario and 16 percent in the 2007 Replay”). There are no remaining mysteries about CRTs to be solved, but FHFA for some reason wants to pretend that there are.
This encapsulates what’s so wrong with the Calabria-led Federal Housing Finance Agency: they tout themselves as a “world-class regulator,” yet they seem to be operating in a world divorced from reality. Calabria and others at FHFA refer to CRTs as a triumph of “bringing private capital into the mortgage market,” but their staff has put out a report showing the truth to be just the opposite: by requiring huge amounts of annual interest payments while providing minimal absorption of credit losses in return, CRTs siphon tremendous amounts of capital out of the mortgage market, and weaken the companies FHFA regulates. Then there is the glaring contradiction between Calabria’s intense publicly-stated concern about the gap between Fannie and Freddie’s current level of capital and the (greatly excessive) amount he would like them to hold—which has led him to feel that FHFA must restrict the amount of high-risk business it permits the companies to do—and his repeatedly pushing them to issue CRTs that burn up their retained earnings and retard their capital growth.
There is something missing here. FHFA’s primary task is to regulate two companies that today take only one type of risk in one country on one type of asset (credit risk on U.S. residential mortgages), and it is sitting on a mountain of data that permit the quantification of that risk. But it seems not to know some of the most basic facts about it.
Since Fannie was put into conservatorship, it has published a chart in its quarterly Credit Supplement that shows the cumulative default rates of its single-family conventional book of business by origination year. Even a quick perusal of these charts makes clear that Fannie’s credit performance over the past two decades falls into three distinct groups: the years prior to 2004, 2004 through 2008, and the years after 2008. The 2004-2008 books are the outliers. And the difference between Fannie’s 2004-2008 books and the business it did before and after that period becomes even sharper when you include data on average loss severities, available in Fannie’s Connecticut Avenue Securities Investor Presentation (the default rate times the loss severity rate equals the credit loss rate).
Between 2004 and 2008, Fannie had a weighted average credit loss rate of 3.75 percent, driven by an 8.8 percent average default rate and 42.5 percent average loss severity. In contrast, during the previous five years—1999 through 2003—Fannie’s weighted average lifetime credit loss rate was just 45 basis points, the result of a 1.6 percent average default rate and a 28.0 percent average loss severity. And the credit performance of Fannie’s books from 2009 through 2020 is shaping up to be even better than that of the 1999-2003 books. The average “ever-to-date” default rate on Fannie’s books of business from 2009 through last year is well under 1.0 percent, while the weighted average loss severity of the 2009-2013 books (the only ones with enough seasoning for the data to be meaningful) has been 27.5 percent—virtually the same as the average of the 1999-2003 books. Thus, Fannie’s post-2009 books currently are performing consistent with a lifetime credit loss rate far less than the 45 basis-point average of the 1999-2003 books.
These are the data, but to turn them into a credit risk management strategy—whether for a credit risk transfer program or a regulatory capital standard—one needs an analytical overlay; specifically, is there any reason to think that the sharp deterioration in credit performance between 2004 and 2008, not just for Fannie and Freddie but for all mortgage lenders, was an anomaly, and not reflective of the inherent risk of residential mortgages?
In fact, there is, and I described it in a post titled “Some Simple Facts”: “In the late 1990s, the Federal Reserve under Alan Greenspan declined to regulate risky lending practices in the newly-emerging subprime market, favoring market regulation instead. Neither the Fed nor Treasury changed their regulatory stances when many of these practices began spreading to the prime mortgage market in 2003, nor when private-label securities (PLS) became the dominant means of secondary market financing for all single-family mortgages in 2004. In the absence of any prudential regulation, near-unlimited access to mortgages for unqualified borrowers through PLS issuance fueled an unsustainable boom in home sales, construction and prices that continued until the fall of 2007, when the PLS market finally collapsed. With PLS financing suddenly gone, and other lenders pulling back in an attempt to protect themselves, housing sales and starts plummeted, and home prices fell by 25 percent peak-to-trough before they could stabilize.”
I noted in the same post, “We learned from our mistakes. Post-crisis, the Fed and Treasury (and even Greenspan) admitted their deregulatory posture during the previous decade was an error. Congress in 2010 passed the Dodd-Frank Act, requiring lenders to apply an ‘ability to repay’ rule to mortgage borrowers and, through its qualified mortgage standard, effectively prohibiting the riskiest mortgage products and loan features that proliferated during the PLS bubble.” It is significant that almost all analysts who have examined the credit losses from Fannie and Freddie’s 2004-2008 books of business, including FHFA, have concluded that about half of them stemmed from products and risk features no longer permitted by Dodd-Frank. This means that even in the extremely unlikely event of a repeat of the 25 percent decline in home prices experienced during the Great Financial Crisis, the probable lifetime credit loss rate on Fannie and Freddie’s worst five years of business would not be 3.75 percent, it would be less than 2.0 percent—the average loss rate actually recorded on the 2004-2008 book, reduced by half to account for the absence of the products and risk features the company financed before the crisis, but no longer does.
FHFA should know this. Based on the historical data it has, it should know that a typical book of Fannie’s (or Freddie’s) single-family credit guaranty business is likely to have a lifetime credit loss rate of between 30 and 50 basis points, and that even a repeat of the severe home price declines of the mid- to late 2000s shouldn’t push credit losses on any book of business much above 200 basis points. Given that, it makes no sense to have credit risk transfers that don’t even kick in until after cumulative credit losses exceed 50 basis points, and go on to cover loss rates in excess of 400 basis points. Yet that’s how Fannie and Freddie’s CRT programs have been structured from the beginning. It’s no wonder that, as FHFA’s May 17 CRT report confirms, they’ve been such a colossal waste of money.
Except the FHFA report doesn’t actually come out and say that Fannie and Freddie’s CRT programs have been a colossal waste of money; it says they deserve more study. Of course, they don’t, and that’s the problem with FHFA under Calabria. The facts say one thing, he says another, and as Director he gets his way, whether it’s on CRTs, business risk limits, or capital. Changing this counterfactual approach to Fannie and Freddie’s regulation very likely will require the Biden administration to change its FHFA Director.
HOWARD ON MORTGAGE FINANCE 
https://insidersgame-com.medium.com/why-the-supreme-court-case-draining-fannie-and-freddie-of-all-equity-is-such-a-travesty-86fd3021793f
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Hitting the nail on its head. How does NWS benefit FHFA? FHFA did not get a penny of the money. Does NWS make housing market stable or houses more affordable? Or do FHFA employees have better morale or higher productivity, as result of NWS?
Alito needs to explain it.
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It can be proven the exact opposite. FHFA required Fannie and Freddie to impose a 50 basis point fee for refinances above $125,000 last year. This passed the cost to homeowners in order to try and increase revenues
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The amazing point isn’t even that. It’s that the lynchpin of this obviously garbage ruling wasn’t even correct on the facts.
What a complete kangaroo court.
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Unfortunately it does benefit the agency because of the view (we disagree with) that it by “extension” serves the “public interest” which is the overall goal of all regulation.
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HERA borrows a clause from FDIC Act.
Please note that “in the best interests of the regulated entity or the Agency” is essentially same as “in the best interests of the depository institution, the depositor, or the Corporation” in Incidental Powers section of FDIC Act.
Can FDIC treat its troubled memebers as FHFA does GSEs? The opinion has serious side effect on FDIC and its banks. They should ask SCOTUS to explain.
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I’ll discuss this and other aspects of the Supreme Court’s ruling in a post I’m intending to put up on Monday morning.
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I always look forward to reading your posts, but this one should be especially interesting given the developments the last week!
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Sandra Thompson has been named acting FHFA director.
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Even if the Biden administration cancelled the SPS liquidation preference and reworked Calabria’s capital rules (two huge if’s), who would invest in the GSEs under HERA’s current SCOTUS-interpreted structure? A new administration could replace the FHFA director immediately and once again sweep funds and rework the capital rule to accomplish anti-GSE policy goals. The agencies are functioning, but the old capital paradigm seems irreversibly broken save legislation to amend HERA.
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You make an excellent point. In the past, investors in Fannie and Freddie common and preferred stock always knew the companies had political risk, but they viewed that risk as being legislative, in the form of a bill adverse to the companies’ interests–which never actually came to pass–not, as it turned out, executive (the conservatorship forced on the companies by Treasury) and certainly not judicial (having the Supreme Court uphold the taking of their profits in perpetuity as legal). It will be the challenge of the Biden administration, or some future one, to figure out how to alleviate the concerns of this now much broader definition of “political risk.”
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Tim,
Wouldn’t a capital raise enable release from conservatorship, after which time the twins wouldn’t be any more risky than Apple or Starbucks? In other words, even with the law allowing for a conservator to nationalize a company that it’s to help rehabilitate, once out of conservatorship, wouldn’t the twins be as safe an investment as other companies that are currently safe and solvent?
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With the Supreme Court’s ruling, the net worth sweep has only been suspended, with Treasury’s liquidation preference continuing to grow in line with Fannie and Freddie’s earnings. And according to the terms of the January letter agreement, once the companies reach full capitalization (in the last few quarters they’ve been moving further away from it, because of their rapid growth) the dividends on Treasury’s senior preferred will get turned on again. What investors would put new money into either Fannie or Freddie under those conditions?
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Tim, I would argue that if this occurred, and the NWS was turned back on, that would qualify as harm under yesterday’s ruling.
I’m certain that the 4th Amendment/Letter Agreements that occurred post orals entirely changed this dynamic in the eyes of the justices. They clearly thought the issue was moot, and as I read it, don’t understand the growing ‘escrow account’ created by the quarterly sweep and how that operates.
Plaintiffs barely had the opportunity to discuss this other than the one page letters that were circulated in Feb/March. It’s as if those were lost in translation and SCOTUS considered their job done once they read those notes. Consider what Kagan and Alito said in their opinions that they believe the lower courts should be able to quickly resolve the matter… My interpretation of that is that they truly believed that no harm was being committed at that point and their job was done.
If the NWS returns with a full dividend to Treasury, I think that would change things significantly. However… the issue would be… Who could file a lawsuit and stop it? Obviously not shareholders… Which makes me think that it could happen as soon as tomorrow.
This ruling is so messy that it makes me think that Cooper and Kirk should write for clarification on these issues. Not sure if that’s possible with a SCOTUS case. My other thought is that the 4th Amendment/LA could considered ‘New Evidence’ in an updated filing/re-petition if that’s possible, or maybe that has to wait to be inserted into the remanded case.
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If the net worth sweep were to be turned back on (which I don’t believe it will be), it would be done under the leadership of a (now) constitutionally appointed FHFA director, and thus would not “qualify as harm under yesterday’s ruling.”
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Tim,
My guess, which seems quite reasonable to me, is that because we aren’t in fog of war, nor is there need for circular borrowing to pay interest, to go against the letter of agreement by sweeping profits under the current climate would be seen as both arbitrary and brazen theft. Perhaps even more comforting is I don’t think such a maneuver would serve what I hope would be the intentions of the new FHFA director. Lastly, it seems to me that court found occasion not to address the sweep in our favor because they postured itself as thinking that no more harm will be done as we retain earnings (though they conveniently ignored the 1:1 preference for each dollar). 🤷♂️
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Tim/Soto
Remember that as putrid (IMHO) an opinion as Collins was re the APA claim, it was a statutory interpretation opinion regarding HERA, which as to the anti-injunction clause goes away once the GSEs exit conservatorship.
Now it is fair to ask how exactly, given the opinion, will the GSEs exit conservatorship. A capital raise is out of the question unless some extraordinary assurances are given by the next FHFA director…and if so, even those assurances would not necessarily bind the FHFA. The GSEs could proceed as is with capital retained and the senior preference growing for a dozen years, which might be just fine for the Biden Administration, but let me posit that the Biden Administration won’t last for more than three years (speaking as to his age rather than as to governance).
So during the next three years, congress will meet in committee, discuss and likely do nothing. There will be no changes instituted by the Biden Administration other than a new FHFA director who hopefully installs a more realistic capital standard, and the litigation goes on…the Fairholme case in front of Judge Lamberth, the CFC case and…Collins. Perhaps the Collins complaint can be amended (leave to amend a complaint is usually liberally granted at this stage of the proceeding) to add a claim, and the 5th Circuit has already shown it is without “Federalist Society Cabal” bias.
Assuming the Ps still want to fund this litigation (easy for me to say), this saga is not over until it is over. and it is not over.
rolg
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Rule of law guy, what future actions will the Supreme Court ruling regarding Collins vs Yellen have on the FDIC? I’m thinking there’s a lot of unintended consequences that could occur if a large bank is placed under FDIC control, since HERA and FDIC law is so similar.
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@Brian
great question. usually the FDIC is “non-political”. now it seems it can become as political as it wants to.
rolg
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If motivated, Biden could get this done in a few months, just like the dissemination of vaccines. The heavy lifting is done and the investors are already in the queue.
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This ruling seems to suggest that only constitutional rights may protect shareholders in the case of the GSEs. Supreme Court ruled that the conservator did not exceed the authority when entering NWS. However, it also admitted that such actions might not be in the best interests of the GSEs and it did not say anything about whether they violated shareholders’ right to property or not. One thing puzzles me is that Mr. Thompson did not use a taking claim against NWS by citing “Constitutional Avoidance”, even when Justice Breyer pressed on the issue. I am curious what is your take on the prospect of a taking claim.
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My batting average on predicting the outcome of cases involving Fannie and Freddie is below the Mendoza line, so I’m not the best person to ask this question. Judge Sweeney certainly seemed to be struggling with it (to put it mildly) in the Court of Federal Claims, and after more than seven years she hadn’t even gotten to the point of deciding whether she had jurisdiction over the case yet. I don’t know anything about her replacement in the case, Judge Schwartz, but if I had to pick a favorite for “last to the wire” in all of the court cases it would be that one.
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Thank you for the perspective, Tim!
As Chief Roberts implied during the oral argument, the future values of the GSEs mostly depend on the on-going political discussions. It probably becomes a strategy for judges to stay out of the picture as much as they can. Agree that, for Fannie and Freddie, the judicial branch does not look like a savior so far.
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Tim,
Although the Court ruled that the NWS was legal, can we deduce that the Court also ruled by good and necessary inference that there needn’t be a monetary accounting of the NWS? I realize the NWS was structured as being in perpetuity and doesn’t pay down Sr. Pfds. per se, per the 3rd amendment, but surely the Court can’t expect the GSEs to get out of C-ship without some sort of pay down of the Sr. Pfds. (It’d be a bit arbitrary to *begin* the pay down at some future date.)
Lastly, does the administration need some sort of political cover in order to mark the Sr. Pfds “paid in full”? Any thoughts how they can walk away from the sweep?
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First of all, I’m sure the Court felt no need to address the implications for ending Fannie and Freddie’s conservatorships when it made its ruling on the APA and constitutional issues. On the issue of political cover, I don’t know how the Biden administration will think about that. Right now it’s in “no man’s land.” The Trump administration began a recap and release process with the January letter agreement suspending the sweep indefinitely (while continuing the liquidation preference indefinitely as well–a fact whose significance seemed to have escaped the Justices when they claimed this suspension mooted the request for a prospective remedy). But with the loss at SCOTUS, you now have two companies who are allowed to build their earnings but have no hope of accessing the capital markets because all of their past accumulated earnings belong to Treasury. As I noted elsewhere, the Biden administration has three ways it can undo this knot: (a) nationalize Fannie and Freddie, and keep the right to their income stream in perpetuity, as it now has with the liquidation preference, (b) “wind them down and replace them” (and we know how past attempts to do that turned out, or (c) deem the senior preferred to be fully paid, cancel the liquidation preference, and release them. My bet is the third option, and their “cover” for that would be to declare that this is the best public policy for the mortgage market, and the nation.
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If (a), then receivership? Hoping for (c).
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Having been in this since 2014 what I’ve come to realize is always expect the wrong action to take place. What’s best for public policy, the mortgage market and the nation has never been the direction this saga has ever followed. I find it to fly in the face of all of the historical actions that have taken place with respect to how Fannie and Freddie should be resolved. Some how, some way, the GOVT will get everything they want out of this. Option 3 is not that option. It will be some hybrid of 1 & 2.
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(a) and (b) seem mutually exclusive, in which case there could be no such hybrid.
As for full blown nationalization, I don’t think the Federalist backed Court will stand for that, which leaves us with wind down or release. Wind down cashes out as receivership. Don’t see that happening.
I’m still interested in my previous question. Would nationalization require R-ship?
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I’m not a bankruptcy lawyer, but I believe the answer is no.
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@Ron/Tim
FHFA could authorize a squeeze out merger right now with a Newco that would freeze out all shareholders other than Treasury…and it would be challenged in court. as things stand now, the GSEs are economically nationalized…so there is no need to act before all of the litigation ends.
I suppose we should watch the FHFA director nominee’s senate confirmation hearings, to see if any senator has the gumption to ask how this should all play out.
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“FHFA could authorize a squeeze out merger”
We should be so fortunate!
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Tim,
Well said, and one certainly hopes that you are right about (c). That is the only realistic way to protect the U.S. Government from a major housing downturn with the potential to monetize the warrants. Look forward to your potential role should you choose to participate.
You are dead-on that the Justices glossed over the continuing liquidation preference. Their lack of accounting knowledge is glaring, as there IS a Prospective remedy that they said is mooted by Trump/Mnuchin/Calabria’s actions.
(a) and (b) have issues that you aptly and expertly highlighted.
Do you have any comments on Fairholme Funds v. FHFA &/or Fairholme Funds vs. The United States (U.S. Court of Federal Claims) in terms of what SCOTUS has now ruled?
VM
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I may have a different answer on the implications of yesterday’s SCOTUS ruling for these two litigation paths (breach of contract and regulatory takings, respectively) after a few days of reflection, but right now my thoughts on them are not positive, and run along the lines of: “If plaintiffs can’t get a favorable judgment from the Supreme Court in a case (the APA violation) where precedent as well as the facts so clearly support them, and the $100 billion-plus remedy could have been granted with the stroke of a pen, how likely is it that they will prevail all the way through the appeals process in cases where a similar-sized remedy would have to be paid in cash?”
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Thank you very much
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Dear Tim, for some reason I Re-read The DC circuit reply brief for the breach of contract claim (breach of implied covenant of good faith and fair dealing). I find that the judge opinion and this route of litigation is distinctly different from the thus far failed cases of APA claims. In fact we have won nothing along this route and SCOTUS effectively puts an end to this line of enquiry, pursuing the pained logic of stated law text as per lower courts along the way. In DC circuit, it was also dismissed from the outset but the breach of claims survives. What’s interesting in here is that the Judge’s replies relied strongly on the available facts and allegations leading to the NWS and were by now PROVEN such as the part on that by 2020 the cirmulative dividends paid by GSEs will exceed Treasury investment.
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@RF
I did a little reading on the Lamberth case as well. Recall in effect that in 2014, Lambeth stated in his opinion denying the ultra vires claim that the shareholders were screwed, but congress gave FHFA the right to screw them. now, there is a case before Lamberth to see whether there is a remedy at common law (Delaware law re implied duty of fair dealing) for how the FHFA screwed the shareholders. Lamberth is perhaps enough of a wild card to make this claim worthwhile.
rolg
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Tim,
Can you explain why option C could be better public policy than just keeping status quo ? couldn’t the same housing policies be carried out with perpetual conservatorship ?
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“Perpetual conservatorship” is an oxymoron. Fannie and Freddie have been conserved. FHFA, uniquely, has come up with the concept of a “non-conserving conservator”–which the Supreme Court has just ratified–but conservatorship by definition is temporary. If a financial institution gets into difficulty, conservatorship is the way a regulator has to attempt to restore it to profitability. If it is successful it returns the company to its former status, and if it is not successful it puts it into receivership and liquidates it, according to well-established bankruptcy procedures. Fannie and Freddie were restored to profitability years ago, but Treasury and FHFA have refused to return them to their former status, because they’ve hoped to have been able to do something different with them. This is now the Biden administration’s problem, and it has to decide what it wants to do. Fannie and Freddie will stay in conservatorship until then, but endless conservatorship is not an acceptable end point.
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Tim,
Although you have all good points above about perpetual conservatorship being an oxymoron, “acceptable” is a matter of perspective. It’s not acceptable to me, not to you, and probably most who care about home ownership and the rule of law. However, given the history here, there appears to be no motivation to move off of the status quo. I would now call it “nationalization” under the guise of “perpetual conservatorship”. Some on the senate banking committee postulated that the status quo is “working fine so why fix it?” So I don’t expect Biden to do anything during his first term. It would take heaven and earth to move this in advance of any of the other court cases (takings or fair dealing, throwing away remand in Collins).
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Both the Obama administration and the Trump administration had a plan for getting Fannie and Freddie out of conservatorship–“wind down and replace” for the former, and “recap and release” for the latter–they just couldn’t execute them. I don’t agree with you that the Biden administration will be content with doing nothing with the companies for its entire first term; how quickly it will come up with a plan and try to make it work is another question, to which I don’t at this point have a good answer.
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https://www.americanbanker.com/news/biden-will-fire-fhfas-calabria-after-supreme-court-ruling
Biden will fire FHFA’s Calabria after Supreme Court ruling
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Click to access 19-422_k537.pdf
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As everyone can read, the justices upheld the notion that the anti-injunction clause bars shareholders’ suit against the government for taking Fannie and Freddie’s profits in perpetuity. That was my feared “less than 10 percent but not zero probability” worry that the anti-Fannie and Freddie “Federalist Society Cabal” would find a way to prevail on this issue, as indeed they did. I’ll read the full opinion, but it won’t change the headline.
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So this conversvitorship was completely different than any in history because a 3rd party got added to the ownership structure by the legislature (FHFA) and somehow the mushy look thru to protecting the taxpayers explains away all?
In retrospect, it should’ve been obvious that any opportunity to shut this line of inquiry down and never look into the merits of the 2009-11 valuations of the agencies’ holdings was going to be taken.
Another one down the memory hole.
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So the saga continues. According to a WH Official and Bloomberg, Calabria will be replaced, that’s certainly the good news! I’m optimistic that at some point private capital will be invested to protect taxpayers. Susan Wachter might be the FHFA Director best suited to achieve those aspirations.
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Having been punted (or fumbled) out of the Supreme Court, the ball on Fannie and Freddie now is in the court of the Biden administration. It almost certainly does not want to nationalize them, nor does it want to attempt to replace them with an untested alternative (and certainly not one along the lines proposed by the companies’ competitors and opponents over the last dozen years, which would make the secondary mortgage market less efficient, and drive more business to banks). But what does this administration want? I hope we get some clues sooner rather than later. These “non-conserving conservatorships” have lasted far too long already.
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Tim, in your opinion does the Biden administration have the will to move forward and fix, or get FnF out of conservatorship? Out side of a court forcing an outcome this has always been an administrative solution. Can or does Biden team pick up where Trumps left off? At a minimum we need to wait for Senate confirmation of a new director and new capital plan.
Lastly since this seems the area we look for direction do you lend any credibility to the last part of the 4th PSPA where FHFA/Treasury endeavor to come up with solutions to terminate the conservatorship and raise capital by 9/30/2021?
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I truly do not know what the Biden administration will do with Fannie and Freddie (who SCOTUS has now tossed on its plate). But I agree that its choice of a new director will give us a good clue. As for Treasury Secretary Mnuchin setting a September 30, 2021 deadline for his successor and FHFA to “come up with solutions terminate the conservatorship and raise capital,” I would characterize that as “kicking the can down the road, and pretending the road is short.”
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Sandra Thompson named as Acting Director.
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The shareholders have standing to bring their constitutional claim.
The shareholders’ constitutional claim is not moot.
The shareholders’ constitutional claim is not barred by the Recovery Act’s “succession clause.” §4617(b)(2)(A)(i).
The shareholders’ constitutional challenge can proceed even though the FHFA was led by an Acting Director, as opposed to a Senate-confirmed Director, at the time the third amendment was adopted
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And this constitutional claim is remanded to a district court whose Court of Appeals en banc granted plaintiffs only a prospective remedy for the net worth sweep approved by an acting director it agreed had been appointed unconstitutionally.
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Tim , I think that the fact that they remand it saying that retrospective relief may apply is a diplomatic way of rejecting the en banc opinion. I bet there will be some retro
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I don’t think so. I agree with Justice Kagan’s take on the remand, in her concurring opinion:
“My final point relates to the last sentence of the majority’s remedial section. There, the Court holds that the decisive question—whether the removal provision mattered— ‘should be resolved in the first instance by the lower courts’… The court noted that all of the FHFA’s policies were jointly ‘created [by] the FHFA and Treasury’ and that the Secretary of the Treasury is ‘subject to at will removal by the President’…. For that reason, the court concluded, ‘we need not speculate about whether appropriate presidential oversight would have stopped’ the FHFA’s actions… ‘We know that the President, acting through the Secretary of the Treasury, could have stopped [them] but did not’…. That reasoning seems sufficient to answer the question the Court kicks back, and nothing prevents the Fifth Circuit from reiterating its analysis. So I join the Court’s opinion on the understanding that this litigation could speedily come to a close.“
The opinion on the statutory claim was 9-0, and the remand to the Fifth Circuit on the constitutional claim was pro-forma, with virtually no chance of any retroactive remedy to plaintiffs being granted.
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Some but how much? and Only if “the relevant inquiry is whether the plaintiffs’ injury can be traced to “allegedly unlawful conduct” of the defendant” and Gorsuch alludes to this traceability problem (due to exec privilege) in his in partial concurrence and goes so far as to suspect the Court is framing its guidance in such a way to achieve no retrospective relief from the lower courts: “The Court declines to tangle with any of these questions. It’s hard not to wonder whether that’s because it intends for this speculative enterprise to go nowhere. Rather than intrude on often-privileged executive deliberations, the Court may calculate that the lower courts on remand in this suit will simply refuse retroactive relief.”
Further, the ruling kneecaps the retro relief with guidance to a damage period with a confirmed director and notably, most of the damages in the timeline would likely to have have occurred under ‘acting director’ DeMarco from the 2009-2013 time frame – source: https://www.fhfa.gov/AboutUs/Timeline
“The answer to that question could, however, have a bearing on the scope of relief that may be awarded to the shareholders. If the statute does not restrict the removal of an Acting
Director, any harm resulting from actions taken under an Acting Director would not be attributable to a constitutional violation.”
No thought seems to be given to the obvious strategy the next party could take if they wanted to avoid constitutional scrutiny – just never confirm the director!
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What about severability? Is the removal for cause severable from the rest of HERA? Did the decision address this? If not, is that something that could influence relief on remand?
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Justice Alito did not address the severability issue in his opinion, but in his concurring opinion Justice Gorsuch said this, “Indeed, while never uttering the words ‘severance doctrine,’ the Court today winds up implicitly resting its remedial enterprise upon it—severing, or removing, one part of Congress’s work based on speculation about its wishes and usurping a legislative prerogative in the process.” From this I conclude that the Court intends that the provision making the FHFA director removable by the President only for cause be struck from the statute, leaving the rest of it intact.
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@ROLG, how does the opinion help other lawsuits in Federal and DC Circuits?
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Tim
my quick reaction: https://ruleoflawguy.substack.com/p/quick-reaction-to-collins-scotus
as to what effect this opinion has on the viability of a retroactive remedy for post 2014, the scotus majority has permitted it to be assessed by the 5th Circuit, in effect overruling the 5th Circuit’s prior decision that retroactive relief was not available. so I think the constitutional claim post 2014 should not be dismissed out of hand as a chimera. As Collins Ps will argue, there may be many reasons why POTUS control over Treasury alone might not have stopped the distributions.
rolg
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I’m not putting much hope on a favorable ruling on the constitutional remedy on remand; I think that ship has sailed. My focus now will turn to what the Biden administration wants to do with these two companies, which, if properly capitalized and regulated, could do more to advance its objectives for housing in general, and affordable housing in particular, than any other tool it has in its arsenal.
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Tim
your focus should be addressed to the post-calabria FHFA, which is where you will provide much valuable insight. but somewhere down the road, the GSEs will need to come out of conservatorship with substantial capital, and that will likely involve the cooperation of the equity capital markets, and so from an investor’s point of view, maintaining the Collins remand, pursuing the Fairholme class action in federal court and the Fairholme taking actions will keep the heat on, albeit not at the high temperature that is deserved.
rolg
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I’ll likely do a “where do we go from here” post shortly, but not long after that I want to get something out on Fannie and Freddie’s capital. In the Calabria rule, there was a stunning mismatch between the level of capital he is requiring for the companies and the actual risk their business in its current–and greatly “reformed”– state presents to the financial system. The data and facts on this are publicly available, but nobody seems to be aware of them. And I’m more than a little surprised that the companies’ current common and preferred shareholders haven’t made the connection between proper, but not excessive, capitalization and the value of their shares. I do believe what I’ve said before–that Calabria’s ridiculous capital requirements are what killed the recap and release Mnuchin had pledged to do–and I hope the Biden team doesn’t make the same mistake. I’ll do what I can to help them not do so.
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Tim
Here are my latest thoughts on Collins, in the event you and your readers may have an interest:
https://ruleoflawguy.substack.com/p/any-read-through-from-arthrex-to
rolg
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Thanks for posting this here.
As I’m sure many have done, I’ve been closely monitoring the recent decisions coming out of the Supreme Court, and have been struck by the unusual combinations of justices for both the majority and minority opinions, as well as the number of, lineup on and (in a few cases) the length of the concurring and dissenting partial opinions. It will be fascinating to see what finally does come out in Collins v. Yellen, and we shouldn’t have to wait much longer.
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Why do I get the feeling everyone is pretty nervous?
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Credit to John Carney: On relation between HERA and FIRREA
Kavanaugh’s dissent in today’s Borden v. U.S. that might be helpful to the GSE plaintiffs.
When Congress “borrows terms of art in which are accumulated the legal tradition and meaning of centuries of practice,” we generally assume that Congress “knows and adopts the cluster of ideas that were attached to each borrowed word in the body of learning from which it was taken.”
Kavanaugh took it from Judge Brown dissent in Perry case:
When Congress lifted HERA’s conservatorship standards verbatim from FIRREA, it also incorporated the long history of fiduciary conservatorships at common law baked into that statute. Indeed, “[i]t is a familiar maxim that a statutory term is generally presumed to have its common-law meaning.” Evans v. United States, 504 U.S. 255, 259 (1992); see Morissette v. United States, 342 U.S. 246, 263 (1952) (“[W]here Congress borrows terms of art in which are accumulated the legal tradition and meaning of centuries of practice, it presumably knows and adopts the cluster of ideas that were attached to each borrowed word in the body of learning from which it was taken and the meaning its use will…
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Carney was being coy, but my read is that Kavanaugh’s Borden v US dissent points to him (and probably the 3 other Justices that joined him: Roberts, Alito, and Barrett) ruling that HERA’s definition of a conservator’s preserve/conserve assets mandate is no different than that in any other law Congress has ever passed. The NWS is antithetical to that and would thus be void.
Four votes would be only one shy of victory, and I think Gorsuch/Thomas/Breyer/Sotomayor/Kagan would make for strange bedfellows in a Collins majority that rules against the plaintiffs, though they did so in Borden so who knows.
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The advisory opinions podcast with David French had a good walk through of the grouping in this case earlier this week. I’d suggest listening to it.
After reading the opinions and listening to their analysis, I firmly believe Gorsuch joined Kagan most likely because of the TEXT of the statute. Thomas seems to take a stronger textualist position as well, but from a somewhat different angle. Add in the language of Kanavaugh’s dissent (pulled from judge brown) and I feel good about Collins simply because Roberts, Alito, and Barrett have seemingly put their stamp of approval on that reasoning at some point during the drafting process.
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Tim
My latest thoughts on Collins in the event you and your readers might find it of interest:
https://ruleoflawguy.substack.com/p/will-chief-justice-roberts-protect
rolg
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Thanks. Hopefully we’ll get the SCOTUS ruling before the Fourth of July, then we all can begin speculating on what’s likely to happen in the next phase of the Fannie/Freddie saga.
Since no one has asked about the recent paper by Don Layton titled “The FHFA’s Report on Credit Risk Transfer,” with the subtitle “Another Controversial Document Further Erodes Confidence in the Agency,” I thought I’d take this opportunity to volunteer a few brief comments about it.
I had been wondering how Layton might respond to the FHFA piece on CRTs, since he has been such a strong advocate of them. As the subtitle of his paper indicates, he has decided to lump the CRT report in with three other recent regulatory actions–the capital rule, the “living will” regulation, and the January letter agreement requiring Fannie and Freddie to limit the amount of some of the business they do–and make the case that FHFA is biased and a bad regulator, and that as a consequence its CRT report shouldn’t be taken seriously.
I think the capital rule is a disaster, and am no fan of either the restrictions Calabria has put on Fannie and Freddie’s business or its (unnecessary and intensely bureaucratic) living will requirement. But I also think one needs to address the CRT paper on its merits. Layton pointedly does not do this, saying he will “not do a soup-to-nuts analysis of the CRT report.” Instead, he focuses on “four important benefits of CRT either not mentioned or just slightly referenced in passing,” which is the bias he claims the paper exhibits. In his view, these four ignored or downplayed benefits are: (a) systemic risk reduction, (b) taxpayer risk reduction, (c) capital reduction, and (d) market discipline.
Where Layton’s paper falls short, however, is that he doesn’t make the case for how CRTs could have these “four important [theoretical] benefits” if even in a repeat of the loss performance of Fannie and Freddie’s 2007 books of business (their worst by far) they still cost them $20 billion MORE than they return in loss transfers. That neither reduces systemic risk nor protects taxpayers; by weakening the companies (through having them pay out $30 billion and only getting back $10 billion), it does the opposite. And while the CRTs DO reduce the companies’ capital, it’s not in the way Layton intends.
The problem with Fannie and Freddie’s CRTs is that they kick in at too high a level of cumulative loss, they insure against risks that are far too remote, and they can prepay rapidly and thus disappear before they can be called upon–as the ever-to-date experience (admittedly in a highly favorable economic and financial environment) and the performance simulations show. While they may be great in theory, in practice Fannie and Freddie’s CRTs are extremely costly giveaways to Wall Street and the investor community, that increase the companies’ vulnerability to the credit risk they end up retaining.
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For posterity, I’d like to remind readers of your blog that CRT investors were also asking for bailouts at the first sign of trouble in March of 2020.
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Mr Howard
Sometime ago, the Trump administration asked SCOTUS to expedite decision/opinion of GSE suites against them so they could better formulate housing policy going forward.
Was the decision ever made public, or did I miss it somehow?
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Craig Philipps interview:
https://t.co/4IkzXD1mWh?amp=1
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I listened to this interview, and thought it was excellent. I commend it to all readers. A good part of the time was spent on issues related to Fannie and Freddie (more on that in a minute), but I also was interested in the segments where Phillips talked about his approach to government service after a career in the private sector, and his work at Treasury overall, particularly the four papers he produced on financial system regulatory reform–banks and credit unions; capital markets; asset managers and insurance companies, and nonbank financials (“fintech”)–which was his much more reasoned way to respond to the generic, blunt and unhelpful policy imperative to his administration to “repeal Dodd-Frank.” Well done by Phillips.
On Fannie and Freddie, people should listen and draw their own conclusions, but I was struck by two things. One was Phillips’ discussion of what happened to derail Mnuchin’s stated goal before he even had been confirmed to get Fannie and Freddie out of conservatorship “reasonably fast” (which Phillips says he shared). Phillips said Mnuchin’s and his plan was to stop the net worth sweep “on day one,” but that when it came time to produce the President’s first budget there was a “horrific” reaction from several in the administration (Phillips didn’t say this, but I know who one of them was–Larry Kudlow) that doing so would increase the deficit, and that you couldn’t release Fannie and Freddie before they were “reformed.” This second reason was what I had detected early on–the Financial Establishment marshaling its forces to block any move to undo the nationalization they had engineered at the end of the Bush administration. Phillips next recounts a series of “competing priorities”–many of them totally legitimate, like tax reform, bank regulatory reform, and the pandemic–that kept Mnuchin (and Phillips, until he left in 2019) from making the removal of the companies from conservatorship a top priority. One of these was waiting for Mel Watt to be replaced by President Trump’s own person. I inferred from what Phillips said about Watt–that he thought Watt also wanted to get Fannie and Freddie out of conservatorship, and would have done whatever Mnuchin and he, Phillips, asked of him–that Phillips was not among those who wished to defer reform until Calabria was on board. Phillips left soon after that, and (this is my recounting, not what Phillips said) the lead on getting Fannie and Freddie out of conservatorship shifted to Calabria, who did want to do it, but on his terms. Phillips made one final comment about why nothing happened after the election, and before Mnuchin left Treasury. Phillips said that Mnuchin was being told by friends and colleagues that “you can’t make big moves like this at the end of your term,” and Phillips thinks Mnuchin felt “conflicted” by his past relationships with many of those who were pushing him do that, and couldn’t bring himself to. (Score another one for the Financial Establishment: does the phrase “giveaway to hedge funds” ring a bell?)
The second aspect of the interview that struck me was the way Phillips talked about his view of Fannie and Freddie compared with Calabria’s. Phillips said he thought that Fannie and Freddie already had been reformed–none of the bad practices at the companies prior to the crisis (which he didn’t specify) existed any more, they had the best technology and excellent management, with good ethics and strong principles–and what they needed now is capital. He contrasted his view with those (unnamed) people who, he said, “thought they were evil, and had too much influence on the Hill,” and blamed them for the 2008 crisis. Phillips never said that he thought Calabria was one of those people, but from his statements it’s easy to conclude that he did. He did describe Calabria’s views as thinking that the government’s role in housing was too large, as was Fannie and Freddie’s share of the market. And it was telling that when Phillips was asked about Calabria’s initiatives to reduce innovation at Fannie and Freddie–because doing that helps “level the playing field”–he responded that he didn’t agree because “no one else is doing that innovation, and innovation helps homeowners get lower rates.” Maybe I’m hearing what I want to hear, but I took this part of the interview as confirmation that Calabria was the obstacle to getting Fannie and Freddie out of conservatorship during the last two years of the Trump administration: he wanted to get them out, but as grossly overcapitalized and overregulated entities who, by being much less efficient than they otherwise could be, would be less competitive with the “private sources of capital” he favors. But it’s not easy to raise the huge amounts of capital required to bring them out on that basis, particularly with a regulator who does not want them to be successful. And that’s where we are now.
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The issue I have with this narrative is that Mnuchin picked Calabria and worked with him for many years prior. If they had such opposing views on how to handle the GSE’s, don’t you think Mnuchin would have that idea?
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I believe Mnuchin agreed with picking Calabria as FHFA director because of Calabria’s history with HERA, and his known position that the net worth sweep was not legal under that statute (since the sweep had to be unwound before Fannie and Freddie could exit conservatorship, which both men wished to have happen). What I am positing is that the terms Calabria set for that exit–particularly the companies’ onerous bank-like capital requirement, which Mnuchin may well have agreed with in theory–made the process of recapitalizing them too lengthy and uncertain to be accomplished in way that would have given Mnuchin the clean “win” he needed in order to justify giving up the net worth sweep (and the $15-20 billion it was bringing to Treasury each year) right before he left office.
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Tim, any thoughts or insights regarding Freddie’s hiring of Michael DeVito as CEO, former Wells exec? Thank you
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I had never heard of DeVito until I read about his hiring at Freddie. I’m going to resist the instant reaction of “if he’s a former Wells exec, that’s probably not good” (for one thing, I’m a former Wells exec, although mid-level and quite some time ago); I’ll wait to see what he says and does at Freddie before forming any opinions about him.
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Tim,
A few reactions to your commentary:
• You have consistently highlighted that the STACR and CAS structures provide too little benefit for their cost. The FHFA analysis supports that, particularly with respect to the susceptibility to fast prepay speeds.
• That said, any regulated institution would be required to hold capital against risk. Fannie and Freddie had essentially zero capital when the CRT requirement was put in place. They are building capital now, but are far away from any reasonable capital requirement, and even farther away from the requirement that FHFA set and FSOC seconded. Without sufficient capital, if Fannie and Freddie take risk, it could quickly become taxpayer exposure. Just from this perspective it makes sense to shift some of the risk to private investors through CRT to reduce taxpayer exposure.
• Beyond the immediate situation, doesn’t it make sense to have Fannie and Freddie distribute rather than concentrate credit risk on their balance sheets as they did in the past? Interest rate and prepayment risk is distributed through MBS issuance. I do think there is value in using CRT for price discovery with respect to mortgage credit risk similar to how the MBS market prices prepayment risk. Even if the experiment to date has been mixed.
• I have advocated for simpler, more transparent forms of CRT that don’t overly rely on capital market structures. Simply allowing for deeper levels of credit enhancement (including but not limited to deeper MI) could both conserve on the need for GSE capital and provide some level of price discovery with respect to credit risk.
• Unfortunately, the FHFA capital rule does not provide any reasonable level of capital relief for any forms of CRT, either capital markets-based or through deeper MI. I suspect this is why Fannie Mae has stopped issuing CAS.
I’m left with a number of questions:
• Are there structural changes to STACR/CAS which would lead to a better cost/benefit tradeoff?
• If these changes were made, would there still be a market for CRT, or are the investors there only for the high (expected) returns to date?
• Are there changes to the FHFA capital rule which would lead to a better assessment of CRT tools that transfer risk on better terms?
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Mike–As you know, Fannie and Freddie’s relative lack of capital is the result of FHFA and Treasury having required them to remit all of their earnings to Treasury starting in 2013. The taxpayer has fared quite well from that arrangement, and will continue to do so even should the Supreme Court take the first step in reversing the net worth sweep with a ruling favorable for plaintiffs on the APA issue in the Collins case.
Beyond that, I simply disagree with your statement that “if Fannie and Freddie take risk, it could quickly become taxpayer exposure.” As I noted in my post, the companies’ losses on their 2004-2008 books were outliers, caused by the last attempt by their opponents to replace them with “private sector alternatives”–in that instance, private-label securitization. Excluding those years, Fannie’s credit losses have never exceeded 11 basis points as a percent of their owned and guaranteed mortgages, even in recession years. Fannie could cover that loss rate four times over with its current average guaranty fee (net of TCCA fees) of 44.9 basis points. So, no, it doesn’t make sense, even with the low level of capital the companies now have, to “distribute rather than concentrate that risk on their balance sheets,” particularly if doing so is almost guaranteed to cost them money. What sensible business pays to give profitable business to someone else?
I don’t have any great ideas for how to fix securitized CRTs to make them economic for the companies to issue, although perhaps the investment bankers can come up with something. On the issue of capital credit for CRTs, I have suggested many times to many people that they need to come up with an analytically sound measure of “equity equivalency,” that makes $X of (contingent and limited) CRTs the economic equivalent of $Y of upfront equity. So far, no one has been able to do that.
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mike
interesting post.
my reply is that in any transaction, you want to be the party with superior information and acumen. akin to the buffetism that if you sit down to a poker table and don’t know who the patsy is, the patsy is you…in any transaction, you want to create a transactional surplus, not deficit.
in a CRT transaction, just like most issuances, the party with the superior info/acumen is the issuer, the GSEs. at the pricing that is available to the GSEs in a CRT transaction, 10 times out of 10 the GSEs should walk away.
but they dont, since they were constrained by their regulator, and the manner in which the conservatorship has been conducted (ie in the worst interests of the GSEs), to do the deals or else. issuers often dont walk away for agency problem issues (management has a greater interest in cashing in options than doing a fair transaction), but you would have to look far and wide to see a situation like the GSEs…where there is a regulator’s gun to the GSE head to hit the fricking bid. so “dumb money” gets rewarded in CRTs, and the facts set forth in Tim’s post bear this out. So enough of the “protect the taxpayer” homilies…this is just Wall Street getting the better of Main Street (represented by the GSEs mission to promote the housing finance market) once again.
rolg
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Thank you Tim. You have made it painfully obvious that Calabria is an emperor out to destroy his subjects. Let’s hope he’s out of there before he can make that happen.
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Tim ,
Thank you for shedding light on this complicated and critical issue. The truth is that for the Average Joe it is getting very difficult to own a home. We are heading to be a country of renters.
Calabria is putting his own ideology over the wellbeing of the American people.
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Director Calabria should be commended for the courage to put the facts on the table to enable a more informed public discussion.
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Adolfo–I agree with you on this. But at the same time I feel, as one who has spent my career trying to ensure that the benefits of Fannie and Freddie’s federal charters be channelled to as many potential homebuyers at the lowest cost possible, that the Director’s consistent and gross mischaracterizations of the actual risk of the companies’ business need to be “put on the table” as well.
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Tim – Thank you for your continued thought provoking blogs and comments. To your response to my comment, I believe taxpayers, borrowers and markets are very well-served by Director Calabria’s clear-eyed view of the extraordinary risk that Fannie Mae and Freddie Mac pose. I also think anyone interested in CRT can agree that FHFA providing this kind of transparent, comprehensive information and deep analysis on the actual costs and realized/potential benefits of these transactions, for the first time that I am aware of, merits great appreciation. As I had no role in the published report, I can only speculate that there are many reasons FHFA may have chosen not to reach more definitive and permanent conclusions at this time. I would urge a more tempered assessment of what that may or may not imply, and keep in mind how challenging it is to issue a report of this depth and substance at any government agency. The staff of FHFA continue to do an admirable job and should be commended for another significant contribution to the mortgage market.
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Ongoing conflation of size and risk in this saga.
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Adolfo
With respect, the last time Director Calabria was clear eyed about the GSEs was when he co-authored the paper with Mr. Krimminger as a private citizen, regarding how the Net Worth Sweep was illegal. Since then he has not only defended the NWS in court as an “independent” agency Director, but also defamed the very capable GSE employees in an open session of Congress, castigating them without evidence. If your hagiography is to be Mr. Calabria’s swan song, a prelude to his prompt replacement after SCOTUS issues its Collins decision, then so be it and may he go on to bigger and better. But let’s keep the story straight.
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Adolfo–We disagree both on whether Fannie and Freddie’s risks are “extraordinary” and on whether Director Calabria’s view of those risks is “clear-eyed.”
On the first, unlike virtually any other major financial institution, and particularly commercial banks, Fannie and Freddie’s credit risks are quantifiable. For that reason, I like to avoid describing them with an adjective, whether it be “extraordinary” or something else. I’ve laid out the parameters of that risk in this post. As to Director Calabria’s view of those risks, it is anything but “clear-eyed”. Before he was appointed to head FHFA he was on record as agreeing with the view of what I call the Financial Establishment that Fannie and Freddie should be required to hold the same percentage of capital as banks are required to hold for their mortgages. Back when Fannie, Freddie and banks all made most of their profits from loans held in portfolio that was at least defensible (although Fannie and Freddie hedged their mortgages against their debt costs, and banks did not), but today, when the companies only do credit guarantees, it is not. Nonetheless, Director Calabria ignored the directive of the HERA legislation he professes to revere–which requires him to use a risk-based stress test to determine the companies’ regulatory capital–and simply imposed his pre-determined Basel 4.0 percent bank minimum on them. You would know better than I what happened next, but whatever the process was, a ludicrous amount and variety of conservatism and cushions were added to the risk-based standard to push its required capital above the Basel 4.0 percent bank minimum. That turned HERA on its head.
I don’t know why Calabria chose to do that (although I have my suspicions), but it is unambiguous that he did. I worked with Paul Volcker to develop the 1992 risk-based standard for Fannie and Freddie, so it is blatantly obvious to me how far away from a true risk-based capital standard FHFA’s 2020 version is. I vehemently disagree with that, and believe it greatly harms the low- moderate- and middle-income Americans Fannie and Freddie were chartered to serve. For that reason, I will work to get the Calabria capital rule thrown out, and replaced with one that better balances taxpayer risk with benefits to current and prospective homebuyers. And yes, it’s possible that my understanding of Calabria’s actions on the capital standard may have influenced my view on how he might perceive the companies’ CRTs, but I don’t think I’ve been unduly harsh on him.
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Tim – the FSOC statement on the review of the secondary mortgage market is an excellent summation of the risks posed by the GSEs. That statement reflected the consensus views of Treasury, the Fed and FHFA after rigorous consideration. Its conclusion was clear about the appropriateness of the capital rule, which was very carefully structured to protect low and moderate income borrowers without sacrificing safety and soundness. How did that 1992 standard work out? Not well, as I recall. Wish the companies had actually held sufficient capital heading into the crisis, things might have turned out differently. I am deeply saddened by the failures of the Enterprises, driven by excessive risk, a lack of capital, unrealistic earnings goals, certain housing goals, poor managerial judgment and implicit guarantees. A strong regulator with a careful eye on risk and corporate culture is critical to avoid another terrible failure by these companies.
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I gave my reaction to the FSOC’s endorsement of the FHFA capital rule in a post (appropriately) titled “The Director Digs In”: “It is hardly news that a group dominated by bank regulators would prescribe bank-type and bank-level capital for Fannie and Freddie. They have done so for at least three decades, and I strongly suspect that there is little institutional recognition at any of the FSOC-member institutions that the one (weak) rationale that used to exist for applying bank-like capital requirements to the companies—that they, like banks, held large amounts of mortgages in portfolio, funded by debt—no longer is true. And that leads to the second disqualifier of the FSOC review: it contains almost no documented facts, and literally no risk-related data; its conclusions and recommendations all stem from unsupported statements and generalities.”
And I addressed the 1992 Volcker standard in my book. Volcker specified that the stress test only was applicable if Fannie and Freddie did not make major changes in their underwriting. We (at Fannie) proposed that FHFA’s predecessor agency, OFHEO, link its capital stress test to our pricing models, which would incorporate any changes in product or risk features. OFHEO refused; it wanted to build its own model. We tried to talk them out of that, but they insisted. It took them ten years to finish their version of the risk-based standard, and when they did it was easy for us to game. That mistake in implementing the 1992 standard was on the regulator.
Finally, your blaming of Fannie and Freddie for their “failures” is right out of the bank-supporter playbook. As I detailed in the amicus brief I did for the Collins case now before the Supreme Court, the companies did not fail; they were nationalized by Treasury for policy purposes, because Treasury and the Fed didn’t want to have to rely on them as the only significant sources of mortgage finance after the PLS market failed and banks stopped lending because of mortgage delinquency rates triple those that Fannie and Freddie were experiencing. Your repeating a fiction about what happened during the crisis—and using that fiction to justify overcapitalizing and overregulating Fannie and Freddie to the point that they can’t carry out their chartered missions effectively—doesn’t make it true.
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Tim,
Your response speaks to many things, including the understanding of a former FHFA Principal Deputy Director.
If Mr. Marzol won’t engage you here, your response will show not only to speak to his understanding but to personal integrity. This issue has been dodged enough by too many of the elite, which transcends political affiliation.
I hope Mr. Marzol will engage you intelligently and with the truthfulness and honor you’ve deserved. Frankly, I’m tired of the obfuscation. Perhaps Mr. Marzol will show himself to be different, a man of true substance. Here is a (another!) chance for the FHFA.
So very grateful for your transparency, accessibility and integrity.
RD
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Thank you Adolfo. We want the public to know the truth.
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Lynn – thank you for your continued commitment to public service and transparency. Please thank your team for the exceptional research piece they recently put out on the history of mortgage credit risk. Another true public service.
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Tim- I just confirmed that the previous statements by Adolfo, were not from him. Just spoke with him on the phone.
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Lynn–I’m surprised that you say that; the administrative page of my blog site shows the comments to have come from Adolfo’s personal email address (which I’ve used for corresponding with him for some time).
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Let’s put down the pom poms and get down to substance.
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What “Courage?”
Friend Adolfo, you have no credibility as someone who worked hand in hand with Calabria and likely share MC’s ideological approach to his current job.
Your response would have some value if you just answered Tim’s challenge about the costs of CRTs.
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Since when did competence in one’s job performance, telling the truth, and following the law become courageous? If it takes courage to do the right thing at the FHFA, then there truly is a problem with this regulator/conservator.
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Great info. Thanks.
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This is a really great article, Tim. Your statements are sound, logical and irrefutable. I feel that Dr. Mark Calabria should make a restatement of his position due to these new facts to justify any further actions he takes. Maybe Calabria should be removed, but I’m just afraid of who would take his place. A fair and favorable Supreme Court ruling is needed right about now.
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Tim
Thanks for this post. I have a question concerning whether the interest paid by the GSEs on the CRTs is truly a cost of insurance, as opposed to in part a debt capital cost for the money raised by the CRT. I may be betraying my CRT ignorance, but dont CRT investors lend money to the GSEs, under terms in which they are paid interest for the capital lent, and may get less than principal back if their reference MBS pools suffer losses beyond a certain amount? If I am right, then some portion of the “$15.0 billion in interest and premiums to CRT investors” is not pure insurance cost…and if I am right, then one would need to back out some pro forma interest cost, at which the GSEs could have borrowed without credit insurance, to determine what the added (and wasteful) cost of the credit risk transfer.
rolg
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You are correct in your analysis of the interest payments on Fannie and Freddie’s securitized CRTs. They have two components: One-month LIBOR (soon to be replaced by the “Secured Overnight Financing Rate,” or SOFR), which is the debt cost component, and a spread over LIBOR, which is the insurance component. During the lifetime of Fannie’s CAS and Freddie’s STACR programs, however, the spread component has been far larger (although I haven’t calculated the exact proportions), and Fannie and Freddie typically can borrow at a cost of less than LIBOR, so that difference also would need to be factored into the equation. And in any case, this allocation of the interest cost between the debt and insurance components would not change the empirical observation that the CRTs Fannie and Freddie have issued to date have been “staggeringly noneconomic.”
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Tim
Agreed, staggeringly noneconomic. moreover, I suspect that part of the attraction to regulators and CRT investors is that this credit insurance premium is optically made to look like a conventional component of interest on money lent, as opposed to a straight reinsurance premium for credit loss risk assumed. while it “looks” like CRTs are raising “private capital”, CRTs are really a rip-off reinsurance program under the guise of a capital markets transaction. if there are any CRT investors out there reading this, prove Tim and me wrong.
rolg
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The last thing any CRT investor is going to do is show themselves. Its blatantly obvious that this scam has been going on for years as a giveaway to the buyers through obfuscation. I was once on a CRT call wherein the Fannie representative represented that the CRT issuance transferred something like 90+% of the credit risk in the reference pool. This is such an insane thing to claim that it is laughable on it’s face, however their assertion was that the credit risk was limited to the backward looking loss severities ever recorded by the GSE’s issuance. The point is they put that out in multiple press releases claiming the same misleading definition surrounding the entire program; it is just pure comedy. They’re either lying or incompetent or both. Adolfo Marzol fails to mention that the financial establishment controls the Fed, the treasury and the FHFA. You’re not fooling all of the people all the time and you should be embarrassed.
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