An Unexpected Ruling

~ jtimothyhoward

This past Wednesday the Supreme Court made its ruling in Collins v. Yellen, and it went heavily against the plaintiffs. On the most important issue—the legality of the net worth sweep under the Administrative Procedures Act, or APA—plaintiffs lost outright. In an opinion authored by Justice Alito, the Court ruled that, “The ‘anti-injunction clause’ of the Recovery Act provides that…’no court may take action to restrain or affect the exercise of powers or functions of the Agency as conservator or a receiver,” and that, “Where, as here, the FHFA’s challenged actions did not exceed its ‘powers or functions’ ‘as a conservator,’ relief is prohibited.”

The ruling on the constitutional issues was more complex, but for plaintiffs not much better. Here, the Court made four major rulings: (1) “The Recovery Act’s restriction on the President’s power to remove the FHFA Director…is unconstitutional,” and the President may remove him or her at will (indeed, President Biden already has replaced Director Calabria with one of his three Deputy Directors, Sandra Thompson); (2) “Shareholders no longer have any ground for prospective relief” because the January letter agreement between Treasury and FHFA “eliminated the variable dividend formula that caused the shareholders’ injury” (I believe this is an erroneous ruling, since the letter agreement did not eliminate Treasury’s liquidation preference, and only temporarily suspended the sweep); (3) the Acting Director who agreed to the net worth sweep, Ed DeMarco, was removable by the President (although the statute is silent on this), which limits the retroactive relief plaintiffs may seek, and (4) the “harm caused by a confirmed Director’s implementation of the third amendment could then provide a basis for relief.” This last issue was remanded to the lower court, and my view on it is similar to that of Justice Kagan, who in her concurring opinion said: “It’s hard not to wonder whether…[the Court] intends for this speculative enterprise [the remand] to go nowhere,” while noting that the Court “may calculate that the lower courts on remand in this suit will simply refuse retroactive relief.”

I was not optimistic about the chances of success on the constitutional claims in Collins—although I was pleased that the Court paved the way for Director Calabria’s removal—but I had been highly confident that plaintiffs would prevail on the APA claim. I did not, though, count on all of the justices agreeing on a strained reading of the statute, nor on their giving no weight to the background facts on the case presented by plaintiffs (and me, in my amicus curiae brief). Yet that is what occurred.

Whether the anti-injunction provision in the Housing and Economic Recovery Act (HERA) bars relief on the APA claim depends on whether the net worth sweep exceeded FHFA’s statutory conservatorship powers. In the Perry Capital case, Judge Lamberth ruled that the sweep did not, because, he claimed, the statute said that the conservator “may,” rather than “shall,” take certain actions, and also because section 4716 (b) (2) (J) in HERA, titled “Incidental Powers,” said FHFA could “take any action authorized by this section, which the Agency determines is in the best interests of the regulated entity or the Agency.” The Fifth Circuit Court of Appeals hearing the Collins case en banc convincingly overturned both of these holdings in its decision. The government dropped the “may versus shall” argument in its brief to the Supreme Court, but kept the argument that the incidental powers provision in HERA turned FHFA into a conservator with essentially unlimited discretion. Justice Alito seized upon this to justify his ruling on the APA claim: “Instead of mandating that the FHFA always act in the best interests of the regulated entity, the Recovery Act authorizes the Agency to act in what it determines is ‘in the best interests of the regulated entity or the Agency (emphasis added).’ Thus, when the FHFA acts as a conservator, it may aim to rehabilitate the regulated entity in a way that, while not in the best interests of the regulated entity, is beneficial to the Agency and, by extension, the public it serves. This distinctive feature of an FHFA conservatorship is fatal to the shareholders’ statutory claim.”

Except that’s not what HERA says. Section 4716 (b) (2) is called “General Powers,” and it has 11 subsections, labeled (A) through (K). Section 4716 (b) (2) (D) is titled “Powers of Conservator,” and it reads in full: “the Agency may, as conservator, take such action as may be—‘(i) necessary to put the regulated entity in a sound and solvent condition; and ‘(ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.” After five more subsections comes subsection 4716 (b) (2) (J), “Incidental Powers,” and this is where the clause appears saying that FHFA may “take any action authorized by this section, which the Agency determines is in the best interests of the regulated entity or the Agency.”

Incidental means “accompanying but not a major part of something.” A plain reading of the statute, therefore, is that the permission granted FHFA to act in its own interest is limited to the exercise of its incidental powers, and does not extend to the conservatorship as a whole. Otherwise, what is the purpose of having specified those powers in section 4716 (b) (2) (D)? In a 2001 decision, Whitman v. American Trucking, Justice Scalia famously wrote, “Congress, we have held, does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.” Justice Alito looked into the mousehole of the “Incidental Powers” section of HERA and said he saw an elephant in there, and the other justices said they saw one too.

Equally unexpected was the Court’s accepting the government’s fictitious and disproven rationale for having entered into the net worth sweep. Justice Alito’s recounting of the context of the sweep could have been taken from any one of dozens of the government’s filings in the APA cases over the years: “Recall that the third amendment was adopted at a time when the companies’ liabilities had consistently exceeded their assets over at least the prior three years…. If things had proceeded as they had in the past, there was a realistic possibility that the companies would have consumed some or all of the remaining capital commitment in order to pay their dividend obligations, which were themselves increasing in size every time the companies made a draw. The third amendment eliminated this risk by replacing the fixed-rate dividend formula with a variable one.”

In its brief for the Court, counsel for the plaintiffs, Cooper & Kirk, told a very different story about how the sweep came about, and what its true purpose was. Cooper & Kirk discussed the temporary or estimated book expenses FHFA directed the companies to make, and how they had begun to reverse in the months before the net worth sweep was imposed. They noted in particular Treasury’s being aware of the imminent release of both companies’ deferred tax asset reserves, a Fannie executive’s expectation of a “golden age of earnings” ahead, and Treasury’s statement that “every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers.” And at Cooper & Kirk’s request I filed an amicus brief with the Court, laying out the facts in considerably more detail, with cites and footnotes. The Court neither acknowledged nor refuted any of these factual submissions; it simply ignored them. 

Cooper & Kirk had been concerned something like this might happen. In their brief they wrote: “Plaintiffs’ statutory claim comes to the Court on a motion to dismiss, and at this stage of the litigation the Complaint’s factual allegations must be accepted as true. Despite grudgingly acknowledging this most basic rule of civil procedure…Defendants contradict the complaint on nearly every page of their brief that discusses application of Section 4617(f) to the facts of this case….Defendants know that these statements contradict the Complaint, yet they persist in making them because the “risk” of unaffordable 10% cash dividends that the Companies supposedly faced in mid-2012 is the starting point and necessary factual premise for Defendants’ entire argument that the Net Worth Sweep preserved and conserved the Companies’ assets.” Cooper & Kirk concluded their argument on this point by saying, “The Court cannot credit this claim given the Complaint’s contrary factual allegations,” yet the Court went ahead and did precisely that.

So, what is one to make of a unanimous ruling on the APA claim in Collins by the highest court in the land that relies on a reading of section 4716 (b) (2) (J) of HERA so strained as to not be credible (virtually identical language exists in the Incidental Powers section of the FDIC Act, and it has never been read to apply to FDIC conservatorships as a whole), and a refusal to credit, or even consider, the facts of the case as alleged by the plaintiffs? We cannot know for certain, but there is a suggestive clue in the partial concurring opinion of Justice Gorsuch, in which he questions what he calls the “novel and feeble” direction to the lower courts in the remand on the constitutional issue to “inquire whether the President would have removed or overruled the unconstitutionally insulated official had he known he had the authority to do so.” In the midst of his discussion of this topic we find this sentence: “It is equally possible that—had Congress known it could not have a Director independent from presidential supervision—it would have deployed different tools to rein in Fannie Mae and Freddie Mac.“

Where did this notion that the purpose of HERA was to “rein in” Fannie and Freddie come from? That is not what was happening at the time. In the summer of 2008, when HERA was passed, the private-label securities market had collapsed, banks had pulled way back on mortgage lending because of soaring delinquencies, and Congress five months earlier had raised Fannie and Freddie’s loan limits from $417,000 to $759,750, making them “the only game in town,” as Treasury Secretary Henry Paulson described them to the Financial Crisis Inquiry Commission. No one was talking about “reining in” Fannie and Freddie as the crisis was unfolding. To the contrary, that’s why Paulson nationalized them. He knew they were the only game in town, and wanted them under governmental control in that situation. This also is when what I call the Financial Establishment created and began to disseminate its fictitious version of the financial crisis—that its cause was not the foolish experiment with unregulated private-label securitization, but Fannie and Freddie.

I believe this version of Fannie and Freddie as problems is the only one the Supreme Court justices have ever heard, and some may have been hearing it for thirteen years. All six of the conservative justices (Roberts, Thomas, Alito, Gorsuch, Kavanaugh and Barrett) are members of the Federalist Society, for which “reining in” or eliminating Fannie and Freddie has been a crusade for more than two decades. And it’s likely that even the liberal justices have not heard a kind word (or a real fact) about the companies throughout their careers.

This interpretation of the justices’ pre-oral argument mindset with respect to Fannie and Freddie not only would explain the bizarre unanimous verdict on the APA claim, but also could explain why the Court took the highly unusual step of granting certiorari on an interlocutory appeal of the decision on the APA claim by the Fifth Circuit en banc in the first place. The en banc panel had ruled that the lower court’s dismissal of this claim had been wrong on the law, and sent it back for a trial on the facts. There, plaintiffs almost certainly would have prevailed—likely in a motion for summary judgment—because of the vast amount of evidence produced in discovery for the Court of Federal Claims proving that Treasury knew that its stated rationale for the net worth sweep was false, had admitted this to itself, and then lied about it to the public (and the courts). An appeal to the Supreme Court of a decision favoring plaintiffs on the facts would have left scant room for reversal. It is not hard to envision some of the more virulent opponents of Fannie and Freddie in the Federalist Society going to one or more of their conservative justice colleagues and saying something to the effect of, “You shouldn’t wait for this case to come back to you after a ruling on the facts; if you grant cert now at the interlocutory stage, you still can rule against these terrible companies on the law, and avoid having to deal with the facts at all.”           

However it may have come about, there can be little question that the Court’s ruling on the APA claim in Collins was imposed upon the case rather than deduced from it. And this has implications for both of the major net worth sweep-related cases remaining in the lower courts—the breach of contract claims before Judge Lamberth in the DC Circuit, and the regulatory takings claim in the Court of Federal Claims previously before Judge Sweeney and now before Judge Schwartz. While the case for each has been strengthened by the loss on the APA issue in Collins (if the government has the right to take shareholders’ property, shareholders have the right to compensation for that action), the path to a final judgment favoring plaintiffs still runs through the Supreme Court. The Court’s ruling in Collins ought to reinforce to counsel in these cases the wisdom of anticipating heavy hands on the scales of justice as they prepare and present their legal and factual arguments.

In the meantime, the spotlight will shift to the Biden administration. It has inherited a mess. Fannie and Freddie are closing in on thirteen years in conservatorship. No one doubts they have been “conserved:” they are extremely profitable, and arguably now have the highest-quality books of credit guarantees in their histories. Yet (ex-FHFA Director) Mark Calabria has given them a ludicrously high target for the amount of capital they must attain before they can exit conservatorship, which would take them nearly a decade to reach through retained earnings alone, and they do not have access to the capital markets because even though the net worth sweep has been suspended, Treasury’s liquidation preference in the companies remains, and continues to grow with their retained earnings. Fannie and Freddie are thus stuck in limbo, with no evident way out on their own.

I believe the Biden administration understands that this is its problem to fix. If it does not attempt to, its economic team will look weak and ineffective. But beyond that, Fannie and Freddie have the potential to play enormous roles in helping to meet the administration’s priorities for housing in general, and affordable housing in particular. There is no chance of any housing-related legislation getting through this Congress, so the Biden team will need to rely on the tools it has. Two of its most important ones, Fannie and Freddie, have been hamstrung (deliberately, I believe, and for ideological reasons) by the now-departed FHFA director. With support from the administration’s top policy figures, a new FHFA director could take the lead on getting Fannie and Freddie properly capitalized and regulated, canceling the net worth sweep and settling the remaining lawsuits, and creating a path for the companies to quickly and safely exit conservatorship, thus putting them back in their traditional roles of buoying the economy by making mortgage credit more available and affordable to a wide range of low- moderate- and middle-income homebuyers. While this may not happen for a while, I am confident that it will at some point. And if it does, then last week’s unexpected Supreme Court ruling will have been only a temporary setback for the homebuyers who benefit from Fannie and Freddie financing, and the investors who must provide the new capital that make this financing possible.

214 thoughts on “An Unexpected Ruling”

    1. Re the Roberts suggestion that GSE shareholders “send a letter to FHFA director”, this was utterly surreal…standing before you, virtually, CJ Roberts are Ps who have been suing the FHFA for 7 years to void the NWS…now, you think a letter is required to show harm? J Breyer had a similar suggestion during Collins oral argument. amateur hour at SCOTUS

      rolg

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  3. Tim,

    Would appreciate your thoughts on how Gary Hindes presciently mentioned that SCOTUS/APA was NOT the end-all, but in his latest piece he specifically did not mention Lamberth or other ‘relevant’ Court cases on the horizon. Hindes essentially went with ‘soft’ arguments about morality, theft (greatest since the Louisiana Purchase, ‘never-ending wars — how about never-ending Conservatorships?’, et al. Kind of like a call to arms to man the barricade without gunpowder….or bullets…..I think we all agree the USG is likely to do nothing without a gun to its head. Did SCOTUS/APA take away the gun, or was the shot fired a ‘Hollywood blank’?

    Hindes mentions you prominently, but as you yourself mentioned, SCOTUS simply IGNORED your writ/brief and apparently looks upon your opinion(s) as biased to F&F and therefore to be highly discounted, even discarded.

    What is likely to happen with F&F and when IYO? TIA

    VM

    P.S. Has to be highly frustrating for you. Many of us share in that frustration!

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    1. I think the audience for Gary’s piece are policymakers in the Biden administration, who have inherited two companies that have been incapacitated by a sequence of actions by past administrations, and now are not in a position to help the current one meet its objectives for housing affordability. I am not one who agrees that the government will only act on Fannie and Freddie “with a gun to its head,” and I don’t think Gary is either. Leaving the companies in a state where they have been conserved but are stuck interminably in conservatorship, and have been grossly overcapitalized by a FHFA Director who opposed them ideologically (as most Democrats do not) to the extent that the pricing of their higher-risk loans is unaffordable to borrowers would not reflect well on the Biden economic team. I don’t know when they’ll come to that realization–a lot of us, including Gary, are working to speed that up–but I think they will at some point.

      I also have a different reading of the SCOTUS ruling in Collins than you do. I think the conservative majority had decided on its ruling before the court granted cert in the case. And their intent was to rule on the law and NOT on the facts. They didn’t just ignore my amicus; they ignored a legal directive that every first-year law student knows: that in a motion to dismiss (which is what they were ruling on) the facts as alleged by the plaintiffs must be taken as true. I’m still stunned that they did that.

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      1. “I think the conservative majority had decided on its ruling before the court granted cert in the case. And their intent was to rule on the law and NOT on the facts.”

        And hence very few questions during orals on the APA. Very disappointing to say the least.

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      2. I sincerely hope you can speed it up, but there are people like parrot who would like them to remain in conservatorship forever. I still cant wrap my head around how Obama tapped guys likes Parrott.

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    2. Yes, I had read the Layton piece (which came out yesterday).

      The results of the 2020 and 2021 Dodd-Frank stress tests run on Fannie and Freddie were released earlier this month, and have received almost no publicity. I find that surprising, since they reveal that the tests run this year (on year-end 2020 data) showed that neither Fannie nor Freddie needed ANY capital to pass them, and Fannie also was able to pass the 2020 test (run on year-end 2019 data) with no capital.

      In his piece, Layton points out that FHFA did not publish the results of the 2020 test–which should have come out a year ago–until this month, when it released the results of both the 2020 and 2021 tests together. He speculates that Director Calabria may have withheld the 2020 results, using Covid as a (weak) pretext, because they did not conform with the capital standard he was proposing, which had a “risk-based” requirement of more than 4.0 percent. I find it hard to argue with this interpretation, which Layton says “appear to show politics and ideology unduly distorting proper regulation.”

      The timing of both the release of the FHFA Dodd-Frank stress tests for Fannie and Freddie and Layton’s analysis of it are helpful for the piece on Fannie and Freddie’s capital that I will be putting up next week. The companies now are locked into an essentially endless conservatorship by a series of actions based on a provably fictitious view of their past and present risks. In next week’s piece I will give actual data on Fannie’s historical and current credit risk–which are publicly available–and note that if you plug today’s data into the companies’ Great Financial Crisis experience they would need NO initial capital to survive it. I’ll also discuss how Calabria came up with his requirement that Fannie had to have 4.55 percent capital for its June 30, 2020 book to be considered “adequately capitalized.” (Preview: his 4.0 percent minimum is imposed arbitrarily, and his “risk-based” requirement is full of assumptions, exclusions, and cushions engineered to produce a result that exceeds that minimum.)

      To get Fannie and Freddie out of conservatorship and back to being able to price the one product they are allowed to offer–credit guarantees on residential mortgages–on an economic basis, all the Biden administration has to do is abandon the fictions and embrace the (readily available) facts about them. It is in its best interest to do so.

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      1. Agencies such as the FHFA cannot be arbitrary or capricious, under the APA. if they are, under the APA, anyone aggrieved by an arbitrary or capricious agency action has a right of action to void the agency action (and seek damages).

        if FHFA refused to take into account the (very favorable) results from the 2019 stress test that it had implemented when promulgating the “Calabria capital rule”, and indeed kept these stress results unpublicized so as to insulate the Calabria capital rule from proper formulation and public commentary, then I believe that there is a claim to void the Calabria capital rule.

        Any such action would have the salutary effect of publicizing the inappropriateness of the Calabria capital rule, which may benefit the GSEs going forward, whether or not it ultimately voids the rule.

        who would have standing to bring this action? the GSEs certainly, but I would believe any GSE shareholder should be able to prove that the Calabria capital rule adversely affects that shareholder’s interests (and all other shareholders…hence a class action), insofar as it has been unreasonably promulgated and has resulted in an unreasonable agency action.

        rolg

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        1. How about any homeowner with a mortgage that has refinanced in the last 12 months would have standing. I refinanced my mortgage early this year and paid the .5% agency refi fee implemented by Calabria due to the excessive capital rule. That action caused me harm by imposing additional cost of $2,100 in fees to refinance.

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      2. MrFidlsticks, thanks for posting Mr. Layton’s stress test results piece; it’s a great read. And Tim, thank you for sharing your initial insights on the matter. I can’t wait to read next week’s piece on Fannie and Freddie’s capital, as I’m sure you’ll dive much deeper into the subject.

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  8. Tim,

    Chris Whalen wrote a piece attacking the GSEs’ current LLPAs, saying Sandra Thompson should “walk-the-walk on improving access to credit for low-income borrowers and roll-back the LLPAs for the GSEs to pre-2008 levels” and that “removing the LLPAs will likely push both GSEs into the red given the footprint reductions already put in place by former Director Mark Calabria.”

    https://www.theinstitutionalriskanalyst.com/post/is-there-racial-bias-in-gse-lending-ask-president-barack-obama

    Could you please explain what the ramifications of such a LLPA rollback would be on GSE income, capital levels, prospects for release, etc? To me this seems like another line of attack on the GSEs aiming at keeping them in perpetual conservatorship, but the Biden administration might do hasty or ill-advised things in the name of affordable housing.

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    1. I’m not going to do any detailed commentary on a Chris Whalen piece. But I will say that Fannie and Freddie’s loan-level price adjustments (LLPAs) on their higher-risk loans are a direct result of the arbitrary and unjustifiably high capital requirements FHFA, under Mark Calabria, has put on them. If Brother Whalen is so concerned about the impact of LLPAs on lower-income borrowers, perhaps he should suggest to FHFA that it put more reasonable capital requirements on their loans.

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      1. Thanks for the response. Chris Whalen is certainly a biased and low-quality source (both on full display when he misspelled David Stevens’s name and called him “an all-around good guy”). I only brought up the piece to try and understand what the impact of his proposal might be; it’s one I hadn’t seen before.

        For now I will just assume that Whalen is once again throwing things at the “arguments for permanent conservatorship” wall to see what sticks.

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    1. For readers new to this blog, I have a longstanding policy of not discussing or publicizing work I do privately, and that means some of what I learn through these activities I don’t share. The purpose of the blog is to provide information and analysis related to Fannie, Freddie, and mortgage finance that may not be available elsewhere; it’s not intended as, nor is it, a source for “inside scoops” or rumors.

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    1. Reading the government’s brief in the Collins remand has not changed my view that plaintiffs have a very slim chance of obtaining retroactive relief for alleged harm done by a confirmed FHFA director who could not be removed by the President. And I doubt that the case will be remanded to the district court for fact finding, and believe it is even less likely that, were it to be remanded, the en banc panel would instruct the district court that the government bears the burden of proof in the case.

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      1. Tim

        “…I doubt that the case will be remanded to the district court for fact finding…”

        you may be right, your batting average is higher than mine, but I don’t know how the question posed by POTUS, as hypothetical as it is, can be answered without fact finding. now as to the burden shift, this is a strong ask, but recall that the defendant was unconstitutionally structured…on some scorecard balancing equities, one could find that shifting the burden to the defendant is appropriate when the defendant has violated the constitution. will a majority of (or any) 5thC judges be holding that scorecard? Ps reply is due 9/8 btw.

        rolg

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    1. Thanks. As you detail in your piece, plaintiffs unquestionably have the better factual argument in this case. But they did in the APA case in Collins as well. I’ll be interested to see if the government’s summary judgment filing this fall shows how it intends to defend itself, should the case, as expected, go to trial.

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      1. Tim

        Right. We can expect the government to try to win the case on the law in its SJ motion, as the facts are not in its favor. The government will comb through the SCOTUS Collins opinion and try to find something to use to try to knock Ps out of the box. I am not aware of anything in Collins that precludes the implied covenant.

        rolg

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  12. Tim, thank you for taking a sane approach to the issue. What do you think is the next catalyst as courts can drag this on forever and it is likely they will not do anything on deadline of Sep 30th requirement by LOA : they either postpone or respond with something that is not meaningful. Is this going to be a status quo for how long? FHFA and Treasury are same, so who is the boss now? Just don’t know what would it take them to resolve it?

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    1. Neither I nor anyone else knows what the catalyst will be that changes the status quo for Fannie and Freddie, or when that might occur. The best I can do is to cite a maxim from the economist Herb Stein in the mid-1980s, “If something can’t go on forever, it will stop,” and remind readers of my “bad 1980s rock group”: TINA and the Warrants, with TINA being an acronym for “there is no alternative” to Fannie and Freddie as secondary mortgage market credit guarantors, and the warrants referring to the fact that having a healthy and well functioning Fannie and Freddie is in the administration’s best interest not just from a housing policy standpoint but also financially.

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      2. Can I add that I think it would be a huge political blunder if the Biden team fails to address this. We just witnessed what their fate would look like under a hostile Republican administration. They wouldn’t be supporting affordable housing. Rather they’d be on a slow road to eventual demise. That can’t be what the Biden team wants.

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      3. Tim, re your comment about Tina and the Warrants, why do you suppose the Biden Administration is so “stuck in the mud” about realizing the value here?

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        1. I believe that Fannie and Freddie’s conservatorships have not yet become an area of focus for the Biden administration, and no senior person or group of people have been asked to take charge of figuring out what to do about them. And of course the administration has quite a lot on its plate right now, and it’s still August, with lot of key players out of town. Hopefully I’ll have a better idea about the chances of the Fannie and Freddie issue getting closer to the forefront as we move through the fall.

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          1. Budget reason might not be the only they would use warrants. I think they might use warrants for funding to increase affordable housing. Probably Biden Admin. has no clue yet, but will soon realize in time. hopefully sooner than later.

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          2. Treasury temporary authority was amended in HERA in regards to use of proceeds.

            (C) DEFICIT REDUCTION.—The Secretary of the Treasury shall deposit in the General Fund of the Treasury any amounts received by the Secretary from the sale of any obligation acquired by the Secretary under this subsection, where such amounts shall be—

            (i) dedicated for the sole purpose of deficit reductions; and

            (ii) prohibited from use as an offset for other spending increases or revenue reductions.

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          3. You nailed the incentive to initiate for any kind of settlement talks: the warrants.

            Even with that incentive nothing will come of it and the warrants will expire unexercised.

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    1. This is a proposal by FHFA for new housing goals for Fannie and Freddie for 2022 to 2024, replacing those for 2018 to 2021, that soon will expire. FHFA, presumably at the direction of the new Acting Director, Sandra Thompson, proposes to significantly increase the goal percentages (or, in the case of the multifamily goals, units) for all categories from what they had been previously, and also to create two new subcategories for purchases or guarantees of single-family low-income loans.

      I am not in a position to judge the reasonableness of these new goals, and will not be submitting a comment on them. I do, however, have some initial reactions to the proposal.

      First, I’m not surprised to see Acting Director Thompson increase the housing goals: it’s an obvious, and easy, way for her to appear to be “doing something to increase the availability of affordable housing.”

      I then would ask, however, “what happens next?” In 2022-2024, FHFA will require that 28 percent, instead of 24 percent, of Fannie’s mortgage acquisitions meet the Low-Income Home Purchase Goal, and that 26 percent instead of 21 percent meet the Low-Income Refinance Goal. But what will cause that to happen? Will originators experience a comparable percentage increase in the mortgages they make that fall into these categories (as secondary market entities, Fannie and Freddie only can guarantee the loans that primary market lenders originate)? Have the companies been given new tools to help them be more competitive in the guarantees they offer on these low-income loans (we know the answer to that one–they will be more handicapped by the phase-in of the Calabria capital requirements, which will force them to either greatly increase their guaranty fees for higher-risk loans, or restrict their acquisition of these loans to keep their required amount of risk-based capital from moving even higher). Or might this be an initiative whose purpose is to give Fannie and Freddie an incentive to shrink their total business, by making the only way for them to meet the percentage goals for their low-income business be to greatly restrict the dollar amount of “non-goals” business they do (that is, “increasing the percentage of the numerator by shrinking the dollars of the denominator”)? We’ll see what the commenters say.

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    1. It should. If you scroll down to my comment on the just-released 2021 Dodd-Frank stress tests for Fannie and Freddie, it’s becoming increasingly clear even to a lay observer that the policies of the Calabria-led FHFA towards the companies have been divorced from reality, to the detriment of low- moderate- and middle-income homebuyers the Biden administration professes to want to help. An acting director can’t fix that. It will need a person of stature taking over as Director, with a mandate from senior economic policy officials, to stop basing policies (and capital requirements) for Fannie and Freddie on fictions invented about them by their ideological and competitive opponents, and start basing those policies on actual facts.

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    1. This tweet refers to FHFA’s latest annual report on Fannie and Freddie’s CRT programs, for 2020, which it put out on Tuesday. It’s a “just the facts” report, and makes no criticisms or recommendations.

      FHFA sets annual targets for two types of CRT transactions by both companies–securities issuances (CAS and STACRs for Fannie and Freddie, respectively), and insurance/reinsurance programs (CIRT and ACIS). The targets are for CRT transactions in the current year (for this report, 2020) that cover the credit risk in loans acquired or guaranteed in the previous year (2019). The report notes that both companies paused their CRT programs in the second quarter of last year “as a result of adverse market conditions stemming from the COVID-19 pandemic.” It said that while Freddie returned to the CRT market in the third quarter, “despite improved market conditions in the second half of 2020, Fannie Mae continued to pause issuance of new CRT transactions to evaluate the potential impact of FHFA’s Enterprise Capital Framework.” The consequence of this pause by Fannie was that, “Through the end of 2020, the targeted UPB of 2019 acquisitions covered by Fannie Mae and Freddie Mac was 82 percent and 98 percent, respectively.”

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      1. “FHFA Announces Results of Fannie Mae and Freddie Mac Dodd-Frank Act Stress Tests”
        https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Results-of-Fannie-Mae-and-Freddie-Mac-Dodd-Frank-Act-Stress-Tests.aspx

        Tim, am I understanding this correctly? For 2021 the GSEs are projected to have combined total losses of only $31b [$11b in “Total comprehensive income (loss)” and $20b in “Credit losses”]. Why is this so radically different from any of the capital rules proposed (by Watt or Calabria) where they proposed the GSEs to hold anywhere from 5-10x+ this amount?

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        1. The results of the Federal Reserve’s “Severely Adverse Scenario” used to assess the capital adequacy of large commercial banks, and run for Fannie and Freddie earlier this year, are even better than you describe. They show that in a scenario in which real GDP falls by 4 percent and the unemployment rate rises by 4 percent, Fannie and Freddie each remain profitable throughout; they do not have to dip into their capital at all (and in fact add to their core capital modestly).

          As to why these results are so different from what one would expect given the Calabria (or even the Watt) FHFA capital requirements, it’s simple: despite the mandate from HERA to do so, FHFA does not base Fannie and Freddie’s capital requirements on the companies’ actual risks and revenues; it sets them arbitrarily, to be “bank-like,” in response to the demands of the companies’ opponents and competitors.

          I wasn’t surprised at all at the latest Dodd-Frank stress test results. I’m currently working on a piece I’ll put up on the blog sometime after Labor Day (when all of the Washingtonians are back in town) in which I substitute the stress losses from Fannie’s current underwriting and book of business–derived from data published by both FHFA and Fannie–and its current average single-family guaranty fee, net of administrative expenses, for the stress losses and actual charged fee of Fannie’s 2007 book, which went through the Great Financial Crisis. Whereas the actual 2007 book would have needed about 200 basis points of initial capital to survive the crisis as a going concern, had that book had today’s credit quality and average net guaranty fee, it could have survived the crisis with no initial capital at all. This is consistent with the just-released FHFA stress test results.

          Director Calabria had to have known about these results when he said, as he was leaving FHFA, “When the housing markets experience a significant downturn, Fannie Mae and Freddie Mac will fail at their current capital levels.” That was a flat-out lie; FHFA itself says they’ll still be making money even in the Fed’s “severely adverse scenario.” I’m hopeful that someone senior in the Biden administration will realize that it’s in the administration’s best interest to stop basing Fannie and Freddie’s capital on fictional numbers made up by people who oppose them on ideological or competitive grounds, and instead use actual, verifiable facts about their business and risk as the basis of their capital requirement. Doing so would enable the administration to quickly get Fannie and Freddie out of conservatorship, and back to their traditional roles of supporting affordable housing by financing it on an economic basis.

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          1. Tim

            look forward to this next posting. it might be an appropriate vehicle to point out to those seeking “reform” for Fannie and Freddie, without further specification, that indeed they have already been reformed, given the differences in the current and 2007 books of business.

            rolg

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          2. Another important completed reform is that Fannie and Freddie no longer are in the portfolio investment business, which had been the number one reform priority for the companies’ critics pre-crisis. Treasury mandated their exit from that business on the first day of the conservatorships.

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          3. Tim

            Right.

            Policy types tend to view “reform” as a structural, all-encompassing top to bottom enterprise. go big or don’t go at all. in my view, this relates to their own need for self-importance, but that might just be my view. hence the poorly thought-through “reform” proposals from Corker etc.

            instead, good reform is always narrowly focused on very clearly understood deficiencies. Fannie and Freddie need creditworthy books of business and need to focus on the securitization/guaranty business, its reason for being, with a small portfolio of whole loans only large enough to “feed” this purpose.

            these reforms have already been done. mission accomplished. current policy types in the Biden administration should realize that the reform objective has already been accomplished for them, and not look for fictional problems to fix.

            rolg

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          4. Tim:

            Do you know if your upcoming blog post may include some discussion regarding Fannie Mae’s FY2010 adoption of FASB’s new accounting standards, and on the impact that those standards could (or would) have on any capital-requirements scheme the Biden Administration may put forth?

            As you probably know, the new standards had a significant effect on the company’s balance sheet on January 1, 2010, escalating on-balance sheet assets to over $3.2 trillion from $869 billion just the day before. If the minimum statutory capital requirement formula were applied as prescribed by law, Fannie Mae’s on-balance sheet minimum capital requirement would have gone from $21.7 billion to $80.0 billion – a 268.7% increase.

            Do you think it’s necessary and reasonable that the company include loans backing Fannie Mae MBS held by third parties in the calculation (2.5%) of the on-balance sheet assets for the statutory minimum capital requirement? And, if it is a statutory requirement to include all on-balance sheet assets in this calculation, regardless of changes in accounting standards that have a significant effect on regulatory law (e.g., the GSE Act) and the regulated entity, is there anything the regulator can do to counteract this destructive confluence?

            As always, I very much appreciate your thoughts and your blog; and I look forward to your upcoming piece after Labor Day. Thank you.

            Best regards,
            Bryndon

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          5. No, I do not intend to discuss the January 1, 2010 implementation by Fannie and Freddie of the FASB standard on accounting for variable interest entities (VIEs) in the post I’ll be putting up after Labor Day.

            For readers who don’t know what this is referring to, prior to that date Fannie and Freddie were permitted to classify their mortgage-backed securities as qualifying special purpose entities (QSPEs), and thus were not required to consolidate them on their balance sheets as VIEs. The companies’ capital requirements in the 1992 legislation reflected this difference: their on-balance sheet mortgages, which exposed them to interest rate as well as credit risk, had required minimum capital of 250 basis points, while their off-balance sheet MBS, on which they took only credit risk, had a minimum capital requirement of only 45 basis points. (Non-mortgage assets were capitalized at 250 basis points as an element of conservatism). When the FASB removed the QSPE exemption in 2010, Fannie and Freddie had to put their MBS on their balance sheets. FHFA, however, sensibly kept the required minimum capital for these now on-balance sheet MBS at 45 basis points by regulation, since the economic substance, and risk, of those obligations hadn’t changed.

            With Treasury’s mandate for Fannie and Freddie to exit the portfolio investment business, neither the 2018 (Watt) nor the 2020 (Calabria) FHFA capital standards preserved the distinction between mortgages on which the companies take only credit risk (MBS) and loans funded with debt on which they take both credit and interest risk. The Calabria standard requires the companies to hold 250 basis points of capital, plus a “prescribed leverage buffer amount” of 150 basis points, for a total of 400 basis points, against all of the mortgages they finance. As I’ve discussed elsewhere, this minimum requirement is—not coincidentally—the same as banks are required to hold for their on-balance sheet mortgages (which have both interest rate and credit risk). Having set this minimum, Calabria then used an array of assumptions, exclusions, cushions and elements of conservatism to push Fannie’s calculated “risk-based” capital standard comfortably above his arbitrary minimum.

            My next post will call Calabria (and FHFA) out on this. I’ll focus on Fannie (since it’s easier to analyze and explain the financials of one company than two.) We now have data that allow us to say how much initial capital Fannie would have required to cover the credit losses suffered by its December 2007 book (the one that went through the Great Financial crisis). We also know how Fannie’s credit quality and average net charged guaranty fee have changed since then, so we can make a very close approximation of how Fannie would perform during a repeat of the 2008-2012 stress experience, but with its current book. Spoiler alert—the result is little different from what FHFA just published for its 2021 Dodd-Frank stress test results: as a going-concern (rather than as a liquidating book, which is not realistic), Fannie would not need to touch its initial capital throughout a repeat of the Great Financial Crisis stress scenario, using its current book of business and average net guaranty fee. That means ALL of the 4.41 percent risk-based capital Calabria insists Fannie must hold at June 30, 2020 to be “safe and sound” is cushion or conservatism.

            There’s more to this, but that’s for later.

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          6. Tim,

            I look forward to that new post.

            Now that FHFA is essentially another arm of the Biden administration, do you think it’s more realistic to assume that the GSEs’ credit boxes will expand in the name of affordable housing? If so, the riskiness of their books should increase from today’s very low levels, though not anywhere close to 2007.

            I haven’t been able to find a way around the language of HERA requiring a minimum capital standard of at least 2.5% of balance sheet assets, which are now $7T. A minimum capital standard of $175B at the absolute lowest would violate the spirit of the law, as you very helpfully explained to me a while back, but the letter of the law seems clear.

            Fannie Mae’s 2020 10-K calculates the minimum capital standard as “Generally, the sum of (a) 2.50% of on-balance sheet assets, except those underlying Fannie Mae MBS held by third parties; (b) 0.45% of the unpaid principal balance of outstanding Fannie Mae MBS held by third parties; and (c) up to 0.45% of other off-balance sheet obligations, which may be adjusted by the Director of FHFA under certain circumstance” (top of page F-64), but the “except” part in (a) doesn’t appear in HERA.

            If Fannie Mae (this is also true for Freddie Mac) can, presumably with the blessing of FHFA as conservator, make such an interpretation of HERA now, could they continue to do so post-conservatorship?

            This seems to fall in the same category as FHFA refusing to give the GSEs capital classifications while in conservatorship, even though I have found no part of HERA that justifies it. (It’s in 12 CFR 1237.3, but that relies on Section 1364(e)(1) of the Safety and Soundness Act which only makes restrictions on capital distributions). Something that could be challenged but probably won’t.

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          7. I WISH FHFA was “another arm of the Biden administration.” I’m afraid instead that it’s on “Calabria-programmed autopilot.” As I’ve said elsewhere, I believe it will take a new director to get Fannie and Freddie out of the disastrous mess they’re now in, where they have a hugely negative core capital position legitimized by the SCOTUS ruling on the net worth sweep, a capital requirement and threshold for escaping conservatorship set by an ex-director who didn’t think they should exist at all, and a new acting director who wants them to finance more affordable housing, but seemingly doesn’t understand that they have been left bereft of all of the tools they used to be able to employ to do that. As for your concern that HERA may not allow FHFA to lower the companies’ minimum capital below 2.5 percent, I view that as a high-quality problem. Personally, I would take a simple 2.5 percent minimum capital requirement for all of Fannie and Freddie’s business–rather than the hairball of a “risk-based” standard they have now– in a heartbeat.

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          8. I agree wholeheartedly with your reply Tim. But please, how does one get any confidence Biden’s team gets this and will take the necessary actions to fix the problem?

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  16. Tim, I was curious about your thoughts after the Q2 earnings, particularly for Fannie Mae. Their net interest income increased $1.5B in the second quarter of 2021 (to $8.28B), which the press release said was driven primarily by an increase in net amortization income. That seems like quite an explosion. Do you expect them to maintain this level of interest income over the next 2-3 years? Given the current interest rate environment, it would seem that people are not likely to refinance into lower interest rates. How might this impact recapitalization plans/timeline?

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    1. Fannie was pretty clear that its earnings in the second quarter were boosted temporarily by two factors: sharply higher net interest income due to faster amortization of up-front guaranty fees during last quarter’s refinance wave (particularly earlier in the quarter), and $2.5 billion in credit-related income driven primarily by the impact of much higher home prices on its calculation of likely future credit losses (which the company now needs to reserve for under the new Current Expected Credit Loss, or CECL, accounting standard).

      I think we may see unusually high net amortization income at Fannie for another few months (although not as high as in the second quarter), but as I’ve indicated earlier the drawdowns in Fannie’s loss allowance–that have been going on since 2013–are very close to having run their course. After peaking at $90 billion at the end of 2011 (an artificially high number produced by exceedingly conservative home price and credit loss assumptions by FHFA), Fannie’s single-family mortgage loss reserve is now down to $6.2 billion at June 30, or 18 basis points of its outstanding single-family guarantees. I can’t see the reserve getting much lower than that before it starts moving up again. (The multifamily loss reserve at June 30, by the way, was $1.05 billion.)

      Over the next few years, Fannie’s earnings will be driven primarily by its average guaranty fee rate and the total volume of business it does. Fannie’s average guaranty fee rate will probably drift a little higher than the 45.2 basis points it reported for the second quarter (the 47.9 basis-point average fee it reported on new business for that quarter was boosted by the effect of the 50 basis-point adverse market fee in effect then, but now expired), but the biggest change in the company’s profit outlook is the fact that its book of business has grown so much in the last couple of years. Fannie’s total book of business has grown by 9.8 percent in the last twelve months, and by 17.4 percent in the last two years. (Freddie’s book has grown even faster, which is a point I’ll return to.) The primary driver of this growth has been the explosion in home prices in the last year. After growing at a relatively modest rate of 5.4 percent between June of 2019 and June of 2020, home prices shot up by an average of 16.3 percent nationally in the last 12 months. That pace almost has to slow down, but even so home prices likely will continue to trend at above-average rates for the next several quarters, and I expect Fannie’s business growth to continue to be above trend as well. That will be good for profits, but it’s not good for the company’s capital deficit.

      Fannie mentioned in its press release that its net worth increased from $16.5 billion at June 30, 2020 to $37.3 billion at June 30, 2021– a jump of $20.8 billion. What it did not mention is that, because of its strong business growth, its required capital grew by almost as much: from $171 billion to $189 billion, or by $18 billion. This means that in spite of its surprisingly high profit growth in the last four quarters Fannie was able to cut its massive core capital deficit by less than $3 billion. Freddie actually went backwards on its capital gap, and by a lot. Freddie’s total book of business has grown by an astounding 18.9 percent in the last four quarters. Because of that, the capital it will require to meet what I call the “Calabria standard” increased by $24 billion– from $112 billion at June 30, 2020 to $136 billion at June 30 of this year. Over that same period, Freddie’s core capital increased by only $10.7 billion (from $11.4 billion to $22.1 billion), so Freddie’s capital gap is now $13.3 billion WIDER than it was a year ago.

      I’ll write more about this in the future, but neither Fannie nor Freddie have any realistic chance of retaining enough earnings to meet Calabria’s criteria for being eligible for release for conservatorship under a consent decree–which is 3.0 percent core capital, well under the 4.1 (for Freddie) to 4.5 (for Fannie) percent core capital requirement of the Calabria standard–within the next decade and a half, and that’s without any further book growth. This is the “interminable conservatorship” problem the Biden administration now confronts, and needs to solve. It won’t solve itself.

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      1. Tim,

        Well said. Knew you would like the second half of the recording much better than the first 50 minutes.

        You keep mentioning Calabria’s core capital ratios. If they are scaled back to what you believe should be more ‘reasonable,’ does this make the capital build any easier/shorter? If so, by how much, or is the problem chronic for whoever is FHFA Director?

        Any comment on Arrowood’s insistence that they, and other holders like them, believe that damages should be bound to pre-NWS holders and not all current JPS and Commons holders?

        Any comment in what appears to be JPS holders fighting amongst themselves in terms of ultimate goals and outcomes? This latter part appears to have been addressed by a female Justice who apparently feels any investor/speculator getting involved with a USG-regulated entity nearly at any point, should not be surprised at a washout due to say, a NWS.

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        1. Let me start with the core capital issue, since that’s not well understood and has important implications for current holders of Fannie and Freddie common and preferred shares.

          In both its earnings press release and investor call, Fannie emphasized the increase in and current level ($37.3 billion) of its net worth, then simply said “we remain undercapitalized.” Many may not know that net worth (also called “total shareholders equity”) includes two balance sheet items that are not included in the statutory definition of core (or tier 1) capital–accumulated other comprehensive income (AOCI) and Treasury’s senior preferred stock. At June 30, 2021 Fannie’s AOCI was quite small ($57 million), but its senior preferred stock ($120.8 billion) was huge. Under Fannie’s 1992 capital statute (and HERA), the senior preferred does not qualify as core capital, because it’s cumulative. For that reason, Fannie’s core capital at June 30, 2021 was not $37.3 billion (as some might assume), but a negative $83.5 billion.

          How much core (or tier 1) capital does Fannie need to hold to either (a) be eligible for release from conservatorship under a consent decree, per the January FHFA-Treasury letter agreement, or (b) be considered adequately capitalized (i.e., meet both the minimum and risk-based standards under the Calabria capital rule)? We don’t know exactly, because both the Calabria minimum and risk-based capital numbers are calculated using data that Fannie, Freddie or FHFA don’t disclose regularly. The Calabria rule expresses Fannie and Freddie’s capital not as a percentage of their total assets (as the 2018 FHFA rule did), but as a percentage of their “adjusted total assets.” And the Calabria capital rule defines adjusted total assets as total assets “with adjustments to include many of the off-balance sheet and other exposures that are included in the supplemental leverage requirements of the U.S. banking system.” What are those? We don’t know; we have to wait for FHFA to tell us. The last time FHFA gave us a figure for adjusted total assets was as of June 30, 2020, and at that time Fannie’s were 3.2 percent more than its total assets (Freddie’s were a whopping 17.9 percent more).

          We know what Fannie’s total assets were at June 30, 2021–$4.158 trillion. If we assume that its adjusted total assets are higher by the same 3.2 percent (they may not be), that would make its core capital threshold for being released from conservatorship $129 billion, or $212 billion more than it has now. How long will it take for Fannie to fill that gap using retained earnings alone? That will depend on its annual earnings, and the change in the size of the book. Over the last four quarters, however, the combination of Fannie’s very strong earnings AND unusually rapid book growth trimmed only $2.8 billion off of what previously had been a $215 billion core capital shortfall. And that’s just to get to 3.0 percent capital. Fannie’s June 30, 2020 risk-based capital requirement was 4.41 percent of adjusted total assets; today that would be $189 billion, or $273 billion more than it now has.

          These massive capital deficits are simply too large to be overcome over any reasonable time frame. They are the result of four things: (1) the original act by Treasury and FHFA to balloon Fannie’s losses by loading temporary or estimated book losses onto its income statement, and requiring them to offset the losses with non-repayable Treasury senior preferred stock; (2) Treasury and FHFA imposing the net worth sweep just as those artificial losses were about to begin reversing, preventing Fannie from keeping the resulting retained earnings; (3) the Supreme Court ruling this June that the net worth sweep was legal (thus denying Fannie the remedy of having the senior preferred unwound, which would have boosted its core capital by $120.8 billion), and (4) the unjustifiably high Calabria capital requirement.

          In my view, this capital situation injects considerable uncertainty into the path for success of the remaining outstanding lawsuits for regulatory takings (in the Court of Federal Claims) or breach of contract (in the DC Circuit). Plaintiffs don’t agree on what was taken. Was it the company’s earnings (in the derivate suit), shareholders’ rights to dividends and a liquidation preference (in the direct claim), or something else? And if there WAS a taking or a breach of contract, what’s the appropriate remedy? One could certainly argue, for example, that the right to receive dividends (whether on preferred or common shares) that are potentially $273 billion or more in retained earnings from being turned on isn’t worth very much.

          I am hopeful that shareholders won’t have to go down the legal path to get value out of their current investments in Fannie or Freddie, but that instead this value will be received as a consequence of the Biden administration realizing that it has inherited a huge problem in the secondary mortgage market that won’t solve itself, but will need to be remedied through the administrative steps I’ve outlined elsewhere, including at the end of the current post.

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          2. No. Canceling or eliminating the senior preferred would add the $120.8 amount of the senior preferred to Fannie’s core capital, but not the full $151.7 billion of Treasury’s liquidation preference. The difference between those two numbers–$30.9 billion–is the amount of retained earnings Treasury and FHFA have allowed Fannie to retain (that otherwise would have been swept), and this amount already is reflected in Fannie’s net worth, and core capital.

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    1. I only was able to listen to the arguments by plaintiffs’ counsel (Bennett, Hume, Rosenberg and Barnes) before I had to drop off the stream, but I thought the Federal Circuit Court of Appeals judges were very tough on them. Bennett was on the defensive almost immediately, and even Hamish Hume–who I have a lot of respect for–was on his heels for most of his allotted time (and sounded frustrated that his arguments either weren’t being understood or weren’t connecting). Rosenberg and Barnes fared a little better, but the overall impression I got was that the judges weren’t buying what any of these lawyers were selling. I will listen to the whole session tomorrow–both the questioning of the government’s lawyer(s) and plaintiffs’ counsels responses–but my impression from the first 50 minutes of today’s oral argument at the Federal Circuit was NOT encouraging.

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      1. Although I agree it seems like the direct claims may be lost cause in this case, If you listen to the government portion, you will notice the Judges were equally harsh on them as well (and seemed very reluctant to buy into the government’s lawyer argument to dismiss the derivative takings claim).

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        1. This was a derivative case, all along. It was clear in 2013, and it’s even more clear now. After listening to the audio, it’s clear the Federal Circuit will affirm the dismissal of the direct cases and dismiss the derivative illegal exaction and breach of fiduciary claims. The derivative Fifth Amendment takings cases, however, will proceed to trial. One step closer to getting our companies back.

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          1. I have not listened to CFC appeals ct oral argument, but what I find perverse is that no P has ever motioned (to my knowledge) the federal court to certify the direct/derivative issue to the Delaware Supreme Court, which is the only court in the US which can authoritatively rule on this question of Delaware law.

            rolg

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      2. Tim,

        Look forward to your response. IMHO it gets better as there is not many areas for the USG to hide and this was highlighted in the second half.

        Big Picture: The Plaintiffs chop themselves up. No conciseness, and very unfortunate contradictions and confusion, even to the extent of mixing up the Attorneys’ names! Too many Plaintiff participants, too many interruptions by the Judges. Get the feeling the Plaintiff’s attorneys just were not able to convey everything they wanted.

        Key example…..Arrowood’s claims appear to be highly aggravating to say the least. They concern Direct claims only (if they are allowed) combined with their insistence about ownership pre- vs. post-Conservatorship seems to undercut necessary Plaintiff cohesion. Thank goodness Arrowhead was relatively brief, but there were times it was Arrowood vs. Fairholme and it was not pretty. USG had one attorney only and there was obvious cohesion in taking this approach, but there were instances where he stumbled and could not answer simply. Hope the Judges realize this is David vs. Goliath.

        USG reaffirmed strongly how the USG saved Fannie & Freddie through massive infusions of Capital (Funds) and that this saved the Housing Market and the ‘Public Good’. This has to be frustrating to you Tim.

        Continuing issue of Direct vs. Indirect Claims is confusing, but the Court of Appeals for the Federal Circuit made it clear, they are not bound by other Court’s decisions but did defer to SCOTUS on some key issues.

        First Hartford and Citigroup were prominently mentioned. First Hartford seems to be a major thorn in the USG’s side. Citigroup looks to be an issue of “fraud committed by the Directors in relation to purchasing (presumably) Citigroup shares.”

        Look forward to your opinions and wrtieup Tim. Thank you in advance.

        VM

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        1. Listening to the whole oral argument (as I just finished doing) changed my view on it.

          I thought Stern did an “okay” job in defending his positions on behalf of the government that the succession clause bars all challenges–including on constitutional issues– to FHFA’s actions as a conservator, and that FHFA was not the government when it entered into the net worth sweep. But I also sensed that neither Judge Prost (sp?) nor O’Malley agreed with him on either. So I expect the derivative claim on a regulatory taking be allowed to proceed.

          The rebuttal by Rosenberg (who wisely substituted for Bennett) was a surprise. He essentially made the same points about the right to a dividend and the company’s liquidation preference being a direct claim as Hume did, but his discussion went unchallenged. Rosenberg also said, to the point ROLG makes above, that “if the Court thinks these are derivative claims, it should certify the question to the Delaware Supreme Court.” So I’m now left wondering whether the direct claim will be allowed to proceed too.

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          1. Does anyone know the anticipated timeline for this case? I haven’t seen a scheduling order.

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          2. @Tim

            the whole derivative/direct claim issue is very nuanced, even metaphysical. same with the issue in Jacobs/Hindes, re whether a preferred can own the residual earnings reserved by the Delaware General Corporation Law (DGCL) for the commons. in Jacobs/Hindes, the 3rd circuit decided the case adverse to Ps, as a matter of statutory interpretation, without citing a single Delaware case. as someone who has had over 30 yers experience with the DGCL, the question whether a preferred governed by Delaware law can validly own the residual profits of a corporate enterprise is far from as clear as the 3rd circuit would have it, and I rather think that if that question was certified to the Delaware Supreme Court, it would have held otherwise than the federal 3rd circuit. as for the derivative/direct claim issue in CFC appeal court in Fairholme, these CFC appellate judges have no experience with the issue…yes they can read cases, but then so can first year law students, and the result you are likely to get is drivel. Ps in each of Fairholme and Jacobs/Hindes should have fought like hell to get the Delaware question certified…or at least motion to seek certification. pretty late in the day to ask for it in oral argument.

            rolg

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  18. @Michael

    govt asserted executive privilege, which is a strong defense to the production of “executive department internal deliberation” documents. so Ps may have thought it was a losing fight to get the requested docs, or Ps thought they have enough evidence otherwise. settlement is not a likely reason imo.

    rolg

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  19. @FG

    I am not going to entertain speculation (scotus has invited enough on remand) except to point out that the current administration may believe it is bound to the letter agreement status quo, whether for the reason you pose or others, which of course is a status in which no cash flow is being directed to Treasury, the spigot is turned off even as the preference amount grows. this may have implications for the current administration as to how to monetize Treasury’s economic position in the GSEs.

    rolg

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    1. This filing tells us what plaintiffs’ counsel in the Collins case are requesting of the Fifth Circuit Court of Appeals, and why. The request is that, “The Court should remand this case to the district court with instructions to enter a permanent injunction requiring, at a minimum, that Defendants amend the purchase agreements to either: (1) reduce the liquidation preference on Treasury’s senior preferred stock to zero and end further increases to the liquidation preference except as necessary to offset any further draws on Treasury’s funding commitment; or (2) convert Treasury’s senior preferred stock to common stock.” The “why” is because plaintiffs claim that the unconstitutional restriction placed on President Trump from removing the Obama-appointed Director, Mel Watt, early in the Trump term prevented Treasury and FHFA from completing their plan to release Fannie and Freddie from conservatorship—which would have included one of the steps plaintiffs are requesting as relief—before the end of the Trump term. This delay constituted “irreparable harm” to the plaintiffs, therefore the requested relief is appropriate. Counsel for the government very likely will argue that Mel Watt’s remaining in place as director for two years was not the reason the Trump administration was unable to complete its plan to remove the companies from conservatorship before the end of its term, and therefore the plaintiffs do not deserve relief.

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      1. What are your first impression thoughts on the merits of this argument? The recent Craig Phillips interview (referenced in the brief) appears to make it seem as if the Trump admin shelved GSE reform specifically because of the Admin’s inability to fire Watt.

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        1. My views on the merits of the legal (or factual) arguments in all of the Fannie and Freddie net worth sweep-related cases have not aligned well with the opinions of the judges, but I also want to read the government’s brief before offering any opinion.

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      2. Tim,
        I left a comment on this blog after SCOTUS came out with its ruling, in which comment I suggested that the Craig Phillips Interview was the “smoking gun” evidence that we needed to prevail on the constitutional issue. Now, Plaintiffs in Collins have argued exactly along these lines. While I respect your editorial power, I must say I am disappointed you have deleted and not published my comment. Why?

        Michael

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        1. Michael– In checking my “blog log,” I note that you did submit a comment for approval, but I did not accept it. I can’t recall why (sometimes a good comment gets submitted but in a context where it takes an important discussion that has not yet run its course in another direction, so I choose not to accept it). In any case, I have approved this comment. As to your characterization of the Phillips interview as a “smoking gun,” that may be overstated. My recollection of the interview (and I have not checked this by going back and listening to it) is that Phillips did not think that Watt would oppose the plan of the Trump Treasury and FHFA to recapitalize and release Fannie and Freddie, and thus did not think the plan should be stayed pending Watt’s replacement. If that’s correct, it’s a “hand hold” the government undoubtedly will grasp in building its argument against the relief plaintiffs seek. (This is one of several reasons I want to wait to see what the government says before offering any view about the strengths and weaknesses of each side’s arguments.)

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          1. Hi Tim, thank you and I very much appreciate the transparency!
            I had listened to the interview a few times. It is true that Phillips thought that he personally could work with Watt, but he then says that [nevertheless what he personally might have thought] “it was ultimately decided [by people other than him in the administration presumably] we needed to wait for the end of Watt’s term”.
            I am eagerly awaiting the other side’s argument as you do, and wonder how they will respond. So far, the facts seem to be clearly on our side but I was thinking that as well in regards to the APA argument, so my view may not count much. Just logically, I can not clearly see how the other side may argue against this with a straight face. Too much was put out by the administration in writing and plans and action to end the conservatorships, and David Thompson argues these points very well.

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          2. I feel like the finger pointing at moments in the past to prove “what might have been” simply proves Gorsuch’s point about remedy. They should not be looking at alternative realities to determine remedy. It should have been done by SCOTUS. Being in this situation though, it’s hard to say who’s alternative version of reality the 5th circuit will accept and what remedy will result. It all seems like voodoo and the precedent that results will be messy.

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          3. @fisher

            “It all seems like voodoo and the precedent that results will be messy.”

            absolutely, but there is possible advantage in that for Collins Ps.

            If 5thC remands to DCt with instructions to hold an evidentiary hearing as to what the Trump administration would have done had it been able to replace Watt at the get-go, AND places upon the govt the burden of proof to essentially prove that there would have been no material difference, then the outlook seems to improve for a favorable holding that, no, the govt has not met its burden of proof that the 2 year delay did not frustrate the Trump administration. This would be a win on the merits leading to a remedy…now will the 5thC instruct the DCt as to what the remedy should be (capital structure revision), if the result of the evidentiary hearing is such that the govt has not met its burden of proof, as requested by Collins Ps in this filing? This may be a bridge too far…but the context of this case is that the 5thC has shown that it is not well disposed to the govt’s position in this case…

            messy indeed, but this would be a fine mess if it bounces from the 5thC back down to the DCt in the manner the Collins Ps have requested in this filing…so messy that it is unlikely imo that scotus would want to sully its hands with this case again should the gov’t try to bounce it back up.

            rolg

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      3. In that Craiig Phillips interview he actually provides the counterfactual if they stopped the sweep from day one they could have had them capitalized by the end of the 4th year of the Trump term. He did indicate he felt he could work with Mel Watt and thought he would go along with what they wanted, however, every one of the prepared remarks and prepared testimony statements put out by Mel Watt said “I want to reaffirm my strong belief that it is the role of congress, not FHFA to make these tough decisions that chart the path out of conservatorship and to the future housing finance system.” He also indicated that he was proposing a capital rule but that it would remain suspended while in conservatorship. So taking all this into account, Craig Phillips may have felt he could work with Director Watt, the rest of the administration was aware that Watt would not chart the path out of conservatorship, he wanted congress to do so. At this same time there was the hot topic about firing Richard Cordray at the CFPB and it was well documented that if Trump fired him he was putting together a legal defense to challenge it. It was reported that Trumps advisors told him not to fire him while the CFPB case was being appealed. January of 2018 the appeals court reversed the CFPB decision saying the provision was constitutional. This whole counterfactual world the Supreme Court decision is asking to create on remand is ridiculous.

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        1. Watt: “I want to reaffirm my strong belief that it is the role of congress, not FHFA to make these tough decisions that chart the path out of conservatorship and to the future housing finance system.”

          That’s a good point and one that had escaped me. Thx

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        2. @Eric M

          great comment as to the relevant history. there was the “congress must act” refrain, as well as the “contract [NWS] changed the law” refrain from Director Watt.

          “This whole counterfactual world the Supreme Court decision is asking to create on remand is ridiculous”…agreed. but the genius of the motion to shift the burden of proof onto the govt is to have the DOJ deal with the mishigas. while many courts would likely not do this, the 5thC (acting en banc) might very well.

          Rolg

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    2. Couple of thoughts on this filing.

      First, context. remember that scotus reversed the 5thC en banc on every important substantive issue of the 5thC en banc Collins holding…the viability of the APA claim, the removability of the acting director and even the question of backward remedy for the constitutional claim (yes, scotus affirmed on removability of confirmed director, but that was all but a forgone conclusion after Seila Law). So, and of course this is my speculation, this case comes back to the 5thC with an interesting (and rather unique) opportunity for the 5thC judges to do what they may consider to be some rough restorative justice. Judges are people too, and they may actually look forward to having another crack at Collins, at least within the interstices left open by scotus…and ruling in favor of imposing on the govt the burden of proof is just one way in which an exercise of discretion may be informed by context (and judges being human). however, actually providing a remedy itself is likely a bridge too far for the 5thC.

      Second, an expansive opportunity for additional fact finding. Collins Ps are in possession of substantial documentary evidence and testimony that bears upon the Lamberth and CFC cases, but Collins on remand would afford a whole new opportunity to gather evidence from individuals who are not the sort that can be “coached” by the DOJ…such as Phillips, Mnuchin and Trump himself. if the relevant issue is that the Trump administration “ran out of time” and the non removability of Watt is a cause of this, then the testimony from Phillips, Mnuchin and Trump as to what they would have done had they begun with a new FHFA director at the start of the administration can be very damaging for the govt, especially if the burden of proof falls on the govt. proving a counterfactual to a hypothetical will not be easy for the govt.

      rolg

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      1. ROLG, is this SCOTUS remand to be reviewed by the original 3 judges who oversaw the case, or en banc as all the judges were part of the ruling? If its only 3 judges, does it make sense to petition this directly to en banc so that all the judges who were part of the original ruling able to participate and voice their opinion on such a remand (where shareholder odds are probably more favorably)?

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          1. From your link, page 27-8:

            “REMAND FROM SUPREME COURT OF THE UNITED STATES – REMANDS FROM THE SUPREME COURT OF THE UNITED STATES ARE SENT TO THE ORIGINAL PANEL FOR DISPOSITION WHEN THE SUPREME COURT’S JUDGMENT IS RECEIVED. COUNSEL DOES NOT NEED TO FILE A FORMAL MOTION.”

            This seems to imply it gets back to the panel who made the decision that ended up with SCOTUS, which would be the en banc panel in this case.

            Liked by 1 person

          2. @Unfortunate

            good job…but I wonder whether when that original panel’s decision was vacated by an en banc decision, as was the case with Collins, then the original panel retains the case upon scotus remand…remember, when the 5thC decided to take up en banc review, that original panel’s decision became kaput! it strikes me that in the Collins situation, when the scotus remand is from an en banc decision where the original panel decision has been vacated, it makes sense for the circuit court en banc to proceed. we shall see. it would clearly be more favorable for the Collins Ps for the circuit en banc to proceed.

            rolg

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          3. Can we look at 2) convert senior preferred shares to common as a not so subtle offer to negotiate a settlement?

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          4. as to the question whether Collins will be considered on remand by the original merits panel (3 judges) or en banc (all 5th circuit judges), this would indicate that the 5th C en banc will take up the remand:

            “Dear Counsel:
            Patrick Collins v. Steven Mnuchin,
            Secretary, U.S
            USDC No. 4:16-CV-3113
            This letter will serve to advise the parties that the court has directed the parties to submit letter briefs of not more than five pages, addressing how the case, when remanded to the en banc court, should proceed in light of the Supreme Court’s decision in Collins v. Yellen, 2021 WL 2557067 (June 23, 2021). The letter briefs are to be filed in this office by 1:00 p.m. on July 2, 2021.”

            rolg

            Liked by 2 people

          5. ROLG,
            This is fascinating in terms of timing and brevity (5 pages). USG will argue “HERA Conservatorship” as established by SCOTUS supercedes any and all arguments for relief by Plaintiffs.
            Plaintiffs need(ed) to bring their ‘A’ game, now arguing what? — Contract Law, Breach of contract, Unfair dealing….or are these issues not the focus of the 5th Circuit and it is (still) strictly APA?
            Can, &/or will the 5 page summaries ever be made public?
            Do you think this is important/meaningful at this stage, the timing of any rulings, and what the arguments might be if I am off base?
            VM

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      2. just another thought about the unusual context and procedural stance of this filing

        (continuing) Third, the “pivot” point of this filing. it has been rightfully pointed out in these comments that the scotus remand is particularly unusual….messy even. while it invites additional fact finding, it does so with respect to a “what if” question…what if the Trump administration had the clear statutory right to replace Director Watt at the commencement of its term? Would things have been different for the Collins Ps? How does one go about proving/disproving this? usually, scotus does not invite hypothetical/counterfactual inquiries, but in Collins scotus has unambiguously done so.

        and so, this is where the placing of the burden of proof/persuasion plays such a pivotal role. Collins Ps have smartly latched onto the question as to who bears the burden of persuasion/proof in the inquiry, and it offers support in the filing for the proposition that this burden should fall onto the government…it was the government (treasury, in the form of its senior preferred preference) that benefitted from this two year hiatus at the start of the Trump administration, and so it should be the burden of the govt to prove that this benefit of time did not cause Ps harm.

        this was a smart filing by Collins Ps.

        rolg

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        1. ROLG,

          It’s my recollection that Watt was amiable toward a 2.5% capital requirement. I also remember him opposing zero capital buffer, even testing the retention of capital waters by suggesting he might not send over the sweep (he might “dance alone”), and that it was Mnuchin who said to Congress that he was confident that Watt would send over the next quarterly sweep, settling I believe Corker’s nerves.

          So, what might the P’s argument from silence look like when in fact we see (a) no failure by Watt to cooperate (but perhaps even the opposite), (b) Watt’s concern of having too little capital, and (c) a more agreeable capital standard than Calabria’s 4%?

          That the administration ran out of time doesn’t imply that they didn’t squander time. I think P’s need an answer to that. Nor does it imply that Watt’s presence was a hindrance. Moreover, the problem has been widely touted as attributable to not enough political cover and an arbitrary capital requirement, neither of which can be mapped to not being able to remove Watt.

          I don’t see the case.

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          1. @Ron

            you need to see the evidence before you see the case. depositions of Calabria, Mnuchin, Trump and Phillips might be informative, to say the least.

            Rolg

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        2. I suppose this will be my final thoughts on the filing

          (continuing) Fourth, just a little bit of hubris. typically, the Ps have the burden of persuasion, and the court will not entertain a remedy before reaching a conclusion on the merits. here,Collins Ps request both. there is good reason for a court under these circumstances to shift the burden of proof to the defendant govt, and I think the 5thC acting en banc could very well be disposed to do that. as to prescribing in advance what the proper remedy should be in the event the lower court determines that two years of not being able to remove Watt caused Ps harm, I would think even the 5thC would be inclined to defer on that…it can always address remedy on appeal from the lower court…contra, the 5thC en banc may believe that if it has a strong and informed enough view of what a proper remedy should look like, such that it may question what the benefit would be to defer expressing this view until an appeal.

          rolg

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    3. the briefing schedule set forth by 5th C on Collins remand:

      Appellants’ Supplemental Opening Brief: Due July 26, 2021
      Appellees’ Supplemental Response Briefs: Due August 25, 2021
      Appellants’ Supplemental Reply Brief: Due September 8, 2021

      no oral argument scheduled (yet)

      rolg

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  22. Gary Hindes had an interesting update (March 9th, 2021), prior to SCOTUS, where his emphasis on the most promising legal timeline was actually Lamberth. I know Hindes has had success suing the government in the past and is connected with highly competent legal resources. I’m curious which parts of this you and ROLG may agree or disagree with. Also, in your viewpoint how may this influence the Biden Administration moving forward? This seems to align with the Pagliara viewpoints a previous poster shared.

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    1. [Note: Gary’s writings explicitly state that they are not to be shared without his permission, and accordingly I have removed both the link to his piece and the excerpts from it cited in the above comment.]

      I largely agree with Gary, and hope the Biden administration comes to this same conclusion quickly. It does have to deal with the untenable situation Fannie and Freddie find themselves in following the SCOTUS decision on Collins–I don’t believe the administration will view an inescapable and never-ending conservatorship to be a viable alternative–and there is a very simple way to get the companies out if the Biden team has the political will to seize upon it and do so.

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      1. Tim, could you please elaborate on your comment about the Biden administration having an easy route out of conservatorship, if they have the will to do it.

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        1. As you’ll note by re-reading my comment (above), I didn’t say an “easy” route; I said a “very simple” one. The two are not the same.

          The “very simple thing” the Biden administration could do to get Fannie and Freddie out of conservatorship is essentially to reverse what the Bush administration (Treasury Secretary Paulson specifically) did to put them into it. You may know that Paulson forced them into conservatorship for policy reasons—I believe because he was unwilling to leave them as “the only game in town” (his words) after the private-label securities market collapsed, and banks had drastically cut back on their mortgage lending because of soaring delinquency rates (triple Fannie and Freddie’s), and that he also saw in the financial crisis an opportunity to get control of two companies Treasury historically had opposed. Treasury’s intent was to replace them with an alternative more favored by the commercial banks, and to that end it had FHFA add over $300 billion in temporary or estimated non-cash expenses to the companies’ books, forcing them to take $187 billion in non-repayable senior preferred stock from Treasury, paying a 10 percent after-tax annual dividend. Treasury (and the rest of what I call the Financial Establishment) then rewrote history to claim that Fannie and Freddie were the causes of the financial crisis, that the $187 billion was a real cost of their “rescue” (in fact, this amount was repaid in just eighteen months), and that even today the companies are so risky that they can’t be released from conservatorship before they have 3 percent Tier 1 capital, on their way to a full requirement of about 4.5 percent in total capital (more for Fannie, less for Freddie).

          Where we are today is that virtually everyone believes the fiction that Fannie and Freddie caused the financial crisis and are terribly risky, the Financial Establishment in thirteen years has been unable to come up with a workable way to replace them, and the Supreme Court has just said that it is perfectly legal for FHFA to give all of the companies’ net income to Treasury in perpetuity, making it impossible to for them to get out of conservatorship on their own for more than a decade, and even then leaving them where they have to grossly overprice their credit guarantees because of arbitrary capital requirements that bear no relationship to the risks of the mortgages whose credit they are guaranteeing.

          So, what is the “simple thing” the Biden administration can do to fix this? Say the Bush Treasury made a huge policy blunder in taking over, without statutory authority and by coercion, the two companies who were by far the healthiest providers of mortgage credit going into the crisis, then deliberately inflating their book losses to burden them with mammoth amounts of non-repayable senior preferred stock that has led them to remain in perpetual conservatorship. It would say that Fannie and Freddie have paid back all of the $187 billion (now a bit more) they had to draw during the crisis, with 10 percent interest, so that the Biden administration can deem the Treasury senior preferred stock repaid (while pointing out that no regulator anywhere in the world has ever used non-repayable senior preferred stock to “rescue” a company, or for any other purpose) and also cancel Treasury’s liquidation preference. It then would appoint a new director of FHFA, and ask him or her to come up with a true risk-based capital standard for Fannie and Freddie (to replace Mark Calabria’s, which had ridiculous amounts of indefensible assumptions, cushions and conservatism to force the final percentage above the “bank-like” 4.0 percent minimum he insisted on imposing on the companies, irrespective of their risk) that would enable them to them price all of their business—but particularly their affordable housing loans—on an economic basis. With Treasury’s senior preferred stock deemed repaid and its liquidation preference cancelled, settling the remaining lawsuits should not be difficult, and with a reasonable risk-based capital requirement (and a minimum tailored to that requirement, rather than the other way around), it should be possible to release Fannie and Freddie from conservatorship fairly quickly, to enable them to reach full capitalization through new issues of capital (which investors would eagerly buy if the companies are structured to succeed as private companies, rather than struggle per the Calabria standard).

          I view that as simple. Coming up with the political will to do it is harder, but a good place to start would be for senior economic policy officials in the Biden administration to embrace the (readily available) facts about the companies’ past history and current risks, rather than the fictions spread by their critics, opponents and competitors over the past twenty-plus years.

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          1. Tim

            great comment…which could be the basis of a great new post. maybe a post offering the Biden Administration a roadmap forward, that can bounce around the west wing halls until someone sees the path forward.

            rolg

            Liked by 3 people

          2. I’m a bit ahead of you on this. I’ll be doing a short paper for someone in a senior policy position in the administration (I don’t give names), and this is a rough summary of how I’ve been thinking of structuring it.

            Liked by 6 people

          5. A great comment, Tim, but as you know it’s hard to muster political will without the ability to Lobby or hire lobbyists. This would seem to be a freedom of speech issue for the shareholders. I wonder if there’s any way to fight FHFA’s anti lobbying policies through the courts? Sorry to go off course but these thoughts are what came into my mind as I was reading your comments.

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          6. @Tim

            good! you have the “simple” well researched, thought out and expressed.

            as for the “not easy”, I rather think it is a matter of framing. if you frame the analysis as why “give up” on the senior preferred balance, then by responding to this question as posed, you are fighting the uphill fight…having to point out, for example, that 79.9% of what Treasury “gives up” in senior preferred it gains in common equity value, and it really is not a “give up” if you keep the senior preferred but cant induce private capital to return the companies to a path that is self-sustaining and out of conservatorship.

            the other way to frame the question is to compare Treasury’s per annum investment return on the GSEs (depending on what assumptions you make as to common equity value, something around 15%) to Treasury’s return on all of the tbtf bank bailouts in TARP…all low single digits (to the extent there was a return).

            then ask the Biden Administration what objective it wishes to pursue by keeping the senior preferred, instead of booking this fantastic investment return on the GSEs, and getting the GSEs out of conservatorship?

            rolg

            Liked by 1 person

          7. Thank you very much, Tim. I really appreciation your taking the time to provide a more thorough explanation of what a “simple” route out of conservatorship would entail. If today’s “soft” stock market leads to more downside in the days and weeks ahead, maybe that will finally spur the Biden team to get serious about doing something along the lines of what you suggest, if for no other reason than to maintain market and economic momentum. Looking forward to more discussion on this on your site.

            Liked by 1 person

        1. It’s more than a little irritating to read DeMarco insist on legislation to release the GSEs from conservatorship, when of course that isn’t necessary.

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    2. @FG

      it is not clear to me what the shareholders remedy would be if Ps win on the merits of a breach of an implied duty of good faith. But this has become a much more prominent question in my mind post Collins. I hope to do a deep dive on this and report back.

      rolg

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  23. Tim, have you had an opportunity to listen to Jeffrey McCoy and Jason Levine from the Federalist Society discuss the Collins case?

    I was surprised that Jeffrey McCoy seems so unfamiliar with the case, given the fact that he filed an Amicus brief. Both attorneys are understandably pessimistic about the prospects for shareholders moving forward. I’m curious, however, about the overall view of the Federalist Society about the Conservatorship, the rights of shareholders and this case in particular, given the fact that they hosted these attorneys, one of whom at least (Jason), seems favorable toward the plaintiffs.

    https://fedsoc.org/events/courthouse-steps-decision-webinar-collins-v-yellen

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    1. No, I have not listened to this webinar. But one of the participants, Jason Levine, was the lawyer (paid for by a third party with an interest in the case) with whom I worked to prepare my amicus brief filed with the Supreme Court, so he is intimately familiar with the facts of the case, and indeed “favorable toward the plaintiffs”. (I sent him a link to my current blog post, giving my reaction to and analysis of the Court’s ruling in Collins, right after I put it up, and his response was, “Very insightful analysis of a very disappointing opinion.”)

      Because the Federalist Society has so many members with varied views on many different issues–for example, David Thompson, Cooper & Kirk’s lead lawyer on the net worth sweep cases, is a member–it’s not possible to generalize about the Federalist Society’s “overall view…about the Conservatorship.”

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      1. Please don’t interpret my inquiry to be insincere. I truly don’t know the history and politics behind the court, but I’m interested to learn. I understood from your blog post that “All six of the conservative justices (Roberts, Thomas, Alito, Gorsuch, Kavanaugh and Barrett) are members of the Federalist Society, for which ‘reining in’ or eliminating Fannie and Freddie has been a crusade for more than two decades.” I took that to mean that there was a more uniform attitude among Federalist Society members. So perhaps there are more diverse opinions among them. Or perhaps attitudes have shifted over the past 13 years. I’m probably trying to know the unknowable, which is whether there is still a whisper campaign among FedSoc members to rein in Fannie and Freddie.

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        1. There are a number of high-profile ideological or other types of opponents of Fannie and Freddie who are members of the Federalist Society and influential within it. I won’t mention any by name, but those who have followed Fannie for some time (since before the net worth sweep) know who many of them are. The most outspoken would have no qualms about going to their lower court, appellate court and even Supreme Court justice colleagues, giving them misinformation, and entreating them to rule against the companies on any issue that comes before them. I believe Justice Douglas Ginsburg was “flipped” by one of these people in the Perry Capital appeal. And as I mentioned in my current post, the fact that Justice Gorsuch would casually (and inaccurately) describe the objective of HERA as “reining in” Fannie and Freddie is very strong evidence that he has heard the false story of the financial crisis created and circulated by the anti-Fannie and Freddie members of the Federalist Society, and that he accepts it as true. A completely false version of Fannie and Freddie appears to be “in the water system” of the Federalist Society, and that’s seriously problematic.

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          2. Professor Epstein and I have very similar analyses of the SCOTUS legal decision in Collins, and I agree with his summary of it: “The government will always win when the Supreme Court imputes to Congress a definition of a conservator never adopted in the history of the world, by broadly reading a narrow exception for incidental powers to let a conservator gobble up all the money for itself—an action that could never be challenged in court as an abuse of power. A unanimous travesty.”

            But then, unfortunately, Epstein stops. He does not even offer a general reaction to the decision (mine in the current post was that it “was imposed upon the case rather than deduced from it”), let alone offer any opinion about WHY the Court might have done that (in my view it was because the Justices have only heard false stories about Fannie and Freddie and their roles in the financial crisis, they believe them to be true, and thus looked for a reason, no matter how tenuous, to rule in a manner consistent with those prior beliefs). It seems that, as a member in good standing of the legal establishment, Epstein is willing to criticize a SCOTUS decision, but not to go any further—and certainly not question or speculate about what forces or factors might have combined to produce this “unanimous travesty.” And that’s a shame, because it makes it easier for something like the Collins SCOTUS decision to happen again.
            .

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          3. I have little doubt that judges have been influenced to rule as they have. What I find impossible to swallow is that they bought into a false narrative. (Or maybe I’m just unaware of the false narrative you have in mind.) The common false narrative has been handily debunked by what has come to light in what was once the Sweeney court. I needn’t rehash those facts here, but surely what is now common knowledge (the truth!) was certainly understood by most if not all the judges who ruled so badly, especially last month.

            I won’t speculate here, but unless you have a false narrative in mind other than the widespread one, I must continue believing as I have, that the “influence” that has come to bear upon those judges was, let me just say, of a more sinister nature than the well promulgated myths of the WSJ and Bloomberg. It had to have been.

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          4. I don’t know what you have in mind as a “sinister” influence, but the fact that nine justices who never rule unanimously on anything controversial did so on the APA claim in Collins to me makes a conspiratorial interpretation of their ruling unlikely. And I disagree with your statement that the true version of Fannie and Freddie’s history over the last two decades is “now common knowledge.” It is for plaintiffs in the net worth sweep cases and investors in the companies’ securities, but for virtually nobody else. I believe what I wrote in my post–that some of the justices have been hearing the “false narrative” about Fannie and Freddie for thirteen years, and the others have never heard the true version (largely because the financial media consistently refuse to print it). Now the justices read Cooper & Kirk’s brief in Collins (and perhaps my amicus as well, although I suspect that didn’t make it past their clerks), and it tells a story completely opposite from what they “know” to be true. At this point a powerful psychological trait called confirmation bias–a strong instinct to find a way to bring information that is contrary to a person’s belief system into conformity with it–kicks in, and is reinforced by having heard from all of the people with whom you interact that the Collins case was brought by greedy hedge funds seeking to profit illegitimately off the government’s heroic rescue of these two companies during the crisis (a story that WAS told extensively by the media), and further supported by the anti-Fannie and Freddie members of the Federalist Society “working the refs” with advice on how to come to a judicial conclusion that you and everyone you respect “knows” to be correct. You then take whatever path you can find (including claiming to see an elephant in a mousehole) that gets you there.

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    1. It is a sign of the times, and an indication of the dysfunction of our Congress and the divisiveness in our society, that of the three conservatorships that began in 2008–those for Fannie, Freddie, and the pop singer Britney Spears–that of Ms. Spears is likely to end first, with bipartisan support from members of Congress.

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    1. Rule of law guy , you obviously have experience and expertise in doing deals and spin offs of companies. However, how many people inside the Beltway will truly understand the technicalities of what you are putting forth? Perhaps it would be better to wait for President Biden to select a director to fhfa, set forth his housing goals, such as New Capital standards and allow time for public comment. I believe that the advisors for fhfa, Fanny and Freddy should be required to give their assessments for a path out of conservatorship as well. Therefore , you would be better able to observe the landscape, making your proposals aligned better with future outlines so that your comments will be more polished and easier to understand.

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      1. @Brian

        good advice. However, I find that I have a hard time moving on from something disappointing without having my say. Collins SCOTUS was disappointing, and the Modest Proposal is my say. saves on psychiatrist bills.

        rolg

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        1. ROLG–

          In response to the first version of your Modest Proposal, I made an exception to my longstanding rule of not commenting on reform proposals made by private individuals, and only doing assessments or critiques of public proposals from entities with some standing with or recognition by key participants in the mortgage finance industry (e.g., the Mortgage Bankers Association, the Urban Institute or the like). I made this exception because of the many informative and constructive comments you have made on this blog over the years. Our exchanges following my attempt to flesh out and analyze that proposal, however, reminded me of why I set my policy of being silent on the merits (or lack thereof) of private reform ideas in the first place. And, like Mark Twain’s cat, having sat on that hot stove once, I do not intend to sit on it again.

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          1. Tim,
            Citing your yahoo interview from early 2017 in which you said the lawsuits had to be settled first, and the latest letter agreement from January with a heavy emphasis on the lawsuits going away, can the Biden admin really move to do anything to Fannie and Freddie until those court cases work their way through the system? I know Calabria said that with what the Trump admin planned on doing “most of the lawsuits would go away” but with Lamberth’s court and Schwartz’s court potentially awarding a settlement with interest I hope (fear) the plaintiffs will fight to the end as the interest rate clock will be ticking the entire time. That puts us what 2-3 years out? The gov will try its damndest to not pay and a single win along the way will embolden plaintiffs through appeals.

            As an investor I’m just trying to wrap my head around the remainder of what can happen during the Biden admin and outside of “gift” from the Biden admin in the form of a Sr Preferred write down or a final court ruling it appears we go no where fast right? A new FHFA head can go through all of what Calabria did on his/her own terms and head right to the finish line but will still need Yellen to acquiesce on the agreement.

            So can we move forward without the courts realistically? I sometimes think this is what has held things up, but it’s the only leverage we have.

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          2. If the Biden administration wants to end Fannie and Freddie’s conservatorships it will need to not only settle the lawsuits but also end the net worth sweep, deem Treasury’s senior preferred to have been repaid, and cancel Treasury’s liquidation preference in the companies. And in the event that the administration does wish to initiate settlement talks with plaintiffs, my personal opinion is that plaintiffs holding Fannie and Freddie junior preferred stock would be very unwise to insist upon being repaid their principal with accrued interest. Those who have been paying attention already know what the government’s position in the breach of contract and regulatory takings suits will be. It will not count on winning on the facts (discovery in the Court of Federal Claims makes that a very steep uphill climb); it instead will focus on damages, claiming that the net worth sweep did minimal additional harm to holders of Fannie and Freddie common and junior preferred stock because those shares already had suffered extreme and irreparable harm before the sweep was imposed, through the burden placed upon the companies during the initial years of the conservatorships of having to pay an after-tax dividend to Treasury of $18.7 billion per year (since increased to $18.9 billion) in perpetuity.

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        2. ROLG,

          Since we do have to hobble on from Collins I have tried to spend more time on the court records from Lamberth’s court. In the course of my time spent I re-looked at some of the Fairholme discovery materials that were released. To the amateur eye they are nearly a confession of guilt in the convoluted responses during deposition and the clear goal of the admin to take every dollar and leave private shareholders with nothing. It says as much verbatim more than once. One would have to assume the 10,000 plus more documents are on par or worse. Now every one of those documents will be fair game in Lamberth’s court, right? If that’s the case how is that not a breach of contract of fair dealing violation? Or not a taking in Schwartz’s court when nothing was given in return for the NWS? I know everyone was biased on the APA claim that went against us but if the released documents give any look into what else there is I don’t know how there isn’t one argument plaintiffs can prevail with.

          I guess one can’t have faith in the court system at this time but can in the level of dirt those documents will likely reveal.

          What’s read at this point on the evidence and Lamberth vs the SCOTUS which was purely a statutory ruling.

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          1. @matty

            this is what success looks like in Lamberth’s court: Lamberth hears all of the discovery and testimony and concludes that the government had lied to him in Perry…death spiral a total chimera…Lamberth concludes that no reasonable investor could have expected that the government would have nationalized the GSEs under such a fraudulent manner…Lamberth concludes that the government breached its duty of fair dealing…but this is only a decision on the merits…you next have to get the right remedy, which in this situation would not just. e compensatory damages (what Ps lost) but rather unjust enrichment, which doesnt just look to what the Ps have lost, but what the government unfairly obtained…then you might get a big damages remedy.

            this is what I think “should” happen…but it is a lot to ask for it to actually happen. I would have thought that a Collins win in SCOTUS was more likely

            trial July 2022…decision maybe before end of 2022.

            rolg

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      2. Your new version still legitimizes the government swindle. Why is the government entitled to convert SPS that has been paid in full, plus more? Why exercise the warrants that was a fraudulent agreement between two government agencies?

        Liked by 2 people

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        1. @guido

          yes, IMO Treasury is able to profit much more handsomely after SCOTUS Collins than if the case was decided the way many of us think it should have been. my proposal reflects my assessment of the real world situation, unfortunate as it is.

          rolg

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    2. ROLG

      Great read, but in a counter-cyclical market it has been proven the only model that will work.

      As has been written before, properly pricing risk is a guarantor’s best business model.

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      1. @MY

        the upside to cross subsidization is that it works as an economic matter; the downside is that it doesn’t work as a political matter…leads to “private profit, public loss” complaints.

        the simplest solution from a corporate finance POV is to focus risks for the relevant investor to bear, and generally speaking, the private investor wants to bear only conventional mortgage risks, and the federal govt as an investor/allocator of treasury funds wants to support/bear only low income housing risks. the private/public partnership model for the GSEs was good in theory, and is bad in practice…at least in the beltway.

        rolg

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        1. ROLG
          Curious on your thought about the politics involved. I always think that the cross-subsidization is the beauty in the GSEs structure, which implicitly has middle-class families finance the risks coming with low-income housing mortgages. By doing so, the GSEs can achieve their affordable housing missions and become TINA. Your proposal is going to transfer that responsibility and the risks explicitly back to federal government. That seems a more dramatic change than winding down. I personally think the proposal is fair and reasonable, but I doubt it is politically viable. Then “private profit, public loss” is more or less just a rhetoric used by politicians or special interest groups. I don’t think there is an honest case to back up that claim. Fundamentally, the majority of risks are on the shoulders of middle-class families. The GSEs might take a share of risks but they are compensated reasonably well for that. Federal government has a huge stake in housing finance for the sake of the housing market and overall economy, but it has not taken on any serious risks yet. The GSEs are pretty well structured for the government and for the cause of affordable housing, then what more do they want?

          Best
          Alan

          Liked by 1 person

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          1. @Alan

            as currently structured, treasury wants (since NWS in 2012) all of the GSEs’ equity in this private/public partnership. this proposal gives treasury all of the equity for the low income housing business it is most concerned with, and lets treasury use its existing GSE 79.9% warrant position to fund it. this should be attractive to treasury once it realizes that it can never “privatize” the GSEs as is after Collins.

            rolg

            Liked by 1 person

    3. A cute idea, but in reality the Feds will never give up a 79.9% interest in the GSEs, even for 100% ownership in a LIH Co. They would be crucified in both the conservative (for allowing the hedge funds to win) and liberal press (for creating a separate but unequal company). I just don’t think it could fly.

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      1. @JW

        sorry if this wasn’t clear, but Treasury would not be giving up a 79.9% interest in the GSEs…they would be selling that interest in connection with primary issuances but the GSEs and investing the proceeds into the LIH Cos. there is no give up.

        rolg

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        1. ROLG—

          You posted your “Modest Proposal to ‘Reform the GSEs’” on an evening in which I was away from the blog, and it received numerous comments (some of which I have removed, in keeping with my objective for the blog that it be a source of information and fact-based analysis, rather than a forum for personal opinions or “airing one’s point of view”). But since you did post this here, I’ll offer a few quick reactions to it.

          My over-arching ones are that your definition of the problem for which a corporate-finance-style restructuring is the solution is overly simplistic, and that the solution itself—half nationalized entity, half private company—is too complicated, and would draw objection from both sides of the traditional Fannie-Freddie divide.

          I’ll start with the notion that it might be possible to drop Fannie and Freddie’s “low income” business into a subsidiary. To do that, one first would have to explicitly define what that business is. Most lenders would say it’s the business Fannie and Freddie do that was subject to the housing goals of the 1992 Federal Housing Finance Enterprises Safety and Soundness Act—loans from borrowers whose incomes are at or below the median of the area in which they live. Traditionally (before the conservatorships), this definition encompassed about half of the loans the companies financed. And with this definition, a second problem crops up: historically, there has not been a particularly tight relationship between goals-related business and credit risk. Yes, in the aggregate the goals-related business was riskier, but there was a very significant percentage that was not, and also a significant percentage of higher-income business that needed higher capital and fees (because of risk) than the average goals-related loan. This not a simple matter of “lower-income, high-risk business goes into this bucket; higher-income, low-risk business goes into that bucket.”

          I said in my post that with the Supreme Court ruling that the net worth sweep was legal, it handed the Biden administration “a mess.” Let me elaborate on that a bit. The opponents, critics and competitors of Fannie and Freddie all thought that when Secretary Paulson succeeded in taking them over by pretending to rescue them during the financial crisis, the result was that they would be “wound down and replaced” with a secondary market mechanism more to the anti-Fannie and Freddie groups’ liking. To that end, what I call the Financial Establishment created a fictitious version of what the companies are, how they operate, and what risks they have. Those fictions are now very widely accepted as true (including, as we have just learned, by all nine justices of the Supreme Court). Yet over the past thirteen years no one has been able to come up with a workable replacement for the companies. So now, the consensus is to keep them, but only if they are “reformed” in a way that solves the fictitious problems the Financial Establishment has invented and promulgated. This is the mess that needs to be cleaned up.

          A good place to start would be with the facts about Fannie and Freddie’s current business. Near the end of your piece—after you’ve proposed splitting Fannie and Freddie’s business into two parts—you recommend for the portion of the book Fannie and Freddie retain that “FHFA’s revised capital standard would be a truly risk-based standard for non-banking mortgage finance guaranty companies without excessive conservatism, and would reflect the de-risking that will have been accomplished by transferring the low-income housing mortgage business out of the GSEs.”

          Yes, FHFA does need to propose a “truly risk-based standard” for Fannie and Freddie, but not for just a part of their business (the allegedly lower-risk part)—for all of it. And FHFA needs to admit that with Dodd-Frank and the other changes that have been made to Fannie and Freddie’s underwriting since the crisis, the credit quality of the loans they are financing today is dramatically higher than it was pre-crisis. That’s a documentable fact. The companies have been “de-risked” (although that’s not a term I like to use, because it’s too amorphous) already. And their net guaranty fees are double what they were pre-crisis, so they are much better able to absorb credit losses from the risk that does exist in their books with revenues rather than capital. For that reason, there is no need to try to “split the baby” into two hard-to-define or manage parts in order to get Fannie and Freddie out of conservatorship; there is a much simpler and less controversial way to do so, if one is willing to embrace the facts about them and act accordingly.

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          2. Tim

            Thanks for your review and reply.

            I believe that there IS a need to “split the baby”, but it is a need based upon beltway historical and perceptual reasons, rather than the financial characteristics of the current mix of Fannie’s and Freddie’s businesses.

            Fannie and Freddie need to get off the beltway radar. They can do no right by both the low income housing lobby (they are not doing enough to support low income borrowers) and the private mortgage market lobby (they are doing too much conventional private mortgage business as a favored participant with an “unfair” advantage over mortgage bankers), all at the same time.

            so my argument is less about the facts that you point out concerning Fannie’s and Freddie’s current books of business than it is about “solving a problem” that has strong and long beltway roots, and which remains a problem even if it is currently based more upon perception and memory than present facts.

            as for the notion that this proposal needs to carefully separate the two lines of business, yes that would need to be done, but Fannie and Freddie generate and analyze so much data that I think one or more rubrics or algos (even with self-learning features built in) could be created and implemented that would do a very useful job. both lines of businesses would continue to be “conducted” by Fannie and Freddie, with the low income business operated by them pursuant to a license and administrative services agreement on behalf of the LIH Cos (though certainly LIH Cos would have their own senior management).

            You would have to squint real hard to notice perceptible differences between Fannie and Freddie before and after this restructuring with respect to on the ground operations. The principal differences between before and after adoption of this proposal would be in the respective mortgage pools and resulting MBS guaranteed by Fannie and Freddie, on the one hand, and the LIH Cos on the other hand. I would imagine that once the low income housing line of businesses are separated out and on their own, the LIH Cos could implement new strategies and test new best practices that can target the low income business directly, but which would not be implemented when, as now, the low income business is subsumed within the whole of Fannie’s and Freddie’s businesses.

            Fannie and Freddie in my view are successful examples of a private/public partnership when looked at dispassionately, and its current profitability certainly supports that view. but passion over Fannie and Freddie prevails in the beltway (as well as the concomitant distortions of fact and partisan bickering between the two low income housing and mortgage banking “camps” represented in DC). there is no magic wand that can be waved for these camps to see the success that Fannie and Freddie are demonstrating currently.

            the most sensible solution is to give each camp its due…a federally focused, low income and extremely well-capitalized vehicle in LIH Cos, and a de-federalized Fannie and Freddie carrying on the remaining mortgage finance business “on a level playing field” with other mortgage finance participants (with state charters and continued prudential FHFA regulation).

            rolg

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          3. Tim

            one more point that I failed to mention. if there is to be an explicit federal backstop guaranty of MBS passed by Congress and signed into law by POTUS, it makes much more sense in my view to focus this federal backstop guaranty on the LIH Cos guaranteed MBS rather than on all of Fannie’s and Freddie’s guaranteed MBS. With this proposal, the magnitude of the federal credit exposure would be much smaller and its financial utility much greater. This should be favored by both the “Brookings” and the “Cato” constituencies.

            rolg

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          4. You and I have very different perspectives on both the problem to be solved and the best way to do it. You state the problem this way: “Fannie and Freddie need to get off the beltway radar. They can do no right by both the low income housing lobby (they are not doing enough to support low income borrowers) and the private mortgage market lobby (they are doing too much conventional private mortgage business as a favored participant with an ‘unfair’ advantage over mortgage bankers), all at the same time.”

            Without legislation repealing or substantially changing Fannie and Freddie’s federal charters, I don’t think it’s possible to “get [them] off the beltway radar.” In anything like their current form—including, I believe, the structure you propose—they will always be political, and politicized. The trick will be finding a capital and regulatory scheme that all stakeholders will at least tolerate.

            Other than direct subsidy programs, Fannie and Freddie are the best resources the affordable housing groups have; nobody else can match their scale and scope of impact. If today these groups feel that the companies aren’t doing enough for them—and I agree they’re not—it’s because the capital standards that have been imposed upon them force them either to set guaranty fees for affordable housing loans that are too high to make economic sense to their borrowers, or to simply ration their volume of affordable housing business, to avoid pushing their total capital required capital even higher. I’ve lost count of the number of times I’ve read something like, “The best way Fannie and Freddie can support affordable housing is by being well capitalized” (without specifying how that amount of capital is determined). That’s nonsense; the right way to help these borrowers is to price their business economically, and fairly.

            And what you refer to as the “private mortgage market lobby” is not mortgage bankers (there are precious few independent mortgage bankers left); it’s bank portfolio lenders, who have been complaining about Fannie and Freddie’s “unfair advantage” over them for more than thirty years. These are the same people, however, who insist that Fannie and Freddie hold an equal amount of capital to back the credit risk of their MBS guarantees as banks hold for mortgages on which they take both credit risk and the interest rate risk of funding long-term fixed-rate mortgages with short-term consumer deposits and purchased funds. This indeed is an “unfair advantage,” but it runs the other way.

            The political reality is that Fannie’s and Freddie’s opponents, critics and competitors want to make their business less economic so that bank portfolio lenders can have a larger share of the $10-trillion mortgage market at higher spreads to their cost of deposits, and make more money. If your position is, “well, that’s the way it is, so let’s just cut a deal that gets Fannie and Freddie out of conservatorship,” I don’t support that. I believe it’s bad public policy, and that we can, should—and hopefully will—do better.

            Liked by 1 person

          5. Tim –

            Thanks for sharing your thoughts on the issue!

            If the purpose of putting the GSEs into conservatorship was to save the GSEs or save the economy, then that mission was accomplished a long time ago. The prolonged conservatorship is unquestionably intended for reforming the GSEs and their private/public partnership. Agree, whoever came up the fictitious ideas of replacing the GSEs had completely misunderstood their functions and importance in the economy, and no wonder their proposals went nowhere.

            First, the mission of affordable housing has enormous economic impacts that not many people can appreciate, which is much more an economic policy than a political ideal. Therefore, any policy changes undermining that mission would be disastrous to the economy.

            Second, the structure of the GSEs is well designed to expand home ownership by fundamentally having middle class borrowers share the cost of financing the risks in low-income mortgages, which lowers lenders’ risk-exposure and therefore increases the availability of credits.

            Last, any additional costs or inefficiency imposed on the GSEs would be transferred to either lenders or middle-class borrowers, and inevitably passed onto the whole economy one way or the other at some point. A extremely-safe-but-less-efficient capital rule would increase the borrowing cost, negatively impact the housing market and hurt the overall economy in a long run, which does the opposite of protecting tax-payers. “Truly-risk-based standard” is critical in this sense and shall not be overridden by some narrow-sighted ideological principle.

            I wish that the next FHFA director would be someone like you, who can understand how the GSEs function internally and appreciate their indispensable contributions to the economy. More importantly, this director shall be focused on the big picture and not be dragged by non-sense political rhetoric like “private profit, public loss”. After all, no one can reform a working system to solve a non-existent problem without making a mess. Once all the tools become available, a little bit art in politics should solve the dilemma, and may everyone sees a happy ending in this drama.

            Alan

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          6. Tim

            I understand your viewpoint. I am trying to understand and conceptualize what change may be most realistic to accomplish given the political situation, as well as most likely to have a good result. I may propose something that may be second-best, but I still think it would be better than the status quo.

            as to the federal charters, the FHFA director can authorize a reincorporation merger of each GSE into a shell Delaware corporation which can be accomplished with the filing of a few pages of paper. and if anyone thinks the FHFA director doesn’t have that power, I wold urge them to reread Collins.

            rolg

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          7. ROLG,
            Actually agree, though this would be the shadiest outcome possible IMO. Welcome to Collins.
            What impact would this have on current shareholders, Common & JPS? i.e. would this leave a direct legal line to Takings & Unfair Dealing?
            VM

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          8. @VM

            if treasury and FHFA were to implement my proposal, the legacy public shareholders would remain at the GSEs with the senior preferred redeemed out in the LIH Co spin, and treasury selling down its common stock warrant position to fund the LIH Cos (which they would own 100%.

            The GSEs would be smaller state chartered entities that would have to start paying state taxes but without a low income housing mandate…low income housing business would be continued on the GSEs behalf by the LIH Cos (which could do as much or as little low income housing business as it wished). as I envision it, the GSEs infrastructure and business processes would remain intact, and in fact this infrastructure would continue to conduct the low-income housing business on behalf of the LIH Cos pursuant to a license and administrative services agreement.

            rolg

            Like

        2. ROLG – I believe your LIH Corp idea is well thought out and OK idea but also a long shot with too much work to create and divide the business. Curious how you feel the LIH Corp would differ from FHA? Wouldn’t both have the same objectives and goals? One uses conventional loan guidelines and the other utilizes FHA loan guidelines?

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          1. @FannieFan

            the LIH Cos would be subject to market discipline since they would be securitizing their mortgages and selling MBS to institutional investors, and guaranteeing the MBS issued. As ESG concerns increase within the institutional investor community, so should the market for these LIH Co guaranteed MBS. They would be sufficiently well capitalized by the proceeds of Treasury’s sale of the GSEs’ warrant shares so that their guarantee would be money good.

            While I am only somewhat familiar with HUD programs, I believe they are more grant/subsidy programs than what the LIH Cos would do, which is to focus exclusively on supporting a secondary investment market for mortgages that would have “expanded” credit criteria.

            rolg

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          2. @FannieFan

            “too much work to create and divide the business”

            not so. as I have set it forth, the documents could be drafted in a week and the whole transaction could be consummated days after the documents are executed.

            rolg

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          3. I had the same question as to how LIH Co. would be different from the FHA, but until someone defines the characteristics of the mortgages that go into LIH Co. that will remain an open question. Still, even at a very high level there are some data and analytical tools we can use to help evaluate the LIH Co spinoff idea.

            Let’s start with an assumption that the LIH Co. spinoff gets the riskiest one-third of the current Fannie Mae’s loans, and the “conventional” new state-chartered Fannie gets the less risky two-thirds (and that both companies do business with similar risk profiles going forward). Data published by FHFA in 2014 (when its average required capital was about 3.0 percent) broke down Fannie’s business by risk percentage. Back then, the guaranty fee on the riskiest one-third of Fannie’s business was 1.56 times the average guaranty fee on its entire book, while the required capital on the risker business was 1.68 times Fannie’s average required capital. The comparable data for less risky business was a guaranty fee 0.72 times the average fee, and capital of 0.67 times the average.

            So, how much capital would a LIH Co. defined this way need? We can calculate it. At the end of March Fannie had average total assets of $4.07 trillion, and total required capital of $190 billion. So, LIH Co would be $1.36 trillion in size, and have required capital of $105 billion. (The “conventional” company would be $2.71 trillion in size, and require $85 billion in capital.)

            ROLG said the LIH Co. would be “very well capitalized” by the proceeds from the sale of the warrants exercised on 79.9 percent of Fannie’s common shares (including the warrants). We know that if Treasury exercised its warrants for 4.6 billion shares of Fannie common and sold them at Friday’s closing price of $1.37, it would have $6.3 billion in proceeds. That’s $98.7 billion less than it needs to adequately capitalize LIH Co. Where will the rest come from? To get all of it from the sale of the warrants, the price of the common would need to be a little over $23 per share. Is that reasonable?

            We can guess at that, too. I peg Fannie’s normalized earnings at about $11 billion after-tax. The conventional company would be two-thirds the size of the current one, with an average guaranty fee of not 43.5 basis points but 31.3 basis points, and its administrative expenses would be not 8 basis points but 12, because it would be bearing (by contract) the cost of running LIH Co. Put all these together—smaller book, lower fees and higher admin expenses—and you’ve got normalized earnings for the conventional company of around $3.3 billion. On 5.76 billion shares outstanding, that’s an EPS of $0.57 per share, before dilution from the new equity it still would need to raise to get from its March 31, 2021 capital level of $30.2 billion to the $85 billion it will need to be considered adequately capitalized (or more, if it grows from here).

            So, no, the new conventional company is not close to being a $23 dollar stock. And that leaves LIH Co. well short of the capital it needs, even before you start asking questions about it, like, “Wouldn’t it have to go on the federal budget (since it’s wholly owned by Treasury)? And if the conventional company exchanged its federal charter for state charters, wouldn’t its MBS become ineligible investments for foreign central banks and other official institutions, forcing up their yields and making them less competitive as a financing mechanism?” And there’s also the FHA question.

            For these (and other) reasons, count me as a skeptic on the feasibility of the LIH Co. spin-off solution.

            Liked by 1 person

          4. Tim

            1. “We know that if Treasury exercised its warrants for 4.6 billion shares of Fannie common and sold them at Friday’s closing price of $1.37, it would have $6.3 billion in proceeds. That’s $98.7 billion less than it needs to adequately capitalize LIH Co.”

            As I described clearly in my proposal, the Treasury senior preferred would have been redeemed in the spin off, in exchange for the right to have the GSEs conduct the low income business on behalf of the LIH Cos pursuant to the license and administrative services agreement going forward, and presumably all of the inventory whole loans meeting the low income classification at the time of the spin.

            So good god, no, 79.9% of the GSEs’ common stock interest with no senior preferred outstanding would not equal $6.3B…more like something well in excess of $100B….this would be the capitalization off the LIH Cos.

            2. “The conventional company would be two-thirds the size of the current one, with an average guaranty fee of not 43.5 basis points but 31.3 basis points, and its administrative expenses would be not 8 basis points but 12, because it would be bearing (by contract) the cost of running LIH Co.”

            No. the GSEs the day after completion of my proposed transaction would be essentially the same size as the day before the transaction…I can imagine only the inventory low income whole loans at the time of the transaction being spun off to LIH Cos in order to kick start their securitizations. LIH Cos would grow their businesses from ground zero from future low income mortgage securitizations that there LIH Cos would guaranty, going forward.

            it is fine to be skeptical, I welcome it, but I am skeptical of skepticism that doesnt take into account the transaction I am proposing.

            3. “Wouldn’t [debt associated with the LIH Cos] have to go on the federal budget (since it’s wholly owned by Treasury)?”

            Treasury may want to own senior preferred in the LIH Cos…with a net worth sweep dividend…with some suitable housing not for profit trust owning the common equity…seems to me treasury has already figured this one out…

            there are many objections that one can pose, and I suspect all of them can be solved in a fashion that will lead to a far better system than what you have now, which you have described as “a mess”.

            rolg

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          5. ROLG:

            Responding briefly to your three points:

            1. Treasury’s redemption of its senior preferred won’t add a nickel to Fannie (or Freddie’s) capital, just as having unwound the senior preferred as a result of a victory on the APA claim before SCOTUS would not have increased the companies’ capital by a nickel. If you look at past versions of Fannie’s earnings press release, at the end you’ll see a table titled “Condensed Consolidated Statement of Changes in Equity (Deficit)”–which for some reason no longer appears there–and here you will note that the senior preferred (an addition to capital) is offset dollar-for-dollar by a negative account called “Accumulated deficit.” Either redemption or cancellation of the senior preferred would be offset by an equal reduction in the accumulated deficit, leaving capital unchanged. Many people get this wrong; you’re not the first.

            2. If Fannie’s “low income” loans are not transferred to LIH Co., in what sense will the company’s risk be reduced? What’s the point of the restructuring? And if it’s only new low-income business that goes to the subsidiary, what would happen is that over time the new, “conventional” company would shrink to be two-thirds the size of the combined companies, as old low-income business runs off and is not replaced. The end result still would be a much smaller and much less profitable company, with LIH Co. having far higher revenues than the “conventional” company Fannie’s shareholders retain. That’s a big negative for current Fannie shareholders.

            3. I believe the answer is “yes,” the assets of LIH Co. would be on budget; that’s a high political hurdle to clear.

            Liked by 1 person

          6. Tim

            1. you suggested that the value of 80% of the GSEs’ common stock after the senior preferred was redeemed was less than $7B. I responded that this was ludicrous. this value is higher by a measure 15X IMO. you responded in terms of regulatory capital, but this is not a capital question. this is a question as to what value, cash on the barrelhead, could treasury put into the LIH Cos to capitalize them…cash on the barrelhead after treasury sold down its 80% GSE equity interest is not less than $7B!. dont patronize me about not understanding regulatory capital.

            2. how could you possibly put into the LIH Cos the historical low income business? these loans have been securitized, guaranteed and sold off as MBS. these will run off for the benefit of the existing GSEs’ business. it can only be the low income business going forward. how could on your view 1/3 of the total GSE business (I dont agree that it would necessarily be as much as 1/3, but that would be a negotiation) end up being “far higher revenues than the “conventional” company Fannie’s shareholders retain” (2/3rds of the total business)? this makes no sense. yes there will be run off, and eventually the GSEs’ earnings will be reduced…but not to $3B NI for Fannie IMO….this is a function of G fees going forward.

            3. if you think the LIH Co assets would be on budget if treasury took a preferred interest only in the LIH Cos, then you will have to explain why the GSEs’ assets aren’t on budget of treasury now…and you cant.

            Tim, there is a legacy bias that you may have understandably that is preventing us from discussing this profitably further. which is certainly not my wish, but you are being remarkably dismissive and noncomprehending…which is fine, it is your blog.

            rolg

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          7. ROLG—I was afraid our discussion of your “Modest Proposal” might end up at a place like this. And I agree that we probably ought to stop the discussion, at least for a while.

            For other readers, though, I’d like to try to do a little clean-up work. (As ROLG says, it IS my blog, and the only reason I do it is to try to add facts and sound analysis to a dialogue that often doesn’t have much of either.)

            ROLG’s Modest Proposal was very vague and conceptual—including not even defining what “low income” business would be done by LIH Co.—so the only way I knew to evaluate the idea was to make some assumptions about what it actually was. One assumption I made was that LIH Co. would do the “high risk” business Fannie now does, and the new “conventional” company would do the rest of it. I think that’s a reasonable assumption, and it helps to highlight an important point: particularly with the Calabria capital rule, Fannie’s high-risk business has much higher guaranty fees, and requires much more capital, than the lower-risk business. That means that over time the Modest Proposal would transfer most of the current Fannie’s revenue to the LIH Co. subsidiary owned by the government, and thus reduce the earnings stream of the company owned by its shareholders. One might say, “Oh, but this could change in the future,” but the change would be only one of degree: with risk-based pricing, higher-risk business always has much higher capital and guaranty fees than lower-risk business. I cited data from a 2014 FHFA study (which showed risk-based fees on the riskiest one-third of Fannie and Freddie’s business to be 2.2 times the fees on the rest of their business in the first quarter of 2014) in support of that point.

            I did interpret the Modest Proposal as transferring one-third of Fannie’s existing business to LIH Co. You of course wouldn’t transfer the MBS (they’re owned by the investors) but you could transfer the contingent liability for those MBS—that is, the requirement to make good on the timely payment of principal and interest on the mortgages underlying the MBS—as well as the income associated with them. ROLG says that’s not what he intended, so that’s fine; we now know that the income and risk-transference aspects of his proposal would occur over time.

            Our biggest disconnect took place on the capitalization of LIH Co. by Treasury. It’s a fact that the current value of Treasury’s warrants for 79.9 percent of Fannie’s common stock is $6.3 billion. So, when ROLG wrote, “So good god no, 79.9% of the GSE’s common stock interest with no senior preferred outstanding would not equal $6.3 billion…more like something well in excess of $100 billion,” I inferred he was making the same mistake many others have made, in asserting that canceling the senior preferred (shown as $120.8 billion on Fannie’s balance sheet) would raise the company’s capital by a like amount (it won’t). He told me in no uncertain terms that this was NOT what he was doing, but still left me to guess why he thinks that his restructuring would increase the current $6.3 billion value of Treasury’s warrants for Fannie common stock “by a measure of 15x IMO.” To do that, I would go back to the same framework I used in my initial response: try to estimate the earnings stream of a company that does not do whatever new business is being transferred to LIH Co., and use those projected earnings—together with a P/E estimate—to put a value on the common stock of the “conventional state-chartered” company shareholders own under the ROLG proposal, then multiply that by the 4.6 billion shares Treasury will own after it converts its warrants. Having the size and income effects of not doing new high-risk business phase in over time (rather than occurring immediately as I’d initially assumed) obviously would raise the near-term earnings of the new conventional company, but because those earnings would be falling towards a sustainable equilibrium (once the large majority of the high-risk business had amortized or prepaid), it also would negatively affect the P/E multiple investors would put on those earnings. (I could try to estimate both the new earnings and the P/E, but pausing the discussion on this topic means, “Don’t do that.”)

            To conclude, I apologize for misinterpreting some of the features of ROLG’s Modest Proposal, but I was just trying to get to something I could analyze. I like to think that if I do have a “legacy bias,” it’s to get as much data and factual information on an issue as I can, analyze them objectively, and come to a merits-based conclusion. If I ever stop doing that, I’ll stop doing this blog.

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    1. David Dworkin (the president and CEO of the National Housing Conference, and a former colleague of mine when he was in government relations at Fannie), who I think quite highly of, is absolutely right about the greatly improved credit quality of the loans Fannie and Freddie are financing today. And there is another important fact David didn’t mention: the companies’ average net guaranty fee (total guaranty fees, less administrative expenses and the fees paid to Treasury pursuant to the 2011 TCCA legislation) has more than doubled from where it was before the financial crisis. The reality is that better quality business combined with much higher guaranty fees make Fannie and Freddie dramatically less vulnerable to credit stresses compared with where they were fourteen years ago.

      It’s astounding to me how both FHFA and Treasury (and, now, the Supreme Court) continue to ignore readily available facts about Fannie and Freddie when discussing and making policy about them. On the day Director Calabria was asked to step down as Director of FHFA, he made this parting remark: “When the housing markets experience a significant downturn, Fannie Mae and Freddie Mac will fail at their current capital levels.” That comment was unsupported, ridiculously inaccurate, and gratuitously inflammatory. As I’ve mentioned elsewhere, prior to the Great Financial Crisis (which was triggered by egregious errors in financial regulatory policy, unlikely to be repeated), the highest Fannie’s annual credit loss rate ever got, even in recessions, was 11 basis points. Today, Fannie’s net guaranty fee is over 43 basis points, which would cover that 11 basis-point loss rate almost four times over. (Fannie’s credit loss rate in 2020, by the way, was zero.) Does Calabria truly not know that, or does he, and is just abusing his position of authority to try to harm the public perception of these companies he so evidently dislikes? Changing the fact-free mindset at FHFA (and elsewhere) will not be easy, which is why I believe the Biden administration must appoint a new permanent director from outside the agency, with significant mortgage finance experience.

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  28. Tim,

    Any thoughts on Sandra Thompson comments and listening sessions?

    https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Virtual-Listening-Session-Closing-the-Gap-to-Sustainable-Homeownership.aspx

    Seems she gave some credit to Calabria for strengthening the GSEs and she intends to build on the past couple of years. To me it seems to fit with the idea that they have built some capital (strengthened), and she will focus on improvements (fair lending for certain, but less clear is what capital plans she has or conservatorship plans by extension). It seems she fits well with Biden’s plans and might be a potential nomination for director.

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    1. My reading of these prepared remarks by Ms. Thompson is not as positive as yours. She starts off well enough, saying what we all know: “Today there is a widespread lack of affordable housing and access to credit, problems that are especially concentrated in communities of color.” But then she goes off track in saying, “As a regulator, I know what expanding access to credit looks like. And I know what irresponsible lending looks like. Irresponsible lending is not an expansion of access to credit. FHFA will continue to protect the financial system and our nation’s borrowers from irresponsible business practices at our regulated entities, and by extension their business partners.”

      Does Thompson really think that the way FHFA can help promote affordable lending is to “protect the financial system and our nation’s borrowers from irresponsible lending practices at our regulated entities” [i.e., Fannie and Freddie]? What about giving them risk-based capital requirements that will allow them to set guaranty fees on lower credit-score business commensurate with these loans’ risk, rather than force them to be priced against an arbitrary and unjustified 4.5 percent “bank-like” amount of capital? And does Thompson also really think that, absent FHFA’s vigilance, Fannie and Freddie would behave irresponsibly? (I know Calabria thought that, because he said so.)

      With due respect to the Acting Director, I believe the Biden administration would be better served by appointing a permanent FHFA director who can bring a fresh perspective to the complex issue of how to regulate and oversee Fannie and Freddie in a way that meets a very high level of safety and soundness objectives, but at the same time allows them to still carry out their chartered missions on an economically sensible basis.

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      1. Thompson’s predictable, but disappointing, cant shows me nothing but a bureaucrat–with 20 plus years at FDIC (yawn) and more recently a few years at FHFA where she was in charge of little which bears her imprint.

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    1. In this 40-minute message to his investors (who are holders of Fannie and Freddie junior preferred), Tim gives a very good overview of the breach of contract case before Judge Lamberth in the DC Circuit and the regulatory takings case now before Judge Schwartz in the Court of Federal Claims, and also expresses his view that the Biden administration is likely to see it as being in its interest to get the companies out of conservatorship. Definitely worth a listen.

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  30. Thank you for the excellent analysis Tim. Obviously, this is a disappointing ruling for a country that is supposed to value the rule of law. Looking forward, do you have a sense for what a settlement may look like, and of course how current junior preferred shareholders would fare?

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    1. The SCOTUS ruling changes the dynamics of a potential settlement of the outstanding lawsuits. Now, plaintiffs pursuing the breach of contract claims in the DC Circuit and the regulatory takings claim in the Court of Federal Claims have the most prominent “seats at the table.” They are requesting that damages be paid directly to them, so a settlement of all lawsuits by the government will need to satisfy that request. (There are many ways to do this, and I won’t speculate on which is most likely.) But then to release Fannie and Freddie from conservatorship and restore them to their former status of shareholder-owned companies, the government also will need to deem that their senior preferred stock has been fully repaid and cancel it, and also eliminate Treasury’s liquidation preference. Given the SCOTUS ruling on the APA issue in Collins that the net worth sweep was legal, its cancellation (and the elimination of the liquidation preference) now will need to be voluntary, and come at the impetus of the administration. Its reasons for doing this would be a determination that it cannot justify keeping Fannie and Freddie in conservatorship indefinitely, and a policy conclusion that there is no good alternative to the companies as the cornerstones of the U.S. secondary mortgage market.

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      1. Tim

        I agree that “[the senior preferred] cancellation (and the elimination of the liquidation preference) now will need to be voluntary”, but let me put out there something that is worth considering. IF the Ps win on the merits of the breach of implied duty of good faith case in front of J. Lamberth, the govt will seek to value the damages owed as equal to the value of the public stock at the time of the NWS, and argue that this is a very low number. However, Ps will argue for a high value, and the best theory to obtain this would be through the remedy of “unjust enrichment”, a damages theory that looks not just at what Ps lost, but what the govt (defendant) was able to gain, and this is an open ended inquiry that would take into account the govt’s windfall profit. unjust enrichment is in the nature of an equitable remedy and may be available if J. Lamberth is convinced by the P’s discovery that the govt was a bad actor in adopting the NWS. so while voluntary, there may be some prospect of avoiding what might be a wildcard remedy award from a wildcard federal district court judge.

        rolg

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      2. Tim,
        You use terms like “seats at the table”, “They are requesting that damages be paid directly to them”.

        Is there a chance that not all JPS holders will be treated equally should a settlement occur, and that the U.S. Gov’t. may only need to ‘pay off’ the specific litigants bringing the suits leaving the rest of the securities holders holding an empty bag?
        VM

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      3. It seems that Biden’s team has a strong incentive to repair the damage that Calabria et al. has done to these institutions and return them to the public equity markets, rather than leave their fate to a future administration. So it will eventually be in their interest to deal with the JPS. So even though it may not be obvious right now, this is why you say SCOTUS’ ruling will eventually just look like a bump in the road?

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        1. The SCOTUS ruling is more than “a bump in the road;” it was a major setback and a serious complication to the goal of getting the companies out of conservatorship and back doing business on an economic basis. But, for reasons I outlined (briefly) in my post, I think the Biden administration will end up overcoming the obstacle of the SCOTUS ruling, although it make take them some time.

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          1. Tim,

            What are you seeing or hearing from people in DC what gives you confidence that the Biden admin would recap and release the GSEs?

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          2. The only evidence I have about the potential orientation of “people in DC” towards Fannie and Freddie is indirect–the fact that after the SCOTUS ruling President Biden dismissed FHFA Director Calabria almost immediately, making clear that some senior policy people in the administration were not happy with his stewardship of the companies. While one could speculate that what they found objectionable about Calabria was his intent to “recap and release” them, I doubt that; the path he had put the companies on–requiring them to reach 75 percent of a ridiculously high capital number, which they would have to do through retain earnings alone, before they could be released under a consent decree–would take them longer to complete than the end of a second Biden term (should it get one). No, I think it’s much more likely that they were unhappy with how he so obviously had handicapped Fannie and Freddie with unjustifiably high capital requirements and intrusive micro-regulation, and they would like the companies to have a director who will not be hostile to their missions. As I noted in my post, I believe the administration knows it’s now up to it to figure out how to end Fannie and Freddie’s conservatorships, and the easiest way to put them in a position where they can get back to supporting low- moderate- and middle-income homeownership is to give them reasonable capital requirements, settle the lawsuits, cancel the net worth sweep and Treasury’s liquidation preference, and allow them to tap the public equity markets to recapitalize quickly.

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      4. I keep hearing that the current administration has no intention of removing the GSEs from conservatorship. At what point do they realize that to have a lasting impact on affordable housing and other policy objectives, that they will need to release these entities from conservatorship? It seems like it would be a major policy blunder to leave their fate up to a future administration.

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  31. Tim,

    Good afternoon. An article authored by a Georgetown Law Professor appeared this morning. It quickly summarizes 3 possible outcomes as a result of the Collins opinion. I was curious if you agree with the possible outcomes and what you thought #3 might entail. #3 mentioned in the article seems it could align with the Brookings (utility model) paper authored by Susan Wachter.

    https://www.creditslips.org/creditslips/2021/06/collins-v-yellen-the-most-important-and-overlooked-implication.html

    Thanks.

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    1. @Brian

      I like Levitan but this is a vapid comment. yes, the treasury nationalized the GSEs with SCOTUS approval, so treasury can now implement any and all reforms with no one else’s approval. no kidding!

      the GSEs have always been a “problem” waiting for an executive department solution, and yes now more than ever. the last comment treasury secretary Yellin made that I could find re the GSEs is a reference of the need for congressional reform…which means she doesnt want to touch the GSEs and knows that congress wont either, so it is the status quo is good as far as she is concerned.

      it will take a great American as the new FHFA director to stop the can kicking…may we be so lucky.

      rolg

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      1. @rolg
        Respectfully, I see a different path. With many pressing issues facing the US, growing inflation threat, ballooning national debts, growing competition from China, it is a trying time for this administration. With the backing of the Collins ruling, nothing really stops treasury from monetizing its sizable equity interests in the GSEs, which should help their initiatives financially. I am willing to bet that Secretary Yellen will take actions. I only hope it will be done in a proper way this time.
        Cheers.

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    2. I think we’re going to see a lot of articles like this in the next few weeks and months, authored by people who have some interest in the issue, a forum, but not a thorough grounding in the subject matters they’re writing about (secondary mortgage market finance, or Fannie and Freddie).

      In the case of this article, the author uses the words “reform,” “privatization” and “restructuring” loosely, without defining them or detailing what he means. I would argue, for example, that compared with the pre-conservatorship Fannie and Freddie, the companies are indeed “reformed”: they no longer are in the portfolio investment business (thanks to Treasury), have significantly tighter underwriting (thanks to Dodd-Frank and internal reforms) and also no longer engage in business practices some found objectionable (the most prominent being lower guaranty fees for volume originators). On “privatization,” the most common meaning of that term is the removal of Fannie and Freddie’s federal charters, which no one is advocating today. And I don’t know what Mr. Levitin is thinking about when he mentions “restructuring;” he gives some “for examples,” but doesn’t offer any concrete notion of what a restructured Fannie or Freddie would look like.

      As I interpret Levitin’s third “possible future” for the companies, it seems to be, “Since the Supreme Court said that FHFA could do whatever it wants with the conservatorship, then it also should be able to do whatever it wants to get them out of conservatorship, and I think it will.” I don’t agree with that premise, in the first instance, and if I did Levitin doesn’t offer anything concrete as to what FHFA might do if it felt it had that tabula rasa.

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      1. Tim or ROLG,
        Will the plaintiffs in either the COFC or the Lamberth case have an opportunity to conduct depositions of i) the auditing firm that was in place when the accounting entries were made contemporaneously with the decision to place the GSEs in conservatorship, ii) individuals that were involved and named in the various emails we all have seen regarding the GSE “golden years” and future profitability estimates, iii) any treasury officials or iv) board of director members? Thanks ahead for your insights.

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        1. @jb

          it is my understanding that Ps have already taken all of the depositions and paper discovery necessary. some of this discovery made ts way into the Collins amended complaint, but it has not been put into full view yet. but all of this discovery would be germane in the breach of implied duty of fair dealing suit before Judge Lamberth, which is scheduled to go to trial summer 2022.

          rolg

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  32. Thanks for your explanation, Tim. I just could not bring myself to read the Supreme Court opinion beyond the first few sentences. A certain tweet by an anti GSE reporter before the ruling makes me believe that he knew the outcome of the decision well before Wednesday. Tim, you’re a very talented and elegant writer and many of your contributors to this column have a deep understanding of the law and prose as well. If not now, could you or one of your readers investigate and write a book about the underlying coercion of the Courts that have led to these type of biased influenced decisions? It could be that someone on the inside of the Federalist Society, or some other insider would be willing to come forth anonymously to tell what was really going on behind the scenes of the Supreme Court. Someone in the know somewhere may not feel right about selective Justice.

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    1. @Brian

      I take your comment with all seriousness, but this investigation would likely require access to communications of SCOTUS justices and members of Congress…who are not subject to FOIA.

      rolg

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  33. Tim, thanks for all this year’s shedding light on such a complex issue. TINA remains TINA, so the last thoughts in your article will become true.

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    1. [For readers who may not know, “TINA” is an acronym that stands for “There Is No Alternative,” and it’s used to express the idea that despite their critics and opponents, Fannie and Freddie have the best business model for doing secondary mortgage market credit guarantees, and thus are likely to survive over the long term. That’s certainly held true so far, despite concerted attempts to devise replacement mechanisms for them.]

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  34. Tim,

    President Biden recently nominated Nellie Liang as Undersecretary of Domestic Finance at the Treasury Department. She is, or at least was until recently, the Miriam K. Carliner Senior Fellow in Economic Studies at the Brookings Institute; her bio on their site says she is currently on a leave of absence (which might last while she serves at Treasury). Janet Yellen herself was a Distinguished Fellow in Residence (Economic Studies) at the Brookings Institute until recently.

    One of Biden’s rumored potential picks for FHFA director is Michael Calhoun, currently the president of the Center for Responsible Lending at, you guessed it, the Brookings Institute. Calhoun co-authored a Brookings Institute paper, along with Lewis Ranieri, in February advocating for a utility model for the GSEs, including the need to take private shareholder returns into account.

    Two questions: what do you think about Calhoun, and if Biden does pick him would it be a vote of confidence in Calhoun and Ranieri’s plan?

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    1. Midas–You’re mistaken about The Center for Responsible Lending. It is not affiliated with the Brookings Institute; it was started by Martin Eakes of Self-Help in Durham NC about 20 years ago, and is now, I believe, a stand-alone nonprofit (and doing very good work).

      I don’t know Mike Calhoun, but I would be inclined to view him favorably because of his connection with and experience at CRL. I know I read the Calhoun-Ranieri paper when it came out, but I honestly can’t remember what it said. If Calhoun is appointed FHFA director I’ll obviously read it again, because then it certainly would be of more relevance.

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        1. No, because under current law that’s not possible.

          There are many different versions of the “utility model,” but almost all have in common caps on the returns on equity (ROEs) a company can earn. FHFA today could set a cap on Fannie and Freddie’s returns in its capacity as conservator, but drawing on last week’s Supreme Court ruling it apparently can do anything at all as conservator. Once the companies are out of conservatorship, however, FHFA can NOT put limits on their returns; doing so would require legislation.

          I have long favored limited ROEs for Fannie and Freddie as part of an amendment to the PSPAs agreed to by the companies, FHFA and Treasury that, among other things, would include reasonable capital requirements and non-intrusive regulation, and have an objective of quickly returning them to shareholder-owned status in a manner that would allow them to safely, and profitably, carry out their chartered missions. I still do.

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          1. Tim,

            Thank you for the correction regarding the CRL.

            As for whether FHFA could limit FnF’s returns, one of FHFA’s principal duties is to “(B) ensure that (v) the activities of each regulated entity and the manner in which such regulated entity is operated are consistent with the public interest.”, and one of its two main authorities is “(B) to exercise such incidental powers as may be necessary or appropriate to fulfill the duties and responsibilities of the Director in the supervision and regulation of each regulated entity.”
            https://www.law.cornell.edu/uscode/text/12/4513

            Given how expansively and permissively all the courts, including SCOTUS, have read HERA regarding FHFA’s powers as conservator, wouldn’t FHFA easily be able to justify return caps (and a bunch of other stuff) based on the above language? If the Supreme Court itself can say that the NWS could plausibly be in the public interest, a cap on returns is a much easier pill to swallow. It would take quite the brave soul to challenge those return caps in court in light of the Collins ruling.

            Another way to cap returns without technically capping returns is to maintain the language from January’s letter agreement that sweeps all net worth excess over full capitalization to Treasury. This would still allow FnF to pay dividends on its junior preferred and common stock because that money never hits net worth, and it would remove any incentive FnF have to increase shareholder returns beyond those dividends (defeating one of the main criticisms of FnF’s pre-conservatorship business practices).

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          2. While it’s tempting to say that the SCOTUS ruling on the net worth sweep means that we can throw all the rules and norms that we thought applied to FHFA as either a conservator or a regulator out the window, I think that’s an over-reaction. I don’t look for FHFA to try to test the outer limits of HERA on its own (remember that the net worth sweep was a Treasury initiative, and Treasury actually was concerned that FHFA might not go along with it).

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  35. Tim,
    This is very well written and spot-on. Thank you for your time and expertise.
    IMO there is something nefarious going on at SCOTUS.
    Political decisions reached without exploring the facts weakens everyone — the courts, the legal system, the investors, but most of all democracy and the nation itself.
    SCOTUS cannot be so superficial that they follow a Federalist ‘mantra’. They are there to seek the Truth and Justice. Sadly, this is not always the outcome, but when BLATANT, it fundamentally weakens us all.
    VM

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  36. Thank you, Tim! Your post reinforces my concern about the court’s impartiality, which should be the cornerstone of its credibility in delivering sound and just rulings. IMHO, the ruling, filled with erroneous facts, faulty reasonings and biased opinions, does not serve the public well and does the opposite of protecting the institution. It is a sad ruling.

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      1. This glaringly different interpretation of virtually identical incidental powers language in HERA versus the FDIC Act (the only difference being that in the latter the FDIC is called “the Corporation,” whereas FHFA is referred to as “the Agency”) is one reason why I did not expect a majority of the Supreme Court justices, let alone all of them, to rule that the incidental powers language in HERA was a “distinctive feature of an FHFA conservatorship [that] is fatal to the shareholders’ statutory claim.” But then I also didn’t anticipate that all of the justices would ignore something every first year law student knows–that in a motion to dismiss (which is what SCOTUS was ruling on) the facts as alleged by the complainant must be taken as true; the justices flatly refused to do that.

        As for banks being worried about the incidental powers provision in the FDIC Act being used against them the same way FHFA’s incidental powers were allowed (by SCOTUS) to be used against Fannie and Freddie, I think they can rest easy. The decision in Collins was a rifle shot, not a shotgun blast. And while it did set a precedent that the FDIC could conceivably use to the disadvantage of a bank (and its stakeholders) in a conservatorship, I believe the chances of that ever happening are miniscule.

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        1. How blatantly the court ruled against the plaintiffs is indeed unexpected. The explanation for the unanimous decision could be just that, even if it is dead wrong legally, justices knew they had to make the decision anyway. Therefore justices just bit the bullet all together. Otherwise, it would make no sense.

          For example, in terms of the precedence set in this case, I am concerned that the court has turned the concept of “Incidental Power” completely upside down by allowing a vague description in “Incidental Powers” to override all expressly stated goals. Can other judges use the same legal reasoning going forward? I assume, just for that, no single justice would agree, and therefore they had to all agree. I feel sad for what I can comprehend from the unexpected ruling.

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    1. I did not have an expectation about how quickly Calabria would be dismissed if and when the Supreme Court ruled that he’d been unconstitutionally appointed, but I took it as a very good sign that it happened immediately. It strongly suggests that someone in a position of influence understands the damage he has been doing to Fannie and Freddie, and wanted that stopped as soon as possible.

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  39. Tim,
    Thanks so much for your insights! Would you every consider writing something for one of the major publications? It would be nice to have your points viewed by the ‘general public’ instead of just those of us who follow your blog.

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  40. Pretty remarkable that a single line in a tiny subsection can render all 261 pages of HERA irrelevant. Why did Congress even bother listing out all the duties of a conservator if none of them apply/matter? The logic rendered in this ruling is shameful.

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  41. Tim

    Giving up on the difference between owning 80% of the GSEs’ common equity through warrants and owning the entire capital structure through the senior preferred is the price the Biden administration will have to pay in order to be able to go into the capital markets and allow the GSEs to exit conservatorship.

    Are you confident that the Biden administration i) understands this, and ii) would be willing to take this relatively modest haircut on its Treasury position? I suppose it will have three years to come around on this, and I won’t be holding my breath…but wouldn’t it be one of life’s great ironies to have the Biden administration bite the recap bullet when the Trump administration whiffed so badly?

    rolg

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    1. I doubt that the senior policy people in the Biden administration have focused much, if at all, on the Fannie and Freddie situation, nor do I think they have a clear understanding of what that situation actually is. It is an unfortunate reality that for policymakers in both parties, “most of what they know [about Fannie and Freddie] ain’t so,” because of all of the misinformation pumped out about the companies over the years by their critics, opponents and competitors. Those of us committed to getting to the right answer on Fannie and Freddie have our work cut out for us trying to change that.

      As to your specific point about the government’s stake in the companies, the suspension of the net worth sweep until they attain Calabria’s full capital requirement means that Treasury won’t get a penny of cash from it until after 2030; if the Biden administration were to endorse their recapitalization and release, it could convert all (or some) of the warrants and generate revenue long before that.

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      1. “… the suspension of the net worth sweep until they attain Calabria’s full capital requirement means that Treasury won’t get a penny of cash from it until after 2030”

        In your view, what is stopping the government from theoretically ripping up the letter agreement between Mnuchin and Calabria and re-instating the NWS?

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        1. Nothing stops that from happening. But it won’t happen without it being part of an overall policy call on the companies, and I don’t know what “end game” the Biden administration might have for them that would involve turning the net worth sweep back on.

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          1. What are the odds the Biden admin pursues a utility like model with an organic recap? If they lower the capital requirements to $150b, with ~$45b already on the books would take ~5-6 years to get there. Also keep in mind that the government warrants expire in 2028…

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