A Six-Year Retrospective

~ jtimothyhoward

Tomorrow is the sixth anniversary of the first live post on Howard on Mortgage Finance, “Thoughts on Delaware Amicus Curiae Brief,” and this is the fiftieth post I’ve written since then.

As I said in “A Three-Year Retrospective,” “I began [the blog] in response to my perception that the dialogue on mortgage reform was being dominated by ideological and competitive critics of Fannie Mae and Freddie Mac who over the past two decades had created provably false stories about the companies’ business, risk-taking and role in the 2008 financial crisis, which through constant repetition in the media had become almost universally accepted as true. My goals for the blog were to serve as a source of objective and verifiable facts about the mortgage finance system in general and Fannie Mae and Freddie Mac in particular; to draw on my experience with and knowledge about these areas to provide informed analyses of current developments in single-family mortgage finance, and to use these facts and my analyses as the basis for offering opinions on mortgage-related issues.”

My posts during the blog’s first three years (2016-2018) were written at a time when what I refer to as the Financial Establishment—which I defined as “large banks and Wall Street firms, and their advocates and alumni at Treasury and elsewhere”—was using these false narratives to justify a series of legislative proposals to replace the companies with “private sources of capital.” The proposals had begun with Corker-Warner in 2013 and continued with Johnson-Crapo in 2014, neither of which were brought up for a vote. Then in 2016, after I’d started the blog, the Urban Institute’s “A More Promising Road to GSE Reform” and the Milken Institute’s “Toward a New Secondary Mortgage Market” each proposed to replace Fannie and Freddie with entities that used credit-risk transfer mechanisms as a substitute for upfront equity capital. The former proposed to “merge Fannie Mae and Freddie Mac into a government corporation that is required to transfer all non-catastrophic credit risk into the private market,” while the intent of the latter was to “[r]econstitute Fannie Mae and Freddie Mac as lender-owned mutuals, and build on the credit risk transfer (CRT) initiative to create a private market for mortgage credit risk.”

I did several posts critiquing these proposals—and Fannie and Freddie’s CAS and STACR credit risk-transfer programs in general—and also wrote pieces putting forth my own ideas on the objectives for and recommended approach to successful mortgage reform (the post to read is “Fixing What Works,” written in March of 2016 for the Urban Institute’s “Housing Finance Reform Incubator”). The Promising Road and Milken Institute pieces died deserved deaths, after which, in April of 2017, the Mortgage Bankers Association (MBA) released a 60-page white paper titled “GSE Reform: Creating a Sustainable, More Vibrant Secondary Mortgage Market.” This paper explicitly acknowledged the merits of an equity-based model of credit guarantors, and reversed the MBA’s prior position that credit guarantors should be required to issue risk-transfer securities. The MBA paper included two controversial recommendations: that “FHFA or a successor regulator” be empowered to charter new credit guarantors, and that the securities those guarantors issued—but not the guarantors themselves—be backed by an explicit U.S. government guaranty. These and other aspects of the MBA paper ultimately became the core elements of yet another piece of legislation being developed in the Senate, dubbed “Corker-Warner 2.0.” A working draft leaked in late January 2018, and as I recounted in “Waiting for Mr. Corker” it was roundly and justifiably criticized, with even Senator Corker seeming to realize that it wasn’t going anywhere. The November midterm elections, moving the House under Democratic control, then sounded the death-knell for any hopes that Congress would be the path Fannie and Freddie would follow out of conservatorship, and the legislative reform chapter of the blog came to a close. 

I viewed the first three years of Howard on Mortgage Finance not only as worthwhile but also successful. Nothing bad had happened in Congress, and I felt the shift in focus toward administrative reform would make the facts about Fannie and Freddie more relevant. As I noted in “A Three-Year Retrospective,” [T]he strategy of the banks and their supporters to replace a secondary market mechanism built around Fannie and Freddie that works for consumers with one that works for themselves was dependent on banks convincing Congress of their false definition of the problem and the merits of their proposed solution to it. This deception is much less likely to work in an administrative reform process.” I also was optimistic about the Collins case working its way towards the Supreme Court, where, I said, “the plain text of HERA and the undeniable fact pattern in the case will carry much more weight than they did in the lower courts.”

As we know, I was wrong on both counts. The facts about Fannie and Freddie’s business, role in the financial crisis, and current risk profile have had no discernable impact on the policies or actions towards Fannie and Freddie of Treasury, FHFA, or any executive branch agency in either the last two years of Trump administration or the first year of the Biden administration. And the Supreme Court’s ruling in Collins that the net worth sweep was a legal action by FHFA simply repeated the fictions in the government’s pleadings, ignoring not only the plaintiff’s persuasive and well documented argument to the contrary (and the amicus brief I filed), but also the directive that in a motion to dismiss, which the Court was adjudicating, the factual allegations in the complaint must be accepted as true.

In reviewing the developments of the past three years, I am struck by how successful Treasury and FHFA have been in implementing the post-conservatorship plan for Fannie and Freddie that first was outlined over ten years ago in a December 12, 2011 “Draft Information Memorandum to Secretary Geithner” from Assistant Secretary Mary Miller. This was one of 33 documents produced in discovery for a case in the Court of Federal Claims, released in July of 2017 by Judge Margaret Sweeney, and I discussed its contents in a post the same month titled “A Pattern of Deception.”  Two of the policy options from this memo are particularly notable: (a) “Guarantee fee price increases – pricing for direct GSE guarantees could be increased by a minimum of five to ten basis points per annum (or at a pace determined annually by FHFA and Treasury) until pricing reaches levels that are consistent with those charged by private financial institutions with Basel III capital standards and a specified return on capital;” and (b) “Risk syndication – consistent with the phase-in period of guaranty fee increases, the GSEs could be required to sell a first-loss position (or the majority of the credit risk) to the private market on all of their new guarantee book business within a five- or seven-year time period. It is important to note that risk syndication would likely reduce the earnings capacity of the GSEs (similar to how the winding down of the retained portfolios also limits income generation).”

FHFA Acting Director Ed DeMarco did raise Fannie and Freddie’s guaranty fees by 10 basis points in 2013, and proposed a second 10-basis point increase for 2014, which incoming permanent Director Mel Watt suspended. Then, Director Mark Calabria simply reversed the process, imposing Basel III bank capital standards on Fannie and Freddie—in spite of the fact that they are not banks, and have no business in common with banks—and made them be the ones to raise their guaranty fees, to earn a market return on that capital. The result, of course, will be what Treasury said it wanted ten years ago: guaranty fees far higher than warranted by the risk of the loans guaranteed, to the banks’ advantage (and homebuyers’ disadvantage). Also note that in the December 2011 memo Treasury acknowledged that credit risk transfers will “reduce the earnings capacity of the GSEs,” by causing them to make much more in interest payments than they receive in credit loss reimbursements. This, too, was deliberate—intended to move revenues from Fannie and Freddie to “private sources of capital,” who are vastly overcompensated for the small amount of risk they take.  

Allowing the banking interests to dictate how Fannie and Freddie are capitalized and regulated has produced predictably bizarre results. Since the Great Financial Crisis, Fannie and Freddie’s credit risk has been cut in half (as documented by FHFA), their average guaranty fees have more than doubled, and FHFA’s own Dodd-Frank stress test showed that their December 2020 books of business needed no initial capital to survive a stylized version of the home price collapse experienced during the crisis. Yet in 2020 Director Calabria nonetheless insisted on raising the companies’ capital requirements by nearly 80 percent, to a pre-determined “bank-like” level of more than 4.5 percent of total assets. They now earn over $20 billion per year after tax and have extremely high-quality books of business, yet because the net worth sweep has left their core capital at a negative $126 billion as of September 30, 2021, and they had an indefensibly high capital requirement estimated at $332 billion on the same date, they find themselves nearly half a trillion dollars short of being considered “adequately capitalized” by FHFA, and after 13 years are still mired in conservatorship, with no evident way to exit on their own.

Faced with this situation, FHFA Acting Director Thompson so far has taken three tentative steps, each consistent with the objectives of the ten-year-old Treasury memo. First, she did propose a modest reduction in the companies’ capital requirements, but only if they issue credit-risk transfer securities that cost them $30 in interest payments for every $1 in credit losses reimbursed in a normal environment, and $3 in interest for every $1 in reimbursed losses during a period of severe stress. Next, she directed Fannie and Freddie to raise their guaranty fees on their lowest-risk mortgages even higher than they are now, which likely will drive more of that business to banks—and to the private-label securities market, which was the cause of the 2008 crisis. And on January 13 she told the Senate Banking Committee that if confirmed as Director she would view her role as “facilitating,” rather than initiating, Fannie and Freddie’s exit from conservatorship, and would look to Congress to pass reform legislation first; that is the long-standing position of the banking interests, and if actually adhered to would take us back to where we were during the first three years of the blog.

So this, unfortunately, is where we are now, and why I have to rate the last three years of the blog as unsuccessful. While I’m pleased with the posts I’ve done during this time (“only” 15, compared with 34 in the first three years), I am disappointed in how little practical impact they seem to have had. The banks continue to be able to get whatever they want from both political parties, despite the glaring weakness of their arguments and the economic harm caused by moving billions of dollars from low-and moderate-income homebuyers onto banks’ income statements. And this state of affairs leads me to wonder about the level of activity in the blog in the coming year. I’ve put out the best and most clear versions of the facts about Fannie and Freddie’s past history and current circumstances that I know how to produce, and believe they speak for themselves. Since I do the blog voluntarily, and don’t like to repeat myself, I’m not sure how much more there will be for me to write about in the foreseeable future. (I don’t intend to turn the blog into a running chronicle of the remaining legal cases; that is neither my primary interest—even though I do hold Fannie junior preferred and common stock—nor my area of expertise.) So, while we wait to see what the dogs (Treasury and FHFA) who chased and caught the cars (Fannie and Freddie) end up doing with them, I’ll call attention to the posts I’ve done in the past three years that I would advise my readers to bookmark and refer back to periodically, since the facts about Fannie, Freddie and the mortgage market aren’t going to change:

An Unexpected Ruling (June 2021). This was my reaction to the Supreme Court’s ruling in the Collins case. It’s a “top post” for two reasons. The first is that it includes a link to the amicus curiae brief I submitted to the Court, which is the best and most comprehensive account I’ve done of Fannie and Freddie’s placement into conservatorship and subsequent management by FHFA and Treasury. It’s impossible to read this brief and conclude that the companies’ 2008 takeovers by Treasury in September of 2008 were rescues, or that they required any Treasury senior preferred stock, let alone $187 billion, to survive the financial crisis. Anyone who claims “the taxpayer must be compensated” by converting Treasury’s senior preferred stock to common stock before the companies can exit conservatorship should read this brief. The second reason for highlighting the post is my analysis of the ruling itself, which led me to state, “there can be little question that the Court’s ruling on the APA claim in Collins was imposed upon the case rather than deduced from it. And this has implications for…the major net worth sweep-related cases remaining in the lower courts.”

Capital Fact and Fiction (September 2021). This post gives the facts about Fannie and Freddie’s credit losses following the 2008 mortgage crisis, and the changes in the credit quality of their books and their guaranty fees since that time. It also details how Mark Calabria “used four contrivances [which I list and discuss] to artificially engineer a result for the required amount of Fannie’s ‘risk-based’ capital that was greater than his arbitrary minimum of 4.0 percent.” It notes that “there is a huge difference between the capital required by a risk-based standard for Fannie and Freddie based on fact, and one based on fictions invented by those who oppose the companies on ideological or competitive grounds,” and adds that, “developing and implementing a fact-based capital rule for the companies is astonishingly easy,” as I go on to explain.

Comment on ERCF Rule Amendments (October 2021). This one almost didn’t make the cut, but it’s included because it very clearly illustrates “the glaring inconsistencies between the hugely excessive amount of capital required of Fannie and Freddie by the ERCF [Calabria’s capital rule], 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’.” At least at the staff level, FHFA is well aware of these inconsistencies, and also that, “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.” Yet the ERCF “hairball” remains in place.

Some Simple Facts (October 2019). This post addresses why the large commercial banks are so insistent on giving Fannie and Freddie bank-like capital requirements, without bank-like asset powers. It’s to handicap the companies’ business, and drive more mortgages, at higher funding spreads, into bank portfolios. And as the piece (along with Capital Fact and Fiction) notes, banks have been phenomenally successful at this since FHFA and Treasury have had control of Fannie and Freddie in conservatorship. Some Simple Facts also contains useful background information on the 2008 mortgage crisis and stress testing, as well as a reminder that there is a direct comparable to Fannie and Freddie, and it’s not the banks but the FHA, which does far riskier business than the companies, without private mortgage insurance, and was capitalized and regulated dramatically less onerously even before the ERCF.

115 thoughts on “A Six-Year Retrospective”

    1. I wasn’t actually.

      Calabria has been making extreme–and extremely inaccurate–statements about Fannie and Freddie since before he was Director of FHFA. He’s not going to change, and if anything, this Politico article suggests he’s decided that he needs to overheat his rhetoric even more, with words like “ticking time bomb,” “clueless,” “absolutely stunning,” and saying that “an insolvency of Fannie and Freddie may well be an inevitability at this point”–presumably because he no longer is there as FHFA director to prevent it. Readers should know by now that this is all utter nonsense, driven by smug ideology and an utter disregard for readily available fact, and if they don’t know that then a rebuttal from me won’t help them.

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      1. In the interview Calabria claims the GSEs will exhaust their PSPA’s in a downturn which implies the they will lose ~$80b billion of capital on the balance sheets today in addition to the ~$250 billion of funding commitments provided by the PSPA.

        Someone should direct Calabria to his own FHFA stress test that he performed and signed off on in 2019 that had the GSEs losing a combined $18 billion total based off assumptions worse than 2008. No where near what he is trying warning about.

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      2. TH,
        Very well said. Calabria turned out to be such a huge disappointment. Thought he would make a positive difference. He did NOT, except maybe marginal positive at Best in certain areas, but overall completely substandard given his time as Head of FHFA.
        Undoubtedly there was a group of ‘Financial Establishment’/Federalist Society people represented by Mike Pence-wing and his minions (+ SCOTUS) completely against ANY meaningful non-Conservatorship status quo change at F&F. What a disgrace.
        Do you have any insight as to the delay in oral hearings (Lamberth), and what that might do to a July 11th Trial?
        TIA
        VM

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        1. Re the delay in the oral argument before Judge Lamberth, no, I have no knowledge as to why that occurred, nor as to whether it will delay the July 11 trial (assuming Lamberth does not grant the government’s summary judgment motion to dismiss the case), although past experience suggests it well may.

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      3. Tim,

        Calabria has not been director for some time now. It’s been radio silence. Suddenly this outburst of rhetoric as you noticed with no substantial news that we can see on the horizon. My question is, why now? What does he see that prompted this from him?

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        1. I don’t know, although I did read that at the Mortgage Bankers Association annual secondary market convention on Monday, acting FHFA director Thompson was asked about possible amendments to the Preferred Stock Purchase Agreements for Fannie and Freddie, and responded, “We haven’t started those conversations [with Treasury].”

          And my answer to the “why now” question about the timing of the Calabria interview is that, while he was FHFA director, my recollection is that he would talk to almost anyone who was willing to interview him, whenever they wished to. He is not one to “keep his own counsel,” and seems to relish publicity.

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      4. Tim,

        Do you have any insights (that you’d be willing to share), as to why the current administration seems to have no appetite to resolve the situation with the GSEs? It certainly seems like it should fit with their policy preferences, and that they are missing a huge opportunity.

        Perhaps more importantly, is there anything coming down the pike that might change their view? Would a Democratic loss of Congress be enough to do it?

        Thanks in advance for your thoughts,

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      5. Tim

        Calabria can be best described as a walking conundrum. He has written that it would be best for the secondary mortgage finance market to essentially disappear, so that we can all go back to the 50’s when banks underwrote and held mortgages, and bankers were on a 3 (% borrow)-6 (% lend)-3 (pm tee time) schedule. then he becomes the regulator for F/F, and the $4T secondary mortgage finance market he intellectually abhors. Only in DC can you find such incongruity.

        now Calabria is back at Cato, which is where he was before failing as a FHFA director, which means that he doesnt have a real job but he still wants to be an “influencer”…a public intellectual focusing on housing finance…akin to instagram with a PhD.

        all’s well that’s Orwell in my view.

        rolg

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  2. Calculation of maximum payout ratio as finalized in the ERCF:
    At less than 25% of the buffer filled, the maximum payout ratio is 0%
    At greater than 25% but less than 50% of the buffer filled, the maximum payout ratio is 20%
    At greater than 50% but less than 75% of the buffer filled, the maximum payout ratio is 40%
    At greater than 75% but less than 100% of the buffer filled, the maximum payout ratio is 60%
    At greater than 100% of the buffer filled, the maximum payout ratio is 100%

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  3. Sorry Tim, it seems the “Calculation of maximum payout ratio as finalized in the ERCF:” section didn’t paste properly, if you can fix it with the following to clean it up:

    Calculation of maximum payout ratio as finalized in the ERCF:
    At 25% but 50% but 75% but 100% of the buffer filled, the maximum payout ratio is 100%

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    1. I’m not sure why it’s not pasting properly, Maybe its the “” characters.

      “Calculation of maximum payout ratio as finalized in the ERCF:
      At less than 25% of the buffer filled, the maximum payout ratio is 0%.
      At greater than 25% but greater than 50% of the buffer filled, the maximum payout ratio is 20%.
      At greater than 50% but greater than 75% of the buffer filled, the maximum payout ratio is 40%.
      At greater than 75% but <greater than 100% of the buffer filled, the maximum payout ratio is 60%.
      At greater than 100% of the buffer filled, the maximum payout ratio is 100%."

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  4. Hi Tim,

    Can you explain the dynamic with the Fed balance sheet MBS? I understand there are a ton of MBS that now are not worth their original value because they are from a time of lower interest rates compared with today and the near future. I have heard Fed will “run off” the MBS and/or may sell some to reduce the balance sheet and effectively tighten. The MBS would need to be sold at some discount and Fed would have to take a loss to get buyers, correct? Would they then be competing with new loan MBS for buyers? Would that cause a faster increase then in interest rates on new mortgages and sort of spiral up costs? Like a feedback loop of increasing mortgage costs?

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    1. The Fed currently holds $2.73 trillion in agency MBS (Fannie, Freddie and Ginnie–they don’t break it out any further), up from zero in the fall of 2008. The Fed keeps talking about reversing its program of “quantitative easing,” but it hasn’t begun doing that yet–its holdings of agency MBS are at (or close to) an all-time high, as are its holdings of Treasuries ($5.76 trillion).

      Two things that HAVE happened to the Fed’s MBS holdings are that (a) many of them, as you point out, are now worth less than what the Fed paid for them, and (b) the Fed’s funding spread on its MBS portfolio has narrowed by 25 basis points. The Fed pays for its MBS purchases by crediting the reserve account at the bank used by the sellers of those MBS, and in mid-March the interest rate it pays on bank reserves went up by 25 basis points, from 15 bp to 40 bp. And as the fed funds rate moves higher–which the Fed has signaled it will–the interest rate paid on reserves will rise in tandem, narrowing the funding spread on the Fed’s MBS portfolio still further. But that’s not likely to trigger MBS selling. Last year the Fed earned $107.8 billion (all but $400 million of which was turned over to Treasury), so the profit impact of this decreased funding spread will barely be noticeable.

      When the Fed does start reducing its holdings of MBS–as I suspect it will soon, for monetary policy reasons–that should put at least some additional upward pressure on mortgage rates, relative to what would happen were those holdings to either increase or simply flatten out. But it’s hard to put a basis point number on this. For now, let’s just call it a “headwind,” that will add to the upward pressure already being exerted on mortgage rates by rising short-term interest rates and concerns about the persistence of inflationary influences. I also expect that the first move in any reversal in the Fed’s quantitative easing program will be to allow amortizing and prepaying mortgages to run off unreplaced, with outright selling being held back until later, should the Fed deem it necessary or desirable.

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      1. Tim

        This blog space has been quieter than FHFA and Treasury on GSE reform. Can you share some updates that you could see? Is there a new article coming any time soon? Thanks for everything..

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        1. It’s been quiet for a couple of reasons: there have been no changes in the status quo for Fannie and Freddie–with respect to either the remaining legal cases or potential administrative actions–nor any recent comments or questions from readers worth writing about. I suggested that this might be the case in my most recent post.

          Having said that, though, I should have new post up in the next week or so. Both Fannie and Freddie had tables in their first quarter 2022 10Qs giving details on their new regulatory capital requirements that just took effect, but neither said much about them (Freddie said virtually nothing). There is a lot of relevant and useful information that can be derived from the tables, however, and I’m looking for a way to present it in a way that will be both meaningful and understandable to readers.

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  5. Fannie Mae late Friday disclosed that CEO and Director Hugh Frater will leave the secondary market giant effective May 1, along with two other board members — former Federal Deposit Insurance Corp. Chairman Sheila Bair and Antony Jenkins. Bair also serves as the board’s chairman.

    Fannie named company president David Benson, a former Merrill Lynch executive, as Frater’s interim replacement. The news was contained in a new SEC filing. In a statement, the GSE noted that Frater was retiring.

    In a brief interview, former FHA Commissioner Dave Stevens said Frater’s leaving is a “huge loss” for the company. Stevens also lamented the “revolving door” that seems to be regularly occurring in the C-suites at both Fannie and Freddie Mac.

    In an email to colleagues provided to IMFnews, Bair said, “Last year, I experienced the passing of my former boss, Senator [Bob] Dole, as well as a close family member. Those losses caused me to reassess the need to spend more time with family, friends, good books and good wine.”

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    1. The resignations of board members Bair and Jenkins are far less concerning than the resignation of CEO Frater.

      In the comment below I said that if I were at either Fannie or Freddie I would have told acting director Thompson that the Calabria capital requirement made it impossible to simultaneously meet the goals of earning an adequate return on equity and carrying out the company’s charter mission of making housing more affordable for low- and moderate-income homebuyers. I know that Frater would have had that conversation with Thompson, and the fact that he has chosen to resign is a strong indicator that he did not get the answer he was looking for. It’s difficult to escape the conclusion that Frater is leaving because he cannot justify continuing at a (Congressionally limited) level of compensation about a third of what he could get elsewhere saying “Yes” to a person who seems content to be the caretaker of a perpetual conservatorship whose terms have been set by the banking lobby. The recent departures of Fannie’s former CFO and COO suggest the same thing.

      And it’s disingenuous for Dave Stevens, former president of the Mortgage Bankers Association, to be lamenting the “revolving door” at Fannie and Freddie. First of all, the door is not “revolving,” because nobody’s coming in. And the reason so many are going out is that he and his fellow “bankistas” have gotten what they’ve been asking for for over a decade–having bank-like capital (and stifling regulation) imposed on the companies without their also being given bank-like asset powers. Stevens, of all people, should know that (and I suspect he does).

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        1. and the CFO has left recently…etc.

          almost as if there is a “management strike” at Fannie. which is not an unreasonable response to FHFA regulation.

          rolg

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  6. Tim

    with interest rates rising and mortgage originations expected to decline, I would speculate that there will be a decline of private label securitizations and a consolidation of, or simply reduction in the number of, mortgage originators. one could see banks as well chasing other lines of business that offer more bank for the buck than mortgages in a rising interest rate environment. if so, this implies even greater market dominance of Fannie and Freddie, albeit at lower nominal volumes. and arguably a greater interest within the beltway in seeing F/F expand low income housing targets.

    have you seen this act play out before? if F/F become even more central to housing finance, I am wondering if this near term mortgage finance downturn will redound to F/F’s benefit in ways that might counteract any net income contraction

    rolg

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    1. I’ve seen how Fannie’s (and Freddie’s) business behaves in previous environments of rising mortgage rates and declining mortgage originations, but there will be a significant difference should we see anything similar in the coming months or quarters: the companies are being asked by their regulator to price their business to earn a “viable return” on an amount of capital that’s nearly double what it ought to be, based on the risk of the loans they’ll be guaranteeing–and they are being asked to make those pricing adjustments without adversely affecting affordable housing borrowers, whose loans typically have the highest risk.

      This is uncharted territory. We don’t know what FHFA will consider a “viable return,” but with required capital up by about 80 percent from where it would have been under FHFA’s “conservatorship capital standard,” average guaranty fees will need to rise by at least ten basis points, and probably a good deal more. And with nearly half of Fannie’s and Freddie’s highest-risk business shielded from those increases, guaranty fees on the lowest-risk half would need to rise by over 20 basis points.

      I truly do not know what Fannie and Freddie will do here. If I were at either company, I would go to acting director Thompson and say, “It’s not possible to price to Dr. Calabria’s bank-like capital standard without that having a crippling effect on our business, and housing affordability; you have to revise the standard.” If the CEOs of Fannie and Freddie don’t do that, we’ll have to wait to see how this drama plays out. In my view it won’t take much in the way of fee increases on low-risk (high quality) business to get the private-label securities market started again–and in fact I believe that’s what the Financial Establishment is hoping for.

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  7. Tim

    there was a “fireside chat” with FHFA acting director Thompson that occasioned this article from American Banker: “Thompson says FHFA is preparing GSEs for end of conservatorship”…
    https://www.americanbanker.com/news/thompson-says-fhfa-is-preparing-gses-for-end-of-conservatorship

    I am not holding my breath, but at the same time, I note that often those who are “noisy”, such as Calabria holding media interviews incessantly about the prospective capital markets recap, get less done than those whose activity is less visible and self-advertised.

    do you have any sense that FHFA/Biden administration is proceeding to release, albeit on a geologic time schedule?

    rolg

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    1. I listened to the “fireside chat” with acting FHFA director Thompson on Thursday, and nothing I heard there changed my view of current administration policy toward Fannie and Freddie. Most obviously, Thompson is not leading it; she is doing what she views as her part to carry out the plan outlined over a decade ago by Treasury and updated in 2020 by former director Calabria: to create a path for the companies to exit conservatorship, provided they adhere to capital requirements, mission objectives and regulation endorsed by what I refer to as the Financial Establishment, which are designed to favor banks and Wall Street, at homeowners’ expense.

      It was very clear from this interview that Thompson is not “in on the joke,” and that she sincerely believes the fictions told about Fannie and Freddie within the halls of FHFA and at Treasury. This dearth of factual knowledge makes what should be easy problems at the companies much harder. For example, early in the chat Thompson said it was a top priority to do a “holistic pricing review” to figure out how Fannie and Freddie can earn “viable returns,” while also balancing mission and safety and soundness objectives. She noted that such a review hadn’t been done since 2015, and that it was a “huge undertaking.”

      Except it’s not, if you understand the business. In that 2015 pricing review (for which I wrote a comment letter), FHFA noted that Fannie and Freddie’s guaranty fees “cover three types of costs they expect to incur in providing their guarantee”—(a) expected credit losses, (b) the cost of capital to cover unexpected credit losses, and (c) general and administrative expenses. FHFA then went on to say, “Of these three components, the cost of holding capital is by far the most significant.” That was true then, and it’s even more true today. Going forward, Fannie and Freddie’s expected credit costs should be between 2 and 4 basis points (they’ve been less than zero for the past ten years), and their general and administrative expenses should be about 8 basis points. The cost of holding capital against unexpected losses depends on two variables: the required capital percentage, and the target return on capital. Earning a 9.0 percent after-tax return on the (grossly inflated) 4.65 percent Calabria capital requirement requires Fannie and Freddie to add 51 basis points to their guaranty fees; earning the same return on 2.5 percent capital—far more than necessary to survive a repeat of the 25 percent nationwide decline in home prices that followed the bursting of the 2007 mortgage bubble—requires only 27 basis points of guaranty fee. Figuring this out is hardly a “huge undertaking;” it takes a few minutes with a calculator.

      This is what is so frustrating about watching acting director Thompson talk about affordable housing and safety and soundness. The way FHFA can help Fannie and Freddie support affordable housing is to allow them to price their credit guarantees on an economic basis. FHFA’s own Dodd-Frank stress tests on the companies tells it that they don’t need anything close to 465 basis points of capital—which force the companies to add an unnecessary 51 basis points to their guaranty fee buildups to earn a “viable return”—in order to be safe and sound. But Thompson’s marching orders (couched, of course, as supporting safety and soundness) are to impose “bank-like capital” on them, so that’s what she’s doing. (And you may have noticed that her main initiative in affordable housing is to ask the companies to file equitable housing plans—essentially telling them, “You figure this out, given the constraints we’re putting on you.”)

      Unless and until some senior economic official in the Biden administration steps up and allows Fannie and Freddie to be real companies again, instead of captives of the banking lobby, FHFA and Treasury are going to stay on their current course of “preparing to bring Fannie and Freddie out of conservatorship when they’re ready.” The next milestone in this process will be Treasury deciding what to do about the senior preferred. Everyone knows that Fannie and Freddie can’t raise capital while Treasury’s senior preferred and liquidation preference remain in place. But eliminating those has proven to be a Gordian knot. For years I had thought Treasury was waiting for a high-profile loss in a court case involving the net worth sweep to give it political cover for relinquishing an income stream it has continually (and falsely) claimed to belong to “the taxpayer,” but the Supreme Court’s ruling on the APA claim in Collins—and, more recently, the ruling from the Court of Appeals for the Federal Circuit on regulatory takings and breach of fiduciary duty—has all but eliminated the likelihood that Treasury will be forced to give up the sweep.

      Treasury has two alternatives for eliminating the net worth sweep voluntarily. The first is to declare Fannie and Freddie’s draws to have been fully repaid, with interest (which is true), and cancel the senior preferred and the liquidation preference on its own. Doing so, however, would require it to reverse its stance that the sweep payments are legitimate compensation for its “heroic” efforts in rescuing the companies during the crisis (a fiction Treasury is responsible for having created), and also open it up to criticism for “giving the taxpayers’ money away” to shareholders (including the demonized hedge funds). The second alternative is to convert its $191 billion in senior preferred to common stock in the companies. But that would (a) give Treasury virtually total ownership of both companies, (b) render its warrants for 79.9 percent of the companies’ common stock—which most people see as a valid claim on the companies’ assets (even though it’s not)—essentially worthless, and (c) by forcing Fannie and Freddie to repay their draws of senior preferred twice (first through repayments that Treasury refused to count as repayments, and again through conversion to common), send an unmistakable message to potential future investors in their equity that Fannie and Freddie are treated differently, and more adversarially, than any other publicly traded company, thus imperiling the chances of success of their envisioned recapitalization.

      I honestly do not know what Treasury is going to do about this, and I suspect that it doesn’t either. And if that’s the case, for at least the next several months we are going to continue with the charade of Fannie and Freddie filing their capital plans and FHFA doing its “pricing review,” while the companies experiment with how close they can come to earning a “viable return” on indefensibly high amounts of capital by attempting to raise guaranty fees on their non-mission-related business.

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      1. In regards to the 2nd alternative, converting to common, don’t several provisions of the sr preferred cert of designation nullify that as an option (excluding the idea treasury can do whatever it wants)? Specifically:

        5. No Voting Rights
        Except as set forth in this Certificate or otherwise required by law, the shares of the Senior Preferred Stock shall not have any voting powers, either general or special.

        6. No Conversion or Exchange Rights
        The holders of shares of the Senior Preferred Stock shall not have any right to convert such shares into or exchange such shares for any other class or series of stock or obligations of the Company.

        10. Miscellaneous
        (g) The Company, by or under the authority of the Board of Directors, may amend, alter, supplement or repeal any provision of this Certificate pursuant to the following terms and conditions:

        The creation and issuance of any other class or series of stock, or the issuance of additional shares of any existing class or series of stock, of the Company ranking junior to the Senior Preferred Stock shall not be deemed to constitute such an amendment, alteration, supplementation or repeal.

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  8. Tim

    Plaintiffs and FHFA filed motions under seal yesterday in the Fairholme case before Judge Lamberth. Although they are not styled as such, I assume they are motions for summary judgment. why under seal? perhaps there are references to discovery from Judge Sweeney’s case that remains under seal. also plaintiffs filed a motion for partial summary judgment seeking to invalidate the enforceability of the commitment fee under NY state and federal law (essentially for failure to specify a rate, which present interesting questions of law that Judge Lamberth will likely punt on initially).

    rolg

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    1. I was hoping that plaintiffs’ motion for summary judgment would NOT be under seal, and would contain facts unfavorable to the government. I haven’t asked him (and won’t), but I wonder if David Thompson’s strategy is to not put all the facts out in a public forum yet, and use the lure of keeping them from being more widely known as leverage for a potential settlement. Also, I’d bet that the government’s motion for summary judgement is strictly on points of law, and avoids facts altogether.

      Since both motions for summary judgment were filed under seal, I would think their respective replies will be under seal as well. And I doubt there’s much possibility of a settlement before Lamberth rules on the summary judgment motions. The government has won virtually all of the court cases on points of law, and it won’t want to give in on anything unless and until there is a certainty that the Lamberth case is going to trial.

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      1. Tim

        it is hard for me to see how this doesnt get to trial. Delaware law on implied duty of fair dealing, while nuanced, is highly dependent on the facts of the situation. essentially, good faith is deemed to be a part of all contracts governed by Delaware law (as was the SPSA) where contracts are at least somewhat open-ended. meaning post-contracting action of the parties is required, and there is some discretion permitted by the contract as to how the parties are to act. one might think operating under a conservatorship fits this description. now, some contracts require a single outcome irrespective of faithfulness, since they are highly specified. see https://ruleoflawguy.substack.com/p/fannie-and-freddie-the-nws-and-the?s=w, https://ruleoflawguy.substack.com/p/some-further-thoughts-on-the-implied?s=w and https://ruleoflawguy.substack.com/p/final-thoughts-on-the-implied-covenant?s=w.

        the problem is that Judge Lamberth could conclude that HERA essentially eliminated any state law duty for the government to engage in fair dealing with all other capital structure claimants. while I disagree with this conclusion, it is tempting for a judge who wants to avoid a trial in DC in the heat of July.

        rolg

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        1. Some type of ruling on the law in favor of the government is what I’m concerned about. If Lamberth does indeed to chose to go that route, he will do it by granting the government’s motion for summary judgment, and avoid a trial on the facts. We’ll find out when he rules on the motions, perhaps as early as May.

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    1. There were no differences in this final rule from what acting director Thompson had proposed back on September 16 of last year. As I discussed in my post “Comments on ERCF Rule Amendments,” the proposed rule enshrined the indefensibly high Calabria capital requirement for the companies–thus pleasing the banks–while also giving Fannie and Freddie a capital credit for issuing woefully noneconomic (and misnamed) “credit-risk transfer” securities, which transfer vastly more revenues than credit losses–thus pleasing Wall Street and the investment community, while weakening Fannie and Freddie financially. This was bad regulatory policy when the amendments were proposed in September, and it remained bad policy when the acting director made them final in February, with no changes.

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      1. I hope someone at Treasury–who understands the GSEs and F&F’s potential for positive activity, i.e homeownership and rental financing on large, safe scales–keeps an eye on the Director before she naively manages more destruction.

        Calabria left behind many acolytes at FHFA.

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  10. Tim,

    This is a non-C-Ship question. With fed rates likely increasing quickly to tackle inflation, what should/will Fannie and Freddie do with mortgage rates? Don’t they also need to start pricing to the capital rule now? Since January, rates appear to be spiking, but GSEs trying to keep them low. I just don’t see how much longer they can with spreads tightening.

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    1. There are three elements that determine the level of US mortgage rates: the interest rates on Treasury securities (while the 10-year Treasury is often used as a proxy for calculating mortgage spreads, Fannie and Freddie MBS actually are priced off the entire Treasury yield curve), the spreads over Treasuries required to equilibrate the amount of MBS being sold (both new issues and existing holdings) with the demand for these securities–with these spreads changing over time–and finally the guaranty fees charged by Fannie and Freddie, which get added to MBS yields by primary market lenders when they set the mortgage rates they quote to borrowers. Of these three elements, Fannie and Freddie only exert direct control over the last, and even there that control is fairly limited.

      In pricing their credit guarantees, the companies use a build-up whose three main components are expected credit losses on the pool of loans being priced (which is sensitive to the credit profile of the pool), their administrative expenses, and their cost of capital (which also is sensitive to the credit profile.) If short-term interest rates get high enough the remittance float on monthly interest payments and principal repayments can also become a significant part of the fee buildup, but today it is not.

      When I was at Fannie, the sum of these cost components–including remittance float–was only a little over 20 basis points. In 2021 Fannie and Freddie’s average charged guaranty fee on new business was over 55 basis points–with the 35 basis point increase from the early 2000s being due to the extra 10 basis points Congress requires them to charge and remit to Treasury (effectively a secondary market transaction tax), and the other 25 basis points being driven by FHFA ‘s “conservatorship capital requirement,” which was loosely linked to the agency’s June 2018 capital standard.

      In their 2021 10Ks, both companies signaled that starting last month, they would begin trying to price to the (much higher) Calabria capital standard. They have also been told by acting director Thompson that they should try to avoid increasing fees to their affordable housing borrowers, which in the past have accounted for roughly half their business. It is unclear what success they will have in raising guaranty fees on their lowest-risk business without having much of it go elsewhere–to bank portfolio lenders, or (newly revived) private-label securities execution.

      To circle back and answer your question, then, Fannie and Freddie have no control over the level or slope of the Treasury yield curve, only a limited effect on the spreads between MBS yields and Treasuries (linked to the volume of their new MBS issues), and their fees will be heading higher, not lower, with the “how much higher” being dependent on the sensitivity of the sellers of high-quality (or low-risk) mortgages to the fee increases Fannie and Freddie, at FHFA’s direction, will be trying to charge.

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      1. Thank you Tim for the very thorough response. I am somewhat concerned about the implications of the “double whammy” effect of increasing guarantee fees and interest rates. I just don’t see how it will be possible for the housing market to continue what feels like a bubble from the pandemic in the face of the new mortgage costs. That is, these costs will make current home prices unsustainable. Since so many people have so much of their wealth tied up in their homes, I fear an overall economic impact will result.

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    1. Yes; that was what I and many others were expecting. It was apparent from the en banc oral argument that the majority of the justices were leaning in this direction. And the panel did not say anything about the burden of proof being shifted to the Federal parties (it would have been a great surprise to me had it done that).

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  12. Since the GSEs are now 100% controlled by the government, as affirmed by the courts, is there some mechanism whereby we could force the government to add the GSEs’ debt to the total reported government debt? Would that accomplish anything in terms of getting the government to move (i.e. release the GSEs) in order to keep the debt off its books?

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    1. Judge Lamberth could show his displeasure at having been lied to by Treasury and FHFA in their first round of pleadings by finding for plaintiffs in the breach of contract claim scheduled to be tried in his court on July 11. And the Biden administration also could decide that it needs a functioning Fannie and Freddie to have any hope of helping low- and moderate-income homebuyers with their Build Back Better legislation having been sunk, and switch from policies (and capitalization rates) for the companies based on fiction and designed by the Financial Establishment to move business to the banks and private-label securities market to policies based on fact and designed to enable Fannie and Freddie to help homebuyers.

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        1. my reaction to the brookings event? somewhat cringeworthy.

          near unanimous agreement that i) congress wont act, ii) the administration can act, iii) Calhoun has an excellent plan for moving forward, iv) there is increasing bi-partisan agreement politically for the utility reg portion of the Calhoun plan, and v) there was strong agreement that given the unlikelihood of BBB passage, the monetization of Treasury’s investment for low-income housing was a pressing priority given the increasing gap in racial home ownership disparity.

          but the elephant in the room wasn’t discussed…why did Biden administration just pass over Calhoun for FHFA director?

          and so it goes…let’s continue the conversation, promote dialogue and address housing justice, without calling out the Biden administration for taking a pass on the guy with the brilliant plan that everyone thinks has the solution

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          1. Certainly there is that aspect of the situation. But I had a different, and more positive, take on the presentation. I thought I heard the moderator, Aaron Klein, say that there was a good likelihood that Mike Calhoun would be joining Treasury after the mid-term elections. If that’s the case, he can bring his plan “inside the tent,” and try to build support for it there. And IF the Biden team likes the idea of “$100 billion for affordable housing, paid for by Treasury’s 79.9 percent ownership in Fannie and Freddie,” that could become a very powerful lever for potentially changing the administration’s policies toward the companies.

            During his presentation, Calhoun kept referring to the value of that stake without putting a number on it, and when he finally did, he said it was $100 billion, “according to a 2019 CBO study.” Had I been a participant on the panel, I would have been tempted to say, “Wait, I have an update. According to my Bloomberg screen, as of February 23, 2022, the value of Treasury’s ownership in Fannie and Fannie and Freddie is $5.7 billion. The reason it’s so low is because of the policies the Biden administration’s regulatory officials have been following in managing the companies in conservatorship, which is for the benefit of large banks and other ‘private sources of capital,’ not for the benefit of minority or other low- and moderate-income homebuyers. If you really want to help affordable housing, you will change the way Fannie and Freddie are capitalized and regulated, then bring them out of conservatorship as economically viable entities. If you do that, the market will give you $100 billion, or more, to use for affordable housing.”

            Mike Calhoun, inside the Treasury Department, would an excellent person to make that argument.

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          2. Tim

            I confess that I did not hear that reference to possibly Calhoun going to Treasury in some capacity, but I was multi-tasking during the call and certainly may have missed it. yes that would be movement forward, and if you think abut it, Calhoun’s most value-added would likely be at Treasury rather than FHFA.

            rolg

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          3. Tim, do you have the soundbite/timestamp of the comment re: Calhoun potentially joining the admin post midterms? Seems like material news that as you highlight would potentially help drive the narrative internally.

            Another interesting take away I got was from listening to not Calhoun, but the panelist group, who all represented impactful affordable housing/lobbyists groups. They were initially promised affordable housing funds in BBB that was eventually amounted to $150b, that they no longer have access to as BBB is dead (will be formally dead post mid-terms if there is a “red wave” as expected). All of a sudden all these groups are becoming aware of the “$100b” figure that the government may have at its disposable if it follows the Calhoun plan, and you can already see these groups start to lobby for how that money will ultimately get spent. So much so that they were all in agreement today that this should be done administratively via the Calhoun plan as to access those funds, some even went as far as to say “now” before midterms. Are these housing / lobbyists groups finally on the GSEs side to exit c-ship? (even if it is to further their agenda of getting access to affordable housing funds.) If they are influential and have access to Biden’s team it can make a large difference.

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          4. I believe it was Klein who mentioned Calhoun’s potentially joining Treasury during his introduction of him.

            I agree that the affordable housing groups could be influential supporters of getting Fannie and Freddie out of conservatorship on favorable terms, particularly in light of the diminished prospects for “Build Back Better” legislation. And while many of them have different ideas and priorities for how the monies should be spent, they all would support its being available somehow.

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          5. Tim

            klein referred to his experience after a midterm shellacking, while in the Obama administration, coming in the next day and being asked to draw up a list of can-dos by the administration without congressional approval, and then asking Calhoun, given that this midterm shellacking may recur in 2022, what would Calhoun do IF he was at Treasury. so this was just a hypothetical question. nothing more I think.

            rolg

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          6. Sorry, I misheard that (I, too, was multitasking while listening). But my basic point still holds. If people within the Biden administration like the Calhoun plan, someone will need to tell them that the way to get anything close to the $100 billion he’s talking about is to change the way they’re managing Fannie and Freddie in conservatorship, to unlock that value. Calhoun would be the perfect person to do this, since he understands the issue (he just didn’t talk about this morning), and it’s HIS plan.

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        1. It’s just a formality, making final the proposed amendments to Mark Calabria’s December 2020 capital rule for Fannie and Freddie, which I wrote about (and sharply criticized) in my post “Comment on ERCF Rule Amendments.” What this tells me is that FHFA still shows no signs of deviating from the path of doing exactly what the large banks and Wall Street firms want them to do as regulator and conservator of the companies. We still are awaiting some catalytic event that will change this.

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    1. This ruling by the United States Court of Appeals for the Federal Circuit that, “the Claims Court did not err in dismissing shareholders’ direct claims,” and that it “improperly failed to dismiss the remaining derivative claims” certainly reinforces the view that a different set of rules are applied to Fannie and Freddie than to any other corporation, or entity. And in that sense, yes, the ruling will not be helpful in convincing investors to put the massive amounts of new equity into the companies that former Director Calabria insists are necessary to meet his definition of “adequately capitalized.”

      In my blog analysis of the Supreme Court’s June 2021 decision on the APA issue in Collins (“An Unexpected Decision”), I wrote, “The Court’s ruling in Collins ought to reinforce to counsel in these cases [including this one in the Court of Federal Claims] the wisdom of anticipating heavy hands on the scales of justice as they prepare and present their legal and factual arguments.” Those “heavy hands” turned out to be those of the SCOTUS Justices themselves. In rejecting the breach of contract claims, the Federal Circuit judges repeated the contention of Justice Alito that “HERA explicitly authorized the FHFA, as conservator, to act in ways which were not designed to benefit either the Enterprises OR the shareholder,” and in dismissing the claims of fiduciary duty the judges wrote, “Because the FHFA could adopt the net worth sweep without regard for the interests of the shareholders, we hold that the agency owed no fiduciary duty to the shareholders under HERA.”

      All of this from the interpretation by SCOTUS of language in HERA taken virtually word-for-word from the FDIC Act, that never has been used, and never will be used, to justify a confiscatory act by a regulator against a bank even remotely as blatant as what Treasury and FHFA have been able to get away with when done to Fannie and Freddie. “Level playing field” indeed.

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      1. A truly devastating ruling.

        The passage below (from pp. 45-46) lays out the court’s reasoning in rejecting all of the plaintiffs’ respective arguments and would seem to bar just about any relief a takings court could provide. Heavy hands on the scales of justice, indeed.

        “When Congress passed HERA in 2008, it gave the FHFA the *unrestricted authority to place the Enterprises into conservatorship* or receivership.

        And, as Collins explains, HERA gave the FHFA very broad authority, as conservator, to act in ways that are *not in the best interests of the Enterprises*. Collins, 141 S. Ct. at 1776. As of at least 2008, then, the Enterprises *lost their right to exclude the government from their property*, including their net worth. They also *lost the right to complain if and when the FHFA chose to elevate its interests, and the interests of the public, above the interests of the Enterprises*. Without this right to exclude, the Enterprises *lack any cognizable property interest* on which Barrett may base a derivative Fifth Amendment takings claim. See Golden Pac., 15 F.3d at 1074. This conclusion is bolstered, moreover, by the fact that the Enterprises *consented to the conservatorship*, and consented to one where the conservator had extremely broad statutory powers. Because the Enterprises lacked the right to exclude the government from their net worth after the passage of HERA, and especially after the imposition of the conservatorship, they had no investment-backed expectation that the FHFA would protect their interests and not dilute their equity. We find, accordingly, that the Claims Court erred in failing to dismiss Barrett’s derivative takings claim under Rule of the Court of Federal Claims 12(b)(6). While this logic applies equally to Barrett’s derivatively pled illegal exaction claims, there are additional reasons his illegal exaction claim fails, which we address below.”

        Much of the legal ‘analysis’ that takes place in the comment section of this blog and elsewhere on the internet regarding GSE litigation (which you, Mr. Howard, have recently intelligently, if belatedly, stopped providing) has gone something like this, “the plain meaning of…(insert “may”, or FIRREA, or…)”, “the implication of the longstanding practice of…(here go for the Constitution’s 5th amendment prohibition against gov’t taking w/o compensation, or the duty of a conservator to preserve and conserve its ward’s assets, or…”.

        Those inclined to side with the plaintiffs in these cases (and, one suspects, to invest in the common and preferred shares of the companies’ stock) share a sensibility with Judge Don Willett, who wrote, “Under HERA’s plain meaning, FHFA as conservator has limited, enumerated powers. To begin with, conservator and receiver are distinct and mutually exclusive roles. HERA says FHFA may ‘be appointed as conservator or receiver for the purpose of reorganizing, rehabilitating, or winding up the affairs of a regulated entity.’ In ordinary use, the word ‘or’ is ‘almost always disjunctive, that is, the words it connects are to be given separate meanings.’” And they, like Willett conclude that FHFA cannot…(in Willett’s example cited above, be both conservator and receiver at the same time; in the minds of Howard on Mortgage Finance’s comment section, do 99% of the stuff it has done as regulator).

        “Scottish Enlightenment ‘common sense’ theorist Thomas Reid was famous for comparing arguments to lengths of chain, “The strength of the chain is determined by that of the weakest links; for if they give way, the whole falls to pieces, and the weight supported by it falls to the ground” (Essays on the Intellectual Powers of Man, p. 43). Reid’s project was aimed at David Hume’s skepticism–Reid thought we all had a well-founded, common-sense belief that our mental acts have as their objects distinct physical objects. More people–especially in the U.S.–are familiar with Thomas Paine’s tract on Common Sense than Reid’s earlier work (tho, this ruling is a sardonic reminder of Paine’s “A body of men holding themselves accountable to nobody ought not to be trusted by anybody.”), but Reid’s ‘weakest link’ argument provides an interesting way to look at this case (from a several perspectives–Charles Cooper or David Thompson have built their legal strategy on this idea, saying (paraphrase) we only need to win one, the government has to win them all”). It’s hard to see where any of the court’s findings aren’t supported by the law they amply and ably cite. But I’m reminded of a critique leveled at Thomas Hobbes: his reasoning is infallible but his presuppositions suspect.

        Everything in today’s ruling, essentially, hinges on the GSE’s Boards consenting to conservatorship. No matter how strong the chains in its argument, the presupposition of the case is founded on the board’s consent. As your readers know well, Treasury Sec’y Paulson *in his own words* on how he persuaded President Bush–who asked, “Do they know it’s coming, Hank?”–to allow him to place the entities into conservatorship, “‘Mr. President,’ I said, ‘we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.” (On the Brink, p. 1). That’s not some anecdote buried in an obscure footnote in the congressional record somewhere…that’s how Hank Paulson opens his memoir.

        He admits (boasts?) that he went into meetings he unilaterally called fully prepared to seize the companies by force: “We preferred that they voluntarily acquiesce. But if they did not, we would seize them” (p. 4).

        Paulson wouldn’t disclose to Fannie “how much equity capital” (p. 11) they’d inject or how the ‘deal’ would be structured. In fact he said his team “wasn’t eager” to give Fannie’s team “many details at all” (p. 11). Paulson characterizes CEO Mudd’s reaction to his ‘pitch’ as “stunned and angry” (p. 10), and when Mudd said that Fannie’s board “will want to have a close look at this”, Paulson recounts FHFA’s outside council’s reply was, “I need you to understand that when these gentlemen”–he meant Lockhart, Bernanke, and me–“come to your board meeting tomorrow, it’s not to have a dialogue.” (p. 11).

        When the meeting did take place, James Lockhart, as head of FHFA, then repeated the line (according to Paulson) to GSE CEOs and their senior staffers at the meeting in which this consent was given, “[Lockhart] said that we all hoped they would agree to do this voluntarily; if not, we would seize control. We had already selected a new CEO and had teams ready to move in.” (p. 9).

        Yes, the fact exists that Fannie “consented to the conservatorship” and to a conservatorship “where the conservator had extremely broad statutory powers” per today’s ruling. Any common sense understanding *of Paulson’s own account* of that agreement, tho, is a pretty flimsy link to support the remainder of the ruling. It may strain credulity, it may offend our common sense, but that weakest link has been alloyed with the power of the government.

        A philosopher not mentioned above said the most important part of any task is the beginning. One has the impression that you were right to advise a legal challenge from the initial takeover. The 3rd amendment, at least in the Court of Federal Claims, seems to be dead. The GSE’s consent to the takeover was the beginning of the end.

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        1. It’s amazing to me that following today’s ruling, the courts have now endorsed 1) HERA allows FHFA to manage the GSEs with out any limits (NWS IS OK), and now 2) HERA allows the UST to nationalize the GSEs simply because the boards consented to conservatorship, and naturally shareholders should have expected the government to nationalize the entities without any compensation as a result. You would think such monumental declarations would be clearly spelled out in HERA by Congress, as not to “hide elephants in mouse holes.”

          The judges today reversed Sweeney’s opinion re: derivative takings claims in 3 paragraphs of pages 44-46 without even needing to address the courts binding First Hartford precedent. Why? Because of what they claim to be the “power to exclude” novelty that defendants didn’t even think to brief on! Apparently the power to exclude defense allows nationalization / taking private property without just compensation.

          The ruling can get petitioned to SCOTUS, but will shareholders have any better luck there after the APA ruling? (Although 1 SCOTUS judge did mention this sounds like a Takings case, guess he was wrong as well).

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          1. I recall at least one Justice asking why Collins wasn’t a takings case instead of APA. If the plaintiffs are willing to proceed, I don’t believe all is lost.

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          2. there appears to be the notion that the govt can do whatever it wants to do with the GSEs…but one would think only at a price. I dont buy the premise, but the judicial branch seems agreeable to permit confiscation….now, an appeal to SCOTUS might allow us to see if SCOTUS thinks that nationalization (while permitted(!)) comes at a cost.

            rolg

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      2. Sadly, in Collins, it appears the only reason Cert was granted by SCOTUS was to overturn the APA ruling by request of the government and Financial Establishment. I expect with this, although I hope I am simply cynical and would be proven wrong, SCOTUS on this would conveniently deny cert and “head for the hills” like they did in Collins. I fear what this means beyond just the GSEs and unfairness in this case. It doesn’t only make it difficult to recap the GSEs with outside investment, it should make anyone in congress wishing to “privatize” any government function take a second look. Investors will remember what happened the last time the government floated a charter to private investors. It didn’t end well.

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      3. A little hell for the layman. Was Sweeney/Schwartz THE COFC claims case? Is the Court of Federal Claims now completely off the table with this ruling?
        Did this appeal need to be validated in order to go to trial?
        VM

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        1. Yes, the Court of Appeals for the Federal Circuit was ruling on the multitude of cases in the Court of Federal Claims, originally argued before Judge Sweeney (then transferred to Judge Schwartz when Sweeney retired). And the proceedings before Sweeney were still at the stage where she was trying to determine whether her Court had jurisdiction to hear these cases. She decided to do an interlocutory appeal to her appellate court for guidance on legal issues she was unsure about.

          This interlocutory appeal to the Federal Circuit was thus similar to the interlocutory appeal to SCOTUS in Collins–it was made before the facts in the case had been presented, argued and adjudicated. And in both of these instances, the courts hearing the appeals (SCOTUS and the Federal Circuit) made legal rulings that drew heavily on the government’s (false) version of those facts. I now believe that SCOTUS’s decision to grant cert on the interlocutory appeal in Collins was made precisely to avoid having to deal explicitly with the true facts of Collins. I don’t know if the same was true with Sweeney’s appeal to the Federal Circuit, but it may have been. In any event, I believe all of the cases before the Court of Federal Claims are now dead, and would be surprised if any of the plaintiffs’ counsel appeal to SCOTUS (which already has made its views on these issues known).

          What is different about the remand to Judge Lamberth of what was once Perry Capital and now is Fairholme is that it WILL be argued based on factual allegations. But with SCOTUS and the Court of Appeals for the Federal Circuit having both made such sweeping rulings claiming that HERA gives the government virtually unlimited discretion over what it can do with (or to) Fannie and Freddie, Lamberth now has two precedential rulings to draw on should he decide to conclude that the government’s motives for its actions with respect to Fannie and Freddie (to nationalize them when it became clear that they were “the only game in town” as the 2008 financial crisis was unfolding, then to impose the net worth sweep to prevent them from recapitalizing and breaking away from government control) do not constrain its right to do whatever it wants with them. I hope, obviously, that this is NOT how Lamberth rules, but we will likely learn that this summer or fall.

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          1. Hi Tim,

            This is a very very important point and leaves me wondering a few things… Please humor me….

            It’s revealing how these cases have been adjudicated based on narratives as opposed to facts, as you stated in your previous reply. I believe that this is because discovery was only allowed within Sweeney’s court and that this discovery will formally be presented at the Lambert trial. Is this correct? If so, my understanding is that the plaintiffs in that case will formally present those facts on March 21st via their summary judgement motions in preparation for trial on July 11th (per Gary Hindes ‘Questions for the Nominee’ PDF, pasted below).

            If this is the case, is it possible that the narrative will change from fiction to fact from that point forward? Can any useful facts found in discovery, after being formally presented in the lambert court, be used upon appeal? In other words, when and how can the facts in discovery ever be used to in the COFC and Collins cases, if ever?

            Would love to hear ROLG’s comments on this as well, as it’s been a question I’ve been mulling over for some time…

            Click to access Questions_for_the_nominee.pdf

            Liked by 1 person

          2. As I noted earlier, I believe the COFC cases are dead. If the Collins case heard by the Fifth Circuit en banc in oral argument last month is remanded to Judge Atlas, as I expect it to be, then facts will be presented in motions filed, and potentially at trial, there. And as you note, facts also will be presented in plaintiffs’ summary judgment motion in the Lamberth case due on March 21 and, if summary judgment (or a motion to dismiss) is not granted, at trial on July 11.

            It is, however, not reasonable to expect that once these fact-based motions are made public “the narrative will change from fiction to fact going forward.” There are far too many influential parties, with too great a head start, who have strong vested interests in pushing false narratives about the companies, and they will continue to do so. But what I do hope will happen is that the facts will persuade Judge Lamberth to find for plaintiffs on the breach of contract claim, and also that the prominence given the facts in these cases will help persuade key economic policy officials in the Biden administration that its regulatory and capitalization policies toward Fannie and Freddie not only are impeding the achievement of its goals for affordable housing, but also are based on egregiously (and demonstrably) fallacious notions about their past roles in the financial crisis and current amount of risk in their credit guarantees (unlike banks, their only permitted line of business).

            Liked by 1 person

  15. Tim,
    You make too much sense. Logic, common sense, and Reason seem to be the bane of the entire F&F debacle to date. The ‘Financial Establishment’ gets much of what they want, the result? Complacency, on the Legislative, Administrative/Executive, and Legal fronts.
    Have you seen Ken Hassett’s call on inflation and what needs to be done? 4Q22/1Q23. Very curious on your thoughts if even 25% of his prediction(s) come true, much less 50-75%, or even 100%.
    The Saturday edition of the WSJ Journal Report with Paul Gigot had an excellent first 7 minutes.

    TINA,
    You forget the ‘holy grail’ of 80%, or more importantly going OVER 79.9% ‘ownership’. That means Consolidation of Trillions on the USG Balance Sheet, something every Administration has mightily tried to avoid since the Johnson Administration.
    Yes, the USG/Treasury could sell off portion(s) or put them in a ‘side pocket’ to keep things below, or at, 79.9%.
    Tim’s right, good luck with all that as well as the uneconomic decision of flooding the Market with F&F Common shares.
    We are dealing with bureaucrats (ROLG’s point), seemingly not guided by the Rule of Law, but driven to not let hedge funds claim outsized gains in the JPS/Commons & the Right (Federalist Society, et al) who witness F&F potentially reverting to their former selves in terms of ‘equity’ and to be fair ‘traditional left goals/outcomes’ all the while letting the ‘Financial Establishment’ have more than their pound of flesh.

    Keep up the good work Tim. You are doing ‘God’s Work.’
    VM

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  16. Tim,

    I’m trying to get a sense of what to expect with regards to the growth in each company’s total assets for fiscal years 2022 and 2023.

    Given the extraordinary nature of last year’s financial performance by both companies (a combined net income of $34.3 billion), and that together their total assets at year-end exceeded $7 trillion for the first time, do you see significant increases in each company’s total assets going forward?

    If their combined net income pulls back to $23 billion per year, as you’ve stated, is it possible that each company’s total assets might simply level off? Any guidance you can offer would be much appreciated.

    Cheers,
    Bryndon

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    1. Bryndon– As I said below, I’ve not yet done a full re-estimation of Fannie’s (or Freddie’s) sustainable earnings for the next few years. The $23 billion I used as an example in one of my comments is an educated guess, but whatever the final number is I would expect this year’s net income to be above that, because of the carry-over effects of the recent extraordinarily strong growth in home prices.

      For comparative purposes, I would note that between the end of 2016 and 2019 home price growth (as measured by the Fannie-Freddie repeat sales index for purchase mortgages) averaged 5.0 percent per year, while the growth in Fannie’s book of credit guarantees averaged 2.3 percent per year. But during the last two years home price growth jumped to a supercharged 14.7 percent per year, and Fannie’s book growth averaged 8.6 percent per year. This year home price growth is likely to drop back to the (high) single digits, but Fannie’s book growth should still stay strong–if I had to guess I would say 4 to 5 percent, driven entirely by the higher prices of the homes being refinanced or purchased. The wild card is how much Fannie will try to raise its guaranty fees in response to having its new capital requirements become binding at the middle of this month. FHFA has recommended that Fannie (and Freddie) significantly raise their guaranty fees on their lowest-risk business, and if they actually do that I suspect it will have a material adverse effect on the volume of this business they can attract. We may not, though, have a good read on these fee and volume effects for several months.

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      1. That all makes very good sense. I’m much obliged for your eloquent and informed response. By the way, I would take your “educated guess” over most people’s “well-researched facts.”

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  17. Tim,

    Treasury released its FY 2021 Financial Report today.

    Click to access 2021-FRUSG-FINAL-220217.pdf

    For some reason they doubled their fair value estimate of the value of its GSE equity stakes, see pages 100-102 (pages 107-109 of the pdf).

    In past years it had hovered around $110B but now it’s listed at $220B. I see that the “gross investments” part for each of Fannie and Freddie rose by roughly the amount of their retained earnings, and thus by roughly the amount of liquidation preference increase on the seniors in that time. However, that clearly hadn’t happened last year because the seniors also rose in liquidation preference in FY 2020 but Biden’s FY 2022 Presidential Budget still listed the seniors + warrants at $109B, $3B *less* than Trump’s $112B in his FY 2021 Presidential Budget.

    Here is a table I made showing Treasury’s valuation of its GSE equity stake in past Presidential Budgets.

    Big deal, little deal, or no deal?

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    1. “Big deal, little deal, or no deal” with respect to what? If you’re looking at this annual Financial Report from Treasury for clues on what the future values of Fannie and Freddie common and senior preferred stock might be, my view is “no deal.” Those future values will be dependent on the interactions of numerous unknown factors, the most important of which are (a) what the administration chooses to do with Treasury’s senior preferred stock in the companies, (b) how many shares of each company’s common stock will ultimately need to be issued before they are deemed by FHFA to be adequately capitalized, (c) Fannie and Freddie’s future earnings, (d) the multiple the market assigns to those earnings (which will be affected by its assessment of the companies’ political risk, among other things), and (e) when, how (or if) Fannie and Freddie’s junior preferred stock either is converted to common or redeemed, or has their dividends turned back on. I have no reason to think the authors of this routine annual, and very wide-ranging, exercise have any new information about or special insight into any of these factors, so I would view the 2021 Financial Report as “no deal” as a predictor of the companies’ future investment values.

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      1. ‘“Big deal, little deal, or no deal” with respect to what?’

        Sorry, I should have been more clear. I meant with respect to the idea that Treasury might be seriously considering monetizing its GSE equity stake (possibly in the near future) now that they appear to think it’s worth a lot more than in the past. They have clearly made a big shift in their valuation technique, and the prior technique was pretty consistent across Presidents Obama, Trump, and even Biden (though Biden had only been in office a couple of months when the FY 2020 report was released).

        I find this new valuation strange, especially when compared to those in the 2014-2018 time period while the NWS was in effect. If the discounted Fair Value of all the GSEs’ future income was evidently only worth around $110B in the past, how can the seniors + warrants be worth twice that much now when, under the current agreements used in Treasury’s valuation, they don’t get a dime until the GSEs reach full capitalization? That’s well over a decade away while the seniors remain in place.

        Monetization, probably including a conversion of the seniors to common shares, is the only thing I can think of. And even that has the problem that the GSEs’ combined post-recap/release equity is probably not worth much more than $220B anyway, while (by my calculations) the senior-to-common conversion still leaves Fannie and Freddie around $58B and $50B, respectively, below even a 2.5% core capital standard. If a large equity raise is needed anyway, Treasury won’t be able to maintain $220B of value.

        One other possibility is that Obama’s FV reduction in 2014 was a large contingent liability consideration due to all the court cases, and now that SCOTUS has closed the door on injunctive relief over the NWS that consideration was removed? That’s just a guess.

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        1. I look at the issue of Treasury “monetizing its GSE equity stake” very differently. Treasury now holds warrants for 79.9 percent of Fannie and Freddie’s common stock. Today that four-fifths ownership of two companies likely to earn around $23 billion per year for the next few years is worth less than $6 billion—Treasury’s 7.2 billion shares of common from conversion of the warrants times the companies’ current average stock price of 82 cents. Why is that value so low? It’s the market’s current best estimate of the impact of all of the things that could happen to them in the future, including massive dilution as they are forced to meet capital standards that are far in excess of what is necessary given their business risks, among other things.

          How would that value of Treasury’s ownership in the companies be affected were it to convert Fannie’s $120.8 billion and Freddie’s $72.6 billion of Treasury senior preferred to common stock, say, next week? Doing this would raise Treasury’s ownership of the two companies from its current 79.9 percent to 99.3 percent, but at the same time to effect that conversion the companies would have to issue over 235 billion new shares of common stock at today’s stock prices, raising their total common shares outstanding from 9 billion today to 244 billion post-conversion.

          The most straightforward outcome of this scenario is that the value of Treasury’s ownership would rise from $5.9 billion today (at its current percentage of 79.9) to a proportionally higher $7.3 billion at 99.3 percent ownership. But I think it’s more likely that the value of Treasury’s holdings in Fannie and Freddie would go down. Even after the senior preferred is converted to common, the companies will have core capital of only $75.2 billion, an estimated $250 billion short of their Calabria capital requirement (we’ll know the exact number once the companies begin publishing it next quarter). And they will have 244 billion shares of common stock outstanding before they start raising that capital, not the 9 billion they have today. The market will anticipate the issuance of hundreds of billions MORE shares, and the companies’ stock prices will get punished—along with the market value of Treasury’s now near-total ownership of them.

          I’ll keep saying what I’ve said from the beginning: the way for Treasury to maximize the value of its ownership in Fannie and Freddie is to make them more valuable as investments. So far, for over 13 years, it has shown no evidence that it intends to do that. Converting its senior preferred to common, however, is not the answer.

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          1. the pie size (pre ipo equity valuation) remains the same. sr pfd conversion increases treasury’s percentage of that pie. as such, senior preferred conversion vs writedown is how treasury maximizes its equity stake. not sure how that is complicated.

            your argument seems to suggest that if they take a bigger percentage of the pie the value of the pie goes down more than the value of their differential percentage, thus decreasing the overall value of the pie.

            i’m not sure about that argument.. restructuring is going to happen at a depressed price anyway, and unless treasury needs to cash out now — over time the market will eventually price this post restructuring on the basis of the fact it is overcapitalized

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          2. The point I think you and many others are missing in this analysis is that in converting its senior preferred to common, Treasury would be paying itself in a “currency” (Fannie and Freddie common stock) that (a) is grossly undervalued today, relative to the companies’ earning power, and (b) it, Treasury, already owns 79.9 percent of, so it would mostly be diluting its own ownership, at an extremely low price. Moreover, in doing so it would make filling the remaining $250 billion capital shortfall much more challenging—and depress the stock price further—by leaving Fannie and Freddie with 244 billion shares of common stock outstanding before they’ve raised a nickel of new equity, rather than the 9 billion shares that are outstanding today.

            I believe Treasury would be much better advised to first take steps that positively affect the value of its current 79.9 percent ownership stake, in order to get the stock price up BEFORE it cashes out. The initial and most obvious step in that direction would be to deem the senior preferred paid (as it has been) and cancel it, along with the liquidation preference. Then, Treasury in conjunction with FHFA and the companies could put together a recapitalization plan—with a realistic timetable and plausible assumptions about the amounts of new equity required, the prices at which that equity could be issued, and the number of new shares required—which then would allow the market to value those shares much more fairly, and favorably, than is the case now. Treasury could then sell the shares it receives from conversion of the warrants for total proceeds that I believe would be higher, and probably much higher, than if it were to convert the senior preferred to common now, at depressed prices, and then attempt to sell all of those holdings.

            As you said, I’m “not sure how that is complicated.”

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          3. [Edited for length] 7 billion shares at $5 is $35b for treasury

            244 billion shares at $0.25 is $61b for treasury

            Yes the price goes down but the amount treasury gets out goes up by converting senior preferred, tim. My estimates for fully diluted share counts are higher than yours and my price is lower, but when i do the math for the absolute dollar value of treasurys stake, precapital raise market cap is a constant. Say that constant is fully capitalized market cap minus dollars of capital raise and the npv of some tike to retain additional earnings to hit higher dividend levels

            Anyway. Pre capital raise equity equals z. Say it is $134b. If treasury gets 99% of commons before converting jps its stake is worth $100b. If it only takes 80% via the warrants then its stake is worth $80b. By not converting spspa it would be giving $20b to existing common. On what legal grounds?

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          4. First off, all of the stock prices and market values in your comment above are made up. You persistently ignore the fact that today, in the real world, Fannie and Freddie’s combined market capitalization—their total shares of common times their average stock price—is $7.38 billion. That makes Treasury’s 79.9 percent ownership of the companies, today, worth $5.89 billion.

            We don’t know what Fannie and Freddie’s combined market values would be if they weren’t being kept in conservatorship by two entities—Treasury and FHFA—who still seem to be committed to massively overcapitalizing and greatly overregulating them, but if they were “real” financial companies, treated like all others, a market multiple of ten times earnings would seem reasonable. I haven’t yet done my full re-estimation of what I refer to as their “sustainable earning power,” but let’s say for the moment that it’s $23 billion per year. That would make their potential market cap $230 billion, or more than thirty times what it is now.

            You seem to think that converting the senior preferred to common would somehow get us closer to this theoretical market value of $230 billion. I don’t know why that should be the case. To the contrary, it simply would be another instance of Treasury treating them differently from, and worse than, all other companies, which is why their stock price is so low in the first place. (By the way, your question of, “on what legal grounds” could Treasury not convert the senior preferred is backwards; the senior preferred already has been repaid, with interest, except Treasury refuses to count net worth sweep remittances as “repayments,” and is allowed to get away with that; what should be illegal, but unfortunately isn’t, is requiring Fannie and Freddie repay their draws of senior preferred TWICE—once through the net worth sweep, and again through converting the senior preferred to common.)

            My argument is that if Treasury converts Fannie and Freddie’s senior preferred to common, while that will raise its ownership from 79.9 percent to 99.3 percent, it will keep the total VALUE of that ownership close to today’s $7 billion market cap. Cancelling the senior preferred, on the other hand, opens up a path to a valuation of the companies that is much closer to their $230 billion theoretical valuation.

            Through both methods of eliminating the senior preferred—conversion to common and cancellation—new investors still will need to be given a very large share of the companies’ value, as they are far short of being considered adequately capitalized. This complicates the analysis, and makes it difficult to say with any accuracy what Treasury’s stake in the two companies might ultimately be worth. I am convinced, however, that because cancellation of the senior preferred will move the value of the market cap “pie” that’s being divided up closer to $230 billion than to $7 billion, Treasury will get far more economic value from Fannie and Freddie by converting its warrants and selling them at a higher market price than by trying to stretch its (pre-new equity raise dilution) ownership from 79.9 percent to 99.3 percent through a short-sighted and poorly thought-out conversion of the senior preferred to common.

            Put more simply, while 99.3 percent is larger than 79.9 percent, as you note in your comment, 99.3 percent of a value “anchored” around $7 billion is much less than 79.9 percent of a value heading towards $230 billion.

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          5. “Converting its senior preferred to common, however, is not the answer.”

            I couldn’t agree more. These unrealistic ideas, that our two companies can come back to full financial health by destroying the actual owners in the process, are beyond ridiculous. If you’ll permit me, here are my thoughts on how to fairly and justly right this wrong.

            https://drive.google.com/file/d/18MJYUB7DHGwjkJ2EERmiwr4BapEbI4U_/view

            Best regards,
            Bryndon

            Liked by 2 people

          6. Bryndon– I am in substantial agreement with you as to what should be done with Fannie and Freddie (although even in the optimistic scenario you outline in your paper I can’t get anywhere close to the $175 share price for Fannie’s secondary offerings of new common equity you have), but I am very uncertain as to what WILL be done. As I’ve hinted at in previous comments, I think the administration is going to wait to see what Fannie and Freddie come up with in their FHFA-mandated capital plans, due next month, before having any serious discussions about what to do with the companies’ senior preferred stock. And until that decision is made, we’ll stay on the “long and winding road” of using only retained earnings in the attempt to fill the mammoth gulf between Fannie and Freddie’s (hugely negative) current core capital and their (wildly excessive) required core capital.

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          8. I see what you’ve done to get the $175 share price value for Fannie: assumed that (a) all of the policy changes you think the administration should make (including unwinding the senior preferred and cancelling the liquidation preference, cancelling the warrants, and reducing the capital requirement to 2.5 percent) do in fact get made; (b) Fannie is able to fully meet its new capital requirement by issuing only an additional 216 million shares of common; (c) Fannie’s sustainable net income available to common shareholders is $15.3 billion per year, and (d) investors put a multiple of 15.86 on those earnings.

            Let’s, then, call your $175 figure Fannie’s “aspirational” share price. As you know, of course, the company’s current market share price is less than 80 cents. The reason for this massive pricing differential is that investors today assign a vanishingly small probability to all four of your sets of assumptions playing out as you believe they should.

            The evidence to date heavily supports investors’ (highly pessimistic) view of Fannie’s future. I personally believe that investors are now too pessimistic, but I don’t expect Fannie’s share price to change much until the evidence of the administration’s policy intent (or, less likely, the outcome of one or more of the remaining court cases) changes. In my view the first opportunity for such a change will be a decision by the administration as to what to do with Fannie’s (and Freddie’s) senior preferred stock. Until I know what happens there, I can’t see much point in making any predictions about Fannie’s or Freddie’s futures (including where their common share prices may end up).

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          9. “The evidence to date heavily supports investors’ (highly pessimistic) view of Fannie’s future. I personally believe that investors are now too pessimistic, but I don’t expect Fannie’s share price to change much until the evidence of the administration’s policy intent…changes.”

            Agreed. My entire analysis is based on the government’s fair and honorable treatment of the companies and their shareholders (both common and preferred). And without that, there is little hope of getting our companies back – and certainly no hope of any outside private capital investment to meet minimum capital standards.

            The title of my piece is somewhat misleading since it’s really about a pragmatic way to recapitalize and release the companies. It’s just that when I began developing this plan several years ago, the paper was intended to be published on the Seeking Alpha website, and they are heavily focused on share values and investor recommendations. So, the “Solving for P” aspect was done in anticipation of pleasing these editors. But, even with that concession, the saga of Fannie Mae and Freddie Mac just isn’t something they care about or can see fitting with their readership.

            Thank you for your thoughtful response.

            Best regards,
            Bryndon

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          10. Tim,

            I’ve been trying to construct a model on FHFA’s ERCF using the information contained in Fannie Mae’s and Freddie Mac’s most recent 10-Qs, but I’m not able to recalculate the adjusted total assets or the risk-weighted assets listed in each company’s regulatory footnote.

            Do you know if recalculating those amounts is even possible with the information that’s been provided in their filings or is this something that requires more information from the companies? Here’s what’s in their notes:

            Fannie Mae

            Note 14 – Regulatory Capital Requirements

            Adjusted total assets $4,529 billion (GAAP $4,285 billion)
            Risk-weighted assets $1,391 billion

            Freddie Mac

            Note 15 – Regulatory Capital

            Adjusted total assets $3,610 Billion (GAAP $3,109 billion)
            Risk-weighted assets (standardized approach) $919 billion

            It’s interesting that in both cases the adjusted total assets were increased from the amounts listed on each company’s balance sheet.

            Any guidance you can offer would be helpful. Thank you.

            Best regards,
            Bryndon

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          11. Bryndon–

            You’re right to be focusing on Fannie and Freddie’s capital numbers: they were the most important new pieces of information disclosed with the companies’ 2022 first quarter 10Qs.

            I’ll answer your specific question first. No, it is not possible to predict, or project, either Fannie or Freddie’s “adjusted total assets” or “risk-weighted assets,” based on publicly available information.

            In its June 2018 capital proposal, FHFA based its minimum capital requirement on “total assets and off-balance sheet guarantees,” which WAS calculable from published data. Mark Calabria wanted to make all aspects of the 2018 capital rule more onerous for the companies, so in the 2020 rule he replaced “total assets and off-balance sheet guarantees” with “adjusted total assets.” As detailed in the final capital rule–from pages 174 to 182–“adjusted total capital” adds as many as NINE other quantities to total assets. I haven’t checked to see how many of these are available somewhere in the 10Qs or 10Ks, but it won’t be many. You just have to wait until the companies publish the totals each quarter. The last time I was able to calculate the percentage difference between their total assets and adjusted total assets was when FHFA published these data for June 30, 2020. Then, Fannie’s adjusted total assets were 3.2 percent higher than its total assets, while Freddie’s were 17.9 percent (not a typo) higher. At March 31, 2022, Fannie’s adjusted total assets had risen to 5.7 percent greater than its total assets, while Freddie’s had fallen to 16.1 percent greater. I have no idea why either change occurred, and there is no way to know.

            It’s also not possible to understand how Fannie’s and Freddie’s “risk-weighted assets” are calculated. Both companies published their risk-weighted assets for the first time with their first quarter 2022 earnings: Fannie’s were $1,391 billion, while Freddie’s were $919 billion. Neither company said anything about those numbers–they just reported them. But it’s easy to calculate their risk-weighted assets as a percentage of adjusted total assets: Fannie’s is 30.7 percent, while Freddie’s is 25.5 percent. That’s a HUGE difference for two companies that essentially are in the same business. And it’s not due to risk. Freddie doesn’t publish detailed risk profiles of its single-family portfolio in its 10Qs, but it does in its annual 10K. At December 31, 2021, Freddie’s single-family book had both a lower average credit score and a higher average current-value LTV than Fannie’s (although not by much). It seems, therefore, that Freddie’s much lower risk-weighted asset total is its reward for issuing the non-economic credit-risk transfer securities that even FHFA admits will lose them money in a stress scenario. But, again, there’s no way to tell.

            Freddie’s capital advantage increases when Calabria’s “stability capital buffer” is added to it. Recall that the stability capital buffer was his way of penalizing the companies for doing more of the one business they are chartered to do; it has nothing to do with risk. Because Fannie is larger than Freddie, it has a (totally arbitrary) $45 billion stability capital buffer, while Freddie’s is only $23 billion. This, plus each company’s “stress capital buffer” ($34 billion for Fannie, $26 billion for Freddie), pushes Fannie’s total risk-based capital at March 31, 2022 up to $190 billion (or 4.43 percent of its total assets), and Freddie’s up to $122 billion (or 3.92 percent of its total assets).

            Freddie didn’t comment on these numbers, but Fannie did, saying, “As of March 31, 2022, our risk-based adjusted total capital requirement (including buffers) represented the amount of capital needed to be fully capitalized under the standardized approach to the rule, and we had a $272 billion shortfall of our available capital (deficit) to this requirement.” Freddie’s capital shortfall on the same basis was $169 billion.

            The total risk-based capital shortfall ($441 billion) for the two companies was in the range I was expecting. It is incomprehensibly large given the credit quality of their current books of single-family business, which have an average current LTV ratio of 54 percent and an average credit score of 752 (they won’t ever get much better than this). FHFA has to fix this. It also has to fix the glaring disparity in required risk-based capital between the two companies, which is an artifact of the interaction of all the arbitrary and excessive non-risk-based elements of the Calabria capital rule.

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    2. The potential outcome of current litigations is not explicitly called out as a factor to change the estimation. Does that mean Treasury knows that the shareholders litigation efforts would not materially change anything at this point?

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      1. Not in my opinion. The motions for summary judgment and trials in the remaining court cases may (and I hope will) give prominence to facts relating to Fannie and Freddie that change the views of top economic officials in the Biden administration as to how best to eliminate the Treasury senior preferred, and whether to make the recapitalization of the companies more feasible by replacing the Calabria capital standard with one more reflective of the actual risks of the companies’ business. These in my view are the most important of the five factors listed above in determining the future value of Fannie and Freddie’s existing common and junior preferred stock.

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    1. Layton continues to begin his pieces with an incorrect description of the problem, which then leads him to prescribe an unnecessarily complex or draconian solution. In this case he says, in his first paragraph: “[T]he GSEs falling into conservatorship was widely regarded as the result of fundamental flaws in their operations and structure. As such, actors across the entire policy and political spectrum considered a simple recapitalization and return to private sector ownership to be unwise.” No, it was the banking interests who said both of these things, and their assertion of “fundamental flaws” at Fannie and Freddie was inaccurate and self-serving. There are many people who do know (and admit to) the facts about the financial crisis, and also understand that getting Fannie and Freddie out of conservatorship need not be much more difficult than it was to get them into it, despite what the banks and their supporters say.

      There is history here. When I finally emerged from my eight-year “time out” from mortgage finance matters because of the multitude of lawsuits stemming from the (invented) charges of accounting fraud against me by FHFA’s predecessor agency, OFHEO, I was astounded to learn that many people who I was convinced knew better were publicly supportive of the Corker-Warner bill. When I said to them, “you know this will never work, right,” I was surprised at their response. To a person, they said that after the conservatorships they couldn’t get a seat at the table discussing the futures of the companies unless they agreed that Fannie and Freddie were “fundamentally flawed” and needed to be replaced. They said they knew Corker-Warner wouldn’t work, but if they admitted this they would be sidelined, so they stayed silent in the hopes they could fix the problems if the bill moved forward.

      I think a version of the same thing is happening now. The bank echo chamber keeps making the same (false) claims, and almost nobody speaks up for the facts, with the companies themselves prohibited from “lobbying.” As I noted in an earlier comment, my hope is that the motions to dismiss and trials in Fairholme, Collins and (eventually) the Court of Federal Claims will serve as a catalyst to shift the dialogue about Fannie and Freddie’s futures from fiction to fact, and this is in turn will convince some high-level person or group of people in the Biden administration to chart a course for the companies’ exits from conservatorship that benefits all stakeholders—the government, existing and new shareholders, and homebuyers—and not just the banks. Otherwise, I’m afraid Layton will be right: Fannie and Freddie will remain in “suspended animation” indefinitely. The banks are very happy with the status quo.

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      1. I’ve just looked at Fannie’s full-year results quickly, and not yet read through the 10K, but I’ll give you my initial reactions.

        The net income figure, at $22.2 billion for 2021, was impressive, close to double the $11.9 billion recorded in 2020. As always, though, I like to break the results into two categories–one-time effects and sustainable elements–and in 2021 there were two significant sources of non-recurrent revenue: $5.1 billion in credit-related expense, and $11.2 billion from net amortization of guaranty fees.

        I keep expecting to see Fannie switch from recording credit-related income (which is not usual) to credit-related expense (which is), but it still hasn’t happened. This year, what drove the credit-related expense number was a surge in home prices and further drawdowns of loss reserves set up as a result of highly conservative accounting conventions adopted (by FHFA) after the crisis. But now there really is not much room for those reserves to move lower. At December 31, 2021 Fannie’s TOTAL loss reserves–which under the current expected credit loss (CECL) standard are supposed to reflect the credit losses it anticipates over the lives of all its $3.9 trillion in credit guarantees–were just $5.8 billion, or 15 basis points of guaranteed loans. (Think about that; FHFA insists that for Fannie to be “safe and sound” it must hold 465 basis points of capital, while the company is telling us that it can cover its lifetime expected credit losses today with less than six months’ worth of net guaranty fees.)

        The surge in amortization of guaranty fee income was due to the drop in interest rates earlier in the year, and the subsequent wave of refinancing. When that happens, fees that were paid up front, as “loan-level price adjustments” (or LLPAs) come into income more quickly than anticipated, because the associated loans pay off. By way of comparison, net amortization income accounted for 33 percent of total guaranty fee income in 2019; that percentage jumped to 40 percent in 2020 (when the wave of refinances began), and stayed at the level in 2021. It will almost certainly decrease this year.

        Two sources of 2021 net income growth at Fannie that were NOT temporary were a sharp jump in the size of its total guaranty book (9.0 percent between the fourth quarters of 2020 and 2021) and a 1.2 basis point increase in its average net charged fee on new business; those both will carry through to future quarters, as will the impact of the outsized 19 percent increase in average single-family home prices this year.

        After I’ve gone through Fannie’s 2021 10K in detail, I’ll do a re-estimate of what I call Fannie’s sustainable net income over the next few years. It certainly will be higher than the $14 billion per year I’d estimated previously (because of the surge in home prices and the likely continuance of guaranty fee increases, reduced by the unfortunate re-starting of the company’s money-losing credit-risk transfer program) but also will be significantly less than the $22 billion reported this year, for the reasons noted above.

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        2. Tim

          Fannie also reported that it has $47.4B net worth…which I am guessing is its regulatory capital as well.

          while far short of what the clabria/thompson dicta would require, I prefer to compare this to what would have been obtainable from the capital markets in a so-called re-IPO at the end of the Trump administration…and >$40B would have been the mother of all equity capital raises. so delay is frustrating, and the GSEs will never obtain equity capital with the senior preferred remaining outstanding and growing, but I continue to believe that at some point the senior preferred will have to be expunged, since the 10% (and more) moment has occurred, and this is the only way to unleash the approximate $100B in value of Treasury’s 80% common stock warrant position…and when that happens, the GSEs will have sufficient capital in hand to address the equity capital markets from a position of strength rather than impoverishment.

          I found this interesting from the earnings call transcript: “For the past 2 years, nearly 2/3 of our single-family book of business has turned over. The quality of our new business is high, but the pricing of that business does not reflect the capital requirements of our regulatory rule.” So business velocity is very strong, and current credit quality is very strong and improving, but the business is not pricing to meet its regulatory requirements…which were established by FHFA with an outdated and jaundiced view of Fannie’s creditworthiness.

          seems to me to be another instance where the regulator is driving froward while looking at the rear view mirror rather than through the windshield.

          rolg

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          1. ROLG–

            You (and others) don’t have to guess at Fannie’s regulatory capital–the company reports it. As of December 31, 2021 it was a negative $73.5 billion. It is that far below Fannie’s reported net worth ($47.4 billion) because the latter includes Fannie’s $120.8 billion in Treasury senior preferred while the former does not.

            As to exactly how far Fannie’s negative $73.5 billion in regulatory (or “core”) capital is from Mark Calabria’s ERCF standard, we don’t know; Fannie is not yet publishing the ERCF number, and FHFA doesn’t either. A rough estimate based on past published ERCF percentages and Fannie’s December 31, 2021 total assets, however, would be $196.5 billion, or $270 billion more than it now has.

            Some readers might have noted that in Fannie’s earnings conference call, its new CFO, Chryssa Halley, said, “the deficit of our core capital to our statutory minimum capital was $100.3 billion as of the end of last year.” That’s technically correct, but only because the ERCF does not become the official standard until February 16 (tomorrow). Fannie’s current statutory minimum capital requirement as of year-end 2021 was only $26.8 billion–essentially 45 basis points of MBS and 250 basis points of other assets. Halley said that Fannie will begin reporting its regulatory capital against the ERCF with its results for the first quarter of 2021, and when it does, expect that core capital deficit to be around $270 billion, less whatever the after-tax net income in that quarter is.

            Canceling the Treasury senior preferred would cut Fannie’s core capital deficit to around $150 billion, but I don’t agree that even this lower figure would allow the company “to address the capital markets from a position of strength.” By raising Fannie’s risk-based capital requirement by an arbitrary 80 percent compared with the June 2018 FHFA standard–while the company’s creditworthiness was improving significantly–former Director Calabria (deliberately) put Fannie in a huge hole that will not be easy for it to get out of as long as the ERCF remains in place.

            Finally, we should all get the notion that “the warrants are worth $100 billion” (for Fannie and Freddie combined) out of our heads. While that was the low end of the $100 – $125 billion range put out by Moelis & Co. in November of 2018, since that time two developments–Calabria’s near-doubling of the companies’ required capital and the more than 30 percent increase in the size of their combined guaranty business–has reduced the maximum value of the Treasury warrants to about $50 billion.

            Liked by 2 people

  20. Tim

    I wanted to let you and your readers to know of this event:

    The path forward for housing finance

    Wednesday, February 23, 2022, 11:00 a.m. – 12:00 p.m. EST
    Online: https://www.brookings.edu/events/the-path-forward-for-housing-finance/

    America’s housing finance engines, Fannie Mae and Freddie Mac, have been in government conservatorship for almost fourteen years. This rescue plan followed the 2008 housing market crash, and since then several proposals have been suggested to restructure or replace the conservatorship. Moving forward, what is the road out and what will that mean for the American dream of homeownership?

    On February 23, the Center on Regulation and Markets at Brookings will host a conversation answering this question. First, we will hear from Michael Calhoun, co-author of a paper proposing one road forward. Then a panel of experts will offer their take, including Diane Yentel, president and CEO of the National Low Income Housing Coalition; Dennis Shea, executive director of J. Ronald Terwilliger Center for Housing at the Bipartisan Policy Center; Bryan Greene, vice president of policy advocacy at the National Association of Realtors; and Margaret Franklin, vice president at Fulcrum Public Affairs.

    Viewers can submit questions for speakers via email to events@brookings.edu or on Twitter using #HousingFinance.

    A potential path forward for housing finance
    Michael Calhoun, President, Center for Responsible Lending
    Moderator: Aaron Klein, Senior Fellow, Center on Regulation and Markets, The Brookings Institution

    Debating the path
    Margaret Franklin, Vice President, Fulcrum Public Affairs
    Bryan Greene, Vice President, Policy Advocacy, National Association of Realtors
    Dennis Shea, Executive Director, J. Ronald Terwilliger Center for Housing, Bipartisan Policy Center
    Diane Yentel, President and CEO, National Low Income Housing Coalition
    Moderator: Aaron Klein, Senior Fellow, Center on Regulation and Markets, The Brookings Institution

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    1. I saw that, and have registered for the webcast. I’ll be interested in hearing what Mike Calhoun has to say, and how the panelists react to it.

      At this point, we definitely need something, or someone, to begin to change the dialogue on Fannie and Freddie’s future to something more based on reality. I don’t know how many readers saw FHFA’s Draft Strategic Plan for 2022-2026 (which would be the five years of Director Thompson’s tenure were she to be confirmed), but here is the entirety of the content of the strategic objective related to managing the conservatorships:

      1. Provide clear conservatorship expectations to Enterprise boards and management;
      2. Develop a readiness framework for the Enterprises;
      3. Oversee the Enterprises’ implementation of capital plans to achieve regulatory capital requirements;
      4. Require the Enterprises to transfer a significant amount of credit risk to private investors; and
      5. Require the Enterprises to update their pricing frameworks to enhance safety and soundness while providing enhanced support for core mission borrowers.

      These are totally consistent with the plan for managing the conservatorships I identified and discussed in the current post, which dates back to a December 2012 memo to Treasury Secretary Geithner: make them meet bank-like capital requirements, make them (or give them an incentive to) “transfer a significant amount of risk to the private sector,” and have them price their business to reflect bank-like capital, which will “enhance safety and soundness” (although how that also will provide “enhanced support for core mission borrowers” is a mystery—and more like a fantasy).

      There is not a word in this strategic plan about getting the companies out of conservatorship (it seems like “we can begin to talk about that once you get close to meeting the capital requirements we’ve set for you.”) If discussions about a release from conservatorship for Fannie and Freddie in any reasonable time frame are taking place in this administration, it’s clearly not at FHFA.

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      1. One head-scratching part objective is #3, “Oversee the Enterprises’ implementation of capital plans to achieve regulatory capital requirements.” The recently proposed capital planning proposed rule specifically tasked the GSEs (by May 20), to “identify the amount of capital they need to raise to close the gap with the ERCF, and to consider the timing of when to raise capital, and what types of capital to raise.”

        Some questions come to mind.
        1) How are the GSEs supposed to accomplish this / any capital raise with the senior pfds overhanging?
        2) How is the FHFA supposed to oversee the “implementation” of that plan that starts and goes nowhere with the senior pfds overhanging?
        3) What is the purpose going through these motions which clearly lead back to the senior pfd overhang?

        Even Mel Watt didn’t direct the GSEs come up with silly exercises like this with no end-goal in sight.

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        1. This is the dilemma I keep writing about. FHFA and Treasury are making policy based on fictionalized versions of Fannie and Freddie’s business and risks, and now they must deal with the consequences of those policies in the world of fact. (That’s why in the current post I used the analogy of the dog who chased the car and caught it.)

          Nowhere is that more clear than in dealing with Fannie and Freddie’s capital shortfall. The companies don’t need to file a capital plan to tell FHFA what their capital shortfall is–they publish their core capital on a quarterly basis, and FHFA is the source of the required capital numbers (based on an “adjusted total assets” figure only it knows). And as you point out, neither company can fill that gap with anything but retained earnings until the Treasury senior preferred is done away with. But here is where fiction and fact collide.

          The easiest way to deal with the senior preferred is for Treasury to simply admit that the companies’ past draws of senior preferred have been repaid, with interest, and to cancel it, along with Treasury’s liquidation preference. But this would conflict with the fictional story Treasury and FHFA have been telling for the past 13 years, that the draws were real and necessary (rather than having been caused by temporary and estimated book expenses that fully reversed themselves in 18 months), and that the net worth sweep was a sensible way to end the “death spiral” of borrowing to pay the 10 percent cash dividends in perpetuity.

          The other way to deal with the senior preferred is to perpetuate the fiction that Fannie and Freddie really still “owe” that amount of money to “the taxpayer,” and to convert it to common stock (which the government then could sell). Doing that, however, would greatly complicate the process of raising the rest of the capital in the fact-based real world. Combined, Fannie and Freddie have 1.8 billion shares of common stock outstanding. Treasury’s warrants for 79.9 percent of their common add 7.2 billion more, bringing the total to 9.0 billion. But the companies also have $193.4 billion in Treasury senior preferred stock on their balance sheets, which they never needed in the first place, and have already paid back with interest (although Treasury doesn’t consider ANY dividends or sweep payments as “repayments”). If Treasury insists that Fannie and Freddie pay TWICE for that money they never needed–by converting the senior preferred to common–at today’s average stock price of 87 cents they would have to issue 222 billion shares to clear their (totally fictional) “debt,” making Treasury the owner of 99.2 percent of the companies. And, with 231 billion shares of common already outstanding, they STILL would be about $250 billion short of Director Calabria’s “bank-like” capital requirement, with hundreds of billions of more shares needing to be issued to close that gap in a reasonable period of time.

          My sense is that whoever in the Biden administration is taking the lead on the Fannie and Freddie issue doesn’t like either of these alternatives. But they are the only two there are. So they sit, like the dog who caught the car, waiting to decide what to do with it. But this can’t, so won’t, go on forever.

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          1. Tim,
            This is beyond well said. Your comments highlight the farce, yet very real, political, economic, finance, and accounting issues obfuscating the Truth.
            If the Treasury owns 99.2% of the Commons, it is Consolidation Time, and that is expressly something the USG wants to avoid (and has bent over backwards avoiding) since the Lyndon Johnson Administration.
            One gets the sense that if something happens (“…this can’t, won’t, go on forever”) it will be done quickly and with a scythe, BUT can the Biden Admin truly keep things under wrap?
            I know you don’t want to do any deep dive in Litigation, but is it not the Litigation b4 the Courts the means by which ‘something’ will be resolved?

            VM

            Liked by 1 person

          2. When I said in the current post that “I don’t intend to turn the blog into a running chronicle of the remaining legal cases,” I meant I wasn’t going to speculate on what might happen at each stage of the process in all of them (since my track record on past court case predictions isn’t great). But I do think these cases could be very helpful in weakening the resolve of certain key economic policy figures in the Biden administration to stick with their fictional versions of Fannie and Freddie’s past histories and the best way for them to exit conservatorship.

            In both the Fairholme (formerly Perry Capital) case before Judge Lamberth and the Collins case likely to be remanded to Judge Atlas, there will be motions filed and trials on the facts. In Fairholme, plaintiffs’ counsel will be filing their motion for summary judgment on March 21, in anticipation of a trial scheduled for July 11. Thanks to discovery granted by Judge Sweeney in the Court of Federal Claims, plaintiffs in Fairholme will be able to document what truly happened with Fannie and Freddie leading up to their placement in conservatorship, the temporary or estimated book losses that forced them take senior preferred stock they didn’t need and weren’t allowed to repay, and then Treasury telling itself privately that the real reason for the net worth sweep was that they knew the companies were about to receive an avalanche of net income as the book expenses reversed themselves, and they didn’t want the companies to be able to recapitalize, while at the same time telling the public (and the courts) that the sweep was intended to prevent a “death spiral” of borrowing to pay the senior preferred dividend.

            Treasury (and FHFA) will have no rebuttal to plaintiffs’ factual assertions, because there isn’t one. And from March 21 forward, the facts about Fannie and Freddie should stay front and center until the Fairholme case, and other cases, are decided at trial. My hope and expectation, therefore, is that those within the Biden administration who have been the strongest advocates of fiction-based policies towards Fannie and Freddie will not be successful in maintaining support for those policies in the fact of this “focus on the facts,” and that others in the administration (including those who had been able to get the nomination of Mike Calhoun as Director of FHFA to the “one-yard line” before the banking lobby got it stopped) will take the lead on resolving Fannie and Freddie’s current state of limbo, and end their perpetual conservatorships with a plan based on fact, and workable for ALL stakeholders—the government, existing shareholders, and the low- and moderate-income homebuyers the companies were chartered to serve.

            Liked by 3 people

          3. Tim

            The Fairholme case in which plaintiffs assert that the government/GSEs breached the implied covenant of fair dealing by adopting the 3rd Amendment of the PSPA (NWS) should be a very fact intensive analysis. I wrote about this at https://ruleoflawguy.substack.com/p/fannie-and-freddie-the-nws-and-the?r=35rec

            Judge Lamberth will be urged by the government to toss the case out on summary judgment because, the government will allege, the GSEs were bankrupt and about to greatly harm the US financial system. Plaintiffs’ exposition of the “Judge Sweeney discovery” should get the case to trial, and then at trial establish that adopting the NWS was so beyond the reasonable expectations of junior preferred shareholders that it breached the implied covenant.

            this is an important case that has been laying in waiting for a long time.

            rolg

            Liked by 1 person

  21. Tim,

    Do you believe there is a point where the conservatorship status quo becomes untenable? One can argue it was acceptable when the government was collecting all the cash profits of the GSEs via the NWS, in exchange for the taxpayers backstopping the GSEs/housing market (ignoring the facts, on the surface this seems fair). But since September 2019, the Treasury amended the NWS so they no longer collect any cash compensation in exchange for that taxpayer backstop (the government can’t spend the increase in liquidation preference like they could cash). Shouldn’t they/taxpayers eventually demand some sort of compensation for this arrangement, for the taxpayers sake? (The optimist in me hopes this comes in the form of monetizing their equity stakes in the GSEs via chartering their exit out of c-ship)

    Thanks

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    1. The “taxpayer” does not play, and never has played, any active role in policymaking with respect to Fannie and Freddie; it is an abstraction whose interests those who do play a role in that policymaking claim (or piously pretend) to represent. My sense is that in the Biden administration currently, Fannie and Freddie policy is being run out of the National Economic Council (NEC), with Janet Yellen at Treasury doing her best to stay out of it, and Acting Director Thompson taking her cues and advice from the “serious people” in the mortgage business (virtually all from what I call the Financial Establishment) who are more than happy to be telling her what they think she ought to be doing.

      I don’t see anyone in the NEC, or elsewhere, turning the net worth sweep back on. And while I am sympathetic with your expectation that the administration should want to get some value out of the companies (in the absence of cash net worth sweep payments for the last 10 quarters), they don’t appear to be focused on that either. As I’ve said often in the past, the way for the administration to get more financial value out of its ownership in Fannie and Freddie (the warrants; I don’t see it converting the Treasury senior preferred to common) is to make the companies more valuable as businesses, and get their stock prices up. Yet by continuing the overcapitalization and overregulation policies of former Director Calabria, they’re getting the opposite–both companies’ common stocks are trading at 84 cents a share, making the value of Treasury’s warrants about $6 billion (a far cry from the $100 billion potential value that persists in the minds of many of the firms’ investors) .

      I don’t see any evidence of the Biden economic team deviating from the course they’re on. The banks are happy with it, and there is no pressure coming from anywhere else to change it. Perhaps there will be a result in one of the remaining court cases that will shake things up. But absent that, I see the powers that be being content to see how high Fannie and Freddie can raise their guaranty fees on the lowest-risk half of their business, and whether they and their investment bankers can come up with something unexpected and clever (I don’t know what that would be) in the way of a capital plan, and unlikely to make any changes to the companies’ “current course and speed” in interim.

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        1. I have my suspicion, but it’s not one I’m willing to make public on the blog. I will say, though, that the person I suspect to have been behind the Calhoun nomination was “outranked” by the person who I believe to have put it on hold, then ultimately put their own choice in.

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    1. Lockhart and Pat Lawler, a Senate Banking Committee staffer during the passage of Fannie and Freddie’s 1992 capital legislation, who, when he couldn’t get the onerous provisions he wanted in that law, then joined the nascent FHFA to try to accomplish regulatorily what he hadn’t been able to do legislatively. Lawler, in my opinion, also is the main reason the Volcker risk-based capital standard in the 1992 Act failed to work properly; he declined to follow what we called the “supervisory approach” to implementing it, and instead had FHFA take ten years to build its own model of Fannie and Freddie’s businesses, which was overly simplistic, and effectively disabled the warning bells of the standard when they were most needed—in the years leading up to the PLS meltdown.

      This is a typical piece by members of the anti-Fannie and Freddie cabal. They repeat the false story that Fannie and Freddie were the causes of the financial crisis and needed to be bailed out, and that their “seriously flawed structures” are what need to be fixed. (We’ve heard that a thousand times before, and as long as the media keeps printing that version unchallenged, we’ll continue to hear it.) But for them to blame the recent surge in home prices on Fannie and Freddie—giving no evidence—is new. Nothing about people moving out of cities to the suburbs because of Covid, or the skyrocketing cost of building materials because of supply shortages, or the fact that “free-market” private equity firms have been buying up tens of thousands of single-family homes on an unseen basis at prices way over the asking price. Nope, the culprits are Fannie and Freddie, and “something must be done!”

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  23. Hello Tim,
    I have been reading your blog for years now and really appreciate the time and effort that you have put into this. I understand moving forward it seems pretty bleak. I think the Banks have won and they will never let go of these GSE’s. There is too much money involved and no accountability.

    I apologize for overstepping myself, but I sent an email to the person who handles scheduling guests for Joe Rogan and suggested that they reach out to you. I told them I have no affiliation with you and I can tell you that I have no affiliation with them either. I am not sure if you would be interested in that, but before you sign off and ride into the sunset, one more Hail Mary might make the difference !!!!!

    Thank you again for everything.
    I have learned a lot from this Blog.

    Liked by 1 person

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    1. I’m not giving up, nor am I “riding off into the sunset”. I’m just expressing the current reality with Fannie and Freddie as I see it, which, if I’m right, isn’t likely to give me much to write about for a while. But I still hold the view I expressed in this comment on the blog, made late last year:

      “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.”

      My uncertainty is around the definition of “too much longer.” My analysis of the situation is that for some reason (probably the influence of the banks) the Biden administration is staying on the course for Fannie and Freddie set by Mark Calabria, which was to allow the companies to be released from conservatorship, but only on terms HE set, which was grossly overcapitalized and overregulated. As I said in my post “Then and Now,” I think Mnuchin couldn’t figure out how to justify canceling the senior preferred on that basis (there was no “quick win” for him, or Treasury, as long as the companies were so far away from the Calabria capital requirement and couldn’t be released, even under a consent decree, during the remaining days of the Trump administration). I don’t see why Secretary Yellen would see things any differently, and the alternative of not canceling the senior preferred but converting it to common—a current popular speculation—would truly nationalize Fannie and Freddie, and, with nearly 100 percent government ownership (compared with “just” 79.9 percent with the warrants), put their $7 trillion of assets on the federal balance sheet. I can’t see a Democratic administration doing that either.

      So, my analysis is that we wait until somebody realizes that the consequences of trying to actually run two companies at the heart of the U.S. secondary mortgage market based on fictions about their business become too obvious and unacceptable to ignore, and at that time maybe the facts will matter again. But that won’t happen immediately. We’ll have to go through Acting Director Thompson’s bureaucratic processes of having Fannie and Freddie file their capital plans (mine would be, “it will take us 20 years of retained earnings to reach your arbitrary and unjustified capital targets as long as the Treasury senior preferred and liquidation preference are in place, and you keep your foot on our air hose”), file their affordable housing plans (again, mine would be, “we could do a lot more for affordable housing if you let us price our credit guarantees on an economic basis”), and try to raise their guaranty fees on their highest-quality business (“people don’t seem to want to pay 60 basis points per year to insure against a loss they think will only be about 2 basis points a year”). That will take some time.

      But, no, I’m not interested in being a guest of Joe Rogan; he’s not the right medium for my message.

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      1. Glad to hear you’re not giving up or riding off into the sunset.
        For my money, there are fewer better Americans than yourself. Truly.

        I would be curious as to what medium for your message you would prefer that would have a wide enough reach to make a dent. I can’t imagine that any of the ‘mainstream’ financial outlets would be the choice as I’ve seen how many there are structured.

        To my mind is very much a question of reach. It has to help people understand why they should care.

        Given the idea of Joe, and I understand the hesitation, I do wonder if there is anyone anywhere else with a similar reach that would have an audience that listens to long form content that would be needed to fully explain the story here.

        I can’t think of one. Maybe Matt Taibbi’s podcast? Chris Irons had Adam Spittler on once, but is on the fringe definitionally. Further, podcast stats are notoriously hard to track. It might make sense for you to start your own? Though perhaps that ship has sailed..

        While your blog is an extremely good resource, getting the story out in this day in age matters more. Narrative wins. That’s why they repeat the lies over and over and over. The tired reference to Orwell is nowhere more apt than in this case.

        Given that, I can think of few good alternatives to Joe’s reach and because the mainstream will never capitulate, outside the box thinking is needed at this point. If the courts are going to find elephants in mouseholes into perpetuity what else can be done?

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        1. My experience with messaging on Fannie and Freddie-related issues goes back over 30 years, to the time FM Watch was set up.

          We (the top executives at Fannie) quickly concluded we were not going to be able to win the broader public messaging battle–we had no support in the financial media (the Wall Street Journal was actively with FM Watch, and even our home-town paper, the Washington Post, was anti-Fannie Mae). Instead, we took our message directly to those who mattered most to us–members of Congress and their staffs who were on our committees of jurisdiction, and key policymakers in the administration. That worked. But post-conservatorship, Fannie and Freddie have been prohibited from lobbying, so that all the members and staffers in Congress–and key administration figures–hear is the Financial Establishment’s version of the story. And that’s a huge problem.

          Since I published my book, I’ve met with numerous Senators and their chief housing staffers (and some on the House side), and had no success. The issue is that what I’m telling them runs counter to everything they’re hearing from everyone else (all advocates for the Financial Establishment), and the staffers and members don’t have any way of separating fact from fiction, and have even less incentive to take a position contrary to that of their large contributors.

          For these reasons, I don’t respond to articles like the one that just appeared in the American Banker from Lockhart and Lawler, and no longer send emails to Congressional staffers. It is, unfortunately, a complete waste of time to do either, because it doesn’t have any impact. Instead, what I try to do is get the facts written up in blog posts or comments, then look for people who can serve as conduits for getting those messages to thought leaders in the industry, Congress and the administration. It hasn’t worked so far (although I thought we got close with the near-nomination of Mike Calhoun as Director of FHFA), but I think the customized and targeted messaging approach is much more likely to be effective than getting on somebody’s podcast and shouting into the gale of wind coming from Fannie and Freddie’s opponents.

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  24. Tim

    very grateful for your blog.

    it is possible for someone who wants to know how to facilitate the financing of the single and multi-family housing markets in a way that benefits fairly all constituents and in a safe and sound manner…reading your blog is the resource. that so much of what passes for policy in DC is motivated by self-interested actors with no motivation to pursue the common good shouldn’t surprise us…but no one should get complacent about this.

    patience is a virtue.

    rolg

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  25. I have greatly enjoyed the blog since its inception and still continue to do so. Thank you. I would be interested in how the influence of the Financial Establishment wends its way through bureaucracy and ends up on the desk of someone like Sandra Thompson. It could be helpful to see sunlight shined on the mechanics of this influence. I would bet others would be interested in that also. That you explored this angle in your book (e.g., FM Watch) was very satisfying to me as a reader.

    One thing for which I’m grateful after having read your blog for a few years is that I’m knowledgeable enough to watch a legislative hearing on the GSEs and understand how little our legislators actually know what they’re talking about, that is, how uninformed they are on important economic details. This leads me to believe their true focus is more on receiving direction from the experts rather than mastering the material. And I believe these experts are often members of the Financial Establishment. I wish I knew more details of how this process works.

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    1. Soto–you are pretty close to having “nailed it.”

      There are no GSE congressional staff experts, not in the personal offices of the members of both the Banking Committees, nor on the committees themselves.

      People may have those titles, but almost none have the knowledge and history.

      The Senate nomination hearing for Sandra Thompson showed how thin that knowledge is. Nobody truly challenged her until Sen. Toomey (R-Pa.) exposed her ignorance regarding her own/FHFA’s statutory responsibility to end Conservatorship.

      That’s why Tim is so valuable; he worked it, lived it, knows it, and has written books and blogged about the many Fannie/Freddie swirling issues both political and substantive!

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  27. Thank you Tim for you insight over the years. It has been very enlightening, not only for what is actually going on, but just how fake fake news is.

    There is one more very troubling factor: it’s obvious and admitted that the companies were taken over by force and didn’t meet any of the criteria laid out in HERA. Yet this has been allowed to stand. I wonder if the banks would go as far as to “persuade” federal judges.

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  28. Thank you Tim. It’s long been apparent that the financial establishment has all the cards and is dealing from the bottom of the deck.The fact that Fannie and Freddie cannot even advocate for themselves is a huge part of the problem. I do urge you to stay involved, if not through this blog then behind the scenes. At some point we will get a shot at making Fannie and Freddie free and independent once more.

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    1. Jeff–I definitely do intend to stay involved behind the scenes, and also on the blog. I just thought I should do some “level setting” about the likely frequency of new posts, given what seems to be the reality of the current situation with Fannie and Freddie. As I said in the post, I don’t intend to keep saying the same thing over and over, and it’s not my wont (as it is for some commenters) to constantly berate people for being too dense or biased to take my brilliant advice. When I think I have something new or important to say I’ll do a post about it, but I think we’re likely entering a “quiet period” for Fannie and Freddie, as Treasury, FHFA and the rest of the Financial Establishment see how the position they’ve been able to put the companies in plays itself out.

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