A Capital Reality Check

~ jtimothyhoward

On April 28, Freddie Mac filed its 10Q for the first quarter of 2022 with the Securities and Exchange Commission, while Fannie Mae filed its first quarter 2022 10Q on May 3. These were the first times either company reported on their actual and required capital under the Enterprise Regulatory Capital Requirement (or ERCF) made final by former FHFA director Mark Calabria in December of 2020 and amended by acting director Sandra Thompson in March of this year.

I had been looking forward to the filings. Having read the text and reviewed the tables of former director Calabria’s final capital rule—and taken note of how much capital it would have required Fannie and Freddie to hold as of June 30, 2020—I was eager to learn what each company’s binding capital requirement was as of the end of the first quarter of this year, how much progress they had made in reducing their capital shortfalls, and what they would say about how they intended to ultimately come into full capital compliance.

I might have expected how they would treat this topic. Both said very little about it. Each reported on their capital requirements using similar (but not identical) formats, very likely designed and approved by FHFA, leaving it to the reader to determine what most of the data meant. Freddie’s 10K did not even identify which of its two capital amounts (risk-based or leverage) were binding, nor state what that capital amount was or how far the company was from meeting it. Fannie, at least, did that, saying, “as of March 31, 2022, we had a $272 billion shortfall of our available capital (deficit) to the adjusted total capital requirement (including buffers) of $190 billion under the standardized approach to the rule,” after earlier having said, “the amount of capital we will be required to hold under the amended enterprise regulatory capital framework remains substantially higher than the previously applicable statutory minimum capital requirement.” But Fannie said nothing further, and Freddie said nothing at all, about the new standard.

Fannie, Freddie and FHFA all can try to ignore or obfuscate the real-world impact of having former director Calabria’s grossly excessive and unjustified new capital requirement now be binding on the companies, but that won’t make this issue go away. Yet before discussing the implications of the Calabria capital requirements, I first need to give some facts and figures about them, since the companies (and FHFA) did not.

The March 31, 2022 capital numbers. Because of the way the ERCF has been constructed, its risk-based standard, and not the leverage standard, is currently the binding one on the companies (and, as I note below, will be for the foreseeable future).

The presentation of the capital numbers in both companies’ first quarter 2022 10Qs was a construction, with no explanation. The total required risk-based capital number was shown as the sum of three components: a (misleadingly named) “total capital” amount, derived by multiplying each company’s “risk-weighted assets” by 8 percent, and two buffer amounts—a “stress capital buffer” equal to 0.75 percent of each company’s “adjusted total assets,” and a “stability capital buffer” linked to FHFA’s definition of each company’s market share. The two buffer amounts are arbitrary but at least straightforward, and together make up the “Prescribed Capital Conservation Buffer Amount,” or PCCBA. “Risk-weighted assets” is a concept drawn from the Basel bank regulatory capital scheme, and FHFA’s version mixes credit risk, other risks, capital minimums and cushions in a way that makes it impossible to untangle analytically. Neither Fannie nor Freddie gave any indication as to how their risk-weighted assets were derived; they just presented a number, which, multiplied by .08 and rounded to the nearest whole digit, is labeled the total capital requirement (before buffers). 

At March 31, 2022, Fannie’s total required risk-based capital was $190 billion, made up of $111 billion in risk-weighted asset capital, a $34 billion stress capital buffer, and a $45 billion stability capital buffer. While the percentage was not published anywhere, Fannie’s total required risk-based capital at March 31, 2022 was 4.20 percent of its adjusted total assets. To get the comparable numbers for Freddie, you have to hunt through its capital table. Doing so, at March 31, 2022 its total required risk-based capital was $122 billion, made up of $73 billion in risk-weighted asset capital, a $26 billion stress capital buffer, and a $23 billion stability capital buffer. Since Freddie and Fannie are in the same business and have very similar credit risk profiles, one might have expected Freddie’s required ERCF risk-based capital percentage to be very close to Fannie’s. It was not. Freddie’s required capital was 3.38 percent of its adjusted total assets, 82 basis points lower than Fannie’s.

Before addressing why the Calabria capital standard produced such significantly different required capital percentages for two companies with essentially the same credit risk profiles (at March 31, 2022, Fannie’s actually was a little better), I first should note that measuring both companies’ required capital as a percentage of their “adjusted total assets” understates the burden this capital places on their business. Adjusted total assets is a concept introduced by Calabria. His final capital rule detailed the types of exposures FHFA can add to Fannie and Freddie’s total assets to create their adjusted total assets. It runs for eight pages (174 to 182), and has nine categories, most of which relate to exposures to derivatives or repurchase agreements (which in my experience posed little financial risk). At March 31, 2022 Fannie’s adjusted total assets were 5.7 percent greater than its total assets, while on the same date Freddie’s adjusted total assets were 16.1 percent greater. I have seen no explanation from either FHFA or the companies as to what specific exposures lead to such a large difference in adjusted total asset add-ons.

There are two more straightforward, and understandable, ways to calculate capital ratios: as a percentage of published total assets, and (for a credit guarantor) as a percentage of average mortgage assets. The difference between adjusted total assets and published total assets is mostly non-earning “exposures,” while the difference between mortgage assets and published total assets is mostly cash and liquidity, on which the companies lose money (because the cost of their debt is greater than the yield on the cash or liquid assets). Fannie and Freddie have to earn a market return on the capital they are required to hold against their liquid assets and their adjusted asset exposures, and their primary way of doing that is through the fees they charge for their credit guarantees. At March 31, 2022, Fannie’s $190 billion in required risk-based capital was 4.20 percent of its adjusted total assets, 4.43 percent of its published total assets, and 4.74 percent of its average mortgage assets. Freddie’s same capital percentages were 3.38 percent, 3.92 percent, and 4.25 percent. Expressing the Calabria standard’s required capital as a percentage of adjusted total assets obscures the important facts that at March 31, 2022 Fannie was having to price to almost 4 ¾ percent capital, while Freddie was having to price to almost 4 ¼ percent capital.

Fannie versus Freddie required capital. Why, though, was Freddie’s required capital as a percentage of mortgage assets at the end of the last quarter so much lower than Fannie’s? There are two reasons—one simple and one not. The simple reason is how the “stability capital buffer” is determined. FHFA computes Fannie and Freddie’s credit guarantees as a percentage of estimated residential mortgage debt (single- and multifamily) outstanding each quarter, and assesses them a charge of 5 basis points of capital for each percentage point their “share of market” exceeds 5 percent. Since Fannie is larger than Freddie, it got a larger capital charge in the first quarter—107 basis points compared with Freddie’s 74 basis points. The only way Fannie could lower this capital charge is by doing less of the one business—mortgage credit guarantees—its charter and regulator now permit it to do.

The second reason for Freddie’s lower risk-based capital requirement at March 31, 2022 has to do with “risk-weighted assets.” The only other date for which FHFA has published risk-weighted asset percentages for the companies is June 30, 2020, as part of its revised capital proposal. Then, Freddie’s risk-weighted assets were 33.3 percent, while Fannie’s actually were somewhat lower, at 32.4 percent. At March 31, 2022, however, Freddie’s risk-weighted assets had fallen to only 25.5 percent of its adjusted total assets, while Fannie’s were 30.7 percent. Had Fannie’s also been 25.5 percent, its first quarter 2022 required risk-based capital would have been 44 basis points less. But since the risk-weighted asset numbers for both companies come from an FHFA “black box,” there is no way to know why Freddie’s risk-weighted assets fell so much more than Fannie’s. (Freddie’s greater use of credit risk transfers can only be a partial explanation, given that Freddie—which always has used more CRTs than Fannie—had higher risk-weighted assets at June 30, 2020.) The lack of transparency in both companies’ risk-weighted asset numbers is highly problematic.

Progress in closing capital gaps. Fannie and Freddie’s first quarter 2022 capital tables also enable us to calculate their recent progress in closing their ERCF capital gaps. We’ll start with Fannie. When FHFA published its final capital rule, it said that at June 30, 2020, Fannie’s total required risk-based capital was $171 billion, its adjusted total capital was a negative $118 billion, and its shortfall to full capitalization was $289 billion. At March 31, 2022, Fannie’s total required risk-based capital was $190 billion, its adjusted total capital was a negative $82 billion, and its capital shortfall was $272 billion. During this seven-quarter interval, therefore, Fannie’s required capital increased by $19 billion, its adjusted total capital rose by $36 billion, and it reduced its capital gap by $17 billion, or 5.9 percent, leaving 94.1 percent of its June 30, 2020 capital shortfall still to be covered in the future.

Freddie’s progress was similar. At June 30, 2020, Freddie’s total required risk-based capital was $112 billion, its adjusted total capital was a negative $68 billion, and its shortfall to adequate capitalization was $180 billion. At March 31, 2022, Freddie’s total required risk-based capital was $122 billion, its adjusted total capital was a negative $47 billion, and its capital shortfall was $169 billion. So over the last seven quarters, Freddie’s required capital increased by $10 billion, its adjusted total capital rose by $21 billion, and it was able to trim $11 billion, or 6.1 percent, from its capital shortfall, with 93.9 percent still to go.

The ERCF allows both companies to begin paying partial dividends and some executive compensation before they are fully capitalized. They can pay out up to 20 percent of their after-tax net income in dividends (common and preferred) and executive compensation once they have capital equal to their risk-weighted capital requirement plus 25 percent of their total PCCBA buffer amounts, and they can pay out 40 percent when they’ve covered 50 percent of their PCCBA. Neither company, however, is anywhere near either threshold. Fannie must cut its capital gap by $213 billion before it can pay out 20 percent of its net income, and to pay out 40 percent it needs to cut that gap by $233 billion. The comparable capital gap reductions for Freddie are $132 billion and $145 billion, respectively.

At the end of this month, Fannie and Freddie are required to file the first of their annual capital plans—described in FHFA’s December 2021 ”Notice of Proposed Rulemaking on Enterprise Capital Planning”—in which they are supposed to detail their “plan to rebuild capital to come into compliance with the ERCF.” These plans will not be made public, but they will contain each company’s proprietary estimates of how much they might further reduce their capital shortfalls over the five-year projection horizon. I obviously don’t know what those internal projections will look like, but I’m certain that during this period both companies will be projecting significantly slower asset growth because of higher interest rates, fewer refinances, and attempts to increase guaranty fees, and also a return to more “normalized” (and lower) earnings compared with the last seven quarters, because of slower amortization of upfront guaranty fees, a shift from loss provision income to loss provision expense, and higher interest costs for credit risk transfers. When Fannie and Freddie run these numbers and give them to FHFA, therefore, I doubt if Fannie projects that it can cut its capital gap by more than around $50 billion by the end of 2026—leaving about $220 billion unaddressed—and I wouldn’t expect Freddie to project a capital gap reduction of more than around $30 billion, leaving about $140 billion still to go.

FHFA and Treasury are likely to be very surprised, and disappointed, by what they will perceive as Fannie and Freddie’s lack of progress in meeting the requirements of the ERCF, because neither understands how little ability the companies truly have to eliminate on their own the huge capital deficits imposed upon them by former director Calabria. For this reason, I believe the executives at Fannie and Freddie must use the opportunity presented by the close sequencing of the initial publication of the ERCF capital data in in their first quarter 2022 10Qs and the subsequent submission of their initial capital plans to FHFA to break their silence about the impossible position FHFA and Treasury have put them in, and, whether publicly or privately, state in no uncertain terms the stark realities of their current capital dilemma, which are neither of their own making nor within their power to remedy:

  • The huge difference between the positive book net worth of Fannie ($52 billion) and Freddie ($32 billion) at March 31, 2022 and their negative “adjusted total capital” on the same date (minus $82 billion and $47 billion, respectively) arises from Treasury’s refusal to consider any net worth sweep payments made by the companies over the last ten years as repayments of its senior preferred stock, even though financially they clearly were. Treasury senior preferred stock is not included in “adjusted total capital”.
  • For as long as their Treasury senior preferred remains outstanding—and Treasury’s $173 billion liquidation preference in Fannie and $104 billion in Freddie exists, and keeps growing—the companies will have no access to the capital markets; their sole means of closing their gaps to adequate capitalization will be through retained earnings.
  • The Calabria “risk-based” standard contains so many arbitrary buffers, cushions, and capital minimums that there is very little scope for Fannie or Freddie to reduce their required risk-based capital through changes in the risk of their books of business. For this reason, and those below, the companies’ risk-based standard will be binding for the foreseeable future, and their (lower) leverage requirements irrelevant.
  • The final Calabria standard was artificially calibrated to produce 4+ percent required risk-based capital at a time when Fannie and Freddie’s books of credit guarantees were near all-time highs in credit quality. It is a virtual certainly that with slowing home price growth, rising interest rates, and fewer refinances, the credit quality of these books will move back closer to normal (then at some point be below normal), and as this occurs the companies’ “risk-based” capital requirements will rise, no matter what they do.  
  • The guidance from acting director Thompson to attempt to earn a market return on FHFA’s (hugely excessive) amount of required capital by increasing fees on lower-risk business will drive more of these loans to banks and private-label securitization, and inevitably leave the companies with a larger proportion of higher-risk business, and as a consequence an even higher required risk-based capital percentage in the future.  

The senior executives at Fannie and Freddie know all this. That, I think, is why they had so little to say about the ERCF in their first quarter 2022 10Qs. But the data released in those 10Qs tell the story without words. At March 31, 2022, Fannie and Freddie had the highest-quality books of credit guarantees in their histories—with an average current loan-to-value ratio of 53 percent, and an average credit score of 752—yet together the companies found themselves $441 billion below their new “risk-based” capital requirement of $312 billion, or 4.5 percent of their average mortgage assets, with no way to reduce that gap other than to continue to retain their earnings at the expense of an ever-rising Treasury liquidation preference, and even then it would take decades to eliminate their capital gaps completely. What else can FHFA or Treasury possibly be expecting them to do to come into compliance with the ERCF as it’s now structured and specified?  

Treasury and FHFA are the ones that created Fannie and Freddie’s capital quandary, and they are the ones that can and must get them out of it. It won’t be difficult to do.

First, Treasury and FHFA must agree to cancel the net worth sweep, and eliminate Treasury’s liquidation preference. Fannie and Freddie already have repaid their senior preferred stock, with 10 percent interest. And Treasury should not require that the companies’ senior preferred be converted to common. To do so would be to require them to repay their indebtedness to Treasury twice, which is unjustifiable, and blatantly unfair. Without the senior preferred, Fannie and Freddie’s combined March 31, 2022 capital shortfall of $441 billion would be cut to $248 billion, or by 44 percent.

Then, FHFA must scrap the Calabria capital standard, and either go back to its June 2018 standard, or propose a new one. Calabria’s “risk-based” standard was cynically designed not to be risk-based, but instead to require Fannie and Freddie to hold a bank-like amount of capital no matter how little risk they took on their credit guarantees, with a “stability buffer” that penalized them for doing more than a token amount of business. There is no reason for the top economic officials in the Biden administration to keep former director Calabria’s punitive capital standard in place, particularly when a Fannie and Freddie with a properly designed capital standard, based on real data and economics, could be of such great value to a key Biden administration constituency—affordable housing borrowers.

This should not be a hard call.

111 thoughts on “A Capital Reality Check”

    1. Two cents….
      Pretty good interview & worth listening to, even though Sheila Blair is definitely a political creature.
      Her comment that she expected F&F to be restructured & released in 6 months after the Financial Crisis….& at most 12 months after being put into Conservatorship caused a chuckle among many.
      On a positive note, she seems firm in her belief that F&F will be released at some point with no real opinion on how Legacy shareholders (JPS + Commons) will or should be treated.

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      1. I hadn’t listened to the interview, but now have.

        I wouldn’t say that Sheila Bair’s thinking about Fannie and Freddie can be generalized to cover that of “traditional conservatives,” simply because she spent almost three years on the Fannie Mae board, including serving as chair for a year and a half, so she has much more knowledge–at least of Fannie as it is currently–than an outside conservative observer of the company. (Fannie’s former CEO, Hugh Frater, once told me that Ms. Bair was a constructive and influential board member.) And I thought her comment that Fannie and Freddie are “very changed organizations” and thus should be released from conservatorship (because “the government is not good at running organizations of this size”) reflected what she’d learned during her time there, as did her observations on the impact of compensation restrictions and the “inability to control their own destiny” on Fannie’s ability to attract and retain good people.

        But I also was struck by the difference a little first-hand knowledge makes. In contrast to her opinions about Fannie as it exists currently, Bair’s recounting of what led it to be put into conservatorship was pure Financial Establishment fiction–blaming its issuance of “cheap debt,” its taking of interest rate risk and being “encouraged” to buy PLS mortgages for housing goal credit without being “asked to look at credit quality.” None of that is close to true. The portfolio was very closely duration-matched and a significant money-maker during and after the crisis (which is why Treasury’s immediate insistence that Fannie wind down the portfolio as soon as it was in conservatorship had everything to do with ideology and nothing to do with helping the company financially; it did the opposite). And while we did buy PLS for housing goal purposes (because HUD raised our goal for lower-income loans financed above the percentage being originated in the primary market) we were buying “super-seniors,” and most of what we bought was wrapped by a private mortgage insurer. FHFA wrote large amounts of those loans off because the prices of all PLS collapsed, but to my knowledge all of those write-downs came back into income later on, and Fannie didn’t lose anything on them. But history is written by the winners.

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        1. Tim, would you ever consider going on the podcast with Tim Rood to share a more knowledgeable perspective what is necessary (and what is not) for them to exit Conservatorship?

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          2. Tim–if you are invited, please find out where and when Rood worked at Fannie Mae since I have been unable to find anyone who remembers him or what he did with the company.

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          3. Bill–In the Bair interview, Rood said he was at Fannie Mae between 2001 and 2006. I have a Fannie corporate directory from 2004, and found him in it. He was on the technology side, in what we called our “e-Business Division,” headed by Mike Williams (who went on to become president and CEO of Fannie following the conservatorship). Rood was one of 36 Directors (the level below Vice President) in e-Business, and one of three with the title of “Director of Dedicated Channel Business Engagement.”

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    1. No, I hadn’t seen it (Layton now has a new affiliation, with the NYU Furman Center, and I don’t get any of their publications).

      I just read the piece, and found it unclear and confusing. He’s making the issue of recapitalization unnecessarily opaque and complex, in part by not getting the sequencing of what has to happen in the right order.

      Start with his section titled “The Market Realities of Raising Capital.” He begins by saying “the amount [of capital to be raised] is immense, far beyond anything ever seen before,” but then goes on to greatly understate that amount, saying “my rough estimate of the amount required is $150 billion for the two GSEs combined.” Where does that number come from? In a footnote Layton says, “By contrast the current FHFA-approved capital rule calls for more than double this amount.” That’s right–as of June 30, 2022, Fannie and Freddie were short of FHFA’s standard by $423 billion. So where does Layton get $150 billion? He never makes that clear. But, confusingly, he uses it as the starting point for the rest of his analysis.

      There are two ways the companies’ current $423 billion capital shortfall could become lower very (or fairly) quickly: if Treasury deems the companies’ combined $193.5 billion in senior preferred stock to have been repaid and cancels it, and if FHFA throws out the Calabria capital rule and replaces it with one that better aligns with of the risks of the credit guarantees Fannie and Freddie currently are making. (Layton alludes to the latter, both in footnote 2 and elsewhere in the paper, but does so in a way that doesn’t tie to his capital-raising analysis.)

      In reality, the companies will not be able to raise any capital before Treasury decides what to do with the senior preferred. It has two basic choices: it can cancel it, or convert it to common. I’ve written at some length as to why canceling the senior preferred is the better choice for Treasury (it makes its warrants for 79.9 percent ownership of the companies more valuable by making the companies’ common stock more valuable, whereas converting the senior preferred to common makes the common less valuable), but Treasury has to be the one to make that call. Treasury then will need to exercise its warrants before any new common can be raised. (Layton has the warrant conversion occurring AFTER new equity has been raised, which if done would give Treasury the right to 79.9 percent of all those new equity shares; investors never would buy new shares on that basis.)

      Once these two steps are taken, new equity raises would be possible. But before this occurs, it would also be highly advisable for someone in the administration to tell FHFA to re-do the Calabria capital requirement. Doing so would both reduce the dollar amount of new equity that needs to be raised and–by allowing Fannie and Freddie to price their credit guarantees on a more economic basis–increase the price of their common shares, thus reducing the number of new shares that have to be issued to raise the necessary dollar amount.

      None of this is rocket science, or that complex. I don’t know why Layton insists on making it seem so complicated, or claiming that it could take until 2030 to do. It almost makes me wonder if he’s obfuscating these things on purpose, because he himself is among those “political and interest groups [that] seem to like the status quo.”

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      1. Tim

        put another way, this is a political issue, and if you can predict future politics, then you can write about it….but he cant, so what is the point?

        rolg

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      2. Tim,

        Many thanks for interacting. His piece was one of the strangest I’ve read on the future of the GSEs. I try not to attribute to malice that which can be reasonably attributed to incompetence, yet unfortunately Layton is competent enough.

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      4. Maybe it’s because, in my forty years of close observation, Freddie officials seldom have taken issues straight on, evaluated them correctly, or acted boldly. Instead, they caviled, used stealth, double counting, and went along and rolled along–with industry and government critics–achieving very little that was unique.

        The institution, Freddie Mac, seldom has been a leader, always following Fannie Mae, and the Virginia guys attracted execs who acted the same way.

        Layton displays these elements.

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      5. “Layton has the warrant conversion occurring AFTER new equity has been raised, which if done would give Treasury the right to 79.9 percent of all those new equity shares; investors never would buy new shares on that basis.”

        Tim,

        I can’t imagine an IB would take the dilution under those sequential terms of: IPO, then dilution due to warrants. Notwithstanding, I didn’t realize the warrant percentage of 79.9% is also applied to any new common shares. Is that what you’re saying? I always thought it applied only to existing common shares at the time of conservatorship, giving Treasury a fixed number of shares.

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        1. Ron–In the September 7, 2008 document from Fannie Mae granting Treasury the warrant, the first two sentences of Section 2 (“Exercise of Warrant; Number of Shares”), state: “This warrant may be exercised in whole or in part at any time during the Exercise Period, by delivery of the following to the Company at its address set forth above (or at other such address as it may designate in writing to the Holder): (a) an executed Notice of Exercise in the form attached hereto; (b) payment of the Exercise Price (i) in cash or by check, (ii) by cancellation of indebtedness, or (iii) pursuant to Section 2.2 hereof; and (c) this Warrant. This Warrant will be exercisable for a number of shares of Common Stock that, together with the shares of Common Stock previously issued pursuant to this Warrant, is equal to 79.9% of the total number of shares of Common Stock outstanding on a Fully Diluted basis on the date of exercise.”

          There doesn’t seem to be any ambiguity in the second sentence.

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          4. The fact that Don Layton doesn’t know that detail about the 79.9% common stock probably tells us all we need to know about where we’ve stood and still stand in this almost 14 year GSE saga. Crazy.

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          5. as to the 79.9% warrants held by treasury, it would make no sense to raise new equity capital before the conservatorship is ended or, more likely, on a path to ending, likely under some sort of contractual arrangement between treasury and the GSEs (and FHFA), at which point investors can understand what the balance sheet (and pro forma income statement) will look like. at the point they invest, investors will expect the warrants to have been exercised, or will be exercised in connection with the capital raise.

            rolg

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      6. I find Mr. Layton’s paper very curious. He must be aware of Tim’s blog postings and Calhoun & Ranieri which both clearly show that releasing the GSEs is a fairly straightforward exercise for the Treasury. All Treasury needs is the will.

        Maybe the Biden Administration won’t take the opportunity to help a generation of low income and minority homeowners, by using the GSEs to impose their stated policy preferences and then releasing them. Maybe they would rather leave the task to a future administration that may not care about such things.

        I didn’t think Calabria was offering anything to those groups, and he was more than ready to release the GSEs back into public equity markets in 2021.

        Maybe Mr. Layton is happy to miss a huge potential opportunity for Democrats to help millions of homeowners and also a group they claim to care so much about.

        I understand that it makes sense to wait until after the midterms. Right now the administration has legislative priorities to address.

        But after the midterms, if as expected, Republicans win the House, shouldn’t this move to the top of the administration’s domestic agenda? Aaron Klein seemed to indicate as much during Calhoun’s Brookings presentation.

        Really bizarre

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  3. Tim

    FMCC is out with its Q2 22 results, and what struck me was the following: i) Net income of $2.5 billion, a decrease of 33% year-over-year, primarily driven by a “provision for credit losses in the current period”, compared to a benefit for credit losses in the prior period, and ii) “Serious delinquency rate of 0.76%, down from 0.92% at March 31, 2022 and 1.86% at June 30, 2021, driven by the decline of loans in forbearance”.

    so FMCC is increasing credit loss reserves while experiencing less credit loss risk represented by loans in foreclosure. is this the effect of that new accounting rule requiring Fannie and Freddie to predict the loss rate on new loans as they are acquired? while no one can predict the future, does it make sense to increase provisioning for losses in a period when loans in forbearance is trending down?

    rolg

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    1. There are two different things going on with Freddie’s credit statistics.

      The decline in the percentage of loans in forbearance is the expected consequence of having many borrowers who took advantage of the company’s Covid-related forbearance policy returning to paying status, and we should expect to see this percentage continue to decline in future quarters.

      The shift from a (positive) benefit for credit losses in the second quarter of 2021 and the first quarter of 2022 to a (negative) provision for credit losses (of $307 million) last quarter is something I’ve been alerting readers to expect for some time. Both Freddie and Freddie saw massive increases in their provisions for loan losses between June 30, 2008 and December 31, 2011, and a consequent huge increase in their loan loss reserves. This was one of the main ways FHFA, in coordination with Treasury, engineered the mammoth non-cash losses that resulted in the need for the companies to take huge draws of senior preferred stock during this period. Since the end of 2011, both companies had been reversing those unneeded loss reserves through positive benefits for loan losses. Finally, at the end of 2021, the loss reserves at each had been drawn down to a more normal level. For Freddie, that was 17 basis points as a percent of outstanding single-family loans guaranteed. So, what should we expect to have happened subsequently? Both companies should now be making positive loss provisions to cover their current-quarter net credit losses (Freddie’s, in the second quarter, were $64 million) and to keep their loss reserve growing in line with their book. That’s exactly what we saw in the second quarter of this year. I consider “normalized” single-family credit losses at both companies to be around 4 basis points per year (they’re still below that), and for Freddie–with its $2.93 trillion in single-family loans guaranteed–that would be $1.17 in loan loss provisions per year, or $293 million per quarter, very close to the $307 million provision it actually took.

      The other reason (aside from the expected shift from a positive to a negative loss provision) for the drop in Freddie’s second quarter 2002 earnings from this year’s first quarter and the second quarter of 2021 was significantly slower amortization of upfront guaranty fees, because of the recent rise in interest rates. This reduced level of upfront fee amortization should continue for the foreseeable future.

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  5. In an entirely unforeseeable development:

    At the Structured Finance Association’s annual conference in Las Vegas last week, Kathleen Pagliaro, vice president of CRT capital markets at Fannie Mae, said the enterprise intentionally front-loaded CRT issuance this year and is now “taking its foot off the gas pedal” as investor demand declines.

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    1. I hope FHFA is paying attention to what is going on here. When home prices are rising sharply and most of Fannie’s (and Freddie’s) new guarantees are refis, investors love securitized CRTs because they transfer huge amounts of income and very little likely credit losses. Now that we’ve switched to more of a purchase market–with higher average original LTVs and somewhat lower credit scores–and the outlook for future home price appreciation is much less certain, investors want fewer CRTs, and on more favorable terms.

      It’s easy to understand why Wall Street and the investment community are such fans of CRTs–they price them to make (lots of) money at Fannie and Freddie’s expense, and can stop buying new issues whenever the chance of actually having a significant amount of credit losses transferred to them gets too high. It’s much less understandable why FHFA–which is supposed to be a “safety and soundness” regulator–pushes them so heavily. I tried to explain the problem with the companies’ CRT programs in my comment on FHFA’s September 16 proposed CRT-related amendments to its ERCF capital rule, but as expected it paid no attention to any of the facts and analysis in this comment and adopted its amendments as proposed. And it’s apparently going to keep pretending that CRTs really will be a net benefit to the issuing entities until it becomes painfully obvious to anyone with a heartbeat that, as currently structured, they have not, do not, and will not. In the meantime, Fannie and Freddie will have lost billions as a consequence of this fantasy of a willfully blind and stubborn regulator.

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      1. The Owl Creek request to SCOTUS for cert on direct takings came out yesterday. The CRT example above seems like a good example of a situation that would be derivative, suing to force FHFA as conservator to stop CRTs. The claims I hope are found to be direct, but I cynically expect SCOTUS will not grant cert. They want Fannie and Freddie dead and they can fix the legal precedent on the next case.

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        1. There is not a winnable suit against FHFA for its CRT policies. FHFA is providing the companies a (valuable) capital incentive to issue CRTs, and it’s up to the companies to take advantage of that incentive or not; they’re not being told or forced to. The problem is the capital rule: it’s been set at an unjustifiably high percentage, and the only option FHFA has given the companies to reduce that percentage is to issue non-economic CRTs, and receive capital credits for doing so. Now, however, the pricing of CRTs seems to have gotten to a level where even the capital credit is not enough to offset the expected CRT interest costs. But that’s not illegal; it’s just terrible regulatory policy.

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  6. Tim, I agree with you up to a point. You stated that, “both Democratic and Republican administrations have fallen for the fiction that Fannie and Freddie caused the financial crisis,”. That may have been the opinion of the popular media and certain people in power, but the official response by Congress in regards to the performance of Fannie Mae and Freddie Mac during the financial crisis was as follows: “We conclude that these two entities contributed to the crisis, but were not a primary cause. Importantly, GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were central to the financial crisis.” I am of course referring to a conclusion made in the financial inquiry commission report submitted January 2011 by Congress. Anyone who reads this report should realize that Fannie and Freddie were caught up in the tide but were not the main reason for the tsunami of mortgage defaults.

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    1. The Financial Crisis Inquiry Commission (FCIC) did make the statement you quote, but the FCIC report was made to, not “by,” the Congress, and four of the ten commissioners dissented from it. More importantly, from the time Fannie and Freddie were put into conservatorship, Congressional efforts led by both political parties focused on replacing what was almost universally characterized as the “flawed business model” of Fannie and Freddie with alternatives more favorable to what I call the Financial Establishment. Only when it became apparent that there were no such alternatives that were realistic enough to garner sufficient support to become law did the focus turn to administrative reform. This was during the term of President Trump, and the result was the Calabria capital rule, which requires Fannie and Freddie to hold MORE capital for the credit guarantees they place on residential mortgages than commercial banks are required to hold against the long-term fixed-rate mortgages funded with short-term consumer deposits and purchased funds they have on their balance sheets.

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  7. [The institutional investors who are buying up large blocks of single-family homes] are getting their capital from pension funds — firemen, policemen, teachers, state pensions, unions. Then there is ‘bought money’, outright borrowings, foreign sovereign funds, wealthy institutions and individuals.

    Nominally this pension $$$ is holding up the values of homes, protecting communities, and making sure (through property taxes) municipalities, schools, emergency services, and debt service gets paid. However is this mantra true or are there unintended consequences from these actions? MHO, these policies cause housing prices to be/remain (artificially) high, and therefore are not beneficial to the beginning homeowner. Institutional buying of single-family homes started during the end of President Bush’s tenure as a ‘cure’ to the ’08/’09 financial crisis and was greatly expanded and utilized by Obama. Then continued through Trump and Biden. One could argue there is a direct cause/effect of America becoming a ‘Renter Nation’ through institutional ownership of single family homes. Pension money $$$ controlled by Institutions can be used to effectively ‘crowd out’ homeowners. Homebuyers, especially those at the margin, simply cannot compete. The higher capital ratios of which you speak could create a defacto ‘barrier’ to individual homeownership that directly and indirectly favors the interests of the Financial Establishment. Without a moratorium against institutional ownership, and eventually a divestiture plan, things will only get worse as Institutions continue to buy up more homes. VM

    On Wed, Jul 6, 2022, 9:02 PM HOWARD ON MORTGAGE FINANCE < comment-reply@wordpress.com> wrote:

    Fishermanjuice22 commented: “This might not be the place, but where does > Blackstone and the other companies buying up single family homes get their > capital? They aren’t doing Fannie/Freddie backed loans are they? Is some of > the financial establishment purposely handicapping (or knee” >

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    1. Mr. Reznik is responding to a comment that I had chosen to delete (that comment now appears a little further down the page).

      I agree with everything he says here, except the statement that “Institutional buying of single-family homes started during the end of President Bush’s tenure as a ‘cure’ to the ’08/’09 financial crisis and was greatly expanded and utilized by Obama. Then continued through Trump and Biden.” That phrasing makes it sound as if these institutional purchases were in some way initiated, supported or encouraged by the administrations in power. That was not the case; they were purely a “private market response” to the collapse in home prices that occurred after the private-label securities market melted down. Indeed, the great irony here was that many of the same firms and individuals who had made tremendous amounts of money originating and packaging toxic single-family mortgages in 2006 and 2007 (pocketing the yield spread premiums on these loans and passing all of the risk on to investors who thought they were buying AAA-rated securities) still had lots of liquidity after the crash and used it to scoop up homes at distressed prices, and have been doing it since.

      And I’d add one important point to this picture. The policy response–from ALL administrations–following the crash was not to tighten regulations on the private-market participants who had caused it; it was to go after Fannie and Freddie, who had not. And one of those reactions was to insist, shortly after the crash, that Fannie and Freddie had to hold “bank-like capital” to prevent another such crash from occurring. This deflection of blame was successful, and it continues to be, with one of its impacts being to penalize the low- and moderate- income homebuyers who were the primary victims of the first crash.

      Even before the 2018 and 2020 FHFA capital proposals, that agency was requiring Fannie and Freddie to set their guaranty fees at levels it thought consistent with what private-market firms would have to charge. This began with the 2012 FHFA strategic plan. In the spring of 2014, FHFA put out a paper in which it broke down the pricing it had set for Fannie and Freddie in a 3 by 3 matrix of loan-to-value (LTV) ratios and credit scores. For the two boxes that covered loans with LTVs over 80 percent and credit scores under 700, the average “target fee” set by FHFA was 120 basis points. And this was at a time when the companies’ average pricing capital was a little over 3 percent. Former director Calabria since raised that average required capital to more than 4.5 percent, so even if the fees for high LTV-low credit score loans only rose proportionally they would be close to 180 basis points today.

      It doesn’t take a genius to figure out what’s happened as a result. Private equity firms and other institutional investors can pay cash for lower-priced homes, while potential homebuyers with low- and moderate incomes have to take out mortgages that, because of the FHFA capital rule, carry huge and unjustified capital charges. Most potential borrowers cannot afford to do that, so they are priced out of the market and forced to become perpetual renters–many in homes purchased by financial institutions. This is not just theory; you can see it from the credit profile of Fannie’s outstanding business. At December 31, 2007, 33 percent the loans owned or guaranteed by the company had credit scores of less than 700; today only 15 percent do.

      And again, this is cruelly ironic. It’s government policy that is producing these results: both Democratic and Republican administrations have fallen for the fiction that Fannie and Freddie caused the financial crisis, and must be capitalized like banks. The consequence of this folly is that millions of lower and moderate income families are being deprived of the opportunity of being able to build wealth through homeownership, while the already rich financial institutions get even richer from being “rentiers.”

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      2. Thanks for all you do.
        Surely Congessmen are aware of the US becoming a renter nation? The question is what incentives do they have to let, or not let, that happen? Lobby efforts to have them let it happen must be strong. Not many Congressmen standing up for citizens affected by this.

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        1. @Carter

          seems to me that an important reason for high housing prices, and hence the onset of “renter nation”, is local and state land/building code/zoning regulation, which is not a federal issue, though congress could make it a federal issue under its commerce clause power should it wish to. perhaps the movement to work at home will permit employees to locate in places at some remove from urban/suburban office locations, and urban/suburban housing building restrictions and land acquisition costs. my hope is that you will see a lot of home building where land acquisition costs are low, and high speed internet is prevalent. sometimes solutions aren’t to be found in the beltway.

          rolg

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          1. Mr. Howard & ROLG,
            Would appreciate your take on what specifically is going on with ROP and Bhatti.
            Could ROP be as simple as, ‘DeMarco signed NWS at Year 3, and 2 years is the maximum for an Acting Director’?
            Heard (& posted) the audio for ROP, but one had to request a transcript from the Court for Bhatti.
            Everything on Track for Monday October 19th/Lamberth, and could any specific developments in ROP & Bhatti have a direct effect on Oct 19th Trial?
            TIA, VM

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          2. @value

            federal district judge schiltz in bhatti pointed out that the “not more than 2 year rule” for an acting principal officer to act without senate confirmation, argued by plaintiffs, is derived by implication from the constitution, which authorizes recess appointments until the next senate term, which can be at most 2 years…there is no bright line 2 year rule in the constitution, but the constitution does require senate confirmation for all principal officers, and does specify just one appointment exception for when the senate is in recess, which when you pencil it out on a calendar is at most a 2 year period for a principal officer to act without senate confirmation.

            Schiltz went on to say this is a good argument but it was above his pay grade as a federal district court judge to interpret the constitution as requiring a 2 year maximum unless it textually and explicitly stated so. it is as if, in schiltz’s view, the judiciary would be ambushing the executive branch by holding it to a rule that may be viewed as not explicitly applicable…and it certainly would be politically inconvenient.

            so the blunt way of looking at Rop at the 6thC is to wonder whether the circuit court judges will have the judicial courage to do what schiltz wouldn’t do.

            rolg

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  8. Tim: Thank you for providing perspective on my previous question relating to the disconnect between rates on conforming vs. jumbo loans. I wanted to follow-up by asking about the GSEs capital ratios (and corporate governance structure) given FHFA’s recent announcement that they will review the ERCF alongside concerns relating to the UMBS fee. More specifically, it seems to be overlooked that there is another publicly-listed GSE with a capital ratio requirement and corporate governance structure that Fannie and Freddie could seemingly adopt, and already has political support: Federal Agricultural Mortgage Corporation (“Farmer Mac”). Similar to the GSEs, Farmer Mac is a shareholder-owned, federally-chartered company that promotes liquidity for borrowers in U.S. agriculture and rural communities. In terms of its capital standards, Farmer Mac is required to maintain a core capital ratio equal to the sum of: (i) 2.75% of on-balance sheet loans, plus (ii) 0.75% of its off-balance sheet (or guaranteed) loans. Further, Farmer Mac has a 15-person board with Class A shareholders (banks, insurance companies and financial institutions) electing five members, Class B stockholders (Farm Credit System institutions) electing five members and the remaining five members being appointed by the President (with no more than three from the same political party).

    Do you have any insight as to why this approach hasn’t been considered (or gained traction) for Fannie and Freddie given their very similar mission, business models and historical credit performance? Thank you.

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    1. I don’t believe that Farmer Mac is a good model for the capitalization of Fannie and Freddie. Although it IS a government-sponsored enterprise, it’s tiny ($23.6 billion in outstanding business volume at December 31, 2021, compared with Fannie’s $3.97 trillion and Freddie’s $2.85 trillion on the same date), not systemically important, and in a different business.

      The 2008 Housing and Economic Recovery Act (HERA) specifies the right approach to Fannie and Freddie’s capitalization: to ensure that they maintain “sufficient capital and reserves to support the risks that arise in the operations and management of the enterprises.” The problem is that the leadership of FHFA has not been able to resist the pleas of opponents and competitors of the companies to add large amounts of conservatism and buffers to the amount of capital Fannie and Freddie actually need to survive a repeat of the 25 percent nationwide decline in home prices that occurred between mid-2006 and mid-2011. This started with the first re-specification of their capital requirement of June of 2018, when FHFA did a fairly good job of running a “clean” stress test, but then insisted that none of the guaranty fees generated during this test be considered as offsets to those credit losses (as is permitted by the Dodd-Frank stress tests run for banks, and in fact happens in reality), requiring instead that all credit losses be backed by initial capital. Then, when former director Mark Calabria re-proposed Fannie and Freddie’s capital requirement in May of 2020, he added (non-risk-based) capital minimums to their stress tests, and also added still more buffers and elements of conservatism to reach a pre-determined capital percentage in excess of 4.5 percent. That’s where we are today, with the companies’ capital set at an artificially high level, forcing them to put non-economic guaranty fees on all of the business they do.

      There is a very simple and workable recipe for setting Fannie and Freddie’s capital in a manner that both protects the taxpayer and allows the companies to price their business as favorably as possible: run an honest stress test, add a reasonable buffer to the results of that test, then set a minimum capital requirement that’s consistent with, but somewhat below, the risk-based requirement. It’s not rocket science; someone in the administration just needs to tell the current director of FHFA to follow HERA and do this, for the benefit of homebuyers.

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      1. This might not be the place, but where does Blackstone and the other companies buying up single family homes get their capital? They aren’t doing Fannie/Freddie backed loans are they? Is some of the financial establishment purposely handicapping (or knee capping) homeowners to favor the Blackstones with the terrible capital rules?

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  9. Anyone else getting the sense that this SCOTUS majority has had enough of Congress not legislating, and instead dumping every issue on its lap? Bodes well for us.

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    1. @Robert

      SCOTUS has no problem reading HERA expansively (ie adversely to shareholders) in collins, while restrictively in West Virginia v EPA case. SCOTUS picks and chooses with no apparent rhyme or reason, unless it is that they simply dont want to deal with finance.

      rolg

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    2. It’s important not to forget that all six justices in “this SCOTUS majority” either are or have been members of the Federalist Society, for which Fannie and Freddie have been the apotheosis of evil since its inception forty years ago. The APA claim in Collins that reached the court in 2020 should have been a clear-cut victory for the plaintiffs on both the law and the facts, yet a fair reading of Justice Alito’s opinion leaves little doubt that he had determined how he would rule from the moment the Court granted cert to hear it, then made the best case he could (which still had gaping factual, legal and logical holes) to justify that decision, and seemed to have had no difficulty in convincing all of his colleagues to concur with it. Any future favorable ruling for Fannie and Freddie almost certainly will be appealed to a court consisting of this same majority, and will have to run the same gauntlet.

      It’s possible that there could be some lower and appellate court ruling in favor of holders of Fannie and Freddie junior preferred shares that doesn’t also benefit the companies, that SCOTUS might let stand (by not granting a writ of certiorari to hear it). But I believe that holders of both junior preferred and common shares of the companies have better prospects for success from a settlement of the lawsuits entered into and endorsed by the administration–most likely pursuant to a lower-court decision favorable to plaintiffs (my best bet here would be Lamberth)–than from a victory in a court case that “this SCOTUS majority” allows to stand.

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      1. Tim

        it is ironic that the conventional federalist society objection to the GSEs, the government’s implicit guarantee permitting the GSEs to engage in a “private gain, public loss” business mode (as the federalist society would put it), is only exacerbated by a decision that prolongs the conservatorship, and hence, the government’s involvement with, and continued risk exposure to, the GSEs.

        rolg

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        1. It’s also incredibly disappointing that the administration isn’t taking this opportunity to rehabilitate the GSEs and lock in their policy preferences now while they have the opportunity. Seems like a huge missed opportunity.

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          1. I believe that for the Biden administration to change from the track former director Calabria put FHFA on, the impetus will need to come from somewhere outside that agency. As an institution, FHFA is too steeped in the mythologies about Fannie and Freddie as problems to be able to be the impetus for a reality-based break from those mythologies, and that includes Director Thompson, whose views of the companies have been heavily influenced by the fictional lore of the post-conservatorship era.

            One needn’t look much further than yesterday’s statement from FHFA on the fees Fannie and Freddie have begun charging on “commingled securities” (structured transactions that include collateral from both entities) to understand how detached FHFA leadership is from the practical impacts its policies have on the mortgage market. It was clear that Fannie and Freddie imposed these fees as a result of the new ERCF capital requirement that assigned a “20 percent risk weight”–or 1.6 percent required capital–to those essentially riskless exposures. Several lenders and trade groups complained about the fee, and when FHFA looked into the issue, it “discovered” that it was the source of the problem: it had given Fannie and Freddie an unnecessarily high capital requirement on commingled securities (the only way either company could lose money on them was if the other one failed), told them they had to earn a market return on that capital, then seemed surprised when they imposed the 50 basis point fee. FHFA’s response was to say it would be “conducting a review of the ERCF in the near-term to ensure that the risks of commingled securities are appropriately reflected.” Commingled securities are only one of dozens of areas where the capital required by the ERCF is disconnected from the risk that capital is supposed to be covering. It appears, though, that FHFA will be content to wait until each of these areas is either brought to its attention by some complaining constituency–or creates a visible market problem–before doing anything about it. FHFA seems incapable of self-reflection or reform.

            I’m still hopeful, however, that someone elsewhere in the administration–at the National Economic Council, the Council of Economic Advisors, or Treasury–will the understand the problem Calabria has created at FHFA, recognize the impact the deliberate overcapitalization of Fannie and Freddie has on the companies’ abilities to support the administration’s affordable housing objectives, and initiate the implementation of the simple and straightforward remedies I’ve recommended in the post “Capital Fact and Fiction” and other places. It may take a market dislocation or a loss in a court case to jump-start this effort–and then again it may not be until the clock starts clicking down to the 2024 election before the Biden economic team wakes up to the fact that it’s at a “now or never” moment where it either makes changes that support its policy objectives, or risks the endless regret of letting the opportunity to do so pass by.

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          2. Thank you for the thoughtful reply, Tim.

            I share your optimism that people within the groups you mention appreciate the GSE problem and how to solve it. They have some very good (excellent) economists in those groups. They’ve read Calhoun & Ranieri. They may have even read your blog. What puzzles me is why they haven’t yet felt compelled to act? As you have said (correctly I believe) the solution is not that hard. But it will take time to implement.

            The idea of leaving this problem to a future administration potentially as hostile to the GSEs as was Calabria is profoundly disappointing.

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          3. “Doing the right thing” with Fannie and Freddie means going against the power of the Financial Establishment, which benefits financially from keeping the companies throttled. Some faction within the Biden administration came very close to doing the right thing last fall, when it got the nomination of Mike Calhoun as the next director of FHFA to the point where on Friday September 10 he and others were told the nomination would be announced the following Monday. But over the weekend forces loyal to the Financial Establishment succeeded in putting that nomination on hold, then immediately ginned up a publicity blitz to build support for making the acting director, Sandra Thompson, the permanent director. Thompson, a career regulator whose only knowledge of Fannie and Freddie was acquired during the post-conservatorship period, posed no threat to the Financial Establishment’s agenda for the companies. She, of course, now IS the director of FHFA, and has been content to keep Fannie and Freddie in the box that former director Mark Calabria–a libertarian ideologue with a long record of stating the companies shouldn’t exist at all–had put them in.

            I don’t expect anything favorable to Fannie and Freddie to happen administratively before the mid-term elections. After that, though, the odds go up. They’ll go up further if plaintiffs in one of the lawsuits–Lamberth, or conceivably Rop–prevail in those cases. But it still will be a political calculation: will the benefits that accrue from restoring the ability of Fannie and Freddie to make a meaningful positive difference in the affordability of residential mortgages to low- moderate- and middle-income Americans outweigh the negative of the political backlash that will come from members of the Financial Establishment, who will make less money if Fannie and Freddie are restored to something close to their former position of efficiency in channeling funding to affordable housing borrowers who need their help to achieve the dream of homeownership?

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      2. Tim, your experience on “inside the beltway” lobbying far outstrips my own, but I’m curious why other staunch FedSoc justices, such as Don Willett in the 5th circuit, do not appear to have any problem ruling in favor of Fannie and Freddie shareholders, even to the benefit of the companies. Is there a newer generation of FedSoc justices that no longer remember the pre-conservatorship animosity toward the GSEs or is this an issue of geographical (inside the beltway) proximity to lobbying efforts by FedSoc.

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        1. I think it’s very much an “inside the Beltway-outside the Beltway” matter. The Federalist Society has many issues about which its members feel strongly (some of them contradictory). But there is such a concentration of vitriol against Fannie and Freddie at the conservative think tanks around Washington that it’s hard for any Federalist Society member in the metropolitan DC area not to be affected by it.

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  10. Tim

    I want to admit to an error I made in response to a post by John D below, and I do so here at the top of your comment thread so as not to bury what is an important post made by John D that should be appreciated by your readers.

    In brief, the 5th Circuit has held that the CFPB ‘s self funding mechanism set forth in its organic statute violates the appropriations clause of the US Constitution. See https://www.ca5.uscourts.gov/opinions/pub/18/18-60302-CV2.pdf

    The FHFA’s funding mechanism, and the scope of executive power that it can exercise beyond specific appropriation by Congress, is in all material respects similar to that of the CFPB. Collins has filed an amended complaint on remand to the federal district court adding a similar claim that the FHFA’s action adopting the NWS should be voided insofar as it was exercising executive branch authority without congressional funding oversight. See https://www.dropbox.com/s/2izg8rncjgos87w/amended%20collins%20complaint%20upon%20remand.pdf?dl=0

    FHFA has moved to dismiss the amended complaint, with briefing papers soon scheduled to be filed.

    If the federal district court accepts Collins amended complaint, there seems to me to be no apparent reason to believe that in light of the 5th Circuit’s holding in All-American re the CFPB, the federal district court wont be bound to hold similarly with respect to the FHFA.

    rolg

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    1. Tim

      an additional clarification. The appropriations clause opinion in All-American was a concurring opinion by Judge Jones to a remand order by the 5th Circuit en banc to the federal district court. on remand the federal district court in All American is instructed to consider all constitutional challenges. Judge Jones and the other concurring judges are, in effect, instructing the federal district judge that in their view, the appropriations clause challenge is a winner. but Judge Jones’ opinion is not dispositive of the claim, which is to be taken up by the All American federal district court. but the collins plaintiffs are well advised to follow suit with an amended complaint adding the FHFA appropriations clause violation claim in their federal district court remand within the 5th circuit jurisdiction.

      rolg

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      1. Tim

        while judge counting is fraught, I note that in reading through from this All American appropriations clause decision to any eventual Collins 5th circuit en banc appropriation clause case, to the 7 (out of 17) judges who would have found an appropriation clause violation in All American without any remand, one might add Judge Ho, who was recused in All American because his wife is a law partner of All American’s counsel but who would be available to hear any Collins case, and Judges Willett and (likely) Smith, who I believe would have joined Judge Jones’ opinion on the merits if they hadn’t decided to resolve the appellate jurisdictional question by first remanding to the federal district court….leading to a hypothetical 9-10 judge en banc majority in any eventual Collins appropriation clause en banc case at the 5th circuit.

        rolg

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        1. ROLG,

          How are you getting 9-10 judges?

          – 5 Judges were part of the CFPB concurring opinion re: appropriations claim + remedy (Jones, Elrod, Duncan, Engelhardt, Oldham).
          – I agree with you that Smith, Ho, and Willet are all likely to join them when forced to make a decision (all 3 ruled for shareholders on the APA claim and voted for full vacate of NWS as remedy on the removal provision separation of powers claim)

          That get’s us to 8.

          – I estimate 7 judges who are probably going to rule against us, as they all previously ruled against shareholders on both the APA claim and denied us remedy on the removal provision separation of powers claim. 5 of them being Democratically appointed (Stewart, Dennis, Graves, Higginson, Costa) and 2 of them Conservative (Haynes and Southwick).

          The 2 wildcard judges are Wilson (Trump appointed after the Collins ruling was issued, so we don’t know where he stands on any of this) and Owen (ruled for us on the APA claim, but denied us remedy on the removal provision separation of powers claim). I hope Owen ends up like Duncan, who was the only judge that was part of the appropriations claim concurring opinion that previously ruled for shareholders on the APA claim but denied us remedy on the removal provision separation of powers claim (just like Owen). We only need 1 of the wildcard judges to rule in shareholders favor to win by my math.

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          1. @Un

            you are right, oldham and englehardt were both joining Jones opinion and writing separately as to appellate jurisdiction. my scorecard was faulty. as well, the CFPB presents a stronger case than FHFA given its active adjudicative activity, but marginally so as to the merits imo. and even if the appropriations clause claim is successful, vs both CFPB and FHFA, there is the remedy issue…judicial restraint augers for a remedy that is more prospective than retrospective, and if retrospective, more so in adjudicative situations than in contracting situations like the NWS. I appreciate your correction.

            rolg

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  11. Tim: First off, thank you for the insight that you have provided on the GSEs over the years—the book, the blog, the briefs. It truly is invaluable. Secondly, wanted to get your thoughts regarding pricing in the mortgage market and two recent developments. One, the rate for a 30-year conforming loan is nearly 100 basis points higher than a 30-year jumbo loan, when historically jumbo loans have been more expensive. Do you believe any of this can attributed to the GSEs recent changes to their pricing framework, and if so, could the GSE’s almost be considered to be in breach of their mission? Two, when comparing a 30-year conforming loan against the 10-year Treasury, the current spread is nearly 300 basis points, whereas the historical average is approximately 170 basis points. Looking back at the past 40 years, the current differential seems to have only occurred two other times—during the financial crisis and the early stages of the pandemic. In neither of those periods, however, was the Fed unwinding more than $2.5 trillion of agency holdings. As a result, would you expect this historically wide spread to persist for a longer period of time here or instead create a catalyst to recapitalize the GSEs so they can step in to foster liquidity in the marketplace?

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    1. I hadn’t realized that the spread between jumbo mortgages (those above the Fannie-Freddie conforming loan limit) had become that wide, in favor of jumbos; historically jumbo rates have been lower than conforming loans. Pricing has to be the main reason. Fannie and Freddie price to the MBS market, and have to include their guaranty fees in their pricing buildup. Portfolio lenders (who hold the large majority of jumbo loans) price to their cost of funds. What appears to be happening is that portfolio lenders are competing against each other for the (relatively small) amount of jumbo loans currently being originated, and that is pulling their yields down.

      Fannie and Freddie pricing, meanwhile, is affected by the factor you note–wider-than normal spreads to Treasury securities. The mortgage-Treasury spread you cited, between the 10-year Treasury and current-coupon MBS, is higher than normal partly because of the current shape of the yield curve, which is essentially flat from 3 to 30 years. (Mortgages are actually priced off the entire curve, so when it has its usual upward slope, that pulls the MBS-to-10 year spread down.) But spreads are also wide because of the supply-demand balance. Since Fannie and Freddie were forced to exit the portfolio investment business (by Treasury) in 2008, commercial banks have picked up about $2 trillion in fixed-rate mortgages, and the Federal Reserve has added $2.7 to its balance sheet (Fannies, Freddies and Ginnies) in its successive “quantitative easing” programs. With short-term interest rates (and banks’ cost of funds) rising, banks are likely stepping back somewhat from the fixed-rate mortgage market, and with the Fed rumored to be soon cutting the size of its agency MBS holdings (it hasn’t yet), that’s probably causing non-bank investors to back up their bids for MBS.

      I would, therefore, expect relatively wide mortgage-Treasury spreads to persist for the foreseeable future. And unfortunately, recapitalizing Fannie and Freddie won’t change this dynamic, unless their capital requirements also are cut significantly. Even when they are recapitalized, Fannie and Freddie won’t return to the portfolio investment business; they will continue to be limited to making credit guarantees on MBS. And because the current mortgage problem is too little demand from fixed-rate MBS investors–and the fear of the Fed running off its portfolio–relative to the envisioned future supply of MBS, recapitalizing Fannie and Freddie won’t really change that.

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      1. @Adam/Tim

        this rather severe spread between conforming rates and 10 year treasuries has developed WITHOUT Fed selling any of its MBS portfolio. it strikes me that the Fed sees this and may very well just go into MBS runoff mode without overt selling…but wont this only extend the time that the MBS purchase market will be dysfunctional (with the biggest MBS buyer out of the market), leading to an increased period of time of excessive conforming mortgage rates?

        rolg

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        1. Although Fannie and Freddie were required to exit the portfolio business beginning in 2008, the impact of this on mortgage-Treasury spreads has never really been felt because just at that time the Fed began buying MBS, and the Fed now holds more MBS ($2.7 trillion) than Fannie and Freddie ever did combined. But when the Fed starts selling–or doesn’t replace all of its runoff–that will be a new and unpredictable dynamic. We don’t have any history of this.

          Even supporters of Fannie and Freddie now talk about their portfolio business as having no benefit other than generating “arb profits” for their shareholders. But that’s not true. The companies’ portfolio purchases served as a cap on how wide mortgage to Treasury spreads could become. Fannie and Freddie’s debt–both bullet and callable–was priced off Treasuries, and those debt spreads were relatively stable. And whenever the investment community favored bullet or callable term debt over prepayment-uncertain MBS, Fannie and Freddie would issue the the bullet and callable debt those investors wanted, and use the proceeds to buy the MBS investors were less interested in. That’s what capped the mortgage-Treasury spreads. Yes, Fannie and Freddie made money from doing this, but it had a significant systemic benefit as well.

          Fannie and Freddie’s historical critics (mainly banks) now have what they always said they wanted–the companies eliminated as investors in mortgages. When the Fed starts selling, or running off, its holdings, we’ll all learn what the companies’ absence as portfolio investors means for the longer-term cost of mortgage credit.

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          1. Tim

            I wonder whether F/F could set up a pass-through platform, so that the trust holders of the pass-through trusts would bear the risk/reward (and the credit arb opportunity), and I suppose F/F could scrape an origination fee and perhaps an on-going supervision fee. in my mind, these pass-throughs would not be guaranteed by F/F, so they “should” bear a higher rate than MBS, but if done in large enough quantity, they might bring down the mortgage/treasuries spread. have these pass-throughs act in stead of the whole loan portfolios that F/F had pre 2008.

            rolg

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          2. In a word, no, for a couple of reasons. First, while in conservatorship “F/F” don’t do anything without FHFA approval (or initiation), and I don’t see FHFA approving (or proposing) anything like what you suggest. Second, even if it did, the market for agency-issued securities without an agency guarantee would not be deep enough to have any noticeable impact on overall mortgage rates. When I was Fannie’s CFO the company had a program it called “Wisconsin Avenue Securities,” which were senior-subordinated tranched securities issued but not guaranteed by Fannie. We never did more than a token amount of business with these.

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  12. Tim

    I quote a recent tweet: “Last year a 30-year mortgage under 3% meant your payment on a $500,000 home was $2,100/month (not including down payment, taxes and fees) but now a 6% mortgage only gets you a $352,000 home for $2,100/month. Unless rates come down, how do we not get 20-30% correction in prices?”

    this seems intuitively correct. and if it is, then shouldn’t we see a “stress test” environment for the GSEs over the next year or so? given the favorable results of the latest regulatory GSE stress test conducted by FHFA (and belatedly disclosed without any read over to the capital rule), one might expect the GSEs to fare quite well during this next year, as they did during the covid pandemic. perhaps this will be necessary to prove to even the ideologically pure federalist types that the GSEs dont need “bank like” capital….especially if there is no treasury secretary who imposes massive fictitious reserves/losses this time around.

    rolg

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    1. The tweet may seem “intuitively correct,” but it’s simplistic to the point of inaccuracy. One can argue that the availability of cheap (3%) mortgage credit was a major factor in driving average single-family home prices up by 33 percent since the end of 2019, but the people who were paying those prices did so with monthly payments they’ve locked in for as much as 30 years. Over the last nine quarters, there was a large imbalance between those who wanted a home at prevailing prices and the supply of homes available; that’s why prices rose so much. Now that mortgage rates have gone up, there are fewer buyers on the demand side, which will take much of the pressure off prices. But even today there still seems to be an imbalance favoring the demand side (because supply is so constrained, and building costs have risen so much), and that’s why home prices are continuing to rise. Before home prices could fall 20-30 percent, they first will have to stop rising. I think they WILL stop rising, but I don’t believe they will fall significantly in the foreseeable future. This is not 2008, when home prices were driven up by four years of irresponsible lending to people who couldn’t afford the loans they were taking on; once lending practices tightened (after the subprime and PLS markets imploded), many who had taken out loans in the prior four years found they couldn’t afford them, and either defaulted or walked away. That put more (foreclosed) homes on the market just at the time demand was collapsing as well, triggering the downward spiral in home prices we experienced then.

      Today’s environment is fundamentally different. Those who bought homes recently did so with sizable down payments, and now have below-market-rate mortgages. They are highly unlikely to default in significant numbers. My expectation, therefore, is for a “soft landing” in home prices, in which Fannie and Freddie’s credit losses don’t rise much either this year or next.

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      1. I also believe the increase to the conforming loan limits Coupled with sub 3% rates was a contributing factor. In 2020 the limit was $510,400, 2021 ($548,250) and in 2022 ($647,200). Prior to 2020 these loan amounts were considered JUMBO so these would have been based on higher purchase prices that required a 20% down payment. After 2020 these loan amounts were available with purchase prices only requiring a 5% down payment. Not all new homebuyers are constrained by monthly affordability, many were constrained by higher down payment requirements for higher price homes. Consumers incentive was not quite as high to save more toward the down payment when rates were sub 3% because the payment reduction was not as significant. Ex. Additional $10,000 down payment lowered your payment $42.16 @ a 3% rate 30 yr fixed. Tim, I know you already know this. The comment is more for your readers.

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        1. @Eric

          having more expensive homes financed with lower down payments seems to me to cut the other way for the
          GSEs moving forward, to increase the risk of adverse future credit losses. I suppose this all comes down to future unemployment. we may be in the early innings of a rising unemployment picture.

          rolg

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          1. Fannie and Freddie each publish the LTV and credit score breakdowns of the loans they purchase or guarantee each quarter.

            I have the Fannie data at hand, and its first quarter 2022 loan acquisition profile shows 15 percent of its acquired loans with LTVs above 90 percent, compared with 10 percent above 90 percent in the first quarter of 2021. But most of that mix change reflects the absence of the large number of refinances that pushed up the lower-LTV totals in the first quarter of 2021. Fannie’s first quarter 2022 acquisition profile is still slightly better than the original LTV profile of its December 31, 2021 book, so there is little evidence that the company is doing more low-LTV purchase money credit guarantees than it typically does.

            Where there IS a difference is in credit scores. The weighted average credit score of Fannie’s first quarter 2022 acquisitions was 748, lower than not just the average of the first quarter of 2021 (761) but also the 753 average of the December 31, 2021 book. This is something to watch going forward.

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    1. I listened to this live, and thought it went as well for the plaintiffs as could have been expected. The government had no good answer to why having Ed DeMarco serve for three years as an acting director of FHFA (before he approved the net worth sweep)–without having either been confirmed by the Senate or given a recess appointment–wasn’t in violation of the constitution. And I thought counsel for the plaintiffs (Pete Patterson of Cooper & Kirk) was effective in making the case for why the court should grant plaintiffs the remedy they seek of voiding the net worth sweep, in spite of the alleged “sweeping consequences” of doing so, noting first that the Supreme Court has made clear in other cases that remedies are the incentives offered to plaintiffs for bringing cases of unconstitutionality to the Court’s attention, then closing the oral argument by telling the three appellate judges that “the only practical consequences [of a decision voiding the net worth sweep] would be putting Fannie and Freddie in a stronger position.”

      I’ve given up on predicting the outcomes of court cases, but based on what I heard I wouldn’t be shocked if the Sixth Circuit Court of Appeals were to rule in favor of the plaintiffs and void the net worth sweep, leaving it to the government to appeal this decision to the Supreme Court.

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      1. none of the three circuit court judges wanted to affirm on the basis that the district court judge held, that the question as to whether DeMarco was validly acting as acting FHFA director was a political question. the de facto officer argument wasn’t winning the day for the govt either. there was some hesitancy as to whether the appointments clause holdings in Administrative Law Judge cases, such as Lucia, should be extended outside that adjudicatory context to a contracting context such as the NWS, and Patterson’s rebuttal point that the GSEs would be stronger was helpful in that regard (and there is the notion that if SCOTUS wants to limit appointments clause remedies to the adjudicatory setting, then they should do it, not an appellate court)…but if the 6th C does not distinguish agency adjudications from agency contracting, it is hard to see how this panel, based upon this oral argument (and the briefing, which Judge Thurpar commented on in a fashion favorable to plaintiffs), doesn’t rule in favor of Rop. still plenty of time between oral argument and decision for Federalist Society members such as Wallison to try to put the fix in however.

        rolg

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          1. more likely 3-6 months. no appeal as of right, SCOTUS decides (4 justices) whether to grant certiorari, which it will likely do if govt loses and not do if plaintiff loses

            Liked by 2 people

          1. to be clear, a Rop win shouldn’t be expected simply because of superior briefing and oral argument. the only govt argument that seemed to resonate with the judges was not a legal argument but the practical argument, that things would get messy invalidating a contract entered into 10 years ago involving billions of dollars…and that is usually enough for judges to walk humbly back their initial analytic conclusions. Judge Thapar is a strong conservative legal theorist, and a Federalist Society member, as was Judge Ginsburg in Perry, and that alone should give one pause. the notion is that it is one thing to say some individual plaintiff like Lucia should get a rehearing in front of a properly appointed ALJ, and another to invalidate an important financial contract affecting a very large financial market…though Patterson did well to point out that the Lucia decision affected thousands of similarly situated plaintiffs as well as Mr. Lucia, so Lucia invalidated many plaintiffs’ ALJ decisions. but simply based on the legal merits, plaintiffs won the day in my opinion

            rolg

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  15. Tim,

    What are we to make of these statements?

    Thank you.

    The Enterprises will publish their first public disclosure reports under the final rule in the first quarter of 2023.

    https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Announces-Final-Rule-Introducing-New-Public-Disclosure-Requirements-to-the-Enterprise-Regulatory-Capital-Framework.aspx

    Under the final rule, each Enterprise will submit its first capital plan by May 20, 2023.

    https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Announces-Final-Rule-Requiring-Fannie-Mae-and-Freddie-Mac-to-Submit-Annual-Capital-Plans.aspx

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    1. The public disclosure announcement is consistent with the final rule FHFA issued a couple of weeks ago titled “Enterprise Regulatory Capital Framework–Public Disclosures for the Standardized Approach.” The new piece of information is that FHFA would like Fannie and Freddie to make their first public disclosures under this rule “in the first quarter of 2023.”

      I am less certain what to make of FHFA’s June 1 announcement about Fannie and Freddie’s annual capital plans, which says, “each Enterprise will submit its first capital plan by May 20, 2023.” FHFA’s December 2021 proposal on “Capital Planning and Stress Buffer Determination” said, “An Enterprise must submit its complete capital plan to FHFA by May 20 of each calendar year, or such later date as determined by the agency, and in the “Legislation and Regulation” section of its first quarter 2022 10Q, Fannie said, “The enterprise regulatory capital framework requires that we provide our initial quarterly capital reports to FHFA by May 30, 2022. ” I took Fannie’s statement in its 10Q to mean the company’s first capital plan would be submitted to FHFA at the end of last month (with the extra ten days having been “determined by the agency”). But this latest announcement from FHFA makes me wonder if there is a distinction between a capital “report” and a capital plan.

      If the two ARE different, then I’m not sure what will have been in the “reports” Fannie and Freddie submitted to FHFA last month. If it was just a recap of their capital numbers (which come from FHFA, so it already knows them), that would be disappointing. As I said in the current post, we already know what Fannie and Freddie’s capital problem is. Adding a year to the timeline for the companies to be required to produce a “plan” for dealing with it–when FHFA should know that no such plan is within the power of Fannie and Freddie to execute–just adds more bureaucratic delay to a process that instead should be sped up. The companies’ (obvious) capital problem is not going to get better by itself.

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      1. Tim,

        Thanks for that. Maybe the annual capital plan and report are indeed the same thing, and hopefully the June 1 remark was a typo on the year. Or else 5/2023 could be the second plan / report, not the first. *shrug*

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  16. Tim,
    Have you had an opportunity to look into the Collins refiling? Apparenty, it is asking the district court to eliminate the liquidation preference and restore FnF to their position before the net worth sweep. What is your assessment? Is there any reality in this new request? I believe the story came from Inside Mortgage Finance.

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    1. It’s not really a “new request”; the plaintiffs opening brief to the Fifth Circuit Court of Appeals asked it to “remand this case to the district court with instructions to enter a permanent injunction requiring, at a minimum, that Defendants amend the purchase agreements to either: (1) reduce the liquidation preference on Treasury’s senior preferred stock to zero and end further increases to the liquidation preference except as necessary to offset further draws on Treasury’s funding commitment, or (2) convert Treasury’s senior preferred stock to common stock.”

      And as I believe I’ve said before, I don’t assign a very high probability to the district court’s reaching the verdict plaintiffs are asking for.

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      1. There is a promising new argument in Collins based on last months CFPB vs All-American Check Cashing decision (5th Circuit en banc)

        In a scholarly concurring opinion in which four other Fifth Circuit judges joined, Judge Edith Jones agreed with All American’s argument, writing that “[t]he CFPB’s budgetary independence makes it unaccountable to Congress and the people.”

        Judge Edith Jones also concluded that there was “no other option” for remedying the separation of powers violation arising from the CFPB’s budgetary independence than dismissing the enforcement action against All American. She distinguished cases involving an improper removal restriction because, as the Supreme Court indicated in Collins, an unlawful removal provision does not take away an officer’s power to exercise his or her authority. As a result, for a party challenging a removal provision to establish a right to a remedy, it must show that the unconstitutional provision caused compensable harm. In the case of an Appropriations Clause violation however, Judge Jones concluded that “a government actor cannot exercise even its lawful authority using money the actor cannot spend.” She stated that “a constitutionally proper appropriation is as much a precondition to every exercise of executive authority by an administrative agent as a constitutionally proper appointment or delegation of authority.” Because the separation of powers violation at issue impaired the CFPB Director’s authority to act, she concluded that “the proper remedy is to disregard the government action.”

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        1. @John D

          the problem is that SCOTUS in Collins found [erroneously in my opinion] that the acting FHFA director who signed the NWS was not subject to removal only with cause. so this All American case doesnt apply to Collins.

          rolg

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  18. Judge Lamberth entered two orders yesterday afternoon (5/31):

    (A) pushing the date for commencement of a jury trial to Mon., Sept. 19, 2022; and

    (B) allowing Berkley to participate in the jury trial and Fairholme to sit on the sidelines

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    1. The second order is not a surprise; both classes of plaintiff (represented by Berkeley and Fairholme) had requested it, and seemed to have had solid arguments for doing so.

      I also can’t say I’m surprised that the timing for the jury trial has been pushed from July 11 to September 19. There had been several delays at the pre-trial stage, and something had to give.

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    2. the sever and stay lets Lamberth impanel a jury to decide facts for both cases essentially, the class action and the separate opt out plaintiffs. there may have been some trial strategy involved in asking for a jury trial in one and not in the other, but that question has been answered by the plaintiffs agreeing to ask for the jury trial to proceed first, and Lamberth appeared more than happy to let a jury handle the facts. the trial rescheduling was expected, and it seems to me that the govt’s motion for summary judgment will not be granted with the pretrial scheduling order…but I want to see that order first before I make book on it.

      rolg

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      1. rolg,

        Can you expand a bit when you say, “impanel a jury”? What is the significance of that, are there alternative ways? Thanks!

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        1. @jb

          it was just that Ps had two parallel cases going in front of Lamberth, one which specifically asked for jury trial and one which did not. jurors have a way of reaching determinations of facts that are different than judges…not better, just different. so is a bench (judge) or jury trial better in this case?

          since the briefing has been sealed, it is hard to assess what facts will be presented at trial, but one surmises that Ps may be able to summon sympathy from jurors more easily than from crusty old Lamberth, given what has appeared in the public domain relating to the adoption of the NWS…and the case is all about whether the govt breached a covenant of fair dealing…so while Lamberth’s instruction to the jury on the Delaware law of the implied covenant of fair dealing will be important, there should be room for jurors to view the testimony In light of their own commercial dealings and sense of what is fair and in commercial good faith.

          it seems to me that there was trial strategy that led to this split choice on fact finder initially, and a resolution between the class and opt out Ps recently as to preferring a jury trial…and Lamberth was happy to let the case requesting a jury to proceed first. same case, esentially, so whatever jury finds in first trial as to the facts will be determinative for second case. plaintiff lawyers have a sense of what a personal injury case is worth in bronx vs queens vs Manhattan, based upon their expected jury pools, and I would dare say that those cases are all worth more than what they would be worth in front of a judge as fact finder.

          rolg

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  20. Hi Tim,

    [Edited] Having been a long-term reader of your blog, thanks for all the input you have given from a justice/legal point of view, and also from a shareholder’s perspective.

    Having seen a lot of the ‘how’, and ‘what needs to be done’, ‘who should do what’, to do with getting both out of conservatorship, I now wonder, WHY? What’s the benefit, for the US gov, Treasury, or even the US people, to have FNMA and FMCC released? Why not the current model, with both entities building capital perpetually because of the 4.5% (roughly) capital requirement, and thus safe to keep the Treasury from another draw, and also maintaining the unique 30-year pre-payable mortgage, and MBS also keeping their price stable assuming implicit government guarantee. Isn’t that exactly what the GOV wanted? Looks like this is the perfect, controllable, no cost (unless you are a shareholder), self-sustaining model to keeping all the priority satisfied.

    So I wonder, why would the US do anything anymore?

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    1. I attempted to address the “why do anything further with Fannie and Freddie” in my latest post, although very indirectly.

      Right now, FHFA is on the path set for it by former director Calabria, which was, “You [Fannie and Freddie] can come out of conservatorship, but only on the terms I’ve set.” What I tried to point out in this post–using data from the ERCF capital tables in the companies’ first quarter 10Qs–is that without a change in either the net worth sweep or the excessive conservatism of the ERCF risk-based capital requirements, it will take both Fannie and Freddie close to three decades to accumulate through retained earnings the amount of capital Calabria insists that they hold.

      When Fannie and Freddie file their initial capital reports with FHFA at the end of this month, each will say, in effect, “we can’t get to where you want us to be, using the only tools we have, at any time in the foreseeable future.” It then will be up to FHFA to respond. It will have three basic postures it can take. The first is, “That’s okay; we’ll wait” (your “why do anything further” option). The second is, “Then you have to shrink your business so that the amount capital you’re required to hold is equal to the amount of capital you have.” And the third is, “We get your point; we’ll see what we can do to eliminate the net worth sweep, and take some of the conservatism out of the capital standard.”

      Of the three, I think option two is the least likely, since it would wreak havoc in the residential mortgage mortgage market, for no defensible reason. Between the other two options– doing nothing and fixing the sweep and the standard–my bet is on the latter, because there so obviously ARE problems there than can, and should, be fixed. But inertia is a very powerful force in Washington, so “doing nothing” can’t be ruled out.

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      1. I also believe the option “doing nothing”, isn’t really doing nothing. Doing nothing is tacitly accepting the Calabria capital standards, which should become obviously untenable in due time to all parties. I don’t think they can just ignore the Calabria capital standards. And GSE management will need to emphasize this point. Thus they either implement new capital requirements or go back to the prior risk-based standards. This is when Treasury will be forced to decide how they want to handle them. As of yet, I’m still not convinced Treasury has given the matter serious thought.

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        1. The Treasury department will not bend over backwards to allow Calabria’s capital standards work. It’s a non starter and most people who have any say in the matter are satisfied with the status quo. Unless a scandal really has wings to fly even a shameful outcome from a jury trial will become a moot point.

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    2. A great question, one I have asked myself many times. And you won’t like my current answer.

      In the short run, there is no benefit to the US government. They don’t need the money they would make from selling the GSEs. In a trillion dollar deficit economy that both parties created and which sees no near-term penalties for printing money, the few billion they would make from releasing the GSEs is peanuts. While there are no potential problems in the near term for hanging on to the companies, there are potentially HUGE political problems from releasing them. Whichever party is responsible for releasing the GSEs, and giving the evil hedge funds a huge win, will likely be condemned by their opponents.

      In the long term, government has proven that they cannot handle running a business. Like any business with no competition, it will become bloated with overpaid help, and charge huge fees to pay for it all. The change will come very slowly, like a gradually heated pot. And the frog (the consumer) will not realize there is a problem until it cannot jump out. Banks will capture the cream of the business, and the middle class will be stuck with exorbitant fees. The lower classes will have scant hope of buying a home. In the worst-case scenario, when the little people finally demand change, taxpayers will end up subsidizing the bloated GSEs so poor people can buy a home.

      Expect increasing mortgage costs for the consumer for many years to come.

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  23. TH,
    A very excellent summary. A ‘Call to Arms’ based on reasonable capital standards and actions is warranted. How does Michael Calhoun’s actions, (additional) $100B extraction s-t goal, fit into this scenario?
    Does Lamberth’s upcoming trial, that may be delayed, fit into any of the capital requirements/framework you mention, or are they completely independent?
    TIA
    VM

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    1. The course of action I recommend for Treasury and FHFA would align well with the Calhoun proposal (which, for those who don’t know, is for Treasury to use the proceeds from converting its warrants for 79.9 percent of outstanding common stock in Fannie and Freddie to create a fund to be used to support affordable housing). As I continually like to remind people, however, the $100 billion value attached to the Calhoun proposal is greatly overstated. It may have been realistic at one point, but it’s now unrealistically high. At today’s closing stock prices, Treasury’s warrants for 7.2 billion shares of Fannie and Freddie stock are worth only $4.9 billion. But the key to getting that value up–and way up– is to make the companies more valuable, by freeing them from the bonds Treasury and FHFA (particularly Calabria) have placed them in. In that sense, my proposal very much does fit with Calhoun’s.

      It’s a bit early, in my view, to speculate on how the Lamberth trial might fit into what I’m recommending for Treasury and FHFA; I’m still waiting for his ruling on the motions to dismiss by the government and the plaintiffs. I think there is very little chance that he will grant plaintiffs’ motion to dismiss, but he may well grant the government’s. That motion offers him a easy “off-ramp” for what otherwise would be a very complex and high profile trial: all he has to do is say, in effect, “I agree with Justice Alito that the language in HERA (even though it was taken nearly word-for-word from the FDIC Act, and has never been read to say this before) transforms FHFA into a ‘super regulator’ with unlimited discretion, and plaintiffs in the breach of contract case should have known that when they purchased their shares in the companies.” But Lamberth also may have taken offense at having been lied to by the government in the initial filings in his court, and thus may wish to have the facts that were withheld from him made available to the public. If that’s how he feels–and if the trial goes forward–then that could well put some pressure on the government to settle a case that could be a great embarrassment to it, and this in turn could affect how the government thinks about and approaches the resolution of Fannie and Freddie’s interminable conservatorships.

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      1. Tim,

        If you read Lamberth’s 2018 ruling denying the governments motion to dismiss, it’s important to note that he already assumed shareholders lost the APA claim for the EXACT reason SCOTUS pointed to, so the SCOTUS ruling in theory shouldn’t change his original ruling in any way.

        Lamberth highlighted that while FHFA as a regulator may act in its own best interest (exactly like SCOTUS used to justify the APA ruling) and that the NWS was a legal action taken, these facts don’t absolve the GSEs themselves (who would be liable for damages here unlike the APA claim) from breaching our implied covenants (it was unreasonable and arbitrary for the GSEs to enter into the NWS, even if it was legal for the government to do so). The government in it’s motion for summary judgement is asking Lamberth to relitigate his ruling from 2018 (that he reinforced in 2019 when he denied the governments motion for reconsideration).

        Let’s hope Lamberth sticks to his guns and doesn’t overrule himself here.

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      2. Tim

        The motion to dismiss briefs are all sealed, so I cant offer any view on the arguments. but in his Perry decision back in 2014 (if I recall the date correctly) Lamberth in the last page of the opinion wrote in effect that while the shareholders got a raw deal with the NWS, it was a deal that FHFA had the power to consummate. I wonder if Lamberth might view the implied covenant case before him as an opportunity to make clear that even though FHFA had the federal statutory power to consummate the NWS, this does not mean that a reasonable junior preferred shareholder would have expected this risk as a result…especially when the GSEs were returning into financial health, their “golden age of profitability” even, a forecast from the Fannie CFO that was totally odds with the government’s affidavit testimony in the original Perry case.

        rolg

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        1. For those and other reasons, I’m not placing any bets on how Lamberth will rule on the summary judgment motions to dismiss. Hopefully we’ll learn of those rulings soon.

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  26. You cite the current average loan-to-value ratio of 53% (and high credit scores) as the highest quality credit book in their history.

    Do the capital requirements make any adjustment for declining LTVs?

    I’m not a mortgage expert, but it seems to me that a 53% LTV mortgage guarantee is far less risky than an 80% LTV. Yet as far as I can tell, GSE capital requirements have increased. I understand incremental assets have increased, but if portfolio-wide LTVs are decreasing then isn’t guarantee risk actually decreasing?

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    1. Patrick–Yes, Calabria’s standard has a “formulaic countercyclical adjustment” for declining mark-to-market LTVs, after a certain degree of home price appreciation. It’s complicated, and requires FHFA to first make an estimate of the “long-term trend of FHFA’s quarterly, not-seasonally-adjusted HPI [Home Price Index] using a prescribed trough-to-trough methodology.” Then, according to the text of the capital rule, “If the deflated all-transactions HPI exceeds the estimated long-term trend by more than 5 percentage points, the Enterprise would adjust upwards the MTMLTV [mark-to-market loan-to-value ratio] of every single-family mortgage exposure by the difference between the deflated all-transactions HPI and 5.0 percent.” Home prices are definitely more than five percent above their long-term trend today (and are likely to be for a while), so Fannie and Freddie are not getting the capital credit for their lower mark-to-market LTVs that they otherwise would. By the same token, however, as home price appreciation slows, the companies will not be penalized for rising mark-to-market LTVs until home price growth comes back within five percent of its long-term trend (which of course will be pushed higher by the recent surge in home prices). Very little about the Calabria capital standard is simple.

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  27. Court hearings, campaign promises, and potential treasury windfall were factors we had hoped would drive change. But with current climate, do you see anything creating a sense of urgency? You’re right – It shouldn’t be a hard call, but I’m not sure how the senior execs at F&F can gain any traction without Treasury having some motivation.

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  28. FHFA seems to be working in the dark. The Biden administration needs to assign some adults to Treasury and FHFA to turn the lights on. Thanks for the update and reality check, Tim.

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