Capital Fact and Fiction

Late last year, the Federal Housing Finance Agency (FHFA) formally adopted a regulation proposed by former Director Mark Calabria that raised Fannie Mae and Freddie Mac’s required capital by more than 80 percent compared with what would have been in effect under the FHFA standard proposed in June of 2018. Soon afterwards, this new capital rule was incorporated into a January 14, 2021 letter agreement between Calabria and former Treasury Secretary Steven Mnuchin, stipulating that before the companies could be eligible for release from conservatorship under a consent decree they would need to hold core (or tier 1) capital of at least 3 percent of their adjusted total assets—at June 30, 2021, about $230 billion—for two or more consecutive quarters. And then this June, the controversial ruling by the Supreme Court that the net worth sweep was a legal action by FHFA allowed Treasury’s $195 billion in senior preferred stock in the companies to remain outstanding. Because Treasury’s senior preferred is not considered core capital under the Housing and Economic Recovery Act (HERA), this put Fannie and Freddie’s combined core capital at June 30, 2021 at a negative $134 billion—more than $360 billion below the threshold for their conditional release from conservatorship under the Calabria-Mnuchin agreement.

Together, these developments left Fannie and Freddie in an impossible position. Their capital problem is obvious. With the net worth sweep blocking their access to the equity markets, it would take them nearly two decades to retain the earnings they need to fill a $360 billion capital gap, and longer if their business grows during that time. Less obvious, but no less serious, is their business problem. For the very long time they would remain in conservatorship, they would have no alternative but to price their credit guarantees to capital requirements that are grossly disproportionate to their credit risk, greatly raising the cost of and restricting the access to homeownership for the low- moderate- and middle-income homebuyers they are chartered to serve.

Fannie and Freddie’s situation is the result of a lengthy sequence of events that began with the decision in the last year of the Bush administration to force them into conservatorship, against their will and while each exceeded its statutory capital requirement, for policy reasons but under the pretense of a rescue. Throughout the Obama administration and for much of the Trump administration, FHFA and Treasury managed Fannie and Freddie in conservatorship in a manner intended to encourage Congress to replace them legislatively with a “free market” alternative—crippling the companies financially by forcing them to take $187 billion in non-repayable Treasury senior preferred stock at a 10 percent after-tax annual dividend that they did not request and did not need, falsely blaming them for the financial crisis, and burdening them with “bank-like” capital requirements unrelated to the risks of the one business they are permitted to engage in. There now is a consensus that replacing Fannie and Freddie with a free-market alternative that exists in theory but not in practice is neither achievable nor desirable. Yet the companies remain entangled in the consequences of past actions and fictions aimed at accomplishing that objective.  

It has fallen to the senior economic officials of the Biden administration to sort this out. Fannie and Freddie are the cornerstones of the $13.6 trillion U.S. residential mortgage market. They have been successfully “conserved,” but because of decisions made in prior administrations—whose objectives the current administration does not share—they are locked indefinitely in conservatorship, and unable to help the president meet his housing policy objectives. There is, however, a simple way for the Biden administration to end the companies’ state of limbo: acknowledge the facts about Fannie and Freddie, admit that their de facto nationalization in 2008 was unjustified and a mistake, and then undo it.  

The “undoing” can be achieved through two complementary actions. First, declare that Fannie and Freddie have paid back all of the $187 billion they were forced to draw during the crisis, including 10 percent interest (which they have done), and deem Treasury’s senior preferred stock to have been repaid and cancel it, along with Treasury’s liquidation preference. This would change Fannie and Freddie’s core capital at June 30, 2021 from a negative $134 billion to a positive $60 billion. Then, appoint a new Director of FHFA, and task him or her with replacing the Calabria capital rule with one based on the companies’ actual business and credit risks. As depicted and discussed in the sections below—which draw on publicly available past and current data from Fannie—there is a huge difference between the capital required by a risk-based standard for Fannie and Freddie based on fact, and one based on fictions invented by those who oppose the companies on ideological or competitive grounds. And, as we also will see, developing and implementing a fact-based capital rule for the companies is astonishingly easy. 

Capital fact

Thirteen years after the Great Financial Crisis began, we know how much initial capital Fannie would have required to cover the credit losses of the $2.531 trillion book of single-family business at December 31, 2007 that went through it. There are two ways this “stress capital” amount can be expressed: for the liquidating book, and on a going concern basis. The former tracks credit losses on the 2007 book over its entire life, and uses as offsets to credit losses only guaranty fee income, net of administrative expenses, from loans in this book that do not prepay. In contrast, the going-concern method incorporates income (and losses) from new business, and runs only until annual total net guaranty fees, from both existing and new business, exceed annual total credit losses, and profitability is restored.

Fannie’s published data make it possible to track the losses on its December 2007 book of single-family business with precision through 2016, and to make very close estimates in the years beyond that. Through December 31, 2012—just before Fannie’s total annual guaranty fees exceeded its annual credit losses as a going concern in 2013—the losses on its 2007 single-family book were $70.0 billion, or 2.77 percent of the December 31, 2007 book. Those losses rose to $91.2 billion at December 31, 2020, for an ever-to-date credit loss rate of 3.60 percent. (Losses from the 2007 book since then have been de minimis.)

We also can use published data to make a conservative approximation of the amount of these losses that were absorbed by guaranty fees. The average guaranty fee rate on Fannie’s December 2007 single-family book was 24.2 basis points, which after 8.0 basis points in administrative expenses left a net guaranty fee of 16.2 basis points. The 2007 book prepaid at a 19.9 percent annual rate through the end of 2012, and at an overall annual rate of 20.9 percent through the end of 2020. From past experience, we know that lower-risk, lower-fee business prepays faster than higher-risk, higher-fee business, so assuming that the average guaranty fee on Fannie’s 2007 book stayed level over time produces a conservative (that is, low) estimate of cumulative guaranty fee income of $14.7 billion through 2012, and $19.3 billion through 2020. For Fannie’s liquidating book, $19.3 billion in net guaranty fees would have absorbed 76 basis points of its 360 basis points of ever-to-to date credit losses, leaving 284 basis points to be covered by initial capital.

On a going-concern basis, the initial capital requirement for Fannie’s 2007 book is almost 100 basis points lower, because it only has to cover stress credit losses until 2013, when its net guaranty fees of $7.2 billion exceed its total single-family credit losses of $4.5 billion (and then continue to), and because some losses can be absorbed by revenues from new business. As a going concern, the relevant numbers for Fannie’s 2007 book of single-family business during the stress years of 2008-2012 are: credit losses from the original 2007 book of $70.0 billion; credit losses from business done after 2007 (principally from the 2008 book) of $5.6 billion; net guaranty fees from the 2007 book of $14.7 billion, and net guaranty fees from post-2007 new business of $13.0 billion. Together, these result in total credit losses of $75.6 billion, total net guaranty fees of $27.7 billion, and losses that need to be covered by initial capital of $47.9 billion—equal to 189 basis points of the $2.531 trillion in single-family mortgages Fannie owned or guaranteed at December 31, 2007.  

But the story does not end there. Since 2007, the credit quality of the company’s single-family business has improved markedly, and its net guaranty fee has more than doubled. The credit quality increase came about because of the sweeping changes in residential mortgage underwriting standards since the crisis, many mandated by the 2010 Dodd-Frank legislation. Data put out by Fannie indicate that between 50 and 55 percent of the credit losses on its 2007 book were from Alt-A or interest-only loans, now prohibited by Dodd-Frank. Taking just these two loan types (about $425 billion) and their associated losses (about $48 billion) out of Fannie’s 2007 single-family book lowers its lifetime credit loss rate from 360 to 205 basis points. And incorporating all underwriting improvements since 2007 lowers the loss rate still further. In its 2018 capital proposal, FHFA stated that “using current acquisition criteria” the credit loss rate on Fannie’s 2007 book of business through September 2017 would have been just 1.5 percent. Meanwhile, on the revenue side, the 16.2 basis-point average net single-family guaranty fee on Fannie’s December 2007 book has risen by 21 basis points, to 37.2 basis points at June 30, 2021.

Cutting the stress credit loss rate by over half and more than doubling the net guaranty fee have a dramatic effect on the amount of capital Fannie’s single-family book would require to survive a repeat of the Great Financial Crisis home price collapse. FHFA’s loss rate of 150 basis points through September 2017 for Fannie’s 2007 liquidating book “using current underwriting criteria” projects to 160 basis points of losses through December 2020. A net guaranty fee rate of 37.2 basis points, with prepayment rates equal to those of the 2007 book, would have produced 165 basis points of guaranty fee income during that time—5 basis points more than the credit losses. And the more conservative estimate of 205 basis points of losses from the current book’s underwriting (adjusting only for its lack of Alt-A and interest-only mortgages) still would have required Fannie’s 2007 liquidating book to have had only 40 basis points of initial capital to survive the Great Financial Crisis.        

On a going-concern basis, today’s underwriting and net guaranty fee produce equally striking stress results, even using the 205 basis-point loss estimate for the current book, and assuming that both the size of the book and average guaranty fee remain level, rather than increase by 12 and 17 percent, respectively, as they did between 2007 and 2012. A net guaranty fee of 37.2 basis points on a level $2.531 trillion book of business produces $9.42 billion of revenue per year. Using the same pattern of credit losses as Fannie actually experienced between 2007 and 2020, a 205 basis-point cumulative loss rate through 2020 results in total single-family credit losses (from old and new business) that start at $3.69 billion in 2008, rise to $13.66 billion in 2010, and fall to $8.73 billion in 2012. At a constant $9.42 billion per year, cumulative guaranty fee revenues exceed cumulative credit losses by $6.69 billion during 2008 and 2009. Revenues fall short of credit losses by $6.33 billion in 2010 and 2011, but then are greater than credit losses again in 2012 and beyond. At no time during the stress period do cumulative losses ever exceed cumulative revenues.  

The reality, therefore, is that based on Fannie’s historical experience, and incorporating its current single-family net guaranty fee and a conservative estimate of the credit quality of its current single-family book of business, the company as a going concern could survive a repeat of the 25 percent drop in nationwide home prices that characterized the Great Financial Crisis—on which the HERA risk-based capital standard is supposed to be based—without the need for any initial capital. Further, FHFA effectively confirmed this last month, when, with virtually no publicity, it released the results of the 2020 and 2021 Dodd-Frank “severely adverse” stress tests, run on Fannie’s business for the end of 2019 and 2020. The company needed no initial capital to survive those either.

Capital fiction

How, then, did former FHFA director Calabria arrive at the requirement that in order to meet his standard of safety and soundness at June 30, 2020, Fannie must have capital equal to 4.55 percent of its $3.761 trillion in total assets, or $171 billion? The short answer is that he concocted it. He ignored the directive in HERA to base Fannie and Freddie’s capital on risk, and instead began with a pre-determination to require them to hold at least the 4.0 percent minimum capital as banks hold for their on-balance sheet residential mortgages, on which they take interest rate as well as credit risk. He then used four contrivances—not counting guaranty fees in the risk-based capital stress test; subjecting low-risk loans to a minimum risk weight; misapplying the going-concern buffer, and adding a capital penalty for doing more than a small amount of credit guaranty business—to artificially engineer a result for the required amount of Fannie’s “risk-based” capital that was greater than his arbitrary minimum of 4.0 percent. Reviewing each of these briefly:

Guaranty fee income in stress tests. Fannie and Freddie are not banks; their one permitted line of business is guaranteeing the credit of residential mortgages. For a credit guarantor, the role of capital is to absorb losses that exceed the dollar amount of revenues from loans that continue to pay throughout a period of stress. This capital amount is determined by running a stress test—in Fannie’s case, one based on a 25 percent nationwide decline in home prices. Not counting any revenues during that stress test produces a meaningless answer. The Federal Reserve counts income in the Dodd-Frank stress tests it runs for large systemically important banks, and FHFA counts income in the Dodd-Frank stress tests it runs for Fannie and Freddie. FHFA’s 2018 capital rule, issued under Director Watt, did not count revenues either, and almost all commenters on that rule said that it should. FHFA calls not counting guaranty fee income in the stress test “conservative,” but it is far more than that. Conservatism in running a stress test would be increasing the prepayment rate on surviving mortgages from the 20.9 percent annual rate experienced by Fannie’s 2007 book of business to some higher annual percentage; setting it at 100 percent (which is what not counting guaranty fees at all does) is indefensible, and invalidates the result.

Net credit risk capital. In its June 2018 capital proposal, FHFA said that using the product and risk characteristics of Fannie’s September 30, 2017 book of business, the ever-to-date credit losses from Fannie’s 2007 book would have been 1.5 percent. This translates to a lifetime loss rate in the 1.65 percent range. The grids, risk multipliers and counterparty “haircuts” used in the 2018 FHFA capital rule pushed this net credit risk capital up to 2.1 percent of total assets. Calabria wanted an even higher number, however, so he put a 20 percent risk weight, or a 1.6 percent capital floor, on all mortgages, which made the net credit risk capital requirement on Fannie’s June 30, 2020 book—whose credit quality was at least as good as the September 30, 2017 book—289 basis points of total assets, or about 125 basis points more than the actual expected lifetime stress losses of that book.

Going concern capital. FHFA’s June 2018 capital rule included a “going concern buffer” of 75 basis points of capital, to “to ensure that each Enterprise would continue to be regarded as a viable going concern by creditors and other counterparties after a severe economic downturn.” Calabria’s 2020 capital rule renamed this the “stress capital buffer,” but kept it at 75 basis points. Both versions of the rule, however, conveniently ignore the facts that Fannie’s risk-based capital requirement is based on a liquidating book of business, and that shifting to a going-concern perspective results in the company having a large amount of loss-absorbing revenue from new business, and also a shorter stress period. During and after the Great Financial Crisis, Fannie needed almost 100 basis points less initial capital to survive as a going concern than it did to cover the losses on its liquidating 2007 book. Put differently, because Fannie’s risk-based capital requirement is (very conservatively) based on a liquidating book of business, it already has a going-concern buffer built into it.

Stability buffer. What Calabria calls the “stability buffer” of 110 basis points of total assets added to Fannie’s June 30, 2020 risk-based capital requirement is unrelated to risk, totally arbitrary, and based on a mischaracterization of Fannie and Freddie’s market share. They are the only two companies whose sole business is guaranteeing the credit of conventional (non-government-guaranteed) residential mortgages. Expressing their size as a percentage of the business done by entities which can originate, service or hold mortgages in portfolio, and then requiring Fannie and Freddie to hold more capital the further the volumes of their credit guarantees rise above a tiny 5 percent share of activities they are not permitted to engage in, is preposterous, and a blatant and clumsy means of penalizing their conventional credit guaranty function in favor of portfolio investing, which demonstrably is far riskier. The stability buffer has no place in the companies’ risk-based capital standard.

*                                           *                                                  *

On the day Mark Calabria stepped down as Director of FHFA (at the request of President Biden), he said, “When the housing markets experience a significant downturn, Fannie Mae and Freddie Mac will fail at their current capital levels.” He had to know this was untrue as he was saying it; he had been sitting on the unpublished results of the 2020 stress test run on Fannie, showing that it could survive the Federal Reserve’s “severely adverse scenario” of a 4 percent drop in real GDP and a 4 percent rise in unemployment with no need to draw on its capital, now $37.3 billion, at all. Yet he had used his position to mislead the public, and also to convince the Financial Stability Oversight Council to not just endorse his wholly contrived 4.55 percent risk-based capital requirement for Fannie, but to go beyond it, by saying in a joint statement with FHFA, “Risk-based capital and leverage ratio requirements materially less than those in the proposed rule would likely not adequately mitigate the potential stability risk posed by the Enterprises. Indeed, more capital might be necessary.”  

This fictional approach to Fannie and Freddie’s capital has gone unchallenged since the beginning of the conservatorships. The Biden economic team must change that, and it can start by acknowledging and embracing the incontrovertible facts about the companies’ past and present credit risk, and instructing a new Director of FHFA to replace the Calabria capital standard with one that draws on those facts. The Calabria standard is not fixable. It was constructed to produce an artificial result, and has too many unrealistic elements that interact in ways that have unintended consequences, such as the refusal to count guaranty fees in the stress test, which pushes the large majority of the cost of that artifice onto the borrowers of affordable housing loans, who are the least able to bear it. Moreover, it is completely unnecessary to have a risk-based standard that is as mind-numbingly detailed and complex as the current one. FHFA can provide an unquestionably high level of taxpayer protection, and at the same time allow Fannie and Freddie to price their credit guarantees on an economic basis, with a far simpler and fully transparent approach to capital.

A rigorous and highly effective capital regime for Fannie and Freddie can be built with just three elements: (a) a true risk-based capital requirement based on a stress test run on each company’s book of business every quarter, with no cushions or add-ons; (b) a single “all purpose” capital cushion, calculated as a percentage of this true risk-based requirement, and (c) a minimum capital percentage. Fannie and Freddie’s required capital would be the greater of the risk-based amount (plus the capital cushion) and the minimum percentage. To implement this regime, FHFA only would need to decide on two numbers: the multiple to be applied to the stress test results (which will change each quarter, based on changes in the companies’ mix of business) that determines the size of the risk-based capital cushion, and the minimum capital percentage. And for each of these, there is one compelling choice.

As basic principles, the multiple FHFA should apply to the results of Fannie and Freddie’s quarterly stress tests should be large enough to provide meaningful protection against unanticipated events or model error in the stress test, but not so large as to override the true risk-based element, and distort the companies’ credit pricing. Thirty percent—or a 1.3 multiple—seems about as large as a capital cushion could be without violating the second principle. Also, in determining the size of the cushion, it is critical to bear in mind that the amount of capital Fannie and Freddie actually will hold—and that will serve as the basis for the pricing of their credit guarantees—will be more than the greater of the minimum or the risk-based standard. To avoid regulatory sanction, company management must meet both their minimum and risk-based standards. If they draw on their capital cushion, whatever its size, they will be subject to prompt corrective action. To avoid that, they invariably will hold excess capital, typically 10 to 20 percent of their required amount. During periods of stress they will first draw down that excess capital, then, if necessary, raise new equity.

For Fannie and Freddie’s minimum capital requirement, the clear choice is 2.5 percent, for three reasons. First, a 2.5 percent capital requirement for the companies’ on-balance sheet assets already is in HERA, as is a 45 basis-point requirement for their off-balance sheet credit guarantees (on which they take only credit risk). When the FASB required Fannie and Freddie to put credit guarantees on the balance sheet in 2010, FHFA sensibly kept their minimum capital at 45 basis points by regulation, since their economic substance hadn’t changed. If FHFA simply removes that regulatory waiver, the result will be to more than quintuple the required capital on credit guarantees relative to pre-crisis times—“serious reform” by any measure. Second, in FHFA’s June 2018 capital proposal, “2.5 percent of on-balance sheet assets and off-balance sheet guarantees” was the more conservative of the two alternatives for Fannie and Freddie’s minimum capital (the other was “1.5 percent of trust assets [MBS] and 4 percent of non-trust assets”). And third, 2.5 percent also is the minimum in the 2020 final Calabria standard—only without the (excessive and unjustified) “prescribed leverage buffer amount” of 1.5 percent, which brings his total to 4.0 percent.

Were this capital regime and minimum percentage to be adopted and implemented today, the 2.5 percent minimum would be far above Fannie and Freddie’s risk-based requirement, and thus be binding. At June 30, 2021, 2.5 percent of their total assets (not “adjusted total assets,” a concept FHFA should drop) was $175 billion. With the Biden administration at the same time deeming Fannie and Freddie’s senior preferred stock repaid and canceling Treasury’s liquidation preference, the companies’ core capital would rise to a positive $60 billion, leaving them with a gap to adequate capitalization of $115 billion.

Fannie and Freddie’s after-tax earnings over the past four years have averaged more than $20 billion per year. With only a $115 billion capital gap, a capital standard that permits them to price their credit guarantees fairly, and without the net worth sweep, the resulting strong investor demand for their equity would open up many paths out of conservatorship for the companies. One would be for FHFA, with Treasury approval, to set a new threshold for their release under a consent decree—say 1.5 percent of total assets—that would take effect upon settlement of an equity issue that meets or exceeds this threshold. Then, each company would be allowed to decide the mix of retained earnings, issues of common stock, or issues of noncumulative junior preferred stock to use to eliminate its remaining capital gap, and obtain its release from conservatorship unconditionally. Other alternatives for a quick exit from conservatorship undoubtedly would be proposed as well.

During previous administrations, following the fictions about Fannie and Freddie has led to their interminable conservatorships. To get them out, the Biden administration merely has to change course and follow the facts. When it does, all of the companies’ stakeholders—and particularly low- moderate- and middle-income homebuyers—will reap the benefits.

53 thoughts on “Capital Fact and Fiction

        1. My reaction to this re-proposal is that it’s the FHFA bureaucracy, led by Sandra Thompson, saying, “We know former Director Calabria’s capital rule is very unpopular, but we can fix it. See?” With the implication, of course, that there is no need not to keep Ms. Thompson in place.

          As to the “fix,” it’s what you’d expect the bureaucracy to do: take something that’s an absolute hairball, tweak it to get the number (as calculated today) down to a level you think most would say is “tough but fair,” and call that a victory. It’s better than nothing, but the fix would be only temporary. Remember, the true risk-based capital number using today’s book of business is around zero. But that’s because we’ve had an unprecedented run of home price appreciation. If you take the Calabria Rube Goldberg machine, tweak it so that it produces answer of around 3.0 percent capital today, when the home price environment becomes less favorable you’ll get a (considerably) higher number, which still won’t be risk-based; it will be an artifact of the interplay of the rule’s arbitrary assumptions and exclusions.

          I’ll comment on the amendments to the rule, in specifics, but my bottom line is that FHFA needs to do a much more thorough overhaul than this for the rule to be something Fannie and Freddie can build a business on, and investors can confidently invest in. I think that Mike Calhoun recognizes this and would be much more inclined to scrap the Calabria rule. That’s why I hope he’s nominated–and it’s also why the Financial Establishment is holding up his nomination, and I think is trying to kill it.

          Liked by 3 people

          1. It also doesn’t address the pro cyclical nature of the rule and is again promoting the failed experiment of CRTs. That used to be a theoretical failure, but it is now a real failure. I can’t believe how soon they want to repeat it.

            On the bright side, this is just a proposed rule. It likely will not be finalized by the acting director. If Calhoun is confirmed, he will have the choice of re-proposing a new rule, or making adjustments to this proposed rule based on his knowledge and comments received. Your comments will be important to getting it right. Starting the rule making process now could help expedite finishing it quickly after confirmation.


          2. Pro-cyclicality is one of many structural problems with the Calabria rule, which is why it can’t be fixed by the sort of “tweaking” Ms. Thompson is proposing. I’ll try to explain this in understandable (and I hope convincing) language in the comment letter I intend to file.

            I am not against credit-risk transfer (CRT) securities in principle; I’m simply against making them mandatory. I believe it should be up go each company to decide to issue them or not. In the past, FHFA set targets for what percentage of a certain group of new mortgage acquisitions it wanted Fannie and Freddie to cover with CRTs. While technically not a mandate, there were executive compensation consequences for not hitting the targets. I hope FHFA drops those in the future.

            It appears that FHFA will (again) be reviewing how much capital credit to give for CRTs. Wall Street (and the Financial Establishment in general) is in favor of a very generous credit, because CRTs are very profitable for investors to own (very attractive yields and very low chance of credit loss) and Wall Street firms to issue and trade. The game that’s being played is that FHFA throws extra conservatism into the capital rule, then allows the company to eliminate some of the capital requirement created by that conservatism by issuing CRTs. It sounds harmless, but of course it’s not: somebody has to pay for this give-away to the investment community–in the form of interest payments paid by Fannie and Freddie to CRT investors in return for very little credit loss transfer coming back–and it’s the homebuyer. A homebuyer subsidy to Wall Street and the investment community is not ideal public policy, but I don’t see many if any in the Biden administration trying to stop that train.

            Liked by 1 person

          3. Tim

            I have always viewed CRTs as a conservatorship-based activity…the GSEs couldn’t build up equity capital with NWS, so CRTs were a necessary second-best means to absorb capital risk. If the new FHFA director is seeking to promote conservatorship release, perhaps any CRT usage can be premised on occurring only during conservatorship, unless post-conservatorship CRT pricing substantially improves over what is available now. I wonder if I am being cynical in believing that the acting director betrays a certain allegiance to a continued conservatorship status for the GSEs now that has put out this CRT capital rule amendment.



  1. Tim,

    I suspect you might be pleasantly surprised at the news today by FHFA/UST.

    Specifically, “FHFA is reviewing the Enterprise Regulatory Capital Framework and expects to announce further action in the near future.” (ideally to re-work it to a more appropriate level as discussed in your post)

    Additionally, they agreed to suspend certain changes made by Calabria to shrink the GSEs footprints as well as to allow the GSEs to continue to build capital.

    Liked by 3 people

    1. Both steps in the right direction. It’s clear that someone in the administration understands that what Calabria did with the capital rule and the business restrictions in the January 14 letter agreement with Treasury were neither justified nor good for the mortgage and housing markets.

      Liked by 2 people

      1. I wonder if a new proposed capital rule will get printed? Would be good to get that ball rolling now so a confirmed director can finalize it right away.

        Can they also make minor tweaks or “clarifications” to the rule while going through the public comment period?



        1. Tim – In terms of the current cap rule I contend that there is a possibility that it can be cancelled – almost immediately by Final Notice with no comment period. The issue is what it would revert to. However, given that amount of time that the new Director would need to turn the ship around, the ability to incorporate enforceable changes that can implement some of the housing goals of the Biden administration without legislation and the opportunity to solicit (and really, really consider this time) comments from all stakeholders, I don’t think there should be a panic like sense of urgency to publish a new Rule. I am not saying sit on this for an excessive amount of time, as Calabria appeared to do, but publish a draft as soon as possible and allow a reasonable amount of time, such as 120 days for responses. But I think the most important point concerning the Cap Rule is that, although you want something that will last for a relatively long time to give a degree of certainty and comfort to the financial world, you are not dealing with the 10 commandments here (or the original 15 according to Mel Brooks). If there is an adverse impact from all or part of the rule, it can be relatively quickly cancelled or amended. We are dealing with new ground here.

          Although the legislative process has become especially contentious and bogged down as of late, the administrative process is relatively fast and efficient, and its public and transparent nature (semi-transparent anyway) gives a great deal of opportunity for stakeholders to have an impact on the final outcome.


  2. Tim,
    the more I read of Calhoun, the more I feel like I am reading your blog. Have you read the Brookings report he wrote with Ranieri? You seem to be aligned with him on many many fronts, including the GSEs Mission and capital.
    Thank you


    1. I read the Calhoun-Ranieri paper when it first came out, and plan to read it again soon. (I’m now out on the west coast with my family–and wlll be for the remainder of the week–so am away from the blog more frequently than usual). As I’ve said elsewhere, the great thing about CRL, and Calhoun, is that they know and respect the facts about Fannie and Freddie’s business, and understand the impact the companies have on the cost and availability of mortgages for homebuyers in general and underserved segments in particular. If Calhoun is indeed nominated and confirmed as the next FHFA director, that would be a very welcome development.

      Liked by 5 people

  3. Tim, do you have any thoughts on Michael Calhoun as a potential FHFA director candidate as reported by Gasparino?


    1. I don’t know Calhoun, but I do know the founder of the Center for Responsible Lending, Martin Eakes, as well as one of its principals, Eric Stein, who spent a couple years as a special assistant to Director Mel Watt at FHFA (and now is back at CRL). Under Eakes and Stein, CRL has done excellent work on the economics of affordable lending. I have to believe that Calhoun has been exposed to that, and if he has, he should have the background that the next Director of FHFA will need as the leader of that agency to switch it from the ideological, fiction-based policies of former Director Calabria to the fact-based ones I discuss in the current post, which will be necessary to move Fannie and Freddie out of their interminable conservatorships and back to where they once again can function effectively as secondary market credit guarantors, while meeting an extremely high standard of taxpayer protection.


        1. I don’t think I’ve seen this video before, but it’s clear from Calhoun’s presentation that he has a very clear and detailed understanding of the role played by capital in the setting of guaranty fees. He also understands which elements of the Calabria capital rule have the largest adverse impact on lower-income borrowers (not counting guaranty fees as offsets to credit losses, and putting capital surcharges on smaller loan sizes and single borrowers), and that the absence of these elements in the FHA’s pricing makes Fannie and Freddie’s affordable housing guaranty fees (unnecessarily) noncompetitive with the FHA.

          I liked the way Calhoun started out his discussion, by saying that two-thirds of Fannie and Freddie’s guaranty fee is the “rent” on the capital the companies are required to hold to protect against a repeat of the home price collapse during the financial crisis. (Today, the cost of capital is closer to three-quarters of the fee on an average loan, and much greater for an affordable housing loan.) What he doesn’t say–and I hope this is something he’ll take away from my current post–is that the amount of capital Calabria says the companies need to survive a repeat of the financial crisis is grossly inflated. To lower affordable housing guaranty fees considerably, the next FHFA director merely needs to tie the risk-based capital reserve to the companies’ actual business risk, which can be easily done by running an honest stress test and adding a reasonable (identified) capital cushion. I suspect that if nominated and confirmed as FHFA director, Calhoun would be both able and willing to do that.


          1. Tim

            later on in video, Calhoun addresses the “utility” model of regulation, which I didnt highlight because it appears to me that at this time (2019) he was gravitating towards rather than espousing it, but he seems to have come to espouse it in the Calhoun/Ranieri Brookings article.

            the influence of Ranieri on Calhoun is interesting to contemplate…Ranieri was a principal market participant in the RTC S&L real estate bailouts when he was at Solly, and certainly was a preceptive observer if not participant in the GFC bailout (I dont know what role his firm played in GFC, but I can confirm that he was instrumental while at Solly in convincing the RTC to use securitization (at the time, still somewhat novel) as a technique to resolve the S&L mess). So Ranieri provides Calhoun the securities market background and gravitas that has been totally missing from the “GSE reform” conversation. Certainly in their Brookings article, there is a detailed discussion as to how the GSE return on Treasury’s investment dwarfs the return on, for example, Treasury’s investment in AIG.

            Simply partnering with Ranieri in that Brookings article sends me a signal that Calhoun is a serious guy who recognizes the capital markets will necessarily be an important tool with respect to ending the conservatorships.



      1. The progressives are now making a push for Sandra Thompson to be named permanent director ahead of Calhoun. Can’t imagine much would get done under her leadership if that were the case.


        1. I would be highly surprised if it were “progressives” that are supporting Ms. Thompson as permanent director of FHFA. Much more likely it’s the Financial Establishment, who are concerned that Calhoun would be open to returning Fannie and Freddie to a position of strength in the secondary market, in order to make them effective in providing support to the affordable housing segment. Ms. Thompson is much less likely to depart significantly from the status quo for the companies, which suits the Financial Establishment just fine.

          Liked by 3 people

          1. Is there any substance to this claim by Whalen that Calhoun will kill the GSEs profitability by “eliminating most or all of the LLPAs”?


  4. A truly excellent article Tim. Very clear and very true. I hope the ones who hold high places read this and have the ability to understand what you are saying. As ROLG said “I can explain it to you but I can’t understand it for you”


  5. Tim, truly an excellent post. I get it, you get it, most of us here get it. I do have one question though – the big elephant in the room. The financial elitist cabal as I believe you sometimes refer to them. What if this is what they want. What if what they want IS to saddle Fannie and Freddie with so much weight they can never be free. To continue to roll the can down the road…knowing that they can – they’ve proven that. Never to add them to the balance sheet but never to let them free. Who know’s why and for what purpose, however, doing the opposite of what’s clearly in the best interests as you laid out doesn’t necessarily translate to what will be done.

    The logic has never been applied that way from the very beginning as you also laid out. It appears that the de facto limbo nationalized (but not nationalized) conservatorship is actually acceptable while they tell us the opposite. No meaningful administration, legislation action or legal decision has otherwise provided any measurable relief. It’s all been to the benefit and timeline of the government. Based on historical actions over the past 14 years there has been no actionable progress to truly get Fannie and Freddie out of conservatorship and to be rehabilitated. That’s my biggest concern right now. The SCOTUS decision really affirmed some pretty terrible opinions about how a conservator can treat the entities which they are tasked with conserving.

    Liked by 1 person

    1. The “big elephant in the room,” as you call it, has been a frequent subject of my posts and comments since I started the blog, now over five and a half years ago. I also wrote a book about it. What I call the Financial Establishment (“financial elitist cabal” isn’t my term) has been trying to restrict or handicap Fannie and Freddie’s business for thirty years, and there is no mystery about its motives: money. The more it can force up the companies’ guaranty fees, the greater the share of the now $13 trillion U.S. residential mortgage market will be financed on-balance sheet by commercial banks, at higher (and more profitable) spreads to their consumer deposits. And for thirty years they’ve used the same strategy: advocating for “bank-like” capital requirements for Fannie and Freddie, without also giving them bank-like asset powers. That allows them to cloak their self-interest in the mantle of safety and soundness, while also crippling Fannie and Freddie’s business. FHFA Director Calabria, who long has been an ideological opponent of the companies, was merely following a well-trodden path.

      As I discussed in the current post, however, the takeovers of Fannie and Freddie in 2008 and the subsequent management of them in conservatorship have been based on fictions about their business and their risks. And it’s led to a situation in which two companies that earn over $20 billion per year will be stuck in conservatorship for close to twenty years unless something is done to free them. I don’t believe that’s sustainable. The Financial Establishment has been pretending that something was about to happen to the companies–“they’re about to be replaced in legislation”, then “they’re about to be released”–but now there’s no obvious next stage. The analogy is that Fannie and Freddie are being kept in jail (conservatorship) for a crime (posing enormous risks to the taxpayer) they clearly didn’t commit. How long can the Financial Establishment sustain that? What’s its next move?

      The Biden administration is in an ideal position to fix this. Democrats historically have supported Fannie and Freddie, and have seen them as powerful instruments in making housing more accessible and affordable to lower-income Americans. And as I said in my post, by drawing on irrefutable facts it can easily say that the Bush administration made a mistake in its de facto nationalization of Fannie and Freddie, and now–given the state of limbo to which that’s led us–it’s time to rectify that mistake.

      Will the Biden economic team take this on? I can’t for certain say it will, but I also can’t see them ignoring such an obvious unsolved problem for three-plus more years, when there is such an easy solution to it.

      Liked by 4 people

      1. The Biden economic team should take on the issue of releasing the GSEs from conservatorship. Your writings have been very clear on the issues and the various approaches to come up with a better solution. The environment is likely the best it can be for releasing the GSEs from conservatorship and as you point out, the solution can be simple.

        Liked by 1 person

      2. And if the Democrats want to do this via new legislation – which is a path that they don’t necessarily need to take – they may only have a short window to do this. But, regardless, they have long wanted to make changes to the GSEs to help the cause of affordable housing and the stars are aligned to do so. But they need to make some decisions in a timely manner. As Redskin coach George Allen used to say – “The future is now.”


      3. Thanks for the holistic review on this matter, Tim! Very informative and insightful!

        I am wondering if you can also share some perspective on that, for big financial firms like Goldman Sachs, Wells Fargo or Warren Buffett, under what kind of scenarios, keeping FnF in conservatorship could be counter-productive to their businesses? I don’t mean name calling here, instead I believe that they are the real driving force behind the conservatorship fiasco. It is inevitably up to them to put an end to this unfinished chapter in US financial history and restore the sanity in this part of the financial world. Therefore, understanding their position may hold the key to a final solution, whatever it may be.


        1. Wells Fargo is a major mortgage originator and portfolio lender, and was an original member of the anti-Fannie and Freddie lobbying group, FM Watch. I believe they feel they clearly benefit from having the companies tied up in conservatorship. I don’t see either Goldman or Warren Buffet as having that much of a stake in what happens to the companies, and for that reason don’t think they’ll use much if any of their political capital to help them.


      4. Yet another great article Tim with acute acurate details.. Not even the current set of GSE leaders stand up for the company and justify their numbers, or bogus stories on the stress test, as you do… Probably they are prohibited from self lobbying or self defending themselves i guess. Wish you get to the helm of the GSEs one more time


  6. Tim, Well done! Please continue to emphasize the greater benefit to homebuyers with a more reasonably capitalized Fannie and Freddie. Your detailed knowledge and presentation skills should be welcomed by all in the Biden administration and Congress in understanding the intricacies of unwinding the conservatorship and bringing this to a conclusion.

    Liked by 1 person

      1. I’m not a resident of Maryland, but that’s not a requirement for meeting with a member of the Senate Banking Committee. And while I don’t discuss or disclose my current or planned contacts in the mortgage finance arena, I will say that I’ve met with Senator Van Hollen in the past.


  7. Tim, thank you for the excellent summary. The sad irony is we waited for Scotus’ ruling on Collins to, in part, provide Potus the ability to fire the FHFA director at will. Between Layton’s recent article and now your article, pointing out MC withheld the stress test results to push his misguided and delusional capital requirements, in hindsight he could/should have been fired for cause IMO.

    Liked by 1 person

    1. Alec–

      The “equity” in today’s press release from FHFA doesn’t mean capital; it’s a reference to fair lending. It’s a follow-on to a HUD regulation aimed at reducing discrimination in mortgage origination. FHFA is requiring Fannie and Freddie to “submit Equitable Housing Finance Plans to FHFA by the end of 2021,” and then to update them annually. FHFA wants these plans to “identify and address barriers to sustainable housing opportunities, including the Enterprises’ goals and action plans to advance equity in housing finance for the next three years.”

      This may seem cynical, but this is the essence of bureaucratic formalism. If I were still at Fannie, my Equitable Housing Finance Plan would be very brief. I’d start by saying that since we don’t originate mortgages, there isn’t much we can do about discrimination in mortgage lending other than to tell the lenders for whom we guarantee mortgages not to do it. I’d then add that while in the past we’d been able to work with lenders to create innovative special affordable housing products aimed at increasing access for minority borrowers, given the completely ridiculous capital requirements you, our safety and soundness regulator, have saddled us with, we can’t do that any more. My next annual Equitable Housing Plan would say the same thing.

      Liked by 4 people

  8. Tim, great informative post, thank you!

    I was wondering if there is any way to quantify exactly how much affordable housing would expand to Americans if the capital requirement were lowered to your proposed 2.5% minimum (or true risk-based standard) vs Calabria’s current 4%+ rule. I believe highlighting the tangible benefits vs a more general statement of its effect (good for home ownership) may be more powerful to policy makers. (Let’s also not forget the TINA warrants monetization benefit for the admin as they can use it to further their administrative agendas to the tune of $50-$100b+).


    1. If you know the target rate of return you can calculate the impact of a drop in required capital on target guaranty fees, which translates into an equal drop in mortgage rates. For a 10 percent after-tax rate of return, moving from 4.55 percent required capital to 2.50 percent capital would reduce Fannie and Freddie’s target guaranty fees (and mortgage rates) by 25 basis points. Beyond that, though, I don’t know how to estimate how many more borrowers would be able to afford homes were this drop to occur. (I know some economists claim they can estimate it, but I’m not confident they really can.) I wish I could, because I agree it would be a powerful argument.

      Liked by 1 person

      1. Thanks Tim, that claim (mortgage rates would drop 25bps) is potentially a powerful one on its own. It would lead to more affordable homes as the average $300k mortgage monthly savings would be ~$50/month (~$600/yr or ~$18k over the life of the mortgage).

        Liked by 1 person

      2. Tim

        If I were lobbying Democrats I would lead with the total savings for lower and middle class homeowners, not how many more would afford homes, if your recommendations were implemented resulting in a 25 bps guaranty fee savings.

        for example, for Fannie Mae, it seems to me that Fannie made $1.359T of new conventional single family loan acquisitions in 2020 (10k, p. 90). the incremental per annum cost of these mortgages to homeowners, beyond what a recapitalized and released Fannie Mae would charge for guaranteeing the MBS securities into which these mortgages would be securitized, would be 25bps X $1.359T = $3.3975B…correct?

        if you told Democrat legislators and the Biden administration that, if Fannie Mae were recapitalized and released in accordance with your recommendation at the start of 2020, they could have sent an aggregate check of $3.3975B to low and middle class homeowners, would they have signed up for that? Democrats talk about “human infrastructure” but this one change re Fannie Mae would have a huge human infrastructure impact.



  9. Tim

    Excellent post!

    Every Senator and Representative should reread this sentence:

    “For the very long time they would remain in conservatorship, they would have no alternative but to price their credit guarantees to capital requirements that are grossly disproportionate to their credit risk, greatly raising the cost of and restricting the access to homeownership for the low- moderate- and middle-income homebuyers they are chartered to serve.”

    Then one should ask them is this what they want? Some might say yes, but the vast majority will say no….and profess ignorance over the fine details of finance. But they no longer have any excuse…you have explained it all for all to understand.



    1. Thanks. The intent of the post is to get the facts (and fictions) about Fannie and Freddie’s past and current credit risk on paper. The next step in the process is to get them in front of decision makers in the administration in Congress, which a number of us will be working to do.

      Liked by 4 people

      1. right….and no small next step, indeed.

        one of my favorite sayings from an old oil patch wildcatter I once knew is, “I can explain it to you, but I can’t understand it for you”…in the case of Fannie and Freddie, ideology and group-think is always an impediment to understanding, especially in DC and in the realm of finance. but you have taken the necessary first step, laying out the facts for administration/congressional decision makers in order for them to be (gently) confronted by their own misconceptions.



        1. Are you implying there needs to be a very simplified summary, perhaps even political cartoon, to motivate decision makers to even consider such compelling facts?

          The stigma of wealthy hedge funds getting richer is an unfavorable impression that has surely played a part in decisions to date…


          1. The financial benefit to “wealthy hedge funds”–and there will be one–gets undue emphasis because of insufficient awareness of and attention paid to the cost imposed on homebuyers by overcapitalizing Fannie and Freddie to make them uncompetitive with portfolio lenders. The latter is far greater in dollar terms, and to senior economic officials in the Biden administration also should be more important.

            Liked by 1 person

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