Comment on ERCF Rule Amendments

~ jtimothyhoward

Yesterday I submitted my comment on FHFA’s September 16 proposed amendments to its “Enterprise Regulatory Capital Framework” (ERCF) rule. That comment is reproduced below.

On September 16, 2021, the Federal Housing Finance Agency (FHFA) requested comment on a notice of proposed rulemaking “that would amend the Enterprise Regulatory Capital Framework (ERCF) by refining the prescribed leverage buffer amount (PLBA) and credit risk transfer (CRT) securitization framework for [Fannie Mae and Freddie Mac]…and also make technical corrections to various provisions of the ERCF that was published on December 17, 2020.”

The proposed amendments not only ignore but would build on, and enshrine, the glaring inconsistences between the hugely excessive amount of capital required of Fannie and Freddie by the ERCF, the actual risks of the companies’ business as reflected in the results of FHFA’s Dodd-Frank stress tests for 2020 and 2021, and the structure and economics of their current CRT programs as discussed in FHFA’s May 17, 2021 report, “Performance of Fannie Mae’s and Freddie Mac’s Credit Risk Transfer.” If adopted, these amendments would actually reduce the companies’ ability to withstand future credit stresses. FHFA therefore must withdraw them, and instead devote its efforts to bringing Fannie and Freddie’s risk, capital requirements, and credit risk transfer programs into proper economic alignment.    

Two publications by FHFA this year—its May CRT performance report and the August 13 release of its 2020 and 2021 Dodd-Frank stress tests on Fannie and Freddie—should have set off alarm bells at the agency that the ERCF’s capital requirements were unreasonably and unjustifiably high, and that former Director Mark Calabria had allowed his ideology to override economics when he replaced FHFA’s June 2018 capital standard with the ERCF.

The June 2018 capital proposal had two main flaws: its risk-based component was tied to current value loan-to-value ratios, which made it procyclical (with capital requirements falling in strong housing markets and rising in weak ones), and it unreasonably assumed that Fannie and Freddie’s guaranty fee income would not offset any credit losses during a period of stress—that is, all stress-period losses had to be covered by initial capital. (It may not have been a coincidence that this latter assumption boosted the companies’ required capital to 3.24 percent of total assets and off-balance sheet guarantees as of September 30, 2017, virtually identical to the 3.25 percent capital percentage proposed by the firm Moelis & Company in its 2016 “Blueprint for Restoring Safety and Soundness to the GSEs,” which was being widely discussed on a bipartisan basis at the time.) Many commenters noted, and criticized, the procyclicality feature and the exclusion of guaranty fees in calculating required stress capital, and urged correction of these flaws after a new Director of FHFA was appointed by President Trump.

That new director was Mark Calabria. When he took office in April of 2019, his views on Fannie and Freddie were well known. In an essay titled “Coming Full Circle on Mortgage Finance,” done for the Urban Institute’s 2016 “Housing Finance Reform Incubator” project (for which I also submitted an essay, “Fixing What Works”), Calabria wrote, “Securitization is a false god that failed us,” conflating the private-label securitization process in which no participant bears any risk of loss—and which was the cause of the 2008 mortgage crisis—with entity-based securitization as done by Fannie and Freddie, who do take risk. Calabria’s prescription for mortgage reform was that, “A more stable and affordable housing market would be best served by returning to an originate-and-hold model of mortgage finance,” and consistent with that objective said, “To retain whatever value there is [in Fannie and Freddie], the current GSE charters should be converted to national bank charters and the GSEs reorganized as bank holding companies (BHCs).” Then, shortly after joining FHFA he said in an interview with Fox Business News, “I think our objective over time is that you have capital levels at Fannie and Freddie that are comparable to other large financial institutions,” adding that 4.5 percent capital was “kind of in the neighborhood of where we’re looking at.”

By the time Calabria put out his initial capital re-proposal for Fannie and Freddie in June of 2020, the actual amount of credit risk at both companies had fallen significantly from where it had been when FHFA’s June 2018 standard was promulgated. One measure of this was the annual Dodd-Frank stress tests run on the companies each year, that replicate the impact of a severe credit shock comparable to the Great Financial Crisis, including an approximate 25 percent decline in home prices. To pass the 2017 stress test, run on year-end 2016 data, Fannie and Freddie had needed capital of 66 basis points of their combined total assets. To pass the 2019 Dodd-Frank stress test run on year-end 2018 data, however, they needed only half that amount of capital—33 basis points of total assets.

Fannie and Freddie’s capital required by FHFA’s June 2018 standard declined significantly over this period as well. When FHFA made its June 2020 capital re-proposal, it revealed that the capital required of the companies by the June 2018 standard of 324 basis points of total assets and off-balance sheet guarantees at September 30, 2017 had fallen to only 225 basis points of “adjusted total assets” (a somewhat larger denominator) at September 30, 2019. This nearly 100 basis-point capital reduction was driven by the same improvements in credit quality as the Dodd-Frank stress tests were reflecting, as well as the procyclical effect of a reduction in the current loan-to-value ratios of the companies’ guaranteed loans during a period of strong home price appreciation.

Calabria, however, wanted Fannie and Freddie’s required capital to be higher, not lower, irrespective of risk. To this end, he added a “prescribed leverage buffer amount” (PLBA) of 1.5 percent to the 2.5 percent minimum capital requirement of “Alternative 1” in the 2018 standard, bringing Fannie and Freddie’s total minimum capital requirement up to the Basel 4.0 percent bank leverage standard (as he had indicated he would). And for the risk-based standard, he made only a technical adjustment to the procyclicality of the 2018 rule, still did not count any guaranty fees as offsets to credit losses, then added enough other buffers, capital minimums and non-risk-based capital charges to raise required capital for his risk-based standard up to 3.85 percent of adjusted total assets (or 4.20 percent of actual total assets). When many commenters said that having minimum capital higher than risk-based capital would encourage excessive risk-taking, Calabria responded not by lowering the minimum percentage but by adding still more conservatism to the risk-based standard, to raise it in the final capital rule, the ERCF, to 4.27 percent of adjusted total assets (and 4.65 percent of actual total assets) as of June 30, 2020.

From 2016 through 2019, FHFA had released the results of its Dodd-Frank stress tests for Fannie and Freddie in August. The results of the 2020 stress test (based on year-end 2019 data) were expected to be released that August as well, during the comment period for the June 2020 capital rule. Calabria did not release them then, or at any other time last year. Instead, FHFA put out a statement saying, “achievement of the purposes of the Safety and Soundness Act will be adversely affected if each Enterprise’s publication of the summary of its Dodd-Frank Act stress test results is not delayed so that each Enterprise may include the alternative [Covid-19] scenarios considered by the Board.” Commenters on the capital rule made their comments without the benefit of the latest Dodd-Frank stress test results.

When FHFA finally did release the 2020 stress test results on August 13, 2021—the same day as the results of the 2021 test (run on the year-end 2020 books) were put out—there was no Covid-related loss scenario, and in the 2020 “severely adverse scenario,” with a 28 percent home price decline, Fannie was able to survive with no initial capital, while Freddie needed just 32 basis points of total assets as capital (combined, they needed 12 basis points of capital). The results of the 2021 stress test were even better: neither company needed any initial capital to survive the 23.5 percent home price decline in this year’s “severely adverse scenario,” and during the stress period they were able together to accumulate and retain earnings equal to 16 basis points of their combined total assets.

No one paying attention, including at FHFA, should have missed the fact that while FHFA’s Dodd-Frank stress tests based on a repeat of the Great Financial Crisis were showing that Fannie and Freddie had gone from needing 66 basis points of capital to survive their stress test to generating 16 basis points of retained earnings as it unfolded, Director Calabria had been using a host of cushions, buffers and add-ons to set a “risk-based” capital requirement for the companies of more than 460 basis points—double the capital required by the 2018 FHFA rule—to survive essentially the same scenario.

This disconnect between the reality of Fannie and Freddie’s actual creditworthiness and their assumed, but fictious, need to cover more than 400 basis points of credit losses in a severe stress scenario was inescapable when FHFA published its May 2021 performance report evaluating the companies’ credit-risk transfer programs. In it, FHFA said it had asked a consulting firm, Milliman, to simulate the performance of the companies’ CRTs on $126 billion of risk in force as of April 30, 2021 under two sets of conditions, a “Baseline scenario” and a “2007 Replay” intended to mimic the credit stress experienced during the Great Financial Crisis (and the Dodd-Frank stress tests). Milliman found that in the baseline scenario Fannie and Freddie’s lifetime CRT costs were $33.60 billion and their “ultimate benefits,” or credit loss reimbursements, were $1.06 billion, for a net CRT cost of $32.55 billion. And in the 2007 Replay, Milliman projected lifetime CRT costs of $30.72 billion, ultimate benefits of $10.10 billion, and a net CRT cost of $20.63 billion.

FHFA gave the results of the Milliman CRT performance simulations without comment or conclusions; instead, it simply said, “FHFA continues to assess the CRT programs, including their costs and benefits as well as the benefits and risks to the safety and soundness of the Enterprises, the Enterprises’ ability to perform their statutory mission, and the liquidity, efficiency, competitiveness and resiliency of the national housing finance markets.” Yet the problem FHFA dodged in its CRT report is obvious. The reason that Fannie and Freddie will make (according to Milliman) 30 dollars in CRT interest payments for every 1 dollar of credit loss transferred in a normal environment, and pay 3 dollars in interest for every 1 dollar in credit losses transferred even in an environment of extreme credit stress, is that the companies’ CRT programs are calibrated to wildly overstated levels of potential credit loss, and have been since their inception. The large majority of the CRTs they issue are pure giveaways to the investment community.

And FHFA knows this, at least at the staff level. In its June 2018 capital proposal, FHFA said that the credit loss rate of Fannie’s 2007 book of business through September 30, 2017 “using current acquisition criteria”—that is, without the Alt A loans, interest-only ARMs and risk layering that resulted in over half of that book’s losses—would have been only 1.5 percent. Fannie and Freddie can cover a 9-year cumulative loss rate of 1.5 percent with the income from their current average annual guaranty fee (net of administrative expenses) of 36 basis points, as evidenced by the most recent results of their Dodd-Frank stress tests. And with a 9-year cumulative stress loss rate for the companies of 1.5 percent, the Milliman CRT performance results make perfect sense. Typically, Fannie and Freddie’s CRTs do not transfer any losses before they exceed 50 basis points of a covered pool of loans, and they continue to provide coverage up to 400 basis points or more. With the expected loss rates of Fannie and Freddie’s post-2007 loans in the range of 2 to 5 basis points per year, only a very small portion of covered pools in a “baseline scenario” will have credit losses in excess of 50 basis points while the CRTs issued against them remain outstanding (as they can, and do, prepay). And even in a repeat of the Great Financial Crisis, only the bottom third of the CRT coverage range of 0.5 percent to 4.0 percent (or more) of a pool balance has any risk of experiencing credit losses.

Once these actual data, from FHFA, are introduced into the analysis, it becomes obvious why the agency’s September 16 ERCF capital amendments (and “technical corrections”) are such a bad idea. They use the lure of a reduction in capital requirements—more risk-based CRT credit, and a reduction in the PLBA—from levels that are indefensibly high, and based on wholly fictitious notions of Fannie and Freddie’s credit risk, to effectively penalize the companies for not issuing CRTs that are virtually certain to lose them tremendous amounts of money under any set of circumstances, thus greatly reducing their ability to handle the credit stress they may one day face in reality. This is the opposite of FHFA’s professed goal. 

Because FHFA’s September 16 amendments would weaken the companies, they must be withdrawn. But that will not be sufficient; the disconnect between the ERCF, the results of the annual Dodd-Frank stress tests run on Fannie and Freddie, and the economics of their credit risk transfer problems will persist until FHFA acts to fix it. And it is clear what needs to be done. The 1.5 percent stress loss rate for Fannie and Freddie’s 2007 book of business “using current acquisition criteria” through September 2017, the Dodd-Frank “severely adverse scenario” stress test results for 2020 and 2021, and the Milliman performance simulations of the companies’ April 2021 CRT books all are based on real data. Calabria’s ERCF is not.

In fact, since the beginning of the conservatorships, proposals for Fannie and Freddie’s capital have never been linked to their risk; they have been driven by the intent of the companies’ critics and competitors to use overcapitalization in the name of safety and soundness to push their guaranty fees to noneconomic levels, and drive business to “free market” alternatives. In 2013, for example, FHFA Acting Director Ed DeMarco required Fannie and Freddie to raise their guaranty fees by 10 basis points not because of risk but to “encourage more private sector participation” and to “reduce [their] market share.” And as recently as April of 2014, the Johnson-Crapo bill from the Senate Banking Committee would have required the credit guarantors who were to replace Fannie and Freddie to hold 10 percent capital to back their credit guarantees—with no reference at all to risk, other than to say that the 10 percent capital amount could be reduced if the guarantors transferred it. The ERCF is only the latest example of a non-risk-based approach to Fannie and Freddie’s capital, but it is the one that currently is binding on them, so it is the one that FHFA needs to repeal and redo.

The persistent and deliberate overcapitalization of Fannie and Freddie has had several negative, but predictable, consequences. Most obviously, you have two companies who today have extremely high-quality books of business and earn some $20 billion per year after-tax, but have no hope of exiting conservatorship in the foreseeable future because they have a core capital shortfall to the grossly inflated levels required by the ERCF of nearly half a trillion dollars, and no access to the capital markets because Treasury and FHFA have elected not to cancel the net worth sweep, which was imposed before the two agencies realized that the correct resolution of the companies’ indeterminate limbo was not to replace them, but to recapitalize them.

Second, Fannie and Freddie’s guaranty fees since the conservatorships have risen by over 20 basis points, and could rise dramatically further if the ERCF remains in place. In order to earn a modest after-tax return of 9.0 percent on 465 basis points of capital, the companies would need to charge an average of 65 basis points on their new credit guarantees, another 21 basis points more than their average gross fee (net of TCCA) in 2020 of 44 basis points. This is a ticking time bomb that everyone would prefer to think does not exist. And even the current level of Fannie and Freddie’s guaranty fees has had a profound effect on their ability to do affordable housing business. In 2007, 36 percent of the loans they purchased or guaranteed had credit scores less than 700; in 2020, just 12 percent of their combined business had credit scores that low.

Finally, and not surprisingly, banks’ holdings, and share, of 1-4 family first mortgages and mortgage-backed securities (MBS) have soared since the conservatorships. At December 31, 2007, banks held $2.23 trillion in 1-4 family first mortgages and MBS, for a 22.2 percent share of that $10.04 trillion market. Outstanding 1-4 family first mortgages and MBS were 15.7 percent higher at June 30, 2021, at $11.62 trillion, but banks’ holdings of them then were nearly double, at $4.42 trillion, for a 38.0 percent market share. This may have been good for the banks—and what they wanted to have happen—but shifting these volumes of mortgage holdings from capital markets investors such as pension funds and life insurance companies to leveraged commercial banks, who are funding them with consumer deposits and short-term purchased funds at a time of record low interest rates, increases systemic risk markedly.

None of these effects are ones senior economic officials in the Biden administration, when they focus on them, will support, or wish to have continue. The change of administration thus puts FHFA in an excellent position to take the lead in breaking free of the misguided, fiction-based policies of previous administrations towards Fannie and Freddie, and shifting to policies based on fact. FHFA must be bold in making this change, and not ignore the need for it or pretend it isn’t necessary, as the September 16 proposed capital amendments do.

And the required changes are straightforward. First, FHFA and Treasury must agree to declare that Fannie and Freddie have paid back all of the $187 billion they were forced to draw during the financial 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. Then, FHFA must replace Calabria’s ERCF with a rule based on the companies’ actual business and credit risks. As I discuss in “Capital Fact and Fiction” on Howard on Mortgage Finance, 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 aligned with the risk-based capital requirement.

Only when the ERCF has been replaced should FHFA turn to the task of determining how much capital credit to give to Fannie and Freddie’s (redesigned and recalibrated) credit risk transfers. Changing the CRT credit before then would be a waste of FHFA’s time, and worse, result in a great waste of the companies’ money.

169 thoughts on “Comment on ERCF Rule Amendments”

  1. Pingback: A Six-Year Retrospective | HOWARD ON MORTGAGE FINANCE

      1. That was my reaction. And, yes, it would mean more delays, at least on this legal track (we also have the remand to the DC District court on the breach of implied covenant claim, and the cases in the Court of Federal Claims).

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      1. ROLG—

        As noted earlier, I agree that the Collins remand is headed to the district court for a trial on the facts (whenever that takes place). I do, though, wish to take issue with your description of the Supreme Court’s decision on the legality of the net worth sweep under the Administrative Procedures Act as “amateur hour at SCOTUS.” In my view, it was the opposite of that: it was a coldly calculated “head shot” by the most conservative member of the court, Justice Alito, his five fellow Federalist Society members, and three uninformed and unwitting liberal justices at two entities, Fannie and Freddie—creatures of the New Deal—that the Federalist Society has loathed and sought to cripple or kill for decades. I’ll have more to say about this when I do my six-year retrospective on the blog early next month, but the reason I’m making this point now is that I am highly confident that the current Court will not permit ANY legal challenge to result in the restoration of Fannie and Freddie to anything close to their former positions of prominence and influence in the U.S. secondary market, irrespective of the merits of the facts in the case that comes before it. The Court may permit compensation to those shareholders harmed by the government’s action of seizing the companies—although that remains to be seen—but it will never issue a ruling that favors the companies themselves.

        I have not followed the Rop case closely enough to have an opinion on your analysis, but I appreciate your sharing it with readers.

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        1. If I may, perhaps you’re talking by each other and are actually in violent agreement. How about, it was amateur hour on the surface (how could they be so clownish?!), and it was also a politically influenced verdict. In other words, Federalist Society influenced and in turn, brilliant legal minds were made to look moronic, as is often the case when one takes up the wrong side of an issue.

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          1. I don’t agree with you. I believe Justice Alito, and at a minimum Justice Gorsuch (who made the comment about “reining in” Fannie and Freddie in his concurring opinion) were not “clownish,” or “made to look moronic” by some insidious external agent; they knew exactly what they were doing. The proof of that, to me, was the brazenness of the argument they used to get the result they were determined to get at the outset: that a clause in a section of HERA titled “Incidental Powers”–lifted virtually word-for-word from the FDIC Act–somehow transformed FHFA into a super-conservator, with the power to do whatever it wished with the companies, including giving their profits to Treasury in perpetuity. That’s not the act of amateurs, or judges who are in over their heads on an issue. To me, it’s an unmistakable sign of one or more people having concluded, “If this is the best argument we can find to justify the result we want, then that’s the argument we’ll make.” I think this is a important point to understand, because it informs how the Roberts court will approach any future Fannie- or Freddie- related case that comes before it.

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          2. Tim

            to your point, recall that insofar as FHFA could as conservator pursuant to “incidental powers” prefer anyone’s interests to the GSEs, it was “the agency”, defined in HERA as FHFA. as you say this language was lifted out of prior FDIC legislation where it was FDIC, NOT TREASURY, that would be the creditor to the conservatee. so while the FDIC has statutory authority to prefer its creditors interest, FHFA has no statutory authority whatsoever to prefer Treasury’s creditor interest.

            oh, but SCOTUS simply read “agency,” defined as FHFA in HERA ,to mean Treasury…and these are textualists!

            rolg

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          3. The reason you give (along with others) was why I did not think the Supreme Court would go back to the “FHFA can act in its own interests” argument first made by Judge Lamberth, but then convincingly rebutted and overturned by the Fifth Circuit en banc. The fact that Alito et al DID resort to that argument nevertheless is why the only conclusion I can draw is that this was a ruling driven by ideology, for which the Court was willing to go against not just the facts but also the law. And it does not bode well for future SCOTUS decisions involving Fannie and Freddie (as companies; it’s possible their shareholders may fare better).

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          4. It is very sad for our country that the supposed last line of defense against injustice is the Supreme Court where decisions are made outside of the facts and then interns and other legal assistants are tasked with finding precedents that will support their arguments. It is sad when justices are servants of politics instead of servants of what is right and just. But Tim is exactly right that this was a cold blooded decision by people who forgot what they are supposed to be doing.

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    1. This piece by Layton unfortunately draws heavily on his credentials as a card-carrying member of the Financial Establishment. Prior to his being asked by Treasury to become the CEO of Freddie Mac post-conservatorship, he had spent 30 years with JP Morgan Chase on the retail (Chase) side of the bank; Chase Home Mortgage was one of the founding members of FM Watch in 1999.

      Layton’s narrative of the history of Fannie and Freddie’s conservatorships tracks closely the fictional version of the takeover the Financial Establishment has been telling from the day that takeover took place. I’m sure Layton believes it, including the “failed business model” aspect of the story (or, as Layton states, the “universal view”…that “significant structural changes [to the companies] were required.”) If your analysis starts with an erroneous view of the origins of the crisis, and continues with an incorrect diagnosis of the problem (the “failed business model”), then of course your prescription for a remedy will be off-base as well. That, in a nutshell, is my critique of this latest piece by Layton.

      Beyond that, he is obviously correct in stating that FHFA cannot end the conservatorships by itself (and, by the way, FHFA did not put Fannie and Freddie into conservatorship, as Layton states, Treasury did; Paulson is very explicit in his book that he didn’t even bother to inform FHFA of his intentions until very late in the process). Section 5.3 of the Senior Preferred Stock Agreement (written by Treasury) says, “Seller [Fannie or Freddie] shall not (and Conservator, by its signature below, agrees that it shall not), without the prior written consent of Purchaser [Treasury], terminate, seek termination of or permit to be terminated the conservatorship of Seller pursuant to Section 1367 of the FHE Act, other than in conjunction with a receivership pursuant to Section 1367 of the FHE Act.” Not much ambiguity there.

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      1. He asked ST where in HERA does it say congress needs to do something to end a conservatorship. He then mentioned it says the opposite.

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        1. Wow. Thompson even MORE of a ‘bureaucrat’s bureaucrat’ than even one could anticipate. Softball questions. NO meaningful questions at all. Why the TWO candidates being interviewed at the Same Time? Thompson was literally an afterthought among the Senators.
          If one hears “work with Congress,” “Congress has to decide on F&F” one more time one will become physically sick.
          ONLY True hope was Calabria/Mnuchin (snicker) and is now squarely in the Courts. While I knew this could happen, I didn’t realize HOW critical the Courts will play in ANYthing meaningful happening.
          Congress, and the Banking Establishment have their thumb on F&F and they do NOT mean to give up anything voluntarily.
          VM

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    1. It should be quite clear that the “power that be” do not want this resolved. Perpetual conservatorship is the goal. No one picked up the hard questions when they were spoon fed to them. That says a lot on both sides. SCOTUS has deferred the decision that is quite obvious. That says a lot. FHFA continues it’s position that it needs Congress – even though it doesn’t. FHFA says GSE’s are undercapitalized should a catastrophic event occur – they are not. This isn’t going anywhere anytime soon. Truly sad state of affairs.

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      1. I said I would wait until Ms. Thompson’s confirmation hearing before expressing an opinion on her suitability as FHFA director at a time when Fannie and Freddie need forceful and clear-eyed leadership. I listened to the first two hours of the Senate Banking Committee hearing, and unfortunately heard what I’d expected to. It is no coincidence that she was so strongly promoted and supported by the banking interests. She is totally invested in the fictional stories about the companies that the Financial Establishment has been telling for the last thirteen years.

        She hit all of the “bankista” talking points, even the ones a senior official of FHFA should know aren’t true. In explaining why credit risk transfers are so important for Fannie and Freddie, she said “They don’t have enough capital to survive a severe event” (which she described as “something really, really bad”), so CRTs “take credit risk off of the backs of taxpayers.” Apparently she isn’t aware of the results of the last two FHFA Dodd-Frank stress tests (how could she not be?), nor of the terrible economics of the companies’ CRTs, as detailed in FHFA’s May 2021 report, “Performance of Fannie Mae’s and Freddie Mac’s Credit Risk Transfer,” which shows they do the opposite of lowering risk to taxpayers.

        Perhaps her worst statement was her claim that FHFA’s role under the Housing and Economic Recovery Act (HERA) is to “facilitate” the removal of Fannie and Freddie from conservatorship by Congress, rather than the agencies (FHFA and Treasury) doing it themselves, as HERA directs them to. She went on to add that only Congress could decide “what form the companies will take…will they be private or public?” This, again, is the pure bank line: Fannie and Freddie cannot be released under their current charters; they must be “reformed” first.

        As I’ve said before, I wish I knew what happened for the Biden administration to have gone from telling Mike Calhoun on a Friday that he would be nominated to be the next FHFA director the following Monday, only to have that put on hold over the weekend, then to have Sandra Thompson nominated for the position, and today to hear all members of the Senate Banking Committee, including Democrats, sing her praises. But the banks clearly have won. It now seems highly unlikely that there will be any administrative release of Fannie and Freddie from conservatorship for as long as Sandra Thompson is the director of FHFA. And it will take a highly visible “wake up call” or crisis—stemming from the consequences of allowing the banking industry to effectively set the pricing for the $6.8 trillion Fannie and Freddie MBS market in a way that advantages themselves and disadvantages low- and moderate-income homebuyers—for a new FHFA director to be named. What a missed opportunity.

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        1. Onto litigation we go…

          1) Collin’s oral arguments coming up on 1/19 with decision expected by the spring time (will the the Trump letter be enough to sway any of the en banc judges?).
          2) Lamberth trial this summer in July (first time facts will matter in courts).
          3) Takings case appeal decision should come any day/week now as the oral arguments were back in August (hoping shareholders survive the derivative takings claim so we can proceed to trial).

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        2. I found this exchange at the Thompson Confirmation Hearing interesting.

          Senator Hagerty: “Is there any point in the law that says Congress must approve an exit from conservatorship?”

          Thompson: “…There are a number of issues that Congress will have to address, specifically, if the enterprises exit conservatorship will the companies be private, will they be public, what form will they be in?”

          Hagerty had started that line of questioning by stating that HERA doesn’t permit indefinite conservatorships and that by definition no conservatorship is meant to be permanent, and asking Thompson if she’d commit to doing everything in her power to fulfill her statutory mandate to end the conservatorships.

          This all reminded me of some Jim Parrott statements from early 2021:
          — In a January 2021 Urban Institute paper entitled The Trump Administration Plays its Last Cards on Fannie Mae and Freddie Mac, Parrott near the conclusion wrote: “…at the end of this, taxpayers will wind up with an interest in the GSEs equal to close to half a trillion dollars and warrants on 79.9 percent of their common equity. That is a good deal closer to government ownership than private ownership, so the next administration could decide that it is easier, and better policy, to simply convert the well-capitalized GSEs into government-owned utilities. And this is indeed what several of us have proposed as the best course of policy.”
          — On Tim Rood’s On the Hill podcast on April 1, 2021 Parrott said (at ~ 21:48): “we may be entering another stage in this debate…we’ve been in the stage of the last 4 years…where the Trump Administration was…the focus was on…getting them ready to go out…getting them back into private ownership…and all of that…my sense is that’s going to change with this administration…so it will be interesting to see what the ‘title of the next chapter’ is going to be”.

          It seems like Thompson’s approach here aligns with what Parrott was talking about.

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          1. I don’t believe Thompson has an “approach” to getting Fannie and Freddie out of conservatorship: she simply is steering the “good ship FHFA” on the course Director Calabria put it on, which is “Fannie and Freddie can get out of conservatorship when they meet the capital requirements I set for them.” (Thompson did amend those capital requirements slightly, but only to encourage the companies to keep issuing the non-economic CRT securities the investment community so dearly loves.)

            As I’ve said frequently, with no access to the capital markets because of the net worth sweep, it will take Fannie and Freddie close to two decades to fill the gap between their current hugely negative core capital position and the 4.5 percent-plus core capital requirement Thompson clearly has no interest in reviewing, let alone changing. Congress could alter that, but it almost certainly won’t (it hasn’t been able to come up with credible Fannie-Freddie legislation in over 13 years, despite the urgings of the banking lobby.) That leaves Treasury—the mastermind (under Hank Paulson) of the original Fannie-Freddie takeovers, and the beneficiary of the (temporarily suspended) net worth sweep and the liquidation preference over the companies’ assets—as the most likely (and arguably only) architect of a potential exit from conservatorship for the companies in the foreseeable future. To date, Treasury Secretary Yellen has to my knowledge made no public statement about anything having to do with Fannie and Freddie. She’s now, however, “on the clock.”

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          2. I try to make sense of the conservatorships. I believe that Parrott’s perspective has been relevant in this fiasco and aligned with the concept of “taxpayers ADEQUATELY compensated”. One of the most striking issues in the GSEs’ pre-conservatorship capital structures was that the enormous amount of money they made belonged to private shareholders. We have seen 2 approaches to solving that problem so far – 1) Hank Paulson’s 80% public ownership plus 10% dividends and 2) NWS’ 100% of profits, regardless of pay-in-kind or cash. At this point, we can say that Parrot was at least one of the agitators to make NWS happen if he’s not the only architect. The problem of NWS (or making GSEs public utilities) is to essentially kill the private/public partnership, in addition to the apparent legal issues in the Takings claims. In contrast, Paulson’s approach would permit the private/public partnership to come back in one day. What surprised me is not that Parrot sticks with that idea, but that Thompson suggested that Congress should think about it.

            If our policymakers or think tanks are so narrowly focused on the money as to how I understand what Parrot was talking about, I think we have a much larger problem than what the conservatorships have. We also know that the US government is a facilitator, instead of a leader, among big interests including the Financial Establishment but not limited to it. So whether the GSEs’ private/public structure survives largely depends on whether it can serve them the most collectively. The conservatorships would stop one way or the other once a conclusion is reached.

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        3. “It now seems highly unlikely that there will be any administrative release of Fannie and Freddie from conservatorship for as long as Sandra Thompson is the director of FHFA.”

          Given your involvement, making such statements does not help. You do not seem to be able to read between the lines. You should know that FHFA cannot act unilaterally. Any desire to admin recap and release would originate in Treasury, who has not diverted from the path set out by the Trump administration. The companies are both still retaining earnings and — at the cusp of being able to restructure and raise capital — pending final capital rule and ST confirmation.

          While you are right that from a business perspective, they don’t need very much capital — you don’t seem to appreciate that they serve as plumbing for the entire banking system — and so to prevent a financial crisis that would erupt from massive sales of agency mbs depressing their price — they need capital — more capital than they need from an operating/business perspective — more than they would ever need for that — and so here we are.

          Best wishes to you sir.

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          1. I made that comment after listening to the nominee for FHFA Director, Sandra Thompson, tell members of the Senate Banking Committee that her role if confirmed would be to “facilitate,” rather than initiate, the companies’ release from conservatorship, and that she was looking to Congress to reform their structure first. This has been the position of what I call the Financial Establishment for 13 years, and both FHFA and Treasury, through two Republican and two Democratic administrations, have been in lock step in reliably delivering whatever the Financial Establishment has asked for with respect to Fannie and Freddie during that time.

            The Biden administration told Mike Calhoun of the Center for Responsible Lending on Friday, September 10 that he would be nominated as the next director of FHFA the following Monday. Over the weekend, that was put on hold—I have little doubt at the request of the banking lobby. Ms. Thompson then became the nominee, and she now is saying she can’t release Fannie and Freddie without their being “reformed.” Treasury Secretary Yellen so far has said nothing about Fannie and Freddie. It is a stretch for me to think that Thompson is freelancing on this—or being deliberately deceptive—while behind the scenes Yellen is working diligently to get the companies out of conservatorship without the reforms Thompson says she wants.

            I’m a holder of both Fannie Mae common and preferred, and I wish I saw things differently. But I feel I have to “call ‘em as I see ‘em.” And I only wish my words and analysis had as much influence on people’s thinking and actions as you imply they do.

            Liked by 4 people

          2. Tim,
            Can you comment on the recently announced Fee increases? You appear to be dead right on in this area.
            Does this help F&F’s profitability, or does it just (continue to) move highly-profitable business to the ‘private’ market, or both?
            How do u feel that in Judge Lamberth’s Court one of the Classes includes Freddie Mac (Common) shareholders, but does not include Fannie Mae (Common) shareholders? TIA, VM

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          3. Unfortunately, we will have to wait a while to see what effect the increased fees on Fannie and Freddie’s higher-quality business has on the volume of that business they do–it’s pointless for me to speculate about it. As I mentioned earlier, however, this segment is highly sought-after, so the companies are being asked to pursue a strategy that easily could backfire.

            The lack of a class of common shareholders in what used to be the Perry Capital case remanded to Judge Lamberth is due to the fact that none of the plaintiffs in that case held Fannie common. Nothing more to it than that.

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    1. I do hope, since the director is now removable at will, that if Biden wants to go in a particular direction with policy, Thompson will oblige. My sense is that she is flexible unlike Calabria. So if Biden wants to still move ahead with the ideas of Calhoun, they can still happen under Thompson. Perhaps Calhoun becomes some sort of advisor if Biden wants his policies. So perhaps, it doesn’t really matter “who” is leading FHFA, what matters is the desire of the Biden administration. I think Thompson better fits the Biden narrative for bringing diversity, mainly women and people of color, into his administration. Her nomination is not necessarily an endorsement of her agenda but more in keeping with a pledge during the campaign. In having two qualified candidates, it was not realistic for Biden to pick Calhoun over Thompson given identity politics.

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      1. I will wait until after next week’s confirmation hearing to make any further comments about Sandra Thompson’s suitability for the directorship of FHFA during a period in which Fannie and Freddie face unprecedented challenges–almost all of which are the result of policies and actions by past directors of FHFA (and Treasury Secretaries). But I would strongly disagree with the notion that “it doesn’t really matter ‘who’ is leading FHFA.” Leadership always matters. For the Biden administration to make the shift from fiction-based to fact-based policies required to successfully get Fannie and Freddie off their current course of perpetual conservatorship, some knowledgeable, experienced and committed person or group of people within the Biden administration must take the lead in charting a new course, then working diligently to follow it. It will not be easy for anyone, and if it will be much harder (and probably not possible) if the next FHFA director does not have either the ability or the willingness to be the “change agent” that agency needs.

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          1. From the release: “In April, upfront fees for high balance loans will increase between 0.25 percent and 0.75 percent, tiered by loan-to-value ratio. Fannie Mae and Freddie Mac refer to these mortgages as high balance loans and super conforming loans, respectively. For second home loans, upfront fees will increase between 1.125 percent and 3.875 percent, tiered by loan-to-value ratio.”

            this fee would appear to be applicable irrespective of risk, a sort of making one group of borrowers (large city metro area high income borrowers) “pay their fair share”, even “fostering [GSE] capital accumulation” as the release states.

            Tim, do you have access to the data sufficient to predict roughly the economic effect on the GSEs on a pro forma basis, assuming the fee doesnt reduce the number of such loans purchased by the GSEs (and assuming some tiering metric, which doesnt seem to be laid out in the release) ? This would appear to be an attempt to improve the returns to the GSEs without an across the board G fee rise, but I cant tell whether this will result in a material change to the GSEs’ financial results.

            rolg

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          2. These targeted fee increases are the beginning of FHFA’s attempts to get Fannie and Freddie to meet its “objective in the [2022 Scorecard] for the Enterprises to update the current pricing framework to increase support for core mission borrowers, while fostering capital accumulation, achieving viable returns, and ensuring a level playing field for small and large sellers.”

            The problem I believe FHFA (and “the Enterprises”) will encounter is that all four objectives in the scorecard cannot be achieved if FHFA insists on maintaining the companies’ required capital at the levels required by Mark Calabria’s ERCF (even adjusted for Acting Director Thompson’s recent proposed amendments, which giveth modest capital relief for issuing CRTs whose interest costs in excess of loss transfers taketh away an amount of net income that effectively offsets the capital savings).

            You’ll note that FHFA used the adjective “targeted” to describe the proposed upfront fees for high-balance loans to borrowers who aren’t first-time homebuyers with incomes at or below the median of the area in which they live. The vernacular translation of that is, “See how much you can get away with charging these higher income buyers before they take their loans somewhere else.” Fannie and Freddie’s pricing at current levels already is not competitive with the pricing at the FHA and bank portfolio lenders, and as I’ve noted previously to earn “viable returns” (and viable is not the same as competitive) on the 4.5 percent capital they are being told to hold they will be forced to raise those fees significantly further. Yet because they also are being required to “increase support for core mission borrowers,” about half of their current customer base—those with low credit scores, or incomes below the area median—will either be exempt from higher fees, or see their fees reduced. So the companies will have to try to pull their average fees up by greatly raising them on only half of their business—the half that has the most alternative places to take it. It’s not hard to envision the private-label securities market (the epicenter of the 2008 mortgage crisis) making a comeback under these circumstances.

            It certainly appears that the leadership and staff of FHFA do not understand, or are insistent on ignoring, the key point of my latest post: that the risk of the loans that Fannie and Freddie are currently guaranteeing, the (unjustified) level of capital required by the ERCF, and the structure and economics of the companies’ CRT programs are badly misaligned, in a way that can’t be fixed by pricing. But it looks like FHFA is going to give that route a try anyway. I can’t help but think of the last verse of Bob Dylan’s “Memphis Blues Again”: “And here I sit so patiently/ Waiting to find out what price/ You have to pay to get out of/ Going through all these things twice.”

            Liked by 2 people

          3. Tim

            “It’s not hard to envision the private-label securities market (the epicenter of the 2008 mortgage crisis) making a comeback under these circumstances.”

            maybe, but I wonder. a lot of institutional investors were burned by PLS, and the benefit of a creditworthy guaranty is something that many of these investors will not disremember readily. I have a suspicion (and I have been wrong before) that this targeted fee will be a net financial benefit for the GSEs.

            rolg

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          4. We should soon find out how much Fannie and Freddie can raise their guaranty fees before the (negative) volume effect outweighs the (positive) higher fee effect.

            In assessing this, it’s instructive to look at the composition of the buyers of Fannie and Freddie MBS and REMICs from before the conservatorships to now. At December 31, 2007, there were $3.76 trillion of combined Fannie and Freddie MBS and REMICS outstanding. Of that, commercial banks held $684 billion, or 18 percent, the Federal Reserve held none, and all other investor types held 82 percent. Now fast forward to June 30, 2021 (the latest date for which I have full data at hand). Fannie and Freddie MBS and REMICs had increased to $6.67 trillion, which seems like a lot, but is only a 3.1 percent annual growth rate. And the mix of buyers of these securities has changed dramatically. As of June 30, 2021, commercial banks held $2.11 trillion of Fannie and Freddie mortgage-related securities (a 32 percent share), the Fed held an estimated $2.00 trillion (an estimated 30 percent share), and other investors held the remaining $2.56 trillion (a 38 percent share).

            It should be pretty clear what’s happening here. Banks are buying Fannie and Freddie MBS and REMICs because it enables them to lower their Basel risk weight on mortgages from 50 percent (on whole mortgages) to 20 percent (on agency MBS), while the Fed is buying Fannie and Freddie mortgage securities to carry out its quantitative easing program (and doesn’t really care about the economics). All other investors, on the other hand, have seen their share of Fannie and Freddie MBS and REMICs fall from 82 percent in December 2007 to 38 percent in June of 2021, because they understand it doesn’t make a lot of economic sense to pay 45 basis points per year (today) to insure against the risk of mortgage credit loss that averages 4 basis per year in normal times, and (according to Fannie and Freddie’s regulator, FHFA) 20-25 basis points per year in a worst-case scenario.

            So, given this as a background, what is likely to occur when the Fed begins to unwind its quantitative easing portfolios of Treasury and agency securities this year (as it has signaled it would do), banks begin to realize that they’ve added enough long-term fixed-rate mortgages funded with short-term consumer deposits and purchased funds in what is increasingly looking likely to be a rising interest rate environment, and Fannie and Freddie try to raise their guaranty fees even further because of staggeringly excessive capital requirements imposed by a director who thinks they shouldn’t exist? Everyone can make their own call, but I know where I’ll place my bet.

            Liked by 2 people

          5. Tim

            the fed is tapering purchases of MBS and Treasuries, but we dont know from the fed yet whether it will maintain its balance sheet size as of the end of the taper, or decide to reduce its balance sheet, and if so, whether through run off (slowish) or outright sales (fastish). and while the fed is economically indifferent, the Treasury is not, and it stands to receive the fed’s annual profits…a very large profit given the current size of the MBS holdings and the fed’s interest spread on MBS. something tells me that the fed will try to keep its MBS level somewhat constant unless long term interest rates really soar, and if there is to be runoff, most of it in the short term will be in the shorter maturity treasuries that the fed holds. but we shall see…

            rolg

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      2. The proposed increase by FHFA for second homes is definitely not small. Currently rates/pricing for a second home is exactly the same as a primary residence at 80% LTV or below. The low end of the increase, 1.125% will roughly translate to an increase of .25% in rate for the 2nd home client. Tim you are exactly right, this low end adjustment will be for the most credit worthy and lowest LTV clients, the safest type of loan for the strongest client who can get their loan from anyone they want. Of course the banks will gladly cater to this sector, and make additional money as well by also increasing the rates/pricing for these customers, but they will only increase it 1/2 as much as the FHFA proposes. So FHFA may be trying to find ways to increase revenues, it just may not end being the revenues of the GSE’s.

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    2. Tim–

      Encourage your readers to ask their Senators, who serve on the Senate Banking Committee, to pepper Sandra Thompson, some tough questions when she appears for her nomination hearing, Jan. 13 (next week).

      Draft the questions (and the correct answers) for the Senators and don’t assume they know the GSE issues as well as you.

      Readers should copy any questions they have to the staff of Committee Chairman, Sherrod Brown (D- Ohio).

      U.S. Senate Committee on Banking, Housing, and Urban Affairs
      534 Dirksen Senate Office Building
      Washington, D.C. 20510

      Phone: (202) 224-7391
      Fax: (202) 224-5137

      Committee members:
      https://www.banking.senate.gov/about/membership

      Liked by 3 people

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        1. Some sample questions, feel free to use and/or edit:

          1. The GSEs have been in conservatorship since 2008 (13 years). Conservatorship, by its definition, is temporary while the entities rehabilitate into health. At what point do you see Fannie/Freddie exiting the conservatorship and are you planning on raising money in the public markets to do so?

          A: The Government can make over $100B by exercising the warrants and selling stock in the GSEs while regulating the companies like public utilities with limited rates of return, maintaining and implementing affordable housing agenda goals.

          2. Why is the capital rule being implemented for Fannie/Freddie similar to banks when they are monoline insurers with only a credit risk profile, no interest risk like banks? The recent stress tests have shown Fannie/Freddie would survive a big housing crisis with a fraction of the current capital standard – well under 50 basis points, or .5% (the final capital rule is over 400 basis points or 4%).

          A: Insurance costs to securitize mortgages will stay low if the capital requirement is reasonably reflected by the credit risk the companies take. 2.5% capital requirement is a reasonable and safe monoline insurance company capital level. 4% will force the GSEs to charge more for their business and will keep them in perpetual conservatorship.

          3. Do you agree that the current capital requirements for Fannie and Freddie are going to unnecessarily drive up the cost of housing for the people who can least afford it because the capital rule hasn’t worked through the GSEs internal systems and the insurance fees they charge will rise significantly from the current 45bps, increasing mortgage rates across the board?

          A: Asking the higher-end customers to significantly subsidize lower-end customers by having them pay much more for their mortgages will simply drive those customers away from the GSEs into the private label market, reducing GSEs’ ability to subsidize affordable housing.

          4. Why not regulate Fannie/Freddie like public utilities they are? Why not lower the capital rule to 2.5% that is over 5x the safety cushion of the most severe stress tests?

          A: The most rational and reasonable solution involves managing the GSEs to reflect their actual risks, which are NOT bank risks. Implementing capital standards equal to banks makes no sense because the banks have access to deposits that the GSEs don’t. The GSEs only manage credit risk and are not involved in market interest rate fluctuations like the banks.
          Lowering the capital rule to 2.5% will allow the GSEs to serve the American homeowners, especially in affordable housing, where the Government can monetize over $100B by selling warrants and using the money for an affordable housing fund.

          5. Do you agree that under the current capital requirements (over 4%), the GSEs will not have a way out of conservatorship because increasing their asset base every year by issuing new MBS will increase their capital requirements?

          A: With the finalized capital rule at 4%+, the GSEs are on a hamster wheel of needing more capital on the balance sheet for every dollar increase in their assets. Without significantly increasing their fees, the companies will not be making enough to keep up with the asset growth and will be stuck in a perpetual conservatorship. The net result is homeownership will decline because the GSEs will be forced to significantly raise their insurance fees.

          6. Do you agree that the credit risk transfer (CRT) program is diluting the capital build at the GSEs where the actual risk transferred for every $1 cost the GSEs $33?

          A: At a cost of $33 for every $1 it gets back, CRTs are absurdly uneconomic. They don’t transfer risk because the prepayment rate of the mortgages and the GSE first loss positions in the deals makes sure that the CRT buyers are never on the hook. The cost of this reinsurance is excessively high and the economic wealth transferred by the GSEs is a one-way financial benefit giveaway to the CRT buyers.

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          1. alecmazo–

            Excellent questions. Check the Senate members and send them to any you recognize, as well as to the Committee staff.

            Liked by 1 person

          4. Great list, Alec. Kudos.

            To expand on question 1, the interested Senator could say to Sandra Thompson:

            a) You recently raised Fannie and Freddie’s guarantee fees, effective April 1, and one of the reasons given was to “improve their regulatory capital position over time.” What exactly are Fannie and Freddie’s regulatory capital, otherwise known as core capital, levels right now?
            (if she doesn’t answer or gets it wrong, remind her the correct answers are *negative* $79B for Fannie and *negative* $47B for Freddie)

            b) As a safety and soundness regulator, do those regulatory capital levels seem safe and sound?
            (a rhetorical question)

            c) This means Fannie and Freddie are *hundreds of billions of dollars short* of the statutory definition of “safe and sound”. What do you plan on doing about that?

            Liked by 1 person

  8. Tim, you have stated that the ERCF will require the GSEs to increase the g-fees to an average of 65 basis points. (Fannie Mae and Freddie Mac ERCF comment letters also estimate roughly the same increase in g-fees.) You have also stated that you believe that such an increase will cripple the companies’ credit guaranty business.

    Do you believe that this issue will be raised during Sandra Thompson’s Senate confirmation?

    Liked by 1 person

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    1. What I wrote was that were the Calabria capital rule to remain unchanged, and IF Fannie (or Freddie) were to price its credit guaranty business to earn a 9 percent after-tax return on that capital, it would need to charge an average guaranty fee of 65 basis points. That was not a prediction; it was math. I don’t know how either company will respond to the Calabria capital requirement once it becomes binding. They have no good options.

      I stand by my statement that a 65 basis-point average guaranty fee would cripple the companies’ business. Any serious observer of the mortgage finance industry knows that the average credit loss rate on US residential mortgages in a normal environment is about 4 basis points per year. And prior to the 2008 financial crisis–which was caused by regulatory inattention to excesses in underwriting in the subprime market that began spreading to the prime market in 2003, and to the complete lack of “skin in the game” by any of the participants in the private-label securitization process–the highest Fannie’s annual credit loss rate ever got in any year was 11 basis points. Why would anyone sensibly pay 65 basis points a year to insure against a risk whose expected loss is only 4 basis points a year, and whose worst-case annual loss is now likely in the 20-25 basis point range? As I noted in the current post, guaranty fee pricing in the 45 basis-point per year range already has driven huge amounts of single-family business onto the portfolios of commercial banks, who will gladly take the credit risk themselves, and can reward themselves on top of that with 300 basis points or more of spread income that comes from taking interest rate risk that their Basel capital rules require zero additional capital to cover.

      Will any of these issues be raised at the Senate Finance Committee hearing? I think it’s highly unlikely. The average Senate staffer hears almost exclusively from lobbyists who support what I call the Financial Establishment, so even if someone like myself attempts to bring the reality of Fannie and Freddie’s current circumstances to their attention, it is so discordant to what they’ve heard over their entire careers that they don’t know what to make of it, and thus dismiss it. (This is not conjecture; it’s an observation based on long experience.)

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      1. Tim,
        This may be a stupid question, but curious if the twins are under a gag order? If they are not, not sure why are they not actively talking about the “make sense” recommendations you have spoken about as well any other topics that will return the companies back to some sense of “normalcy.”

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        1. @Tim/shore514

          your question points to the biggest informational disconnect relating to the GSEs that has caused them to stay in this interminable conservatorship. as for a direct answer to your question, I do recall DeMarco imposing a lobbying lockdown on the GSEs upon entry into conservatorship, and this has extended in practice to limiting any GSE executive commentary about the conservatorship. Tim may want to add to this part of my comment.

          but going further, there is an informational disconnect generally that has stifled all progress to end conservatorship. Most policy makers, and I will include Sandra Thompson and Janet Yellen and many of their predecessors here, could very well offer and execute common sense solutions for the GSEs…they have to look no further than this site for ideas as to how best to promote the GSEs’ mission in an effective and safe manner. These are ideas that are sound, practical and effective.

          but they dont, because there has been the (mistaken) assumption that what the GSEs require is a top to bottom policy makeover…and this puts the supposed solution at the feet of congress. financial regulation is very difficult as it is, but revamping a huge slice of the country’s finance is a fools’ errand.

          just like Saule Omarova’s grand thought to eliminate all deposit banking in favor of a peoples’ bank was both impossible to execute and stupid to do so, even if executable, reforming the GSEs in congress would eliminate what works for a multi-trillion dollar market into a social policy experiment…and most grand experiments in finance end with tears. thankfully, like the peoples’ bank, congressional reform of the GSEs wont happen, though congress wont admit to this yet.

          and so we wait for Godot, with this site serving as a rather solitary bastion of housing finance sanity.

          rolg

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          1. My understanding is that when Fannie and Freddie were put into conservatorship (and this was during the directorship of James Lockhart, not acting director Demarco) they were prohibited from lobbying, and this prohibition has remained in place. Also, no senior official from either company has made any comments to the media (that I am aware of) about the way they have been managed or regulated in conservatorship, nor any public suggestions about potential solutions to their current state of limbo. I would be surprised, however, if they have not made such comments privately to both former director Calabria and current director-designate Thompson.

            On the “information disconnect,” I believe that Calabria knew the facts about Fannie and Freddie’s risks and their role in the financial crisis; he just chose to ignore them because they ran counter to his ideological goal of handicapping the companies to the point of ineffectiveness. And FHFA as an institution is very heavily invested in the (false) proposition that Fannie and Freddie are terribly risky companies that must be painstakingly regulated and massively overcapitalized to avoid their causing another financial crisis. My concern about Ms. Thompson is that she may be steeped in this fictional lore, and thus have neither the knowledge base nor the inclination to move from fiction- to fact-based management and regulation of the companies (which is why the banks have been such enthusiastic supporters of her becoming director).

            As I’ve said many times before, it would be as easy to get Fannie and Freddie out of conservatorship as it was to put them in it, if some critical group of officials in the Biden administration had the political will to do so. I believe they got close with the proposed nomination of Mike Calhoun as FHFA director, but the bank lobby was able to sideline (and probably kill) it. So now we sit, with Fannie and Freddie in the impossible position of having a half-trillion dollar shortfall from the negative core capital they have currently (because of the net worth sweep) to the 4.0 percent-plus required full capitalization set by a director who raised the previous director’s required capital level by 80 percent at the same time as the companies had improved their creditworthiness to the point that they could survive the Dodd-Frank stylized repeat of the Great Financial Crisis solely on the income from their current guaranty fees, with no need for any initial capital at all.

            Given that everyone now is in agreement that there is no realistic (or politically achievable) alternative to Fannie and Freddie remaining at the center of the $11 trillion U.S. residential mortgage market, I personally believe it will be very hard for FHFA, and Treasury, to maintain for too much longer such a massive gap between the fictionalized versions of the companies to which they have been clinging and the realities of the companies’ current business and risks that are so readily demonstrable to any objective observer. The soon-to-be apparent consequences of attempting to do so–whether it be huge hikes in average guaranty fees, a regulatory mandate to Fannie and Freddie to shrink their business to close their (unnecessarily wide) capital gap, or a crisis caused by rising short-term interest rates on the short-funded mortgage portfolios of the banks who have benefitted greatly from the companies’ mistreatment–will force policymakers to face up to the chaos they have created, and to fix it.

            Liked by 5 people

          2. Tim

            “I personally believe it will be very hard for FHFA, and Treasury, to maintain for too much longer such a massive gap between the fictionalized versions of the companies to which they have been clinging and the realities of the companies’ current business and risks that are so readily demonstrable to any objective observer.”

            I would like to agree, but I am fearful that there is a woke-like attitude that bureaucrats/congresspersons have, that the proposition that it makes sense to release the GSEs is somehow unwoke and politically verboten. it takes not only common sense and analytic ability but also courage to think clearly about the GSEs. Does anyone think that Sandra Thompson has the requisite courage to do the right thing, after decades of government bureaucratic service? This is not by any means an indictment of the person, but rather is a candid assessment of the zeitgeist of beltway groupthink.

            rolg

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          3. Since the inception of this blog, I have sought to make it as apolitical as possible, so as to give the ideas and analyses I offer the best chance of being considered on their merits, rather than being dismissed because of a political filter. But in this comment I WILL be political, as I don’t think there is any other way to make what I believe is an important point.

            I suspect most readers have been able to discern my politics, but for those who haven’t (or don’t care), I consider myself a moderate, with views somewhat to the right or left of center depending on the issue. Overall, on a scale of 0 to 100—where 0 is extreme right and 100 is extreme left—I would put myself in the 55 to 60 range. That means that for the nearly six-year life of this blog I have alternated between being appalled and disappointed by the policies and actions of the leadership of the Republican party, and being perplexed and disappointed by the policies and actions of the leadership of the Democratic party.

            As I said in my book (quoting former chairman David Maxwell), “Fannie Mae was political to its bone marrow.” It was a creature of the New Deal, and historically has either been mistrusted or opposed by conservatives. A simplistic, but I believe accurate, characterization of what has happened to Fannie and Freddie since 2008 is that the political right (which I describe using the more neutral term “Financial Establishment”) has been able to get away with whatever it’s wanted to do with (or to) the companies, no matter how unwarranted, counter-factual or outrageous those actions have been.

            We all know what these main actions were:

            – In 2008, Bush Treasury Secretary Hank Paulson reacting to the collapse of the private-label securities market—which left Fannie and Freddie as the “only game in town” (his words)—by bullying the companies into accepting a forced conservatorship, while Paulson pretended publicly that he was rescuing them (while falsely blaming them for the crisis).

            – In 2012, the Obama Treasury reacting to the impending reversal of the temporary or estimated book expenses at Fannie and Freddie that were about to cause their retained earnings to skyrocket by imposing the net worth sweep, while (again) pretending that the sweep was designed to prevent a “death spiral” of borrowing to pay the 10 percent preferred stock dividend.

            – In late 2020, the Trump-appointed libertarian director of FHFA, Mark Calabria (who was on record as saying he didn’t think Fannie and Freddie should exist), almost doubling the “risk- based” capital FHFA had proposed for the companies in June 2018, at the same time as his own agency’s Dodd-Frank stress tests were showing that they could survive a stylized version of the Great Financial Crisis solely with income from their guaranty fees—and no initial capital at all.

            – In mid-2021, extreme conservative Justice Samuel Alito authoring a unanimous Supreme Court opinion claiming that a clause in a section of Fannie and Freddie’s enabling statute labeled “incidental powers” gave FHFA the right to do whatever it wished with Fannie and Freddie, including giving their profits to Treasury in perpetuity (a rationale first put forth in the appeal of the Perry Capital case by members of the Federalist Society, whose other members include all six conservative justices).

            – Finally, in late 2021, the acting director of FHFA, Sandra Thompson, appointed during the Biden administration, issuing a regulation that pretended the gross overcapitalization of Fannie and Freddie proposed by Mark Calabria could be “fixed” by allowing Fannie and Freddie to get a modest reduction in their required capital if they did credit-risk transfers that FHFA itself admitted cost the companies $20 in interest payments for every $1 of credit losses transferred during a normal environment, and $3 for every $1 of loss transfers even in a worst-case environment.

            None of these actions had anything to do with “a woke-like attitude that bureaucrats/congresspersons have.” “Wokeness” is a fairly recent term, used by conservatives to describe what they perceive to be “politically correct” attitudes by liberals (originally with respect to social justice issues, now broadened to virtually any policy or opinion from the left). Fannie and Freddie’s current plight does not stem from “wokeness” by liberals; it is the result of the appetites of big business (the “Financial Establishment”) and the far right for profits and power having gone virtually unchecked for the past 30 years. The blame for this lies with Democrats (who have done nothing to oppose it) as well as Republicans (who have either acquiesced to or actively supported it).

            The (Republican) economist Ben Stein once said, “If something can’t go on forever, it won’t.” My thesis is that the series of lopsided “wins” by the Financial Establishment over Fannie and Freddie during the past 13 years has now reached such an extreme that it contains the seeds of its own undoing. I don’t know when or how this undoing will occur, nor what the catalyst will be that will cause it. But I do believe that there now are such staggering and blatant inconsistencies between what the Financial Establishment has gotten away with pretending are true with Fannie and Freddie and the objective, readily observable reality about them that something will eventually crack, and give way. I hope that happens sooner rather than later.

            Liked by 4 people

          4. Interesting. In the book, All the Devils are Here, by Bethany McLean and Joe Nocera, it was stated, “The GSEs immediately had to fire all their lobbyists, so there could be no running to their friends on the Hill. “Cutting off the head of the snake, ” people involved called it. ” This statement has always been confusing to me. The officials at Freddie Mac agreed to the government’s terms right away, but the board members at Fannie Mae resisted until the following day. How could Paulson have kept the top officials at Fannie Mae from going to their lobbyist before they signed the agreement?

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          5. Paulson was very clever in the way he forced the conservatorship on Fannie. He was very careful (and I would say in one way dishonest) in how he concealed his intent from the company’s Board (the dishonesty was his telling both Fannie and Freddie that they needed to drop their objections to HERA because that was the only way Paulson could deliver on his promise to “preserve [Fannie and Freddie] in their current form,” when his true intent was to nationalize them). Remember Paulson’s comment to President Bush that “the first sound they’ll hear will be their heads hitting the floor. Paulson also put a clause in HERA that exempted members of Fannie and Freddie’s boards from lawsuits “for acquiescing or consenting in good faith” to conservatorship. When he told the Fannie board “there is an easy way and a hard way for me to do this, but I’m going to do it” (I’m paraphrasing here), it was too late for Fannie’s lobbyists to be any help. The Fannie board gave Paulson what he wanted, which was absolute control over their company, at stakeholders’ expense.

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          6. Tim,

            You appropriately name the political right more generally as the financial establishment and then list five unwarranted actions you index to that establishment, yet two of the five actions were taken by the political left – Obama Treasury Sweep and the Thompson CRT blunder.

            That’s not a political statement by me, just an observation.

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          7. If you read my comment closely, I blame the political right for the initiatives supported by the Financial Establishment, but the political left for not opposing them. The Financial Establishment has captured both parties. As to the “actors,” Treasury has been the embodiment of the Financial Establishment since at least the Reagan years. FHFA was Treasury’s lapdog at the time of the conservatorships, but institutionally it became pro-Financial Establishment during the term of acting director DeMarco (a former Treasury staffer), and even more anti-Fannie and Freddie under Calabria. Sandra Thompson has been put at the wheel of a ship whose course was charted by DeMarco and Calabria, and in my view has neither the awareness nor the knowledge to change that course.

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          8. Tim

            I respect your historical political analysis and accounting, and perhaps it is best to acknowledge that mistreating the GSEs has been an equal opportunity story for those across the entire political spectrum over the past 13 years.

            but I am focused on what may happen in the next year or two in the bureaucracy ofFHFA and in Congress. I look particularly at Sen Brown, the current chair of the SBC. He has mused during SBC sessions relating to the future of the GSEs about how regulation of the GSEs should move to a regulated utility model. this is a useful suggestion, but my question is whether he has the courage to promote this view now that he has more power to implement this view, and whether there will be a (woke) cacophony from Ms. Waters and others in the HFSC that will cause Sen. Brown to stand down. hence, more inaction in action.

            I am willing to take bets, and maybe even offer odds.

            rolg

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          9. I wouldn’t be on the other side of your bet against Congress doing anything substantive to address Fannie and Freddie’s current condition; I believe the odds of that are extremely low. And I don’t think a solution is going to come from FHFA, particularly if Sandra Thompson is confirmed as director. (FHFA might have been in a position to take the lead on removing Fannie and Freddie from conservatorship had Mike Calhoun become the director–he has a clear understanding of both the problems the companies face and what are politically doable ways to solve them–but the banks quashed that, in a Democratic administration; I wish I knew more about how that happened.) I believe the only way we get a policy initiative to release Fannie and Freddie–absent some sort of blow-up or crisis that sets off a scramble among all of the interested parties, including in Congress–is for the senior economic officials in the Biden administration, perhaps supported by prominent politicians like Senator Brown, to collectively determine that it’s in the President’s best interest to end the 13-year conservatorships, and for him to get credit for it. To do that, though, they would have to take on the banks, which I think is unlikely without the cover of some catalyst or crisis.

            Liked by 1 person

          10. Excellent comments, @Tim! As always, the insightful information you share is much appreciated.

            Nobody knows what would trigger a correction. However, 2022 would no doubt shift all attention into courtrooms as our political figures remain silent on the GSEs’ future and the Conservatorship.

            In 2021, we already heard SCOTUS’ opinion on two issues, “Is the director’s for-cause removal constitutional?” and “Did DeMarco exceed the authority to enter NWS?”. I find it quite clear that courts did not want to step in to disrupt the so-called “housing finance reform”.

            But for how long and how much, courts can stay out of the legal battles? IMHO, the remaining legal questions make it even harder for courts to exonerate FHFA from what it has done,
            – Did DeMarco’s 3-year acting directorship violate the Appointment Clause?
            – Did Trump’s inability to fire Watts harm shareholders’ interests?
            – Does HERA take away shareholders’ Constitutional rights to property and due process to enable FHFA’s actions such as NWS?
            – Does NWS infringe shareholders property rights?
            – Is the Conservatorship itself Takings?
            – Is NWS a breach of implied covenant of good faith and fair dealing?

            The underlying intention of NWS, stripping off the GSEs capitals as well as the shareholders’ economic interests, would make it virtually impossible to defend FHFA’s actions in front of Constitution. However, how much courts are willing to protect FHFA still remains to be seen. I don’t see any trouble that courts could rule a case with $1million impartially. When it comes to $100 billion, things could be different. One common response would be “even if FHFA violates XYZ, shareholders would have lost their interests anyway without government’s help, and therefore their compensations shall be nil.. ” So, does upholding the Constitution have a price tag? If the answer is no, then we may have a trigger.

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          11. Tim

            you mention the need for a “catalyst”, and I suppose it would be useful to create a new messaging pitch to the Biden Administration…

            “release and recap the GSEs, then monetize the Treasury’s stock to the tune of some $100B that can be directed to affordable housing, and forever refer to Mr. Biden as the POTUS who solved the affordable housing crisis in America”.

            I for one would be happy to give POTUS Biden all of the credit for solving the affordable housing crisis in America…but it first requires the Biden Administration to understand why it was a mistake not to nominate Michael Calhoun in the first place.

            rolg

            Liked by 1 person

          12. Tim, a series of excellent posts! Happy New Year!!

            With respect to many, and with respect to some truly outstanding comments, no one answered Jimm444’s question.

            My original assessment when I looked at F&F some 6 years ago:
            Legislative Action/Congress 20%
            Administrative Action/Presidential-Treasury Sec-FHFA Dir 50%
            Legal Action/Courts 30%

            Key is, “Are you looking for a payoff, &/or a payoff with sustainability in terms of housing finance?”

            Am assuming it is the latter.

            THEN the answer for the payoff part at least, is that the % has increased on the Legal Action/Courts to 70-80%, 0-5% for Legislative Action, and 20-25% for Administrative Action.

            For sustainability in housing finance, 0% Legislative, 25% Administrative, 75%+ Legal, 100% if there is a Crisis.

            Mr. Tim Howard’s comments about a ‘Crisis’ to get Congress moving or lighting a fire under Biden’s Team is spot-on and well worth a careful read. Tim’s and other’s comments about wokeness should not be underestimated. Look at Sophia Omerova’s nomination. To an obviously lesser extent Sandra Thompson’s & Sarah Bloom Raskin’s. Many of the nominations + Biden’s Team decision making is an absolute abrogation to the Rule of Law and support, tacit or otherwise, to the housing-should-be-a-free-commodity woke community.

            Christmas Present for 2022? Sandra Thompson’s nomination gets the BBB treatment, and she isn’t confirmed. Default: Calhoun.

            Liked by 2 people

          13. Jimm444’s question–which I chose to delete because it ended up at the wrong place in the sequencing of comments after I’d been away from the blog for a bit (I’m actually at a resort with my family now, and spending considerably more time on the blog today than I’d planned to)–was “Do you see any of the ongoing court cases helping the ‘face up’ [i.e., policymakers facing up to the chaos they’ve created with Fannie and Freddie] next year?”

            My short answer would have been “no.” Not because I don’t think one of them could, or might, but because I see the remaining court cases as being much more oriented to potentially providing a remedy to shareholders (principally those who hold the junior preferred) wronged by the net worth sweep than to fixing what’s gone so terribly amiss with how the government is treating Fannie and Freddie. I believe this fundamental change in policy towards the companies can only come from the administration, given Congress’s severe dysfunction and the very clear message from the conservative majority in the Supreme Court that it will not tolerate any judicial remedy that restores Fannie and Freddie to their pre-conservatorship position of influence and prominence in the nation’s housing finance system.

            Happy New Year.

            Liked by 1 person

          14. Tim,
            Well said and thanks for your discretion. Did not know you deleted his post/question based on the thread I receive.
            While one can envision the JPS holders compensated in some manner to ‘go away’, with F&F unresolved, it would be fascinating if through this process F&F resolved many of the mortgage finance issues/stresses you have aptly pointed out.
            Appreciate the personal communique.
            Happy New Year to you & your family.
            VM

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  9. Tim

    as I write this, BBB is dead in the water for 2021, at least. given Sen. Manchin’s views, one can wonder how BBB fares in 2022, and whether any BBB mini-me that actually is passed provides any substantial financing for affordable housing.

    I predict the Ds in congress will continue to play politics during 2022, because this is how politicians think, it’s all about political deal making…but for those who want to see affordable housing financed with resources far beyond what BBB would provide, it’s all about financial deal making…for those D politicians who have no clue as to financial deal making, all it takes is a snap of the fingers to monetize the Treasury’s warrant value…even a whistle…and as Lauren Bacall might tell the Ds in congress, you know how to whistle, don’t you….?

    rolg

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    1. As I noted in a comment below, the combined value of Treasury’s warrants for Fannie and Freddie common stock today is less than $7 billion. And, yes, Treasury could monetize that value with “a snap of the fingers,” but what it should do instead is make those warrants much more valuable by undoing the policy mistakes of previous administrations–cancelling the net worth sweep and its liquidation preference, and convincing FHFA to scrap the Calabria ERCF and propose another capital rule that’s truly risk-based– thus making the companies more valuable (and their stock price higher). The “D politicians” can advocate for that, but it will be up to the Biden team–its senior economic officials, Treasury Secretary and Director of FHFA–to actually make it happen. At the moment, though, there are no signs that any of these people are thinking this way. Hopefully that will change in the future.

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      1. Tim

        I focus on D politicians since they have a clock ticking against them…the 2022 election for all reps and many senators. as for Biden’s team, prominent with respect to domestic policy are Ronald Klain and Susan Rice…I dont discern a clock ticking against them…though after this BBB debacle (as viewed within the Beltway), sirens should be wailing in the west wing and resumes tidied up.

        rolg

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    1. Thirty two pages long and conservatorship only mentioned once. Proposed rule after proposed rule after proposed rule. How about actually doing something. What a scam.

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    2. I will read this proposed Capital Planning Regulation as soon as I can (it may not be today), and comment on it once I’ve done so. I did, however, note that in the one-paragraph summary on the first page FHFA says, “The requirements in this proposal are consistent with the regulatory framework for capital planning for large bank holding companies,” so we know that as of yet none of the senior officials at FHFA (including the newly nominated permanent director, Sandra Thompson) have recognized the fact that Fannie and Freddie are not large bank holding companies, have no business in common with large bank holding companies, and should be regulated (and capitalized) like the mono-line residential mortgage credit guarantors they actually are. So I don’t have very high hopes for what this regulation will say.

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      1. Limited, tunnel-visioned bureaucrats–short on creativity and long on bias–in over their heads.

        Calhoun would have been a much better choice than Ms. Thompson, a government careerist.

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        1. I’ve now been able to read FHFA’s notice of proposed rule making on “Capital Planning and Stress Capital Buffer Determination.” My reaction is that it is a bureaucratic exercise in process that is bizarrely detached from the reality of the dire circumstances Fannie and Freddie currently find themselves in—for which FHFA itself (along with Treasury) bears direct responsibility.

          Large commercial banks are highly complex entities, with multiple asset types in multiple currencies around the world, whose loss rates cannot easily be estimated. Fannie and Freddie deal in one US-dollar asset type—residential mortgages—with two variants, single- and multifamily, whose loss rates ARE predictable. FHFA doesn’t need a bank-like capital plan to understand what Fannie and Freddie’s capital problem is, and solving it is much more up to FHFA (and Treasury) than it is to the companies.

          FHFA KNOWS the circumstances. Take Fannie. As of September 30, 2021, its core, or Tier 1 capital was a negative $78.7 billion. It’s that low because immediately after the conservatorship was imposed, FHFA booked $200 billion in temporary or estimated non-cash expenses to the company’s income statement, forcing it to take $116 billion in draws of Treasury senior preferred stock it didn’t need. Treasury would not let Fannie repay this stock when the very large majority of these book expenses reversed and became income; instead, it, along with FHFA, imposed the net worth sweep and took those earnings (that would have become Fannie capital) for itself. Next, former FHFA Director Mark Calabria imposed a ridiculously and unjustifiably high capital requirement on Fannie that bore no relationship to the risk of the loans it was guaranteeing. The most recent risk-based capital requirement we’ve been given for the company by FHFA was for June 30, 2020, when it was 4.41 percent of adjusted total assets. Updated for Fannie’s asset size today, that would require it to hold an estimated $191.4 billion in core capital—some $270.1 billion more that it now has. Again, FHFA knows this, without Fannie having to file a capital plan.

          So, what should Fannie’s capital plan say it should do? Try to raise some of that in the market? Well, that might be possible if FHFA and Treasury still weren’t insisting on keeping the net worth sweep in effect, and only suspending it temporarily to let Fannie add slowly to its core capital through retained earnings (while adding an amount equal to these increased retained earnings to Treasury’s liquidation preference). What investor would buy common shares in the company under those circumstances? So, the only real alternative Fannie has is to retain earnings indefinitely until either two decades (or more) have passed and it finally closes its capital gap, or FHFA wakes up and realizes that it and Treasury must cancel the net worth sweep, and it must re-do the capital standard to where it aligns with the readily quantifiable risk of the company’s one business, and the companies can then go to the equity market with a chance to obtain the additional common and preferred shares they need.

          There is, however, a regulatory possibility that can’t be dismissed, and it’s hinted at on page 7 of the proposal, which says that FHFA “may require an Enterprise to…restrict asset growth or activities, and take other appropriate actions to remediate the violation of the law” [i.e., falling short of its statutory capital requirement]. If FHFA were to leave the sweep in place and not amend the capital standard to remove its layers upon layers of conservatism, then tell Fannie that it has, say, five years to meet its capital requirement, that would force shrinkage of its business, and by a massive amount. Part of me hopes FHFA actually does that, because it would focus wide attention on how ridiculous and indefensible the agency’s policies towards Fannie and Freddie have been, and perhaps finally be the catalyst for sensible change to those policies that we’ve been waiting to see for eighteen years.

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          1. It’s curious that this “bureaucratic exercise in process” seems to perhaps reflect Calabria’s influence. The capital plan requirement seems like a next step in Calabria’s recap&release process. It doesn’t seem related to what expectations are for Thompson’s FHFA. What’s hinted at on page 7 regarding “restrict[ing] asset growth or activities” also seems like something Calabria would advocate.

            Is there any chance that these capital plan requirements could benefit F&F via providing them & their financial advisors the opportunity to formally highlight the enterprises capital raising prospects and how the government could benefit via the warrants? It seems F&F will have the opportunity to present their own “Moelis Plans”.

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          2. I would hope, and think, that Fannie and Freddie’s top managements are in a dialogue with their regulator about not just this capital planning rule, but also their capital shortfall, its (obvious) causes, and the potential solutions to it. This is not rocket science.

            If FHFA really intends to leave the net worth sweep in place, and to continue to require Fannie and Freddie to hold more than 4 percent “risk-based” capital to cover a stress scenario that the Dodd-Frank (bank) stress test says they don’t need ANY capital to survive, then there won’t be an easy solution to this problem. Given the status quo, Treasury’s warrants for 79.9 percent of the common stock of both companies are worth less than $7 billion. To get the value of the warrants anywhere near where they were pegged in the Moelis plan ($100 to $150 billion), the government will have to make the companies valuable again. At the moment it seems intent on doing just the opposite.

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      1. No disrespect intended to Ms. Thompson, but this is a major disappointment. The banks and the Financial Establishment got their way on this one, as was made clear by this quote from one of the weekly mortgage market publications: “David Stevens, a former FHA commissioner, and an advisor to the Biden presidential campaign, said he was delighted with the nomination. ‘Sandra has already proven that she can be a great director,’ he said, adding that choosing her should end persistent rumors about other potential choices for the job.” Those “persistent rumors” were that Mike Calhoun of the Center for Responsible Lending–who knows what’s wrong with Fannie and Freddie, and how to fix it–might become FHFA Director, which is the last thing the banks wanted. Calhoun ALMOST got the nomination, but the banks stopped it. And now they will have a permanent director at FHFA who won’t rock their boat.

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        2. So does this mean no administrative solution from Biden administration? Seems like Build Back Better will require funding from somewhere other than tax raises. Recap and release would support that under Moelis plan, but will not with the overcapitalization in the current and proposed rule by Thompson. It will actually become much worse for affordable housing when loans start getting priced at the rule. That could theoretically trigger an economic slowdown when cost of mortgages makes it impossible to buy homes at current prices. Will need a price correction in the housing market. Maybe Biden wants that, but I doubt it, given the waves in the economy overall that will cause.

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          1. The GSEs cannot raise capital unless g-fees are increased (inadequate rate of return). Mr. Howard indicates that the market probably cannot bear an increase in g-fees. Will FHFA/Treasury wait over a decade for the GSEs to come into full compliance with the ECRF?

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          2. The Supreme Court’s (indefensible) ruling on the APA claim in Collins meant that some senior economic official in the Biden administration would have to make it a high priority to undo the terrible mess that Treasury and FHFA under previous administrations had gotten Fannie and Freddie into (extremely profitable, with very high quality credit-guaranty portfolios, yet nearly half a trillion dollars away from meeting the ridiculously high capital requirements set by a director who opposed their existence, and with no access to the capital markets because the net worth sweep has only been suspended, not canceled). With all of the other competing priorities at the moment—including getting to a version of Build Back Better that all Senate Democrats can agree on—Fannie and Freddie aren’t “top of mind” for anyone in the administration. But they are for the banking lobby. And it seems that this lobby succeeded in convincing someone close to Biden (I think I know who) that Sandra Thompson could be positioned as a great supporter of affordable housing, and that the administration should appoint her now. And obviously, no one else on the Biden team, even the supporters of Calhoun, thought it was worth having a fight over, so (unlike what the banks did when Calhoun was about to be nominated), they let it go.

            I don’t think I’d go as far as to say the Thompson appointment means “no administrative reform” from Biden, but it’s certainly made the path more difficult, and, if reform does happen, pushed it further off. And it will probably take some sort of crisis in the mortgage market to get someone in the administration to decide they have to do something to make Fannie and Freddie viable again. As I mentioned in the current post, if the Calabria capital requirements aren’t lowered, the companies will need to charge an average of 65 basis points just to earn a 9 percent after-tax return on that capital. (And the game FHFA is playing with capital credits for CRT issuance really won’t change this dynamic very much—while Fannie and Freddie will be able to reduce the capital charge component of their fee build-up, they will have to add nearly as much to compensate for the net income they will lose on their grossly non-economic CRTs.) A 65 basis-point average guaranty fee will, in my opinion, cripple the companies’ credit guaranty business, which is the mechanism by which capital markets investors provide financing from homebuyers. And if the banks continue to pile fixed-rate mortgages and MBS on their balance sheets and fund then with short-term consumer deposits and purchased funds, then interest rates move higher (as they may well do if inflation proves hard to bring back down), THAT could easily become the crisis that would get the Biden administration’s attention.

            It shouldn’t have to come to that, but these are the times we live in. If the big banks want something from politicians in either party, they generally are able to get it–although I didn’t think it would be this easy under a Democratic president.

            Liked by 2 people

          3. Tim

            it would be nice if the FHFA director actually had some good ideas, such as Calhoun’s proposal regarding monetizing the treasury’s warrants to vastly increase affordable housing spending, but that clearly is too much to ask from an administration that proposed as a banking regulator someone who wanted to eliminate private deposit banking. but good ideas have their own life cycle and maturation process, and Calhoun’s idea will germinate until someone in this administration, or the next one, is willing to tee it up.

            rolg

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        3. I’m sure there are at least some members of the banking committee that are very tired of the banksters always getting their way, and if they understood the situation would very likely oppose this nominee.

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          1. Biden Administration either deals with Fannie now or in three years the next president will deal with it and it will be under their terms. And many people think Donald Trump will get re-elected and we know what his intent is now based on his letter. Honestly, I got to believe the Dems wouldn’t want to put the fate again in the hands of the next president..

            Liked by 1 person

        1. From my reading of the actual filing (which several people sent me), Judge Lamberth certified all three of the classes–Fannie preferred shareholders, Freddie preferred shareholders and Freddie common shareholders–requested by plaintiffs, without objection by the defendants. It must have been true that none of the cases brought before Judge Lamberth were filed on behalf of holders of Fannie common, since they were not a proposed class.

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  14. Tim

    Collins 5th C en banc oral argument tentatively scheduled for week of 1/17/22. it is my speculation that this oral argument would not have been scheduled if Ps request to shift the burden of proof was not a real option under consideration by the en banc court. it is my further speculation that the Trump Letter had some significant effect in constituting as a live option the question of shifting of the burden of proof.

    in simple terms, the merits are a real problem for the DOJ. SCOTUS has made clear that Director Watt should not have been FHFA director for two years at the beginning of the Trump term IF POTUS Trump would have fired Watt on day1, had it been clear that he had that power. The Trump Letter confirms that POTUS Trump would have done so, and there is no one else whose testimony is relevant to what POTUS Trump would have done than POTUS Trump.

    So what if anything is the Ps remedy? Well, the remedy hinges on whether the recap of the GSEs could have been executed within the 4 year term if begun of day1. This is hard to prove, but it is also hard to disprove, so who has the burden of proof is crucial to the determination as to whether there should be a remedy. If there is a remedy, it is hard to understand how the remedy would be other than putting Ps in the position they would have been had there been a recap…and substantial evidence would be presented that there could be no recap without the write down of Treasury’s senior preferred stock.

    so as you intimated, Collins is becoming much more interesting than one may have thought.

    rolg

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    1. Do you think how far any clandestine capital raise “road shows” had progressed is relevant? In other words, if they were less than two years away from R&R, then is that relevant?

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      1. @Ron

        there is much the can be conjured as to how to carry one’s burden of proof with respect to a hypothetical counterfactual…whether the GSE would have been executed during Trump’s term if Watt was fired on day1. but let’s first wait to see which party has to carry that burden of proof.

        rolg

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    2. Thanks for the insights, ROLG!
      Curious on how you think about the following questions – In terms of the burden of proof, doesn’t the Trump letter pass the threshold and prove that FHFA caused harms to plaintiffs? Then when it comes to the remedy calculation, would that be more like a negotiation between parties and the judges, given there is no jury involved? Would the burden of proof still be a requirement in the remedy calculation?

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      1. @Alan

        so we are in somewhat unchartered waters here.

        1. I assume that the 5th C en banc is holding oral argument to determine whether or not to shift burden of proof to DOJ. If not, all bets are off.

        2.if so, then yes, a court would want to see some justification to shift the burden of proof, to have Ps present evidence that justifies this, and yes I do see the Trump Letter as providing that.

        3. There may be more to moving the burden of proof required by the 5th C en banc than the Trump Letter, but Ps have pointed out in briefing that most of the documentary evidence relating to this inquiry is in the hands of the DOJ and is of such a nature that the DOJ can exert executive privilege to refuse to produce this evidence to Ps…so there is an equitable reason, in addition to the Trump Letter, to shift the burden of proof to DOJ.

        4. SCOTUS created an untenable remand, for a party to prove a counterfactual…and there is much precedent in connection with constitutional violations in which SCOTUS did not require a P to prove a counterfactual to obtain a remedy for a constitutional violation..so this was abject negligence by SCOTUS…and kudos for P to try to shift the tsuris onto the DOJ.

        5. the burden of proof initially relates to the merits question…whether Trump would have fired Watt on day1 and, if so, what is the remedy. while this is not a normal case with a lot of precedent, I do believe that when you shift the burden of proof, that burden relates to not only merits but also remedy….meaning that DOJ would have to prove that a recap wouldn’t have occurred within the Trump term (‘merits”), and the remedy implications are that, for example, the senior preferred preference would have not been eliminated to effect the recap.

        6. as you intimate, this would be the perfect situation for the parties to settle on remedy, since the judge could say to both parties, watch out, you better settle, you may not want to hear what I have to say on remedy (because the judge has no idea what to say on remedy).

        rolg

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        1. Excellent explanations, @ROLG!

          Given the publication of the Trump letter, DOJ would have to submit any relevant documents to contradict the Trump letter before the en banc hearing. It doesn’t feel like DOJ has other choices given SCOTUS specifically described this scenario in their opinion. I also don’t think Mnunchin’s or Calabria’s emails would be sufficient in this case to rebut what is in the Trump letter.

          In terms of proof for damages, I believe that the Recap plan that Morgan Stanley developed should be the most relevant evidence related to what could have happened to the capital structure of the company, which is in government’s possession. Can the court or plaintiffs request that, if DOJ does not voluntarily provide it?

          It really comes down to these documents, and not clear though, if they can be obtained through shifting the burden of proof, FOIA or a court’s order.

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          1. @Alan

            if the burden of proof shifts, all sorts of documentary evidence and expert testimony would have to be introduced at the federal district court trial by the DOJ (and if DOJ cant meet its burden, the Ps win). You might have an interesting scenario where the DOJ may not want to put on the stand the investment bankers that were working on the recap, for fear that the testimony would not be advantageous to DOJ. Not too many investment bankers will say they cant get something done (for a fee), and from the bankers’ point of view regarding cui bono, where will their next fees come from, the institutional investors who stand to benefit along with the Ps, or the government?

            rolg

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    3. I remember the first EN BANC hearing well.

      For the constitutional question, 7 (WILLETT, joined by JONES, SMITH, ELROD, HO,
      ENGELHARDT, and OLDHAM) out of 16 Judges wanted to cancel the net worth sweep based on the constitutional violation alone. 2 more judges, namely Duncan and Owen, thought that the supreme court rulings up to that point did not provide precedent for a remedy beyond striking the violating sentence.

      However, 9 judges, including Duncan and Owen, ruled for plaintiffs in the APA case, so were principally inclined or at least willing to grant a meaningful remedy to us shareholders.

      This gets very interesting in January. SCOTUS has now directly opined that there is a remedy available beyond just striking part of the law. So will this be enough to turn at least Duncan and Owen around? Why wouldn’t it be?

      This leaves us with the question of remedy.

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      2. If you read the en banc majority ruling re: unconstitutional remedy closely, the 9 judges who ruled against vacating the NWS claimed to do so because President Trump wasn’t opposed to the NWS as one of their points… This rationale is completely disproven by the recent Trump letter as well as the fact that the ruling was written in September 2019 and the admin promptly ended the cash payments of the NWS shortly after the ruling was released with the Calabria/Mnuchin duo in charge. It will be interesting what those 9 judges make of the SCOTUS ruling and Trump letter combination today.

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    1. There was a flurry of responses to FHFA’s proposed amendments on the ERCF in the last few days before the comment deadline, and because of the Thanksgiving weekend holiday and other priorities I’ve only been able to take a brief look at most of them. I’ve skimmed the responses from the major institutional or political (trade group) commenters, and so far haven’t seen anything surprising. The entities that historically have supported limits on Fannie and Freddie’s competitiveness, pricing or market share say they support their CRT programs because they move risk away from them (only remote or zero-probability risk, at a very high cost) and protect the taxpayer (which they emphatically do not: CRT programs that cost Fannie or Freddie $30 dollars in normal times and $3 dollars even in a worst-case scenario to transfer $1 dollar of credit losses significantly weaken the companies’ abilities to absorb the credit risks they do face), and are either mute on or supportive of the proposed FHFA changes to prescribed buffer leverage amount (PLBA) and CRT capital credits, and deem them to be the only changes necessary to the Calabria capital rule. And of course the investors in or issuers of CRTs are very happy with the proposed amendments, since they give Fannie and Freddie a strong incentive to issue tremendous amounts of CRTs–and in Fannie’s case, a reason to re-start its CRT program after a year of suspension–that provide highly attractive yields and very low probabilities of actually transferring credit losses.

      I did read the summary of the comment submitted by the Center for Responsible Lending (above), and agreed with almost all of it; I will read the entire document as soon as I can. And I was glad to see the Urban Institute point out the problems with the “countercyclical adjustment” FHFA put into the ERCF in an attempt to mitigate the procyclicality of basing the risk-capital stress test on current value loan-to-value ratios; this adjustment further complicates the capital rule without solving the real problem.

      Yet because the large majority of the comments FHFA received on its proposed rule were positive–as I expected them to be–I believe Director Thompson will simply adopt it as proposed. I don’t expect her to tackle the obvious overcapitalization of the ERCF, or the glaring inconsistencies between the ERCF, the Dodd-Frank stress tests and the structure and economics of Fannie and Freddie’s CRT programs with any urgency, if at all. That level of reform will have to await the Biden administration appointing a new permanent director of FHFA.

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    3. Well, this letter will at least give the Fifth Circuit justices something to think about. The key statement here is, “From the start, I would have fired former Democrat Congressman and political hack Mel Watt from his position as Director and would have ordered FHFA to release these companies from conservatorship.” There is little doubt about the first action. As to the second, President Trump had 20 months to “order” Mark Calabria to release Fannie and Freddie from conservatorship and never did. That, to me, does weaken the hypothetical that he would have done that had he be able to fire Watt. But it will be up to the justices to make this determination.

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      2. Tim, I think the last sentence in Trump’s letter address your point about ordering “FHFA to release these companies from conservatorship.” Trump Claims his administration was “denied the time it needed to fix this problem because of the unconstitutional restriction on firing Mel Watt.” So while 20 months wasn’t enough time to begin and complete the work to release the companies from conservatorship, Trump is stating a full 4 years from day one would have been sufficient.

        Craig Phillips discussed this in an interview where he said had they not had to wait to fire Watt, there would have been ample time to complete the privatization as well. This certainly should tilt the favor in plaintiffs favor.

        Will be interesting to see how the 5th circuit judges try to untangle this mess of a ruling handed down from SCOTUS with Trumps curveball thrown in.

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      3. Tim,

        How do you think this plays with current administration? Will they be forced to take the other side against this Trump letter and double down and try to preserve NWS? Will they want to be the ones that accomplish what Trump claims he would have accomplished if he had authority to fire Watt up front and make a “huge profit” for the American people?

        Clearly this letter helps legally in the 5th circuit for Collins, but I’m wondering if that fails, does it help or hinder the chances of an administrative resolution?

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        1. The Fifth Circuit can’t invalidate the net worth sweep; all it can do is determine that Mel Watt’s implementation of the sweep caused some identifiable harm to plaintiffs, then award damages. It’s possible, though, that if the senior Biden administration officials who have Fannie and Freddie within their purview think there is a chance the Fifth Circuit might require them to pay significant monetary damages, that might be a swing factor in favor of their doing what they should be doing in any event: declaring the senior preferred fully repaid, voluntarily canceling the sweep and Treasury’s liquidation preference, and putting the companies on a path out of conservatorship.

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          1. From what I calculate using FHFA’s Table 2 (dividends paid to UST), Fannie paid $18.232B in NWS dividends between Q1 2017 (beginning of Trump’s term) and Q3 2019 (when FnF stopped paying dividends to UST due to the September 2019 letter agreement). Freddie paid $26.988B, for a total of $45.220B.

            Click to access Table_2.pdf

            That could be what UST is ordered to pay back to FnF, under the assumption that if HERA had allowed it, Trump would have removed Watt in January 2017 and ordered an agreement similar to the September 2019 letter agreement stopping the NWS.

            Perhaps the court would increase the liquidation preference of the SPS by the same amount, but it’s clear from Presidential budgets that each dollar of the SPS liquidation preference is worth much less than one dollar in cash, and it’s cash UST would be ordered to pay.

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          2. Other than the fact that you’ve reversed Fannie and Freddie (between 12.31.16 and 9.30.19 Fannie paid $27.0 billion to Treasury, and Freddie paid $18.2 billion), your numbers are correct. But then you’re into hypotheticals, and you’ve also omitted one significant point: between those two dates, both companies paid somewhat less under the sweep than they would have owed under the original 10 percent dividend requirement (Fannie about $5 billion less, and Freddie about $1.5 billion less). It was the net worth sweep that caused the real harm to the companies, and there the Supreme Court’s curious assertion that an acting director of FHFA is removable by the president and thus constitutionally appointed puts more than all of the damages to the companies caused by the net worth sweep (which occurred in 2013 and 2014) beyond the scope of the SCOTUS remand to the Fifth Circuit for remedy.

            As you know, what Calabria and Mnuchin did in September of 2019 was allow Fannie and Freddie to forego their required sweep payments and thus build up their core capital, in exchange for a dollar-for-dollar increase in Treasury’s liquidation preference in them. That voluntary decision by FHFA and Treasury came at no cost to the Treasury (albeit it did carry the opportunity cost of not receiving the foregone payments). I have a hard time seeing how a court would determine that an equitable remedy for not having made the voluntary decision to (at no cost) suspend the sweep in the first quarter of 2017 would be for Treasury to have to pay $45.2 billion in cash back to the companies (and increase its liquidation preference at the same time) today. And I’d be very surprised were that to happen.

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          3. Tim/midas

            now that we are into hypos, there is a scenario where, if the court were to find that it is more likely than not that the GSEs would have been recapped within Trump’s POTUS term if Director Watt was fired on day1 (yes, a big if), then the expectancy damages sought would be to put the shareholders in the position they would be if there was a recap…and to do a recap, Ps would argue that the SPS preferred balance would have to go away in its entirety (which seems to me to be correct as a practical matter).

            so Collins would argue for essentially the same damage remedy as would be available if the NWS was invalidated. remember, this is exactly what Trump says he would have done in the letter. so game on…but it will be really on if the 5th C shifts the burden of proof.

            rolg

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          4. Tim,

            Thanks for the correction. For some reason whenever I see Fannie and Freddie numbers side-by-side I assume that Fannie’s numbers are on the left.

            My impression was that the remedy is to set things to where they would have been had Trump been able to remove Watt at will. Had the September 2019 letter agreement happened in January 2017 instead then I don’t see why FnF wouldn’t have the extra $45B in cash; the agreement suspended all dividend payments and not just NWS payments.

            Trump’s assertion that he wanted FnF released from conservatorship means he wouldn’t have been in favor of 10% cash dividends instead of the NWS either; as you point out those would have drained FnF’s capital even more effectively than the NWS itself. Those payments would also have rendered/kept the common stock economically worthless, while Trump asserts he would have had UST sell those shares “at a huge profit”.

            All of this is not what I think *must* happen, just what I think would comport with SCOTUS’s ruling. The Fifth Circuit, or perhaps the Southern District of Texas on remand, will have to decide whether retrospective relief is available and what form it would take.

            This is just how I understand the situation, further corrections are welcome.

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  17. Tim

    I found this tidbit interesting (from IMF News): “Banks held $2.859 trillion of residential MBS in available-for-sale and held-to-maturity portfolios at the end of September. That was up 2.8% from June and marked the 14th consecutive quarterly gain.”

    one might infer that banks have ceded much of the mortgage origination market to nonbanks (eg rocket mortgage), which seem to be more efficient, but have maintained their exposure to the housing credit as an investor of GSE MBS. my simple mind would have thought that these banks would want to strengthen the creditworthiness of the MBS guaranty in favor of their MBS holdings by seeing the GSEs recapped.

    as I recall, one of your takes was that having higher guarantee fees for the GSEs increased the profit for banks which originate and hold mortgages…but is the market transitioning such that banks are less concerned with origination profits and more concerned with net interest income afforded by the MBS/deposit rate spread?

    rolg

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    1. From the standpoint of the creditworthiness of Fannie and Freddie’s MBS, banks are perfectly happy with them remaining in conservatorship, since they have the SPSA line from Treasury backing them. Banks aren’t the ones pushing for “recap and release” of Fannie and Freddie; they’re either opposed to it or keeping mum about it.

      On your “originate and hold” question, there are a couple of things going on. First of all, banks do not seem too concerned about their recent loss of mortgage origination share to nonbanks. Since the conservatorships, two-thirds of the near-doubling in bank holdings of 1-4 family first mortgages and MBS–from $2.23 trillion at December 31, 2007 to $4.42 trillion at June 30, 2021 (I haven’t updated my data for September yet)–have come in the form of Fannie or Freddie-guaranteed MBS and REMICs. Banks don’t care who originates the mortgages that end up in those securities; they just buy them on issuance, or in the secondary market.

      And, yes, banks are buying the MBS for the spread income, since their cost of consumer deposits is essentially zero (at the moment; if we see an upswing in inflation that will change). But many banks still do obtain their residential mortgages via the “originate and hold” process. And for those banks, higher guaranty fees for Fannie and Freddie are a benefit to them. All originators, including smaller banks, base their primary mortgage market quotes on the cost of selling into the secondary market. So when that cost rises because of higher guaranty fees, banks who don’t sell into the secondary market still charge the higher primary market rates, and keep the additional spread for themselves.

      Banks who buy Fannie and Freddie MBS don’t get that additional funding spread (it’s absorbed by the higher guaranty fees), but they benefit through a lower capital cost. And that benefit is substantial. It’s hard to know what banks’ net funding spread on mortgages is, because we don’t know how they allocate their administrative expenses. But let’s just say it’s 80 basis points. Unsecuritized mortgages held in bank portfolios have a 50 percent Basel risk weight. On 4 percent capital, 80 basis points of net spread income results in an after-tax return on equity of 15.8 percent. Fannie and Freddie MBS, in contrast, have only a 20 percent Basel risk weight. And on top of that, the administrative costs of buying an MBS in the market are trivial compared to the “brick and mortar” cost of originating them. Banks save far more than the average 45 basis-point cost of a Fannie or Freddie guaranty fee in admin expense, but even if that were all they saved, their ROE on 80 basis points of MBS net spread income at 1.6 percent capital would be almost 40 percent.

      Banks, therefore, are VERY happy with what Treasury and FHFA have done with Fannie and Freddie since the conservatorships. They’re getting higher spread income on the mortgages they originate and hold because the companies’ guaranty fees have been pushed up by 20-plus basis points (and if the Calabria capital rule is not changed will be heading materially higher), and their own capital rules allow them to save on both administrative expenses and capital costs by letting nonbanks do the origination, leaving them with very attractive amounts of (FDIC insurance-subsidized) spread income.

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  19. Hi Tim,

    Thank you for your continued thoughtful work on these important topics. I’m wondering how you think about the impact of a new disclosure in FHFA’s Performance and Accountability Report, released yesterday.

    Click to access FHFA-2021-PAR.pdf

    On page 39, the paragraph under Performance Measure 1.3.3 ends with “FHFA plans to issue a proposed rule on capital planning by the end of 2021.” The figure on page 38 shows that this rule issuance is the only unfinished performance measure relating to the strategic objective called “Responsibly end the conservatorships of the Enterprises.”

    Do you think this rule issuance would be significant? Are there reasons FHFA would issue a rule on Enterprise Capital Planning other than creating a pathway for the Enterprises to retain and attract equity capital?

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    1. No, my sense is that this is just the FHFA bureaucracy going through its “to dos,” one of which is to require Fannie and Freddie to issue capital plans. I will, though, be interested to see when FHFA does issue its “proposed rule on Enterprise capital planning” whether it makes any reference to the capital circumstances in which the companies find themselves, which for Fannie at September 30, 2021 was negative core capital of $79 billion, estimated required risk-based capital of $196 billion, and a shortfall to full capitalization of $275 billion, with no access to the capital markets because of the net worth sweep. I can’t imagine what FHFA might be expecting the companies to come up with to overcome the capital hole that FHFA and Treasury have put them in. Perhaps it will just say, “please file your capital plans.” But if FHFA meets its self-imposed deadline, we should know before the end of the year.

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    1. Simply because Fannie is paying a premium to repurchase these CRT issues, you can’t conclude that they’ve not transferred any credit losses (although I think it’s very likely they have not). Most if not all of Fannie’s CRTs trade at a premium, based on the fact that their loss assumptions at time of pricing have turned out to be much too conservative. I suspect the reason that Fannie is buying these specific issues back is that it’s concluded they are worth more “dead than alive”: that is, the price Fannie is paying to repurchase them is less than the present value of the interest payments it would have to make were it to leave the securities outstanding.

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      1. Tim,

        I don’t quite understand this. Issuing the CRTs in the first place is uneconomical and yet FHFA is giving Fannie and Freddie every incentive to do them. Why would they direct or allow Fannie to repurchase a CRT issue for economic reasons?

        Also, I saw this in FHFA’s fact sheet regarding the changes to the PLBA: “An economically sensible CRT is not one that is low-cost on an absolute basis, but rather one where the cost to the Enterprise for transferring the credit risk does not exceed the cost to the Enterprise of self-insuring the credit risk being transferred using equity capital.”

        https://www.fhfa.gov/SupervisionRegulation/Rules/RuleDocuments/Fact%20Sheet%20-%20Capital%20NPR_Final%20Posted-Updated%209-23-21.pdf (top of page 4)

        It appears FHFA has a different definition of an “economically sensible CRT” than most of us would consider, well, sensible. How does “self-insuring the credit risk being transferred using equity capital” cost anything, especially when Fannie and Freddie cannot actually raise any capital?

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        1. On your first question, I do not know what role FHFA plays in any decision by Fannie (or Freddie) to repurchase an outstanding CRT.

          On the excerpt from the fact sheet on the PLBA change, FHFA is saying exactly what I’ve described it as doing: setting an indefensibly high capital requirement (although it’s not admitting to that) for Fannie if it takes credit risk itself, but then reducing that required capital (which was never necessary to begin with) if Fannie pays far more in interest payments on CRTs than it can ever hope to receive in credit loss transfers, so the buyers of the CRTs (and FHFA) can pretend that risk is being moved away from Fannie when it really isn’t. It is an absolute scandal that FHFA is doing this. It weakens Fannie’s ability to withstand real credit risk, and actually takes “private capital” OUT of the mortgage market, rather than bringing it in.

          I hope some official in the Biden administration recognizes what’s happening here, and puts a stop to this lunacy.

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    1. The press release on this transaction says, “Fannie Mae will retain risk for the first 60 basis points of loss on a $31.7 billion pool of single-family loans with loan-to-value ratios greater than 80 percent and less than or equal to 97 percent. If the $190 million retention layer is exhausted, 20 insurers and reinsurers will cover the next 315 basis points of loss on the pool, up to a maximum coverage of approximately $998 million.”

      What’s missing, though, is the economic context. These are mortgages that carry private mortgage insurance, which significantly reduces their loss severity on default. Fannie publishes data on recent annual default rates and loss severities for these loans in its Connecticut Avenue Securities Investor Presentations. In the January 2021 version of this publication, it says that for its five most recent origination years that have enough loss data to be meaningful—2012 through 2016—the average annual default rate for loans with LTVs over 80 percent and up to 97 percent has been 0.2 percent, and their average annual loss severity has been 0.11 percent. That’s an annual credit loss rate of 2 basis points per year. It would take 30 years of credit losses of 2 basis points per year for the 60-basis point threshold of credit losses to be reached—at which point the mortgage insurers that are counterparties to this deal would have to begin picking up losses—and the term of the insurance is only 12.5 years. On top of that, Fannie is paying for insurance for up to 375 basis points of losses, which is close to 200 years of losses at the current credit loss rate. As I noted in my current post, even in a repeat of the Great Financial Crisis the total losses on an insured pool of loans are unlikely to exceed 150 basis points of the pool balance. This deal is a giveaway to the mortgage insurers, just as similarly-structured Connecticut Avenue Securities deals are giveaways to investors.

      The only reason Fannie is doing these grossly uneconomic deals is to get the capital relief FHFA is proposing to offer them. And that’s the scandal. FHFA knows the Calabria capital standard is far too onerous, but rather than reduce it, it only allows the companies to “buy it down” somewhat by issuing CIRTs or CRTs that will lose them billions of dollars in the real world, through greatly overpaying for insurance that will never pay off. And Fannie’s customers are bearing the cost of that. Shame on FHFA.

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      1. Tim,
        Agreed and extremely well said.
        “And Fannie’s customers are bearing the cost of that.”
        Are these billions primarily coming out of Fannie’s ‘pocket,’ or mortgage holders, or a combination of both? What would be the % Fannie, the % mortgage holders?
        What realistically can be done? TIA
        VM

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        1. At the moment, the costs of Fannie’s risk-sharing transactions are “coming out of Fannie’s pocket,” and thus lowering its retained earnings and slowing the pace of its capital retention. Fannie said in its third quarter 10Q that in the first nine months of the year it had paid a total of $1.025 billion in cash for CAS, CIRT and lender risk-sharing transactions, which is $1.367 billion on a full-year basis. (Fannie actually paid more than that during the first nine months of 2020; shutting its CAS and CIRT programs down for much of 2021 lowered its risk-transfer costs for the year to date.) It’s possible that without FHFA’s involvement and direction Fannie would be doing some type of risk-sharing, but if it did none the increment to its 2021 retained earnings (i.e, the after-tax value of its annualized risk-sharing costs this year) would be $1.08 billion.

          It’s hard to tell if Fannie is passing any of these risk-sharing costs on to homebuyers, or if it is just absorbing them. We know from the July 2014 paper from FHFA, “Fannie Mae and Freddie Mac Guaranty Fees: Request for Input” that in the first quarter of 2014 the companies’ target average fee to produce their desired return on capital was 61.8 basis points, but they only were able to charge 50 basis points. And that was at an average capital percentage of only a little over 3 percent (but also at a marginal corporate tax rate of 35 percent, versus 21 percent today). I noted in my current post that to earn a 9.0 after-tax return on its current “Calabria standard” capital, Fannie would need to charge an average of 65 basis points on its new business. It’s not close to doing that, which means it’s implicitly absorbing this higher cost of capital itself. That may be fine for a company in conservatorship, but if and when it gets out it will be a problem.

          The last point to make on this topic is that FHFA’s current proposal to give Fannie and Freddie a break on their required capital if they issue CRTs won’t help homebuyers. Yes, Fannie and Freddie will be able to reduce the component of their guaranty fees related to capital charges, but they will then have to add nearly an equal amount to their guaranty fee buildup to compensate for the wasted interest payments made on their non-economic CRTs. So in that manner, once the companies ARE pricing to their full cost of capital, it will be homeowners who bear the cost–whether if be for the cost of the unnecessary capital itself, or the cost of the CRTs the companies are issuing to (modestly) reduce the amount of that unnecessary capital.

          As to the “what realistically can be done” question, I did my best to publicize the issue in the current blog post. I’m also trying to get certain people in the financial media (and no, I won’t give names) to do a story on this, but so far haven’t had much success; it’s always been hard to convince anyone to take on an issue that puts the Financial Establishment in a bad light. And I know there are people in the Biden administration who have been exposed to my takes on the capital and CRT issues, but I don’t have a good sense for their appetites for engaging on them–although now they’re very focused on getting their infrastructure and Build Back Better legislation passed.

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  22. Hi Tim,
    You may have addressed this in the past, but if not I was wondering if you could give us your view on it.
    -Fannie reports $4.8B of net income.
    -reports an asset base increase of $223.5B
    That means the lowest possible min cap req allowed by HERA, 2.5% of bal sht assets, went up $5.58B.

    Thus Fannie has *lost ground* relative to its cap reqs needed for release once again.

    Freddie- $2.8B income, asset base up $310.5B
    2.5% of that is $7.76B, meaning Freddie *lost* $5B of ground versus its lowest possible min cap req.

    Any thoughts?

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    1. Yes; the net income increases you cite for Fannie and Freddie are from the second quarter to the third quarter of 2021, while the asset size increases for both companies are from December 31, 2020 to September 30, 2021, which is a three-quarter period. So your “lost ground” observation for each company is based on an erroneous calculation, and thus incorrect.

      Neither company reported what their September 30, 2021 capital requirement would have been under Calabria’s “Enterprise Regulatory Capital Framework,” or ERCF. (In its 10 Q, Fannie said, “We are required to report capital amounts as determined under the enterprise regulatory capital framework for periods beginning after 2021.”) The latest ERCF percentage we have for Fannie was for June 30, 2020, when it was 4.65 percent of total assets. Assuming it’s been the same since then (which it very likely hasn’t), then Fannie’s required capital at September 30, 2021 would have been $195.7 billion, a $10.4 billion increase from its required capital of $185.3 billion as of December 31, 2020. Fannie’s core capital at September 30 of this year (which it does not publish; you have to calculate it) was a negative $78.7 billion, down from a negative $95.7 billion at December 31, 2020. Fannie therefore has added $17.0 billion to its core capital (making it less negative) this year, while its required capital has risen by $10.4 billion, meaning that for 2021 to date the company has managed to come $6.6 billion closer to meeting Calabria’s definition of “adequately capitalized.” Only an estimated $274.5 billion still to go.

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  23. Tim

    3Q 2021 results are out for Fannie and Freddie and they are as stellar as we have become accustomed to recently. The Fannie 10Q: https://www.fanniemae.com/media/41811/display.

    it is remarkable that Fannie (which I focus on) has grown capital by $40B over the past 3 years, during which period there was an economic shutdown from the covid pandemic, resulting in broad based foreclosure and eviction forebearances. the GSEs didnt even break a sweat. A “re-Ipo” is quite feasible given these results.

    I look forward to your thoughts on their financial performance.

    rolg

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    1. Fannie’s earnings for the third quarter were as I expected–not as good as the second quarter, but still above a level that’s sustainable over the next several quarters.

      Two factors have been fueling the company’s earnings recently–still low (albeit now rising) mortgage rates, and exceptionally strong home price growth. Both have resulted in rapid business growth and a lower provision for credit losses. I continue to be surprised as to how low Fannie’s reserve for single-family credit losses is going. At September 30, 2021, this reserve was just $5.45 billion, or 16 basis points of Fannie’s conventional book of single-family business. Under CECL, this supposed to be the companies’ best estimate of that $3.40 trillion book’s LIFETIME expected credit losses. The drawdown in the single-family reserve is the main reason Fannie has recorded a $4.1 benefit for single-family credit losses this year. But that’s not sustainable. Nor is the $8.6 billion recorded to date this year in amortization income from Fannie’s credit guaranty business. That’s been driven by a large volume of mortgage prepayments, which result in the faster recognition of up-front guaranty fees (loan level price adjustments, or LLPAs) on the prepaid loans. As that slows down, that will lower the amount of upfront fees amortized into current-period income.

      Two positives that should carry through are Fannie’s now much larger book of single-family business ($3.40 trillion this September versus $3.09 trillion last September) and the higher average level of single-family guaranty fees–45.4 basis points this past quarter versus 44.4 basis points in the same quarter of 2020. These two factors alone will increase Fannie’s sustainable annual earnings by a little over $1.5 billion, to close to $16 billion after-tax.

      I’ve been waiting to see how the new Calabria capital rule ( the ERCF) that officially went into effect this February would impact Fannie’s charged guaranty fees, and it looks like I may have to wait a while longer. In its third quarter 2021 10Q Fannie said, “In our 2020 Form 10-K we stated that we measured our risk and returns on our current business against the conservatorship capital framework, and that we expected to cease using the conservatorship capital framework to make business and risk decisions sometime in 2021 and to use instead the new enterprise capital regulatory framework and certain risk measures. We now expect our transition to the enterprise regulatory capital framework will continue into 2022.” Fannie gave no reason for this extended transition period.

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      1. Tim,

        First, thank you for the correction above. Tony’s post is a tweet of mine and I had made a careless mistake in comparing the asset base rise in the 9 months to 9/30/21 to the earnings just in Q3.

        Second, do you know which of the two alternatives in Watt’s CCF (Conservatorship Capital Framework) Fannie and Freddie are pricing to? The higher was 2.5% of balance sheet assets and the lower was 4% of non-trust balance sheet assets plus 1.5% trust assets. Or are they pricing to some other part of Watt’s capital rule?

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        1. The Conservatorship Capital Framework is essentially the June 2018 proposed FHFA capital rule. Its risk-based component was 3.24 percent when it first was issued, but as I noted in my post it fell to 2.25 percent at the time the Calabria capital rule came out. So the companies since that time would have been pricing to the minimum capital requirement of the CCF, which I assume they took to be 2.5 percent.

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          1. I wrote my answer on Fannie and Freddie’s CCF pricing too quickly. The roughly 100 basis-point drop in capital required by FHFA’s June 2018 capital standard (based on the CCF) between September 2017 and September 2019 was for the companies’ existing books; the capital they use for pricing new business would not have fallen nearly as much, and may in fact have increased.

            One of my criticisms of the June 2018 FHFA capital standard (which also applies to the Calabria standard) was that using current loan-to-values (CLTVs) as the basis for calculating risk-based capital complicates guaranty fee setting. At the time you price a pool of loans, you know what its original LTVs are, but you have to guess at what the CLTVs will be over the life of the pool. The only way you can do that is by making an assumption about long-term home price growth. And that raises an interesting point that I really hadn’t thought about until now: it’s entirely possible that today, pricing to the CCF (and potentially the Calabria standard as well), Fannie and Freddie’s guaranty fees on new business will be HIGHER than they were a few years ago because, given the extremely rapid growth in home prices over the past several years, the expected long-term growth in future home prices should be lower. (Trees don’t grow to the sky.)

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  24. Am I missing something with todays notice of proposed rule making?

    https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Issues-NPR-Introducing-Additional-Public-Disclosure-Requirements-for-the-Enterprise-Regulatory-Capital-Framework.aspx

    Why would this nugget not just simply be part of the actual capital rule? Why does a requirement for such disclosure even require a rule making? Or 6 months to apply it after the final rule? What would be the purpose of this?

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    1. perhaps the FHFA could also publish a proposed rule, relating to additional public disclosure, that would require FHFA to disclose the results of GSE stress tests promptly. unfortunately, assessing GSE capital risks may not be as important as assessing FHFA’s lack of transparency and regulatory incompetence.

      rolg

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      1. You don’t have to get too far into this notice of proposed rulemaking (NPR) before reading that, “The proposed rule would implement standardized approach public disclosure requirements for the Enterprises that align with many of the public disclosure requirements for large banking organizations under the regulatory capital framework adopted by United States banking regulators,” and soon after learning that a rationale for the rule is “establishing a level playing field for public disclosures between the Enterprises and large, domestic banking organizations.” FHFA admits that “enhanced public disclosures would necessarily be somewhat costly for the Enterprises,” but then goes on to inform us that it will require Fannie and Fannie to disclose even more than banks do, “to reflect the ERCF [the Calabria capital rule], such as those referring to statutory core capital and statutory total capital, adjusted total capital, the prescribed capital conservation buffer amount (PCCBA), and CRT.” Starting on page 22 of the NPR, and running through page 35, are a list of required disclosures that I didn’t even attempt to try to count. The NPR is signed by Acting Director Sandra Thompson.

        I have kept an open mind as to whether Ms. Thompson might be someone the Biden administration could count on to move FHFA off the path of regulating and capitalizing Fannie and Freddie based on fictional depictions of their risks, and to the wishes of the banking community and the Financial Establishment. With this NPR, I can now definitively say that my opinion is, “No.” As did the September 16 proposed amendment to the ERCF that is the subject of my current blog post, the NPR builds on that completely contrived capital rule as if actually were reflective of the companies’ business risk, then asks them to report in micro-detail on minutia that FHFA pretends will place the financial system in grave peril if the public is not able to monitor them closely on a quarterly basis. This NPR is the official dropping of the “other shoe”: gross overregulation on top of gross overcapitalization of two companies who take one risk on one asset type, for which (unlike commercial banks’ assets) ample data exist already, enabling investors and others to clearly see that their risk is exceptionally well managed and controlled, in spite of FHFA’s pretense that the opposite may be true.

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        1. [Edited for length]

          Tim–You have, again & again, over the many years addressed what would be appropriate capital requirements for the GSEs.

          While I know it is your policy to demur on the execution of implementing changes to address the required capital for the GSEs, I was wondering if you may be inclined to opine on “CoCo Bonds”. They are used by European banks (primarily via dictate by regulators). A contingent convertibles expand on the concept of convertible bonds by modifying the conversion terms. As with other debt securities, investors receive periodic, fixed-interest payments during the life of the bond. Like convertible bonds, these subordinated, bank-issued debts contain specific triggers that detail the conversion of debt holdings into common stock. The trigger can take several forms, including the underlying shares of the institution reaching a specified level, the bank’s requirement to meet regulatory capital requirements, or the demand of managerial or supervisory authority.

          Contingent convertible bonds could be an ideal product for the GSEs if they are undercapitalized as they come with an embedded option that would allow the GSEs to meet capital requirements and limit capital distributions at the same time.

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          1. No, I don’t intend to offer advice on what specific types, or combinations, of securities Fannie or Freddie should use to meet their capital requirements. That is a decision I believe is best left to company management, with the advice and assistance of their investment bankers.

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  25. Tim

    I wonder if the irony is lost on the Biden administration.

    we are witnessing the struggle that it is for the federal government to appropriate money for social policy objectives that POTUS wants to achieve with “Build Back Better”. this is either a bug or feature of divided government and the separation of powers, and I wont venture into the political waters to characterize which it is.

    yet, the Biden Administration can implement massive federal investment for affordable housing objectives on its own initiative simply by monetizing Treasury’s financial state in the GSEs by returning them to the public capital markets. All it would take is to nominate Calhoun to FHFA director, who will be confirmed because he is eminently well qualified. then director Calhoun would implement his plan for a massive increase in affordable housing federal investment: https://www.responsiblelending.org/media/new-report-published-brookings-proposes-historic-investment-closing-racial-homeownership-gap

    Does the Biden Administration understand this, or is it too simple and easy for DC?

    rolg

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    1. I think some people within or important to the Biden administration do understand it–that’s how the Calhoun nomination got to the 1-yard line. But to get it past the objections of the banking lobby–which are what got Calhoun’s nomination stopped–getting Fannie and Freddie properly capitalized and on a path to exit conservatorship will have to become administration policy. And this is where the “Build Back Better” saga comes in. Right now, top policy officials are concentrated on, and consumed by, getting it passed with as much substantive content as possible. But once we have a bill (or know that one’s not possible), that’s when the lure of being able to have a significant impact on housing affordability that doesn’t have to go through Congress, and not only has no cost but will bring money into Treasury (through conversion of the warrants and sale of the associated stock) could prove hard to resist–and worth blowback from the banking lobby, although it really doesn’t have any substantive argument in favor of why Treasury and FHFA should keep Fannie and Freddie overcapitalized and in perpetual conservatorship, for the banks’ benefit.

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      1. I think the ongoing Governor’s race in VA may have some impact on whether or not the Biden administration gets going with some urgency in implementing their housing agenda. I went to vote today (in NVA) at my local library. I was stunned, that for early voting, and a middle of the week, and an off year election, the turn out was very heavy. And this polling place is open every day until the election. Right now it could go either way.

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        1. @jimm

          without venturing too far into the partisan political weeds, I have been thinking about this some and I sense a potential pivot point for the Biden administration, insofar as it may view the future of the GSE conservatorships.

          the whole BIF/BBB legislative controversy (understanding that the outcome is not yet written) may lead POTUS to conclude that governing from the middle should receive more emphasis…especially if there is a new R Va governor. time to announce a new policy “win” especially when you can do it without congressional involvement. if a state that went blue in the POTUS election goes red in the governor election one year later, that can capture the attention of the Biden administration.

          BBB sets forth some $150B for housing spending, and this has not been a subject of negotiation and controversy, such as have the tax/climate change etc provisions…but this appropriation is for the next 5 or so years, and POTUS can ensure continuing investment in housing initiatives for a longer term by implementing the Calhoun/Ranieri plan…and not expect any substantial political blowback. this all makes too much sense, which gives me pause…

          rolg

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          1. Rolg – Definitely not intending to digress this blog into a political discussion and I will make no more comments along these lines after saying that the fact that the state has turned increasingly and steadily blue over at least the last 12 years and to suddenly reverse (the GOP candidate would only have to make it very close and not necessarily win) is what will make the Biden admin take notice. Its good that the election is only one year into the admin and hopefully gives the administration time to implement a well reasoned (and funded) housing policy which should include releasing the GSEs.

            Thanks Tim for this forum!

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  26. Tim,
    You are being shunned and treated as a ‘biased source’ by many who do not want the perception of F&F to ‘go back.’ This is highly unfortunate because a lot of what you state makes sense. The Financial Establishment is running the show for their interests regardless of what is ‘right’ or what should be done. This is most unfortunate, but you called how powerful they are.

    Where do we stand on Calhoun? Is his nomination completely DOA?

    Thompson seems to be a simple-minded, maleable Financial Establishment/Banking shill that ‘more capital is good, more capital means an additional buffer should something go wrong.’ Regardless again of the consequences you highlight.

    You are dead right that the Commerical Banks have eaten F&F’s lunch over the last decade and the numbers prove it! Money that could have resulted in profits to F&F, recapitalizing the GSEs to make the housing market more, not less, efficient.

    May I suggest that if you push for Sandra Thompson to formally be made FHFA Director so that the ‘powers that be’ may as a knee-jerk reaction push for Calhoun? I say this tongue-in-cheek since the world seems to be getting madder, not saner.

    Do you have any comment on why the Commons and JPS have experienced (relative) strength very recently?

    VM

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    1. VM– What you call the “shunning” is nothing new and certainly not unique to me: attempting to discredit the messenger when you don’t have a valid critique of the message. I expect it, and frankly am surprised I don’t see (or hear about) it more. I’m in direct contact with a lot of people–including committed “bankistas”– and I don’t get a whiff of it. But it wouldn’t surprise me if among some people privately that’s a common way not to have to answer questions about the points I’m making. My response would be, “Take the name off the top of the piece, read it, and tell me what you think is wrong with it.”

      Calhoun’s nomination certainly has stalled, but it won’t be dead unless and until Sandra Thompson is nominated as permanent director. I don’t expect that anytime soon.

      I don’t speculate about or comment on movements in Fannie and Freddie’s common or preferred share prices.

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  27. Tim,

    Not asking for names, but are there *influential* people in the administration including Treasury and FHFA that resonate with the problem and solution you set forth? Can the bank lobby be defeated without the courts ruling on the side of truth?

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  31. This is by design. The banking lobby has successfully crushed litigation, administrative reform and shareholder rights.

    By hobbling Fannie Mae and Freddie Mac through a 13 year conservatorship, they are free to profit in myriad ways.

    Sandra Thompson is a tiny pawn in the big game. Mel Watt, Mark Calabria and Thompson, albeit from different ideological origins are malleable mainly due to their inexperience.

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    1. Watt and Thompson were and are (respectively) inexperienced in the highly specialized business of mortgage credit guarantors, but Calabria was a “fellow traveler” with the banks and their supporters. His view seemed to be, “If I can’t turn Fannie and Freddie into banks (which is what his Urban Institute essay said he wanted to do), I’ll capitalize them like banks and let them figure out how to deal with that.” Calabria did real harm to the companies, but he may have pushed too far. His “risk-based” capital standard is so blatantly at odds with the results of their annual stress tests, and he has left them so far away from adequate capitalization, and even the 3% capitalization level required for consideration for release from conservatorship under a consent decree, per the January 14, 2021 letter agreements with Treasury, that I can’t see these circumstances being allowed to persist indefinitely. It’s just too obviously an “unsolved problem.”

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  33. Tim,

    I have been one of the millions of people quietly following your posts on the subject. Each of your posts are well thought through master pieces. I applaud your efforts and encourage the leaders at FHFA listen to your opinions.

    Best regards,
    David

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  34. Tim

    great job. as you no doubt recall, Director Calabria never really substantively responded to the many comments, including yours, to the capital rule when proposed. I wonder whether Acting Director Thompson and staff will respond to your comments on this half-baked attempt at improvement. the problem with an acting director is that she will never face senate confirmation inquiry as acting director…so Acting Director Thompson can just duck and sail merrily along…again, typical conservatorship buck passing.

    rolg

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    1. As I discuss in my comment, the post-Calabria FHFA so far has ignored the obvious inconsistencies between the ERCF, the Dodd-Frank stress test results, and the implications of the Milliman CRT performance simulations. That does suggest a considerable degree of bureaucratic inertia, at the very least. Although I submitted my comment to FHFA, the intended audience for my observations extends to other potential commenters on the rule or stakeholders in the companies, as well as senior economic policy officials in the Biden administration. The more people there are making clear that what’s happening at FHFA is obviously wrong and not acceptable, the more likely FHFA leadership will feel pressured to change course, or, failing that, that senior Biden administration officials will appoint a new director who will shake things up at the agency and put it on the right course.

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      1. Tim

        agreed, your public comment can and should be read by a diverse audience outside FHFA…but it is dismaying to the idealistic lawyer in me (or, that idealism which remains that hasn’t been abused by reality) that the whole raison d’être for public commentary on agency rule making was for agencies to receive, engage with, and benefit from a wide diversity of policy views, and this is not being done. while statutory direction (when clear) must be honored, statutes leave so many interstices left to be filled by agency rule making and discretionary action, as is so clear in the example of HERA and the GSE conservatorships. agency discretion was intended by the APA to receive and respond to public comment. I didnt see the Director Calabria FHFA doing this, and I am not holding my breath re the Acting Director Thompson FHFA.

        rolg

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    2. She’s way over her head and clearly doesn’t understand the real political dynamic when she comments to the MBA, as she has this week.

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